By Errett Dickenson and Charles Brumby
Improper handling of hazard insurance checks may result in UCC claims without the endorsement of all parties.
The greatest risks are unknown risks. The known risks associated with servicing a mortgage in default is abundant, and the industry devotes tremendous resources to manage those risks. However, the unknown risks can blindside and cripple organizations. One such risk is how servicers handle hazard insurance checks made payable to multiple parties, usually payable to the mortgagee and the mortgagor. If a mortgagee deposits a multiple payee check without the endorsement of all parties, even into the mortgagor’s escrow account, the mortgagee may face claims under the Uniform Commercial Code (the UCC). As such, the mortgagee must tread carefully.
The common fact pattern is as follows: a property is damaged by an insurable peril and the insurance carrier issues a check payable to the mortgagor and the mortgagee. Often, the mortgagor or the mortgagee receives the check and deposits it without the endorsement of the other, in violation of the UCC, which states: “If an instrument is payable to two or more persons not alternatively, it is payable to all of them and may be negotiated, discharged, or enforced only by all of them.” UCC Article 3-110(d) (emphasis added). Article 3 of the UCC has been adopted in nearly every state. If the mortgagor deposits the check and does not repair the property, the mortgagee is stuck with a property with insurable damages but without insurance proceeds. Alternatively, if the mortgagee deposits the check without proper endorsements (because of standard operating procedures or the mortgagor’s refusal to endorse), the mortgagee may be exposed to substantial legal risks. Under both scenarios, the mortgagee is not made whole.
Tips for Mortgagees
Generally, depending on state law, the mortgagee has priority aver the mortgagor to insurance proceeds up to the mortgagee’s interest at the time of loss. A mortgagee’s interest varies based on three common fact patterns. First, if the property has not sold at foreclosure, then the mortgagee’s interest is usually equal to the payoff of the loan. Second, if the loss occurred before foreclosure sale but subsequently sold at foreclosure, the mortgagee’s interest is generally the loan’s payoff less the amount received by the mortgagee from the sale, even if the mortgagee purchased the property via credit bid. Third, if the loss occurred after the foreclosure sale and the property was purchased by the mortgagee, the mortgagee’s interest is usually that of the owner of the property, and the amount of payoff should not be relevant.
With these principles in mind, we tum to more practical considerations, such as ensuring policies and procedures reflect the applicable law, and how to get to the right result for both the mortgagor and mortgagee. Mortgagees may face substantial risks by depositing multiple payee checks unless all payees endorse the check, or the payees are separated by an “or.” The mortgagee should attempt to contact the mortgagor and have the mortgagor endorse the check before taking any other actions. Once contact is made, the check must be sent to the mortgagor without the endorsement of the mortgagee, otherwise, the mortgagor can easily cash the check and abscond with the funds. Of course, a mortgagor in the process of foreclosure may be unwilling to endorse the check to the mortgagee’s benefit, or the mortgagor simply cannot be found.
When a mortgagee is unable to obtain the mortgagor’s endorsement on a multiple payee check, the mortgagee should have a defined process in place for what comes next.
Ideally, the mortgagee should first request that the insurance carrier reissue the check up to the interest mortgagee with the mortgagee as sole payee, but many carriers will resist, arguing that the insurance policy requires the carrier to list all interested parties on the check. As one might imagine, the larger the loss, the more resistant the insurance carrier is likely to be to reissue the check payable solely to the mortgagee. Despite the insurance carrier’s custom in issuing multiple payee checks, state law and the policy often require payment to be made solely to the mortgagee. If the carrier refuses to reissue, then the mortgagee may need to take legal action to obtain the funds. The mortgagee may need to enlist outside counsel to have a court rule that payment must be made solely to the mortgagee. The various legal options available will depend on the jurisdiction, the terms of the insurance policy, and the terms of the mortgage itself.
Critically, mortgagees must be careful if the damage to the property occurred before the foreclosure sale. As mentioned above, if the sale occurs after the loss, the amount of the sale can impact a mortgagee’s ability to recover funds from the carrier. If the mortgagee is planning to credit a bid on the property at a foreclosure sale, the estimated amount of the loss should be subtracted from the total bid. Depending on the jurisdiction, if a property suffers a $50,000 loss, the maximum bid by the mortgagee at the foreclosure sale should be reduced by $50,000 to ensure that the mortgagee is entitled to the full proceeds of the insurance claim. This may be a best practice regardless of a multiple payee situation and will reduce the likelihood of a partial credit bid or full credit bid reducing (or even extinguishing) the ability to recover the full amount of insurance funds needed to repair the property. The last thing a mortgagee wants is to cause itself to lose out on funds that can be used to repair the property. However, it should be noted that there may be other factors outside of insurance proceeds that mortgagees should consider in determining the final amount of the bid.
Finally, there are situations where a mortgagor obtains the check, either directly from the insurance carrier or the mortgagee, and the mortgagor cashes the check, absconds with the funds, and fails to repair the damaged property. In these situations, the instinct is to file a claim against the mortgagor for the funds, but this often proves unfruitful, and the mortgagee still has a damaged property on their hands. Luckily, there are other potential avenues of recovery available. A claim might be viable against the carrier if it improperly issued the check without the mortgagee as a payee, or in some circumstances and depending on the policy if the check was sent directly to the mortgagor and not the mortgagee first. If the mortgagor cashes the check without the endorsement of the mortgagee or fraudulently endorses the check, then the mortgagee may have claims against the bank that accepted the improperly endorsed check for deposit, or against the insurance carrier’s bank that paid the improperly endorsed check.
For these reasons, mortgagees must understand the risks of improperly handling hazard insurance checks and have a process in place to help mitigate those risks.