Opinion ID: 3016918
Heading Depth: 1
Heading Rank: 4

Heading: The Contractual Provisions

Text: Our UCC holding is also supported by several provisions in the agreements between Tower and FINOVA, which strengthen FINOVA’s claim to the insurance proceeds. The first of these is a contract clause that granted FINOVA a right of approval over any use of insurance proceeds; the second is the insurance agreement, which gave FINOVA the (extensive) rights of a “mortgagee payee.” 12 We take no position on what the result might be under the revised UCC, see supra note 10, either in our hypothetical or in the case at bar. 16
Paragraph 5.4(a) of the security agreement gives FINOVA the right to approve any use of any insurance proceeds by Tower, and allows FINOVA the right to, “in its sole discretion, apply such [proceeds] to the satisfaction of the Obligations.” It is undisputed that Tower repaired the engine without either filing an insurance claim or asking for FINOVA’s approval. But the contract unequivocally grants FINOVA, not Tower, the right to decide how to use any insurance proceeds. FINOVA had the “sole discretion” to decide to apply the insurance proceeds to the satisfaction of Tower’s debt, rather than to repairing the engine. Tower’s decision to repair the engine, rather than file an insurance claim and get FINOVA’s approval on the use of the proceeds, deprived FINOVA of the benefit of ¶ 5.4(a). The Bankruptcy Court cited Pima County v. Ina/Oldfather 4.7 Acres Trust #2292, 145 Ariz. 179, 700 P.2d 877 (Ariz. Ct. App. 1984), for the proposition that Arizona courts would enforce contract clauses similar to ¶ 5.4(a). The Pima County court upheld clauses in a mortgage agreement that allowed the mortgagee to apply any fire insurance proceeds or condemnation awards to the amount of the debt, hold the proceeds as additional security, or release them to the mortgagors, at the mortgagee’s discretion. 700 P.2d at 879. The mortgagors in that case argued that an award for partial condemnation of the property should have been split between themselves and the mortgagee, because giving the full award to the mortgagee left it oversecured. Id. The Arizona court rejected this argument and gave the entire award to the mortgagee, requiring it to use the award either as additional security or to reduce the amount of the mortgagors’ indebtedness. Pima County strongly suggests that Arizona courts will give secured parties the benefit of their bargain with regard to use-of-proceeds clauses, even if it leaves them with what might appear to be a recovery greater than their security interest (but less than or equal to the amount of the underlying debt). The Bankruptcy Court correctly took this as an indication that Arizona courts would uphold ¶ 5.4(a) and let FINOVA decide how to use the insurance proceeds. FINOVA thus had an interest in the insurance proceeds, payable to it independent of any action (including repairs) taken by Tower. It had the right to approve Tower’s use of the proceeds, and 17 to apply them to its own debt rather than to repairing the engine. The Trustee states in his brief that FINOVA “made a bad deal with the Debtor resulting in FINOVA holding a secured and unsecured claims against the Debtor.” But in fact it is difficult to see how FINOVA could have made its deal any more bulletproof than this. It bargained for, and received, an absolute right to the insurance proceeds, and the Trustee’s attempts to restrict that right are unavailing.13
It is well settled, in non-UCC (mainly real property) contexts, that certain mortgagees can claim insurance proceeds on their collateral, even when they suffer no loss. See, e.g., Savarese v. Ohio Farmers Ins. Co., 260 N.Y. 45, 57, 182 N.E. 665, 668 (N.Y. 1932). The cases that so hold depend on the nature of the insurance clause involved. The Bankruptcy Court cited one representative example, Grange Mut. Cas. Co. v. Central Trust Co., N.A., 774 S.W.2d 838, 840 (Ky. Ct. App. 1989), in which a mortgagee bank sued an insurer who refused to pay out on a fire insurance policy because the mortgagor had, at his own expense, repaired the mortgaged property. The Kentucky court stated: The right of the mortgagee under a standard mortgage [insurance] clause is not dependent upon his sustaining loss. That is, the mortgagee under such a clause acquires a right to the insurance proceeds even though he suffers no actual loss, as when the building was restored to its former condition by the mortgagor. 13 At oral argument, counsel for the Trustee sought to minimize the effect of this contractual provision, noting that many contracts are invalidated or modified in bankruptcy. We think, however, that Pima County indicates that the Arizona courts would look to contractual provisions like ¶ 5.4(a) to help define a creditor’s security interest. If ¶ 5.4(a) gave FINOVA the right to apply insurance proceeds to increase its security interest, then those proceeds are part of its secured claim and so belong to FINOVA, not the bankruptcy estate. 18 Id. This language applies to mortgagee payees, but not to loss payees. The difference between mortgagee and loss payees has been spelled out by an Arizona court. A loss payee is “a mere appointee to receive the proceeds to the extent of his interest.” Granite State Ins. Co. v. Employers Mut. Ins. Co., 609 P.2d 90, 92 (Ariz. Ct. App. 1980) (quoting 5A J. Appleman, Insurance Law and Practice § 3335). In loss-payee cases “the policy [is] subject to any act or omission of the insured which might void, terminate, or adversely affect the coverage; and if the policy is not collectible by the insured, the appointee, likewise, cannot recover thereunder.” Id. (quoting Appleman, supra, § 3335). On the other hand, “[i]n contradistinction with a basic loss payee whose rights are totally derivative, a mortgagee payee has an independent agreement with the insurer.” Id. The mortgagee payee is treated “just as if [he or she] had applied for the insurance entirely independently of the mortgagor.” Id. at 93 (quoting Appleman, supra, § 3401). The choice of which category the payee falls under depends on the language of the insurance clause: a “standard” or “union” clause creates a mortgagee payee, while a “simple” clause creates a loss payee. See 4 Lee R. Russ et al., Couch on Insurance §§ 65:8, 9, 32 (3d ed. 1984) (hereinafter Couch). The main difference is that the loss payee “is subject to such defenses as the insurer may have against the mortgagor, while the [mortgagee payee] is not.” Id. § 65:9. It seems clear that FINOVA is a mortgagee payee. The insurance certificate issued to FINOVA provides that “[w]ith respect to the interest of the Certificate Holder, the insurance afforded shall not be invalidated by any act or neglect of the Named Insured,” which creates a mortgagee-payee interest. The certificate also does not specifically state that FINOVA may receive proceeds only to the extent of its interest, which is a normal element of the “simple” (loss payee) clause, see 4 Couch § 65:9. Because FINOVA is a mortgagee payee, it can, by analogy to non-UCC insurance law, recover the proceeds to the extent of its debt, even though Tower repaired the damage to its collateral: A mortgagee may recover policy proceeds under a standard mortgage clause, even though, because of a 19 restoration of the property by the mortgagor, the mortgagee has suffered no actual loss. . . . As a corollary of the view that restoration does not defeat the right of the mortgagee to recover, it is held that the fact that the mortgagor has repaired the damage does not entitle him or her to recover the proceeds of the insurance. 4 Couch § 65:62 (emphasis added). The mortgagee’s “loss is measured in terms of the value of the debt, not the actual economic loss to the mortgagee.” Id. § 65:36.14 The Trustee argues that that it was “erroneous and improper” for the Bankruptcy Court to rely on non-UCC, non-bankruptcy mortgage cases. We are not persuaded. We agree that, if relevant UCC precedents clearly established that Tower has a right to the proceeds, reliance on contrary non-UCC law would be misplaced. Where, however, there are no UCC cases directly on point, see supra Part III.B.1, and what cases there are suggest that FINOVA can recover the proceeds, see supra Part III.B.3, we think it is reasonable to look to analogous non-UCC law to strengthen our conclusion that this recovery accords with basic fairness and the common law.15 14 On the other hand, the mortgagee’s right to retain insurance proceeds “is limited by the mortgagee’s duty, under § 4.7(b), to permit use of the funds for restoration of the loss or damage to the real estate.” Restatement (Third) of Property: Mortgages § 4.7, cmt. d (2004); see also id. § 4.7(b); 12 Couch § 178:58. This provides little guidance in cases where the mortgagor has already restored (and then liquidated) the property—or in cases, such as this one, where a contractual clause specifically gives the mortgagee the discretion of how to apply proceeds. Had Tower followed the requirements of ¶ 5.4(a) of the security agreement, and demanded that FINOVA allow it to use the insurance funds to repair the engine, the Restatement’s approach might apply. In the case at bar, it does not. 15 Similarly, we see no reason to ignore the line of cases exemplified by Savarese, supra, merely because they occurred outside of bankruptcy. As we have already determined that the insurance payments are proceeds of collateral for UCC purposes, see supra Part III.A, FINOVA can recover them under § 552 of the Bankruptcy Code 20 In sum, FINOVA’s contractual right of approval over Tower’s use of the insurance proceeds, and its mortgagee payee rights in the insurance contracts, further support its claim to treat the insurance proceeds as part of its security. Because this accords with our UCC conclusion in Part III, we conclude that FINOVA is entitled to recover the insurance proceeds under the UCC and the Bankruptcy Code.