Here is a new scenario [Option One Mortgage Corp. v. J.P. Morgan Chase & Co., 93 A.D.3d 480, 940 N.Y.S.2d 225 (1st Dept. 2012)] relating to the otherwise recognized concept of a lender’s insurable interest when a foreclosure sale is consummated, but the lender neglects to pursue a deficiency.
The usual fact pattern with which lenders and servicers hopefully are familiar with (to avoid remorse) is this:
There is a fire loss at the premises. By the time the foreclosure sale is consummated, the insurance proceeds have not been paid. The foreclosed property is worth less than the debt, so after the sale the lender pursues a claim against the insurance company for those proceeds. While before the sale the mortgage holder would have been entitled to the proceeds exclusively (because the borrower was at fault) after the sale and in the absence of seeking a deficiency, the debt is deemed satisfied and so the lender no longer has a claim to insurance proceeds because there is no insurable interest. This is why careful consideration must be given to procedures relating to deficiencies when there may have been a fire loss prior to the foreclosure sale.
In the recent case cited, there was a fire loss, the borrower-owners took the insurance proceeds for themselves, the foreclosure proceeded to a sale, and no deficiency was pursued. Instead, the foreclosing party who suffered a loss, sued the borrowers who absconded with the insurance proceeds in a separate action for conversion, negligence and violation of the Uniform Commercial Code §3-419(1)(c). The court dismissed that suit.
The foreclosing plaintiff’s action claimed just entitlement to the insurance proceeds paid to the previous owners of the home who cashed the insurance check but failed to use the money to repair fire damage to the property, was founded upon a paragraph of a mortgage entitled “Borrowers Obligation To Maintain Hazard Insurance Or Property Insurance.”
But the court invoked the accepted principle that bidding at a foreclosure sale and taking title generally terminates the insurable interest which the mortgagee might have held in its capacity as the holder of the mortgage. The court conceded the obvious, that it is correct that where the bid of the foreclosure sale is less than the amount of the debt there could remain a deficiency for which the borrower would be liable. Nonetheless, when no motion for a deficiency is made, the proceeds of the sale, regardless of the amount, must be deemed to be in full satisfaction of the mortgage debt. Therefore, there is no right to recover any deficiency in any action or proceeding. Because the plaintiff indeed made no motion for a deficiency, that failure defeated any right to recover that it may have had as mortgagee.
So in the end, the rule was the same. Thus, proceeding against the former borrowers under some other theory didn’t change the underlying concept.
Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.