Tuesday, October 2, 2012

Another First Circuit case on whether mortgage lender can increase flood insurance requirement

Last week I posted about  Lass v. Bank of America, __ F.3d __, 2012 WL 4240504 (1st Cir.),  in which the United States Court of Appeals for the First Circuit held that, taken as a whole, mortgage documents were ambiguous as to whether the lender could demand that the borrower increase her flood insurance coverage.

The First Circuit issued a companion opinion in the case of Kolbe v. BAC Home Loans Servicing, LP, __ F.3d __, 2012 WL 4240298 (1st Cir.).

As in Lass, Kolbe, a mortgage borrower, asserted that Bank of America's demand that he increase his flood coverage breached the terms of his mortgage contract. 

The mortgage contract required that Kolbe "insure all improvements on the Property, whether now in existence or subsequently erected, against any hazards . . . for which the Lender requires insurance.  This insurance shall be maintained in the amounts and for the periods that Lender requires.  Borrower shall also insure all improvements on the Property, whether now in existence or subsequently erected against loss by floods to the extent required by the Secretary [of HUD]."

Kolbe was required by federal law to obtain flood insurance because his property is located in a special flood hazard zone under the National Flood Insurance Act. The minimum amount mandated by the law is coverage at least equal to the outstanding principal balance of the loan, or $250,000, whichever is less. 

An aside:  I find this provision shocking.  I believe everyone should have adequate insurance, and I support the government regulating flood insurance to the extent that such flood insurance might not be affordable, or available at all,  in flood hazard zones without such regulation.  But I can see no reason why the government should mandate that homeowners are required to have insurance to protect the interests of the lenders but not of the homeowners.  The lenders can protect their interests by including a flood insurance requirement in the loan contract.

Moreover, as the court noted in Kolbe, the National Flood Insurance Act was passed because major floods had required "unforeseen disaster relief measures and placed an increasing burden on the Nation's resources."  By requiring insurance only to the extent of the lender's interests, the law demonstrates that the government is interested in protecting financial institutions but not homeowners. 

Getting back to the decision, Kolbe purchased more than the minimum required amount of flood insurance.  Bank of America subsequently sent notice to Kolbe that he was required to increase his flood insurance coverage to the total replacement cost of his property as identified in his homeowner's policy.  (Everyone:  if you are in a flood plain you should have flood insurance to the replacement cost of your property, regardless of what your mortgage lender says.)

The court held that the insurance provision in the contract was ambiguous, and therefore turned to extrinsic evidence to interpret it.  It noted that HUD treats hazard insurance and flood insurance separately, but also that FEMA recommends replacement value flood insurance.

The court concluded that the extrinsic evidence was also, therefore, ambiguous.  It held that the District Court erred when it dismissed Kolbe's complaint on the ground that the mortgage unambiguously permitted the lender to demand additional coverage. 

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