Are You Ready To Be A Loss Payee?
September is national disaster preparedness month and for good reason. The storms that have hit many parts of the country over the last decade have made us all experts in areas of lending law that we would much rather not have to deal with.
Against this backdrop, a recent case out of the Court of Appeals for the Seventh Circuit provides a great explanation of exactly what a lender’s obligation is with regard to damaged property. See Avila v. CitiMortgage, Inc. (7th Circ, 2015). It’s worth a read. The case involved an Illinois homeowner who bought a home in Chicago in 2005 with $105,000 mortgage from CitiMortgage. Five years later, a fire made the house uninhabitable. The homeowner filed a claim with his insurance carrier and received $150,000.
As is common practice, CitiMortgage was a loss payee on the insurance proceeds and refused to disperse any funds until it reviewed the restoration work. By the way, this is a smart practice but it created much confusion in New York in the aftermath of Hurricane Sandy when elected officials criticized banks, in many cases unfairly, for holding back proceeds. In this case, Citi reviewed the work and found that it was done poorly. The case get tricky because by this point our homeowner had missed several payments and Citi interpreted its mortgage contract as allowing it to put the insurance proceeds toward paying off the now delinquent loan. The home was never repaired.
At issue in the subsequent litigation was a section of the mortgage contract dealing with the proper use of insurance proceeds. Your mortgage agreements undoubtedly have similar language. The contract provided two distinct obligations on the lender. First, insurance proceeds should go toward the restoration of the mortgaged home. However, it also provides that if such a repair is not economically feasible, the insurance proceeds shall be applied to the mortgage loan.
In this case, our homeowner filed a suit in Cook County, Illinois claiming that the bank breached its fiduciary obligation and the insurance contract. The case was dismissed by the district court, but on appeal the Seventh Circuit revived part of the case. First, it rejected the homeowner’s argument that the bank had a fiduciary or special obligation towards the homeowner as the holder of the insurance proceeds. However, it still allowed the case to go forward. At issue was whether the homeowner’s default constituted a breach that allowed the insurance proceeds to be applied to the mortgage and whether Citibank was first obligated to demonstrate that fixing the damaged house was not economically feasible.
We have to assume that property will be damaged and how efficiently your credit union handles these claims will either save or cost you a lot of money. I’m giving you this case as a gentle reminder to make sure you have proper policies and procedures in place to handle property damage claims before the next disaster strikes.