(Note: This Guest Blog is by Corey Harris, an attorney with Merlin Law Group in the Tampa, Florida, office. This is the fourth of a twelve part series he is writing on proof of loss).

As I was watching one of the countless news reports detailing the current mortgage crisis and its effects on homeowners, I began to think of the insurance consequences of homeowners being forced to give up and hand over the keys to their houses. What would happen, I wondered, if a homeowner was to have a covered loss but fail to submit a proof of loss because of a pending foreclosure?

It should come as no surprise that there are mechanisms in place to protect mortgage companies named on a policy, when the insured fails to submit a proof. As is true with others who are insured by a policy, submission of a proof of loss by a mortgage company is many times a prerequisite to recovery. Therefore, if an insured fails to submit a proof, a mortgage company often can submit one instead.

While the mortgage company and the homeowners are many times listed on the same policy, some courts have held that the policy, and thus the obligations arising under it, should be read as two separate contracts. One as the policy applies to the homeowner and another as the policy applies to the mortgage company, thus creating severable obligations for each party. See, for example, United States Fire Ins. Co. v. Hecht, 164 So. 65 (Ala. 1935)(holding that the mortgagee had a severable contract with the insurer and could sue to protect its interests). The Alabama Supreme Court’s findings in Hecht are in line with certain other jurisdictions, such as Illinois, New York, and New Jersey, and were largely based on the mortgagee clauses found in individual policies. As one New York Judge opined:

I think the intent of the clause was to make the policy operate as an insurance of the mortgagors and the mortgagees separately, and to give the mortgagees the same benefit as if they had taken out a separate policy, free from the conditions imposed upon the owners, making the mortgagees responsible only for their own acts.

Hastings, et al. v. Westchester Fire Ins. Co., 78 N.Y. 141 (1878)(Rapalls, J. Concurring).

Reading the policy as two separate contracts of insurance has an important effect on the obligations of the mortgage company in regards to a proof of loss. If a homeowner does not submit a proof, it does not necessarily mean that the mortgage company’s rights to recovery under the policy are foreclosed. By interpreting the policy as a separate contract between the insurer and the mortgage company, the courts have allowed for a mortgage company to file a proof of loss even when the primary insured has failed to do so. Thus the mortgage company may be able to recover under the policy even when the homeowner is not.

Often, however, the homeowner and the mortgage company are not on the best of terms when foreclosure has been initiated or is looming. The relationship between the parties has usually soured, understandably so, and communication and good-will are usually at a minimum. Courts have held that the lack of communication and notice to the mortgage company can unfairly affect its rights to recovery. As one court stated:

This court finds it unreasonable that the interest of a mortgagee should be made so vulnerable to the caprice of an insured-mortgagor. This is especially true when consideration is given to the fact that the mortgagee in many, if not most instances, is not only unaware of the failure of the insured-mortgagor to file a claim for loss, but is even ignorant of the fact that a loss has occurred.

First Trust Union Bank v. Aetna Casualty and Surety Co., 462 N.Y.S.2d 992, 996 (1983).

Therefore once an insurer realizes that an insured has not filed a proof of loss as required by the policy, some courts have found that the insurer must notify any mortgage company of the insured’s failure. Without this notification, an insurer may be disallowed from requiring compliance with any proof requirements as they are applied to the company.

Keep in mind that the law of a particular jurisdiction may be different, and the policy language can alter these general principles.

Unfortunately, today’s economic conditions have caused hundreds of thousands of people to lose their homes in every state. While it is unfortunate that cases like the ones listed above even need to be discussed, the housing market makes these issues a reality for people from Florida to California. As such, it is extremely important for both homeowners and mortgage companies to know and understand their rights and obligations under the respective policies.