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Distributing Insurance Funds After a Natural Disaster

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Editor's note: This story was originally featured in the January issue of DS Newsout now.

One of the biggest mortgage servicing issues facing lenders in Texas, Florida, California, and other states that have suffered from declared disasters relates to insurance claims on damaged properties when the loan is in default. The ability to apply insurance proceeds to delinquent loans is not only based upon the actual language of the mortgage but also when the loss or damage is incurred.

Look to the Mortgage

In relation to the language of the mortgage, there are two provisions, one of which is contained in most mortgages that relate to insurance proceeds. The first provision basically leaves it to the discretion of the lender as to how the proceeds are distributed. The provision sets forth that the borrower is required to maintain insurance on the property against any hazards, casualties, and contingencies, including fire, and includes the following language regarding application of the insurance proceeds:

“Each insurance company concerned is hereby authorized and directed to make payment for such loss directly to lender, instead of to borrower and to lender jointly. All or any part of the insurance proceeds may be applied by lender, at its option, either (a) to the reduction of the indebtedness under the note and this security instrument, first to any delinquent amounts applied … and then to prepayment of principal, or (b) to the restoration or repair of the damaged property.”

With this language in the mortgage, the decision whether to apply the proceeds to the loan or repair the property is solely within the discretion of the lender. While there have been no cases directly interpreting this provision, the language in this provision is clear and unambiguous. If the mortgage contains this language, the lender is free to apply the proceeds as it sees fit, depending on when the loss occurs in relation to the default as explained in further detail below.

The second provision that can commonly be found in mortgages requires either an agreement between the borrower and lender as to how to apply the proceeds or for the repair costs to be so significant as to render it economically unfeasible to complete the repairs. This provision details this as follows:

“Unless lender and borrower otherwise agree in writing, any insurance proceeds, whether or not the underlying insurance was required by lender, shall be applied to restoration or repair of the Property, if the restoration or repair is economically feasible and Lender’s security is not lessened … if the restoration or repair is not economically feasible or lender’s security would be lessened, the insurance proceeds shall be applied to the sums secured by this security instrument, whether or not then due, with the excess, if any, paid to borrower.”

Since most government-backed mortgages contain standard language, state-specific case law must be reviewed. The remainder of the article reviews the case law in Florida in relation to insurance proceeds.

There have not been many reported cases in Florida interpreting this second provision, but at least one case has been brought between the borrower and the lender on this issue recently—that of Alvarez-Mejia v Bellissimo Properties, LLC, 208 So. 3d 797 (Fla. 3d DCA 2016). While this did not address a final resolution of the issue, the court appears to hinge its evaluation on appraisals and estimates as to the cost of repair and the effect of the damage on lender’s security. In other words, this is evaluated on a case-by-case basis and the cost of repair versus the value of the property both before and after the repairs are completed is calculated. Unfortunately, since the typical mortgage does not define “economically feasible,” it is left to the interpretation of the courts. In the Alvarez-Mejia case, one of the judges discussed both economic feasibility and a lessening of the lender’s security in a dissenting opinion. This judge defined “economically feasible” as “economically reasonable” or “practicable” but did not expand further than that in his determination of the term “economically feasible.” The same judge also interpreted a lessening of the lender’s security as “an expenditure for restoration or repair of a property which ends with a property value less than the amount expended constitutes, a fortiori, a ‘lessening’ of the lender’s security. Alvarez-Mejia at 802. Given that these are the two prongs required for the lender to be able to keep the insurance proceeds and apply the proceeds to the loan, these factors are important to be evaluated in each loan and would typically require not only estimates of the cost of repair but also the value of the property both before and after such repairs are completed to assist in making this determination.

It is important for this purpose to note the borrower in the Alvarez-Mejia case was in default long before the loss and, at least one judge in the case considered that sufficient as a matter of law to render repair economically unfeasible.

When Did the Loss Occur: Before or After Default?

Once the lender believes that it has the authority to apply the funds, the question turns to when the loss or damage is incurred. In White v. Ocwen Loan Servicing, LLC, 159 So. 3d 1009 (Fla. 3d DCA 2015), the Court followed the decision of Lenart v. Ocwen Financial Corp., 869 So. 2d 588 (Fla. 3d DCA 2004), as follows:

“[W]here the loss precedes the foreclosure the mortgagee is the creditor of the owner at the time of loss, and has an election as to how to satisfy the debt. The mortgagee may either turn to the insurance company for payment as mortgagee ... and recover, up to the limits of the policy, the mortgage debt; or the mortgagee may foreclose on the property ... If the mortgagee elects to foreclose on the property and the foreclosure sale does not bring the full amount of the mortgage debt, then the mortgagee may recover the deficiency under the insurance policy as owner.”

This line of reasoning has been followed and adopted by at least one other appellate district in Florida. In short, if the loss occurs prior to the foreclosure being completed, the lender can make a claim on the insurance policy and use those funds to satisfy the debt; however, in doing so, that prevents the lender from completing its foreclosure and any pending action would need to be dismissed upon making the claim and applying those proceeds to satisfy the debt. Alternatively, the lender can foreclose on the property and if the foreclosure sale does not bring the full amount of the debt, then it can recover the deficiency from the insurance proceeds. These options provide the lender with the option of making a business decision based upon the condition of the property whether it wants to take the property back and deal with the damage itself or just accept the insurance proceeds and satisfy the debt without having to deal with the damaged property.

About Author: Jane E. Bond, Esq.

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Jane Bond is the Managing Partner of McCalla Raymer Liebert Pierce’s Florida Litigation Group. She has over 25 years litigation experience, with 20 years specifically devoted to business and real estate litigation involving the mortgage lending and servicing industries. Bond has experience representing both appellants and appellees in appellate proceedings before the District Courts of Appeal and the Supreme Court in Florida and has participated in oral arguments before several of the District Courts. For over a decade, Bond has served as speaker, moderator, and trainer on topics related to the mortgage servicing and real estate industries at conferences, seminars, and CLE classes hosted by ALFN, USFN, the MBA, ATIF, the Florida Board of Realtors, and various other organizations representing the mortgage servicing industry. She routinely provides training and informative seminars to clients regarding mortgage foreclosure and litigation issues.

About Author: Matthew Morton, Esq.

Morton
Matthew Morton practices in McCalla Raymer Leibert Pierce, LLC’s Florida Litigation Group. He focuses on foreclosure law and creditor’s rights with additional experience in asset evaluation and probate issues. Morton brings over 15 years of diverse experience to the firm. Morton received his undergraduate degree in Legal Studies from the University of Central Florida. He was barred in Florida in 2000 after receiving his Juris Doctorate from Florida State University School of Law. Prior to joining McCalla Raymer Leibert Pierce, LLC, Morton handled civil cases throughout the Florida Courts, including bankruptcies and appeals.

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