Kentucky Case Alert: Is your Borrower’s Insurance Policy void when you foreclose?
By: David C. Nalley, Partner
A recent decision from the Kentucky Court of Appeals should alert lenders to review their customer’s insurance policies. A provision voiding the policy if foreclosure was initiated was upheld by the court in Papastefanou v. Ky. Growers Insurance Co., 2018 WL 4265653 (Ky. Ct. App. 2018).
In the case, the Borrowers had obtained insurance from Kentucky Growers, and the mortgagees of both mortgages were additional named insureds on the policy. In 2011, the homeowners fell behind on payments and one of the mortgagees foreclosed. In November of 2012, the house burned and was a total loss. The homeowners filed a claim, but the insurer denied recovery to the homeowners based on the following policy language: “The entire policy shall be void … if, with the knowledge of the ‘insured’, foreclosure proceedings be commenced or notice given of sale of any property insured hereunder by reason of any mortgage[.]”
It denied recovery to the mortgagees as well as the policy stated:
If “we” deny “your” claim, that denial does not apply to a valid claim of the mortgagee, if the mortgagee has:
- a) notified “us:” upon commencement of foreclosure proceedings, a change in ownership, occupancy or any other substantial change in the risk of which the mortgagee became aware[.]
PHH had not notified the insurer of the foreclosure action.
The trial court granted summary judgment in favor of the insurer, finding that the unambiguous language of the policy barred all the homeowners’ claims for themselves and their derivative claims in favor of the insurers.
On appeal, the homeowners made three arguments:
- The Policy Language was ambiguous and not plainly and clearly written;
- The insurer should be estopped as the homeowners never received a copy of the policy; and
- The provision violated KRS 304.20-300 on cancellations, declinations and refusals to renew.
The Court of Appeals rejected all three arguments. The court found the language to be clear, and although set forth deep in the policy, it was not in small type or otherwise hidden. The Court rejected the estoppel argument and opined that even if the homeowners did not get a copy of the policy, they could have requested one easily. On the last argument, the Court agreed with the insurer that the insurer did not cancel the policy, but rather that the policy was voided, and as such, the statutory scheme noted did not apply.
Important for Mortgagees – the Court likewise found that the derivative claims in favor of the Mortgage Company were also barred as it too had been given notice of the policy. As the policy had a provision that would have preserved coverage for the mortgagee had notice been given to the insurer, this is an especially tough result.
This type of provision may not be in all standard homeowners policies. If you have a significant portfolio of loans in Kentucky, you may want to review your processes and consider whether an insurance review is needed when a loan goes into default. In this recent case, the mortgage company may have preserved its coverage had it complied with the policy terms and given notice to the insurer when the lender initiated foreclosure.