The case of U.S. Bank v. Tennessee Farmers Mutual Insurance Company*, currently on appeal to the Tennessee Supreme Court, addresses an important issue for the mortgage banking and servicing industry regarding the “standard mortgage clause” contained in most homeowners insurance policies. The issue is specific to the terms of policy issued by Tennessee Farmers Mutual Insurance Company (“Tennessee Farmers”) as applied to Tennessee law, but the Tennessee Supreme Court’s final decision may impact the notice requirements for Tennessee foreclosures.

Contributing author: Toney Brasuell, Esq.

 

Toney Brasuell is an attorney in the litigation department at the creditor’s rights law firm of Wilson & Associates, P.L.L.C. A graduate of the William H. Bowen School of Law, he is admitted to the Bar of the State of Arkansas and to the Bar of the State of Tennessee. His primary area of practice is foreclosure.

The appellant US Bank (“the Bank”) required the homeowner to obtain a fire insurance policy on the homestead. The policy provided for a quid pro quo, i.e., the insurance company will protect the Bank’s interest and the Bank will notify Tennessee Farmers of any increase in hazard. When the homeowner defaulted, the Bank initiated foreclosure proceedings and sent notice to all interested parties but did not provide notice to Tennessee Farmers. Prior to completion of the foreclosure, the homeowner filed bankruptcy and soon after, the house was destroyed by fire. The Bank notified Tennessee Farmers of the fire loss and the insurance company refused to pay. Tennessee Farmers claimed that the foreclosure proceedings created an increase in hazard, notice was required under the fire insurance policy, and the Bank’s failure to provide such notice constituted a breach of the mortgage clause. The Bank claimed that notice was not required and filed suit. The trial court ruled in favor of the Bank and the insurance company appealed. The Tennessee Court of Appeals focused on the language of the standard mortgage clause. Tennessee Farmers’ duties were as follows:

“We will: (a) protect the mortgagee’s interest in the insured building. This 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; (b) give the mortgagee 10 days notice before canceling this policy.”

The Bank’s duties were as follows:

“The mortgagee will: (c) notify us (Tennessee Farmer’s) of any change of ownership or occupancy or any increase in hazard of which the mortgagee has knowledge.” Thus, the case hinged on the interpretation of the language “increase in hazard of which the mortgagee has knowledge.”

The Tennessee Court of Appeals analyzed whether “the Bank had a duty, under the policy, to notify Tennessee Farmers when it commenced foreclosure proceedings.” In the analysis, the appeals court looked to court rulings throughout the country. The analysis, which encompassed courts from Alabama, New Jersey, Pennsylvania and others, unveiled a variety of interpretations of the standard mortgage clause. While an Alabama court reasoned that the “plain, ordinary meaning of the words did not include an event such as foreclosure”, a Kansas court interpreted that the commencement of foreclosure proceedings did increase the risk of hazard. The Tennessee court agreed with the Kansas court and other state courts that foreclosure proceedings created an increase in hazard due to the propensity of homeowners to set fire to their homestead and reap the benefit of the insurance proceeds, and ruled in favor of Tennessee Farmers. The final decision on this issue will lay with the Tennessee Supreme Court, and pending such a ruling, servicers should rely on the advice of their General counsel as to whether notice of a foreclosure sale should be provided to homeowner’s insurance company. *TN Ct App, No. W2006-02536-COA-R3-CV