Facts

The Tennessee Farmers case demonstrates the danger that foreclosure can pose to a mortgagee’s home insurance coverage.  In Tennessee Farmers, the dispute arose from a  foreclosure that commenced in August 2002.  At that time, plaintiff/appellee U.S. Bank sent a letter to the borrower informing her of the bank's initiation of foreclosure proceedings. On October 1, 2002, the borrower filed for bankruptcy, and the foreclosure proceedings were stayed. On April 12, 2003, the borrower's home was destroyed by a fire.  The fire was allegedly caused by her husband’s illegal methamphetamine lab

Subsequently, U.S. Bank filed a claim to collect on the Personal Fire and Extended Coverage Insurance Policy that the borrower obtained from Tennessee Farmers Mutual (the "Insurer") as a requirement for approval of the original loan. The policy contained a “standard mortgage clause” which stated that the insurer would protect the interest of the mortgagee (U.S. Bank) in the insured property.  The clause specifically stated that such protection will "not be invalidated by any act or neglect of any insured person, breach of warranty, increase in hazard, change of ownership or foreclosure, if the mortgagee has no knowledge of these conditions.”  The clause also described the duties the mortgagee must fulfill to retain coverage.  One duty was to “notify [the insurer] of any change of ownership or occupancy or any increase in hazard of which the mortgagee has knowledge.” (emphasis supplied). The language of the standard mortgage clause tracks Tenn. Stat. Ann. Sec. 56-7-804, which also bars cancellation of a mortgagee’s coverage due to foreclosure, provided that the mortgagee gives notice to the insurer of any change in ownership or occupancy or increase of hazard.  The Insurer denied the claim on the grounds that it was never notified of the foreclosure proceedings.

The Case

Following the denial of its claim, U.S. Bank sued alleging breach of contract and violation of several different statutes, including Sec. 56-7-804.  Relying on Tennessee case law, U.S. Bank argued that the commencement of foreclosure proceedings did not create a change in ownership or occupancy or an increase in hazard as described in the policy and therefore U.S. Bank did not have a  duty to notify the Insurer in order to maintain coverage.  The trial court agreed, and granted summary judgment in favor of U.S. Bank.

The Insurer appealed. The Tennessee Court of Appeals reversed the trial court's summary judgment.  The court held that commencement of foreclosure proceedings does indeed constitute an “increase in hazard” that must be reported under both the standard mortgage clause and Section 56-7- 804.  The court stated that “increase in hazard” essentially has the same meaning as “increase of risk of loss.” The court reasoned that since foreclosure increases the level of “moral hazard” (the risk that the insured borrower will intentionally damage or destroy the underlying property in order to obtain proceeds to satisfy the debt), the foreclosure creates an increase in risk from the point when the borrower becomes aware that the process has commenced:  "Experience has taught insurance companies that, when property owners become financially unable to take care of their secured obligations, or are so neglectful of them that … foreclosure must be resorted to, the likelihood of fire becomes greater."  In its decision, the Court emphasized that this particular standard mortgage clause required notification in the event of “any” increase in hazard, no matter how minor the increase or the hazard.  Thus, because U.S. Bank failed to notify the Insurer that foreclosure proceedings had commenced, it lost the protection provided by the fire coverage.

About Safeguard
Safeguard Properties is the largest privately held field services company in the country. Located in Cleveland, OH  and founded in 1990 by Robert Klein, Safeguard has grown from a regional preservation company with a few employees and a handful of contractors performing services in the Midwest, to a national company with over 450 employees.  Safeguard is supported by a nationwide network of subcontractors able to perform any requested superintendence, preservation, and maintenance functions, as well as numerous ancillary services in the U.S., the Virgin Islands, and Puerto Rico.