Consider this nightmare. “Borrower LLC’s” property insurance, which provides protection for Lender, is due to expire. Borrower has its broker send an ACORD 28 “Evidence of Commercial Property Insurance” certificate to Lender. The certificate states that Borrower has obtained property coverage with all of the bells and whistles required by the loan documents from Shifting Sands Property and Casualty for the following year. Everything seems to be in order. Lender or servicer files the ACORD 28 and all is well until there is a loss...
Lender then flourishes the ACORD 28 only to be told that the certificate conveyed no rights and that Lender is not listed as a “lender loss payee” or that Borrower LLC went through a rough patch and cancelled its coverage or that the policy terms are considerably different from what Lender thought.
That can’t happen, can it?
Sadly, it can.
First, a bit of backstory. For many years, it has taken insurers a substantial period of time to turn a quotation for coverage into a finished policy. As an example, look back to SR Intern. Bus. Ins. Co. v. World Trade Center Props., LLC, 467 F.3d 107 (2d Cir. 2006), which arose out of the 9/11 terrorist attacks on the Twin Towers in New York. On the terrible morning of the World Trade Center (WTC) attacks, coverage for the property was almost entirely on binder; even though Silverstein Properties had worked from the beginning of the summer in 2001 to obtain coverage, by the morning of the attack only one insurer representing a small portion of the required program had actually issued a policy. 467 F.3d at 115.
Admittedly, coverage for the WTC was a highly complex undertaking, but there are other cases involving very long delays between the date on which an insurer states that it has “issued” coverage and an actual policy is delivered. An informal survey conducted by an lender industry trade group suggested that there are substantial delays in the delivery of a significant number of insurance policies, that delays are not tied to the complexity or size of the insurance program or policy or to a single insurer or type of policy, and that there is no way to predict in advance whether a delay will occur or how long it will be.
Delays in policy issuance usually are not a problem at initial funding. The lender can delay closing until sufficient documentation is available. Once the loan closes, however, this obviously is no longer the case. The risk arises because insurers generally issue property insurance policies for periods of one year, which generally means there will be several policy renewals over the life of a loan, and therefore several periods during which there is no actual policy for a lender or servicer to review for compliance with loan requirements.
The Mortgage Bankers Association and the insurance industry developed the ACORD 28 “Evidence of Commercial Property Insurance” form in 2003 as a gap-filler—as a form that would convey essential collateral protection rights to lenders during periods that there was not an actual policy. Until 2006, the ACORD 28 form stated that it was “evidence” that policies conforming to the description were in place and that lenders had the rights that were set forth on the ACORD 28 form. The ACORD 28 provided the essential information lenders needed to protect their rights—lender status as mortgagee, loss payee or lender loss payee (more about this in a forthcoming post), notice of cancellation, and limits, among other information.
The ACORD 28 served well until mid-2006, when ACORD, an insurance industry service organization, unilaterally modified the ACORD 28 with language that it was for information only and that it conferred no rights. If a borrower submits an ACORD 28 on a form dated July 2006 or later, this language will be on it. This form of ACORD 28 gives a lender no rights; it is no better than any other “for information only” certificate, which is to say essentially worthless as a gap-filler. The Mortgage Bankers Association worked for many years without success to develop a form that would provide the needed information.
So what do you do as a lender or servicer when confronted with a “for information only” ACORD 28? Are you checking what you get? Especially with non-recourse loans, insurance represents your principal form of collateral protection. Vigilance about compliance with insurance provisions in loan documents therefore seems essential; for regulated lenders, failure to maintain adequate insurance at all times over the life of the loan is grounds for loan reclassification and imposition of an increased loss reserve. All the more reason...
If you are, what alternatives are acceptable? Binders? Specific renewal quotes? Other alternatives? This is a matter for careful discussion and evaluation taking into account many factors such as the nature of your portfolio, your markets for sale of loans, regulatory issues and your risk aversion.
Even if you are vigilant, insurance paperwork is not something to be ignored. It is essential that you meet with insurance and legal professionals to develop comprehensive policies about compliance with insurance covenants and that you enforce those policies. After all, it is your money out there. Do you want to make sure it comes back?