Daily Development for Friday, November 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 dirt@umkc.edu

MORTGAGES; INSURANCE; PROCEEDS: Where damage occurs to property prior to foreclosure, but mortgagee then forecloses before insurance proceeds are distributed, mortgagee is entitled to participate in proceeds only as a security holder, and will receive proceeds

Lenart v. Ocwen Financial Corp., 869 So. 2d 588 (Fla. App. 2004)

Lenart, the mortgagor suffered a fire that significantly damaged his property in 1998. The insurance company disputed the mortgagor’s claim for insurance, and mortgagor thereupon stopped paying on his mortgage.

The mortgagee foreclosed on the property and the mortgagee acquired it at foreclosure. The court doesn’t say what the mortgagee bid on the property, but indicates that the fair market value of the property at the time of foreclosure was $130,000 and that the secured debt was $141,000. Apparently Florida has a “fair value” limitation on deficiencies, and this difference established the amount of mortgagee’s deficiency, even if it bid less than $130,000 at the sale. The court viewed the mortgagee’s deficiency claim as $11,000.

Lenart had a lawsuit pending on the insurance claim dating back to 1998, and ultimately, after foreclosure, the insurer settled for $90,000. Because the insurer was a loss payee on the policy, the insurer cut the check in the joint names of Lenart and the mortgagee, and the mortgagee refused to pay any of the proceeds over to Lenart, taking the position that, as it was now the owner of the property, it was entitled to the entire insurance proceeds.

Remarkably, the trial court granted summary judgment to the mortgagee.

On appeal: Reversed (of course). The court ruled that the mortgagee is entitled only to the deficiency amount out of the insurance proceeds, because at the time of the insured casualty the mortgagee was only a secured party, and did not own the property.

The court distinguished the situation where the mortgagee acquires the property prior to the insured damage occurring. In this situation, the standard (or New York) mortgagee’s clause in the typical insurance policy provides that insurance that is still in effect converts to the mortgagee’s insurance as owner, rather than simply as secured party. In such a situation, the mortgagee would be entitled to all the casualty insurance proceeds because it would have bid for and bought the property on the basis of its undamaged condition, and the mortgagor would have received the benefit of that bid.

Comment 1: The editor has an article on these issues: P. Randolph, The Mortgagee’s Interest in Casualty Loss Proceeds, Evolving Rules and Risks, 32 ABA Real Property, Prob. & Tr. Law J. 1 (1997). In it, he discusses the position of the Restatement of Mortgages, which was then just coming out. The Restatement, and in fact all relevant authority, support the outcome here, but there are some interesting disagreements on other, related issues.

Comment 2: What if the mortgagee forecloses after the property is damaged, but the mortgagee knows nothing of the damage? This could occur either because the mortgagor has disguised the damage or because the damage occurred so soon prior to the sale that the mortgagee didn’t find out about it. The mortgagee’s bid at foreclosure will reflect its perception of the value of the property in its undamaged condition. Thus, it might bid in full value, or the deficiency in any event will be smaller than it otherwise might have been. Should the deficiency be the sole measure of the mortgagee’s protection here? The Restatement says yes - on the theory that careful mortgagees should check the property just before foreclosure, and in any event the injustice of the “hard cases” that will arise is offset by the benefits of a clear rule. The editor disagreed in his article, arguing that the mortgagee should be permitted to demonstrate that for excusable reasons the mortgagee was unaw!
are of
the damage. (Probably if the mortgagor actively disguised the damage, the court might view that as a basis for giving the mortgagee a greater share of the proceeds, but the editor knows of no cases on the point.)

Comment 3: The case at hand contains some questionable dicta, probably stemming from analysis by a precedent case. The court discusses (at p. 591) what happens if the there is damage to the property and insurance proceeds are made available all prior to foreclosure. Of course, the mortgagee might permit the proceeds to be used for repair of the insured damage. But if the mortgagee lawfully elects not to do that, then, the court says, the mortgagee has two choices:

“The mortgagee may either turn to the insurance company for payment . . . 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 pursue the insurance company for payment of the debt, then the debt is fully satisfied and the mortgagee does not have any additional recourse against the mortgagor. If the mortgagee elects to foreclose on the propety 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 unfortunate language first characterizes the mortgagee collecting the deficiency “as owner,” which seems inappropriate. Although the mortgagee may be the owner following the sale, it is acquiring the proceeds in its capacity as secured party. If, for instance, a third party bought at foreclosure, and there was a deficiency, the mortgagee would still have a claim for that deficiency against the proceeds, even if it was not the owner.

But there is an even greater potential problem in the passage that states that the mortgagee would be barred from any further claim against the mortgagor if it elected to apply the insurance proceeds to the satisfaction of the mortgage. This would be true only if the proceeds equalled or exceeded the mortgage debt. Otherwise, the mortgagee ought to be able to collect the unsatisfied balance of its claim from the mortgagor, including by foreclosure. It is unclear whether the court is suggesting some different result, but the editor wants to note this little problem for posterity. With Google, one never knows whether this passage will be found by someone analyzing this case.

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