This article is a follow up to Bruce Wallace’s April 13, 2017 update, "Is your Motor Vehicle Loan Safe?" regarding how insurance policies may not protect the credit union’s lien. Specifically, Mr. Wallace’s update dealt with loss payee clauses under South Carolina law, and the issue of whether there is coverage for innocent insured/lienholders in circumstances involving intentional loss caused by the insured borrowers. In South Carolina, the answer to that question depends on whether the policies contain “Open Loss Payable Clauses” or “Standard Loss Payable Clauses.”

Under North Carolina law, the situation is essentially the same, in that North Carolina law recognizes a similar distinction between two types of loss payee clauses (but with different nomenclature).

You’ll recall from Mr. Wallace’s update that “a loss payee clause (or loss payable clause) is a clause in a contract of insurance that provides, in the event of payment being made under the policy in relation to the insured risk, that payment will be made to a third party rather than to the insured beneficiary of the policy.” In North Carolina, as in South Carolina, there are generally two types of payee clauses. The first type is referred to as the “standard or union mortgage clause.” The second type is the “open or simple loss-payable clause.” As a quick aside before we go further, don’t let the word “mortgage” in the “standard or union mortgage clause” confuse you--it does not mean that this type of clause only applies to insurance policies relating to residential real property – it also applies to vehicle insurance policies as well.

In North Carolina, as in South Carolina, depending on which type of loss payee clause is present in your members’ insurance policies, your credit union may not be protected against the risk of your members’ malfeasance. As Mr. Wallace noted in his update on SC law, “knowing your members’ policies will help the credit union understand the risk.”

Standard or Union Mortgage Clause:

In NC, the “standard or union mortgage clause” stipulates that “the interest of the mortgagee in the proceeds of the policy shall not be invalidated by any act or neglect of the mortgagor.” [1] (again, don’t let the terms “mortgagee” and “mortgagor” confuse you –think in terms of credit union and member/borrower). “This type of clause acts as a distinct and independent contract between the insurance company and the mortgagee and ‘confer[s] greater coverage to the lienholder than the insured has in the underlying policy.’” [2] This type of clause is comparable to the “standard loss payable clause” in S.C. in that—quoting Mr. Wallace , “the credit union, as lienholder, is ‘freed from policy defenses’ which the insurer may have against the member/borrower. The credit union can recover policy benefits even where the insured is complicit in the loss.”

Open or Simple Loss-Payable Clause:

In NC, the “open or simple loss-payable clause” provides “that the loss, if any, shall be payable to the mortgagee [credit union], as his interest may appear.” [3] “In other words, the ‘rights of the mortgagee [credit union] under [this type of] clause are wholly derivative, and cannot exceed those of the [insured].’”[4] This type of clause is somewhat comparable to the “open loss payable clause” in S.C. in that— again quoting Mr. Wallace, “the credit union merely stands in the shoes of the insured. As a result, the credit union can recover benefits only if the insured has a valid claim. If the insured does not have a valid claim, the credit union will not be paid on the claim.”

Clearly, in NC, credit unions will want their member/borrowers’ insurance policies to contain “standard or union mortgage clauses” just as, in SC, credit unions will want their member/borrowers’ policies to have “standard loss payable clauses.” Credit unions do not want to have their coverage as loss payees denied because—for instance—their member/borrowers set fire to their vehicles (or engage in other illicit acts or neglect with respect to the insured collateral).