Daily Development for Monday, April 19, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri firstname.lastname@example.org
MORTGAGES; INSURANCE; FORCED PLACEMENT: Under a clause permitting mortgagee to require and to “force place” insurance in such forms and amounts as it may require, mortgagee can require flood insurance in the amount of the other hazard insurance coverage held by the borrower even though this amount vastly exceeds the amount owed under the mortgage.
Custer v. Homeside Lending, Inc., 858 So. 2d 233 (Ala. 2003)
Mortgagors had an old purchase money mortgage that had an initial principle amount of around $18,000 and had been paid down to around $2000. They had their property insured by hazard insurance for $79,000, but held no flood insurance. Indeed, their original mortgage had not required flood insurance, but did require that the mortgagor “will keep the improvements now existing or hereafter erected on the mortgage property insured as may be required from time to time by the Mortgagee against los by fire and other hazards, casualties and contingencies in such amounts and for such periods as may be required by the Mortgagee.
The National Flood Insurance Act requires federal regulators to impose upon regulated lenders the requirement that the lenders put in their mortgage agreements provisions requiring flood insurance on mortgaged properties that lie within a federally identified flood zone. In addition, the Act permits lenders to notify borrowers that their property is within federally identified flood hazard zones and to force place insurance if the mortgagor fails to acquire such insurance.
It is not clear from the court’s statement of facts whether the borrowers property was subject to the requirements of the NFIA when the mortgage was originally written. Later, however, the mortgage passed into the hands of Homeside, which did an audit that determined that the property was in a federally identified flood hazard zone. It sent letters to the mortgagee asking that they arrange for their own flood insurance in the amount of the insurance that they had obtained for other hazards - around $79,000. It was Homeside’s practice to use this figure if it was higher than the loan balance, reflecting a “assumption that a borrower would want the same amount of protection against floods as against other hazards” even if the loan balance was substantially less.
When the borrower failed to obtain the required insurance, Homeside force placed the insurance, charging an additional fee for doing this. The total cost of such forced placement (including the insurance premium) was $717 for a year. At the time the balance on the loan was less than $2000. The borrowers elected to pay off the loan, but still were required to pay the pro rata portion of the annual premium plus the loan charge. They instituted this action against the lender as a class action, alleging breach of contract, unjust enrichment, breach of implied duty of good faith and fair dealing, fraud by suppression, breach of a duty to third party beneficiaries and breach of an implied contract.
The trial court granted summary judgment and denied class certification.
Upon appeal from the summary judgment - held: Affirmed. The Alabama Supreme Court concluded that the lender was free to force place more insurance than the amount of the loan, under both federal law and Alabama contract law.
The plaintiffs cited a 1999 Louisiana case, Norris v. Union Planters Bank, 739 So. 2d 869 (A. App. 1999), which apparently held that the provision of the NFIA permitting the lender to force place flood insurance for the amount of the outstanding balance of the loan imposed not only a minimum authorization but also a cap on the amount of flood insurance that could be required. The Alabama court, noting that this was a matter of first impression in Alabama, rejected this authority and concluded instead that the NFIA was a minimum authorization and did not limit a lender from charging additional amounts and force placing that insurance if the borrower failed to pay it. Apparently the court was of the view that this would be possible under the “force placement” provisions of the NFIA even if there were no force placement or insurance requirement in the loan itself. It noted that the purpose of the loan was to protect federal emergency response funds from being drained by constant u ninsured flooding claims in areas known to be flood prone.
In addition, the Alabama court concluded that the specific language of the mortgage in this case was an independent basis for authorizing an insurance requirement in excess of the amount of the loan. It cited Alabama authority to the effect that if the mortgage agreement says that the mortgagee can require insurance as it sees fit, that is how it is:
“Under the language of the mortgage [in the precedent case], the right of [the mortgagee] to fix the amount of the insurance was absolutely discretionary at any time. It had the right to determine, unilaterally, the amount of the insurance and even had the right under the provisions of said mortgage to reduce the coverage to zero.”
Despite this strong language, however, the precedent case dealt with a claim that a mortgagee had failed to acquire enough insurance, not that it had acquired too much. As to the claim that there was an overcharge, the court addressed this only in connection with the mortgagor’s claim that there was a “wagering contract,” - a form of insurance agreement invalid under Alabama law. In response to this, the court noted that any insurance required in excess of the insurable interest of the party obtaining the insurance might be invalid if the party arranging the insurance got a pecuniary benefit. Here, however, the court noted that the mortgagors would get the excess of any insurance proceeds over the amount of the mortgagee’s claim, so that there was no pecuniary benefit resulting from the proceeds.
Comment 1: The editor finds the court’s discussion of the theories and authorities ultimately unsatisfying because it does not address the fundamental notion that the language permitting the mortgagee to require insurance necessarily had to be subject to some limit, and the logical limit would appear to be the amount of the mortgagee’s risk, not the mortgagor’s risk. As the mortgagee would be the loss payee and an additional insured under a standard mortgage clause, its complete interest was only in the amount of the outstanding loan.
The only argument the editor could see contrary to this analysis would be that the mortgagee’s insurance interest also included any post foreclosure period. At that time, the mortgagee would be insured as owner. But, again, what is the propriety of requiring the mortgagor to furnish such insurance coverage when the mortgagee easily could arrange for its own?
Comment 2: Interestingly, no other case cites the Louisiana Union Planters decision, although it would appear that this case is an invitation to the “consumer advocates” to start up the ole’ class action machine. The Louisiana Supreme Court did deny review in Union Planters.
The editor doesn’t like to use the concept of good faith and fair dealing here, because he believes it adds little or nothing to the basic interpretive tools courts have always used to interpret contracts that leave contractual discretion in a party. It is normally said to be the intent that the party would use that discretion “reasonably.” Why is the forced placement of insurance beyond that necessary to protect the economic interest of the lender “reasonable?” Surely the lender’s suggestion that this is probably what the borrower would want is inadequate. But that’s all the court gives us.
Cite checking reveals no case that has cited this decision.
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