Property Insurance Issues in Commercial Finance
In any secured finance scenario, the prudent lender must ensure that the collateral pledged as security for the loan is protected against potential loss. This is advisable whether the collateral is comprised of real estate, equipment, inventory or another form of asset. In order to protect such collateral against losses due to fire, flood or other casualty, the lender will often require the prospective borrower to provide evidence that the collateral is appropriately insured against loss. They will also require that the insurance contract be modified so that it also protects the lender through appropriate policy endorsements. A lender must ensure that such endorsements are correct and valid or the lender may not obtain the benefit of the policies in the event of a loss.
The best evidence of coverage for a lender is a copy of the property insurance policy itself, with all endorsements appended. This, however, is infrequently provided by the insurer. Instead, the lender usually receives an insurance certificate from the borrower’s insurance agent detailing the policy’s coverages and other particulars of the contract. Presently, “Acord 28- Evidence of Commercial Property Insurance” is the most commonly used form for providing evidence of property insurance to a lender. The Acord 28 form is a “fill in the blanks” form which provides an area to detail the types of property coverages applicable to the policy, as well as an area for “additional interests,” which identifies any other parties that may have a beneficial interest under the policy.
In reviewing the Acord 28 form, the lender should confirm that the coverage types and amounts are correct and consistent with the lender’s underwriting guidelines. Next, the lender should confirm that they are identified on the form as an additional interest holder and that their name and address are correct for notice purposes. Most importantly, the lender must confirm that the form properly identifies the type of interest held by lender. The type of interest being held depends on the lender’s requirements and the type of collateral. If a lender has only sought the certificate for informational purposes, with no expectation of having rights under the policy, the lender may simply be identified as “certificate holder.” If the collateral for the loan is real property, the lender’s interest should be identified as a “standard” mortgage clause naming the lender as mortgagee. If the collateral is personal property, the lender’s interest should be identified as “lender’s loss payee.” It is important for the lender to understand that the phrases “standard mortgage clause” and “lender’s loss payee” carry with them a very specific significance.
The designation “lender’s loss payee” is distinguishable from “loss payee” in that a lender’s loss payee has separate contractual rights of recovery under the insurance contract independent of the rights of the insured, whereas if the lender is named as “loss payee,” their right of recovery will be conditioned upon, or subject to, the actions of the insured. Thus, if an insured engages in conduct which would release the insurer from its obligation to pay the insured under the policy (such as intentional destruction of collateral), the lender, if properly identified as “lender’s loss payee,” may still recover under the policy, regardless of the insured’s intentional misconduct. In contrast, the lender identified merely as “loss payee” will be subject to the same coverage exceptions applicable to the insured. The same distinction applies to a “standard” mortgage clause – if an insured commits an act causing a loss (such as arson), the lender has a right of recovery regardless of the insured’s conduct if they have a “standard” mortgage clause. In contrast, if they have an ordinary mortgage clause, the lender is unlikely to recover.
The lender will also want to confirm that the insurer will provide the lender with notice prior to cancelling the policy if the insured fails to pay premiums, or otherwise fails to comply with policy terms. Some versions of the Acord 28 form has a “Cancellation” section that contains an affirmative statement that the lender will receive a certain number of days notice from the insurer prior to any cancellation. Other versions of the form contain a less stringent commitment such as “insurer will endeavor to provide notice prior to cancellation.” If the cancellation endorsement contains this less committal language, the lender should contact the agent and request that they obtain an affirmative commitment from the insurer. If the insurer is unwilling to provide this, the lender may wish to modify its ongoing audit practices to confirm payment of insurance premiums and to monitor material compliance by the insured under the policy.
Finally, the lender should understand that the Acord 28 form “Evidence of Commercial Property Insurance” is intended to be for informational purposes only. It does not, in and of itself, operate as an amendment to the insurance contract. In fact, more recent versions of this form contain an explicit disclaimer that it is being provided only for informational purposes. Therefore, upon receiving the form from an agent, in addition to confirming the sufficiency of the coverages and the proper identification of the lender’s interest, the lender should also confirm in writing with the agent that the insurer has been notified of the requested additional interest endorsements and that the endorsements have been incorporated into the policy.
Ensuring that a property insurance policy provides the lender with protection is only one of many factors that a lender should consider in preserving the value of their collateral. The attorneys at MacElree Harvey, can assist traditional commercial lenders and private lenders in properly structuring loan transactions to protect and preserve loan collateral.
The following article is informational only and not intended as legal advice. Speak with a licensed attorney about your own specific situation.