Tuesday, October 8, 2013

First Circuit overturns itself on flood insurance requirement

I posted here about  Kolbe v. BAC Home Loans Servicing, LP, 695 F.3d 111 (1st Cir. 2012), a case in which the First Circuit Court of Appeals overturned the dismissal of the complaint of a homeowner alleging that a mortgage lender did not have authority under the loan documents to demand that the homeowner purchase flood insurance in excess of the outstanding loan amount.  The court held that the loan documents were ambiguous and that therefore the court could not determine the issue as a question of law. 

The First Circuit has now revisited the case in Kolbe v. BAC Home Loans Service, LP, __ F.3d __, 2013 WL 5394192 (1st Cir.) and overruled its prior decision.

Kolbe, the homeowner, contended that the mortgage lender cannot require more than the federally mandated minimum flood insurance, which is the lesser of the balance of the loan or $250,000 in flood zones and $0 in non-flood zones. 

Kolbe's mortgage loan was guaranteed by the Federal Housing Administration.  The mortgage agreement contained uniform covenants that are required by HUD regulations to be in every FHA-insured mortgage.  One of those covenants provided:

4.  Fire, Flood and Other Hazard Insurance.  Borrower shall insure all improvements on the property, whether now in existence of subsequently erected, against any hazards, casualties, and contingencies, including fire, for which 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 filed a class action suit contending that under the contract the bank could not require him to purchase insurance in excess of the balance of the loan.  The District Court granted the lender's motion to dismiss.  Kolbe appealed, and in the panel decision discussed in my previous post the First Circuit vacated the dismissal.  The First Circuit then granted rehearing en banc.

In its en banc decision the court held, first, that the contract provision was a uniform provision used in many contracts, and therefore it must be interpreted uniformly regardless of what an individual contracting party may have understood the clause to mean. 

It held, second, that because the uniform contract language was imposed by the government of the United States, the government's meaning with respect to the language controls.  That meaning is determined in light of the purposes for which the government imposed the language and the context of the relevant regulatory scheme.

The court held that the bank's interpretation was the correct one.  The language of the clause by itself and in combination with other clauses in the contract makes clear that the bank can impose a requirement of additional flood insurance. 

The court also held that under a broader context the bank's interpretation must prevail.  As one example given by the court, if the borrower defaulted on an FHA-guaranteed loan, HUD ultimately would take possession of and sell the property, reimbursing the mortgage insurance fund with the proceeds of the sale.  But if the house had been destroyed by flood then "there is nothing" (a slight exaggeration, but still) for HUD to sell. 

Finally, the United States submitted an amicus brief supporting the bank's interpretation.  The court held that it was required to defer to the interpretation offered by the United States unless that interpretation was clearly erroneous.   

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