The Tennessee Court of Appeals recently decided an important case addressing whether lenders are required to notify property insurers regarding commencement of non-judicial foreclosure proceedings against residential or commercial real estate. U.S. Bank, N.A. v. Tenn. Farmers Mut. Ins. Co., No. W2012-00053-COA-R3-CV (Tenn. Ct. App. Nov. 29, 2012).
In the US Bank case, the owner of the residence failed to make timely mortgage payments, and the bank commenced foreclosure proceedings. Soon thereafter, the owner filed for bankruptcy, which stayed the foreclosure proceedings. After the foreclosure proceedings were stayed, the residence was destroyed in a fire, apparently as a result of methamphetamine production in the home. After the fire, the bank made a claim to recover insurance proceeds, and the insurance company refused to pay the claim. The insurance company’s refusal to pay the claim was based on the bank’s failure to notify the insurance company regarding commencement of foreclosure. The insurance company argued that Tennessee Code Annotated § 56-7-804 requires the bank to notify the insurer of the commencement of the foreclosure proceedings because under the statute foreclosure is an “increase of hazard” of which the bank was aware. When the insurance company denied the claim, the bank filed suit against the insurance company alleging breach of contract, bad faith, and unfair or deceptive practices under the Tennessee Consumer Protection Act (“TCPA”).
The trial court held for the bank, opining that there was no duty to notify the insurer regarding the foreclosure. On appeal to the Court of Appeals, that court reversed, finding that the commencement of foreclosure proceedings did amount to an “increase in hazard,” and the bank’s failure to give notice precluded coverage. The Tennessee Supreme Court then reversed the Court of Appeals and held that the commencement of foreclosure proceedings did not constitute an increase in hazard under the terms of the insurance policy at issue or under Tennessee Code Annotated § 56-7-804. On remand from the Supreme Court, the trial court entered a judgment in the bank’s favor for the amount due on the mortgage plus accrued interest and attorneys’ fees and costs, stating that the insurer’s interpretation of the policy to require notice of the foreclosure proceedings amounted to bad faith and an unfair practice under the TCPA. In this recent opinion, the Court of Appeals reversed and remanded the case to the trial court, finding that there was no basis for determining that the insurance company had acted in bad faith and in violation of the TCPA.
Seemingly, this case applies in a very narrow class of situations, namely, when foreclosure proceedings have been commenced with respect to a residential property and that property is subsequently destroyed by fire. However, lenders should be aware that we have seen an increase in insurance companies changing their policies to address this specific situation as a result of the increase in foreclosure proceedings. Insurance companies are doing this because they perceive properties in foreclosure as increasingly risky because they are vacant, subject to vandalism, and property owners have a decreased incentive to protect the property. Even though the Tennessee Supreme Court has determined that an insured person or entity is not statutorily required to notify the insurer of the commencement of foreclosure proceedings, because of the changes in the insurance policies themselves, including residential and commercial real estate property insurance policies, it is important to discuss this issue.
Whether a lender has commenced foreclosure proceedings or not, it is important to read and understand the applicable insurance policy with respect to residential or commercial real estate. Insurance companies are increasingly including notice requirements regarding a wide array of events, and lenders should be aware of the events that require notice to the insurer.
Out of an abundance of caution, we recommend that lenders require their foreclosure counsel to notify the applicable insurer regarding commencement of foreclosure proceedings at the beginning of the foreclosure as a normal, routine part of their process. It is very simple to send a form letter to the insurer notifying them of the commencement of foreclosure proceedings. It seems that adding a notification to the insurer to the foreclosure proceedings is a cheap solution out of an abundance of caution. This would avoid the possibility of missing a change in or misinterpretation of the insurance policy or a change in the applicable law.
Additionally, these types of notice requirements may apply even in the absence of foreclosure proceedings. For example, an insurer may require lenders to notify them if one’s commercial real estate property is not currently leased (i.e., is vacant) because of the insurance companies’ perceived increased risks that are discussed above. The key takeaway is to be aware of the requirements under the applicable insurance policy.
A few practice pointers to remember:
- Most importantly, review the insurance coverage of your residential and commercial real estate properties to make sure that your investment is adequately protected.
- Once you have adequate protection in place, review your insurance policies (or have counsel review them) to make yourself aware of any notice requirements or other conditions precedent to coverage.
- If you commence foreclosure proceedings with respect to residential or commercial real estate property, review your specific insurance policy to determine if notice to the insurer of the commencement of foreclosure proceedings is required. Even if it is not expressly required, consider giving notice to the insurer out of an abundance of caution as a normal part of your foreclosure checklist.
- Lastly, any time you give notice to an insurer or otherwise, make sure that you adequately document and record evidence of the notice. We recommend sending the mail certified, return receipt requested so that you have a record of the other party’s receipt of your notice.