More on That Ticking Sound: Don't Forget to Obtain or Verify Insurance Coverage
Here's another topic from our "ticking sound" series covering insurance issues and environmental issues:
The subject of insurance for foreclosed properties doesn't seem to come up very often, most likely because there are so many other more pressing problems to worry about. But failing to ensure that the property has adequate insurance – not just "trendy" coverage like environmental impairment insurance but also "old fashioned" property, liability and flood insurance – is absolutely vital to avoid problems that arise all too often.
A lender, servicer or foreclosure purchaser's analysis of insurance on foreclosed property should start with the working presumption that the borrower's insurance will not protect the lender, servicer or foreclosure purchaser after the property is transferred. This may no be so, particularly if care has been taken on the front end to ensure that the lender is included as a named insured on applicable policies, but it still is possible (if not quite likely) that the borrower quietly cancelled the policies to pick up any premium refunds that might be available. Even if the borrower did not resort to such a tactic, the transfer of title from borrower to lender may deprive the borrower of an insurable interest in the property, without which the policy may be void. Some policies also include exclusions or other provisions limiting or precluding coverage for abandoned property, and when the borrower walks away, these provisions may be triggered. The result can be a nasty surprise when a claim occurs later.
How to avoid such issues? The best way is through careful analysis at the time the loan is underwritten and active management of insurance issues throughout the life of the loan. Many commercial loan agreements contain provisions that allow lenders to take an active role in making sure insurance coverage is up-to-date and appropriate. (See, e.g., Omni Berkshire Corp. v. Wells Fargo Bank, N.A., 307 F. Supp. 2d 534 (S.D.N.Y. 2004)(requirement in loan agreement that borrower purchase "other reasonable insurance" as required by lender allowed Bank to require New York hotel to purchase $60 million in terrorism coverage after 9/11 attacks).)
But even if this is not possible, there may yet be ways of solving the insurance problem. Many insurance policies are assignable, and it may be possible as a part of a workout to obtain assignment of the borrower's policies to the lender. The lender may also have pre-existing arrangements with insurers such as portfolio policies that allow it to make the transfer of coverage relatively painless. Whichever route is taken, however, the lender at foreclosure should stop and assess the adequacy of the insurance on the foreclosed property: Are values adequate? Will there be coinsurance issues? Is the property located in an area where there is adequate flood coverage? Is there coverage for my liability as a property "owner" or "operator" for premises liability and other problems?
Answering these bread-and-butter questions and others like them with the help of appropriate legal and insurance professionals can help lenders, servicers and foreclosure purchaser avoid many of the pitfalls that follow from acquiring that piece of collateral.
If you have any questions or war stories, please post a comment.
