The standard Lender’s Loss Payable endorsement (form 438BFU) provides that coverage for the insured’s lender “shall not be invalidated” by “the commencement of foreclosure proceedings or the giving notice of sale” of the insured property, or resulting from the change in ownership of the property.  However, some fire policies not using the 438BFU endorsement contain mortgage clauses that require that a lender must also notify the insurer prior to the loss of “foreclosure” or even of a substantial change in the insurer’s risk.  Such a notice provision can be easily overlooked when a lender is foreclosing upon its security, which is what happened in the recent Provident Bank case.

In the Provident Bank case, homeowners in Tennessee became delinquent and foreclosure proceedings were commenced. The homeowners filed for bankruptcy protection, which stayed the foreclosure proceedings. The property was then destroyed by fire before the foreclosure sale could be completed. The mortgagee submitted a claim for the fire insurance proceeds.  The insurer denied the claim based on a mortgage clause in the policy which required that the lender provide the insurer with notice of any “foreclosure”.

The U.S. Sixth Circuit Court of Appeals found that the term "foreclosure" in the mortgage clause was ambiguous, and could have either meant the commencement of foreclosure proceedings or its conclusion, i.e., the foreclosure sale.  (Provident Bank v. Tenn. Farmers Mut. Ins. Co. (6th Cir. 2007) 234 F. Appx 393.)  The federal Court of Appeals sent the case back to the district court to determine the meaning of “foreclosure”. On remand, the district court found that the term "foreclosure" meant the conclusion of foreclosure proceedings, not the commencement of the process, presumably preserving the lender’s rights to coverage.  (The Provident Bank d/b/a PCFS Mortgage Resources v. Tenn. Farmers Mut. Ins. Co., No. 04-1017-T-An, at 6 (W.D. Tenn. Dec. 5, 2007).)

The lesson to be learned from the Provident Bank case is to review your mortgage clause or endorsement and ascertain if any notice is required to be provided to the insurer in the event the lender is commencing foreclosure. There is no guarantee that a California court would follow the same reasoning as the federal courts in the Provident Bank case involving property in Tennessee. The Provident Bank case is not controlling authority in California.  A lender should also make sure the fire or homeowner’s policy for the property includes the Lender’s Loss Payable Endorsement (form 438 BFU) which has been in use since 1942.  This endorsement contains no such notice requirement.  While certainly not the standard in the industry, lenders may even want to consider sending copies of notices of default to insurers for the properties being foreclosed, by certified return-receipt mail, with a cover letter indicating the policy number, location of the property, identifying the name insured/borrower and the lender, and stating that the insurer is being notified of the commencement of foreclosure under the terms of the mortgage clause of its policy.  While the insurer may simply toss the notice, at least the lender will have proof it provided any required notice of “foreclosure” or the more nebulous requirement of notice of any “substantial change in risk” in the event that the property is later torched by the borrower.