August 14, 2013
By: Joseph A. Ernst, Esquire
Starfield & Smith, P.C.
Builder’s Risk Insurance is specialized coverage designed for buildings that are under construction or undergoing substantial remodeling. Builder’s Risk insurance covers damage to or destruction of a construction project. Many construction projects are funded by a loan that uses the project itself as the collateral. In the event of damage or destruction that is not covered by insurance, the project owner may not have the financial resources to rebuild or rebuild in a timely manner. This may result in a loss of expected income which, in turn, may result in the project owner’s inability to repay the loan. By requiring builder’s risk insurance, the lender is protecting its construction loan in the event of damage to or destruction of the project.
Typically, the Builder’s Risk policy is purchased by the property owner or the general contractor. The insureds under such a policy will usually include the owner, the contractor, and the project subcontractors. In addition, a Builder’s Risk policy may designate a lender that has a financial interest in the property as an additional insured or mortgagee. Similarly, a lender may be identified as a loss payee or assignee of policy proceeds. This type of designation will entitle the lender to all or a portion of the policy proceeds if a loss occurs, but with important limitations discussed below. It is important to note that the lender’s status as a mortgagee does not by itself give the mortgagee a right to the proceeds of the Builder’s Risk policy obtained by the mortgagor. While there are varying ways that a mortgagor can grant the lender rights to the proceeds of a Builder’s Risk insurance policy, the type of arrangement granting those rights can drastically affect the lender’s rights to recover a Builder’s Risk policy’s proceeds once a loss has occurred.
A lender can be designated as an insured along with the policy’s other insureds. In such an arrangement, a lender becomes an “additional insured” or mortgagee under a Builder’s Risk policy. A lender is granted rights to the proceeds of a Builder’s Risk policy as a mortgagee through a standard mortgage clause in the mortgagor’s insurance policy. Traditionally, such a clause states that a mortgagee’s rights shall not be invalidated by any act or neglect of the mortgagor or owner of the property. In a second type of arrangement, the mortgagor arranges for the mortgagee to receive payment of the Builder’s Risk’s policy’s proceeds through a loss payable clause in the Builder’s Risk policy. Under such a clause, the lender becomes a beneficiary of the insurance proceeds, or a loss payee, and is not treated as an additional insured. Rather, the lender is an appointee, entitled to the insurance proceeds to the extent of its interest. A lender becomes a loss payee through an open mortgage clause (also known as a simple loss-payable clause). Such clauses typically state that loss or damage under the policy shall be payable as its interest may appear to the lender. In another type of loss payable arrangement, the mortgagor can transfer its rights to the Builder’s Risk policy’s proceeds through an assignment to the Lender of the right to recover under the Builder’s Risk policy. Once the lender has been assigned the right to receive the policy’s proceeds, sometimes by documents that are not a part of the Builder’s Risk policy, it is not treated as an additional insured but rather, as in other loss payable arrangements, a loss payee.
The standard mortgage clause provides a mortgagee, or additional insured, greater protection than a loss payable clause provides a loss payee. This is because the standard mortgage clause is an independent contract between the lender and the insurer and, as such, the mortgagee does not stand or fall with the mortgagor and acquires rights which give it independent and distinct protection. Essentially, the insurer cannot assert against the mortgagee defenses it has against the mortgagor. In practice, this means that the mortgagee is protected if the mortgagor breaches the insurance contract or commits bad acts, such as arson, fraud, or misrepresentation, which would void coverage. While the insurance contract between the mortgagor and the insurer would be void in such cases, the mortgagee’s contract with the insurer would remain valid, and the mortgagee would maintain its rights to the proceeds of the Builder’s Risk policy’s proceeds. A loss payee or assignee, in contrast, is afforded much less protection as the rights of a loss payee are derivative of the insured’s rights. There is no independent contract between a loss payee and the insurer.” As such, when a mortgagor breaches the Builder’s Risk insurance policy and voids the contract, the mortgagee loses its rights to the proceeds of the policy.
For more information regarding Builder’s Risk Insurance, contact Joe at email@example.com or at 215.542.7070.