Opinion ID: 3016918
Heading Depth: 2
Heading Rank: 2

Heading: The Standard Mortgage Policy Language

Text: 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.