In Cohen v. American Security Insurance Co., the Seventh Circuit rang the death knell on mortgagors’ lawsuits complaining about the cost of force-place insurance bought by the mortgagors’ bank. When a bank makes a loan and takes a mortgage, the mortgagor’s real estate often is the bank’s security – that is, the bank’s assurance that its loan will be repaid, involuntarily if need be. It is important to the bank that the real estate retain its value until the loan is repaid. Accordingly, in the loan documents the mortgagor agrees to buy and keep property insurance. The mortgagor also agrees that should he fail to have that insurance, the bank may buy it and charge the mortgagor the premiums. “Force-place” insurance is the term for the insurance the bank buys upon the mortgagor’s default.
Mortgagors around the country have sued their banks who bought force-place insurance and the insurers who issued it. The mortgagors claim that the insurance the bank bought is too pricey and that the insurer paid the bank a commission, which the plaintiff’s bar prefers to call a “kickback.” One bank was Wachovia, and one insurer was American Security Insurance Co., who, in Cohen, were sued by a putative class for various causes of action brought under Illinois law. The plaintiffs accused American Security of intentionally interfering with the plaintiffs’ contracts with Wachovia, of conspiring with Wachovia, and of aiding and abetting Wachovia’s unjust enrichment of itself at their expense. The Seventh Circuit held that the claims against American Security were dismissed properly, because they derived from claims against Wachovia that were also dismissed properly. The mortgagor’s loan documents explicitly allowed Wachovia to buy force-place insurance. Further, one of the notices the mortgagor signed at closing acknowledged that force-place insurance could cost “at least two to five times greater and provide you with less protection than insurance you could purchase directly from an insurer” and that Wachovia’s affiliated agent could collect a commission on the force-place insurance. Wachovia certainly did not defraud the mortgagor, who claimed that it lied to her by omission. Alleged omissions could be fraudulent only if there was a relationship of trust between Wachovia and the mortgagor. But Wachovia was not her fiduciary. They dealt at arm’s length. Further, insuring the property served the bank’s interests. The loan documentation warned the mortgagor that the force-place insurance was “for our benefit only” and “would not protect your interest in the property.” Plainly, Wachovia acted with an openly “undivided loyalty to itself,” as the Seventh Circuit found. Given the Wachovia’s nakedly selfish motive, the mortgagor would have been foolish to repose any trust that the bank would protect her when it bought force-place insurance.
Will Cohen put an end to a putative class action known as Simpkins v. Wells Fargo Bank? In August, the district court for Southern District of Illinois refused to dismiss the complaint in Simpkins, which was brought against an insurer and a bank on virtually the same facts as those the Seventh Circuit examined in Cohen. Now that the Seventh Circuit has ruled, the district court should dismiss most, if not all, of the Simpkins lawsuit, as it falls squarely within Cohen. The plaintiffs may argue that Cohen does not apply to their claim for breach of fiduciary duty, as the bank in Simpkins allegedly paid for the force-place insurance out of the mortgagor’s funds that the bank held in escrow. Yet the bank’s fiduciary duty would be fairly narrow, as an escrowee “owes a fiduciary duty to act only according to the terms of the escrow.” Int’l Capital Corp. v. Moyer, 806 N.E.2d 1166, 1172 (Ill. App. Ct. 2004). In all likelihood, the loan documents authorized the bank to buy force-place insurance out of the escrow funds if necessary. Once that insurance was bought, the escrowee was expressly authorized to pay for it.
The Seventh Circuit likely would reject an argument contending that there is something illicit in the bank paying for the force-place insurance with escrowed funds. In Cohen, the Seventh Circuit panned a mortgagor complaining that he lost his chance to refuse to pay for force-place insurance as a “senseless” theory because there is no harm in the mortgagor losing his chance to breach his contract. The only difference between a bank that holds funds in escrow and a bank that does not is that in the latter case, the mortgagor might refuse to make payments. Whether the mortgagor would pay out of his monthly loan repayments or out of his escrowed funds, he promised to pay for force-place insurance. The escrowee cannot be liable to the mortgagor for using his funds to make that payment.
Backdating deserves special mention. Loan documents usually require insurance on the property to be continuous. By the time a bank first learns that property is not insured, the property often has not been insured for days, weeks, or months. The bank therefore buys force-place insurance backdated to when the property was first uninsured. Mortgagors complain that backdated insurance serves no purpose but to enrich the insurer with premiums and the bank with commissions. Obviously, the mortgagors contend, the property had not been damaged while it was uninsured. Yet, the Seventh Circuit asked, how could the bank know? The bank is not present at the property, and banks need not pay the expense of inspecting properties upon learning of the mortgagor’s lapse in insurance. Even if the mortgagor were feeding the bank information, it would not be prudent to take the mortgagor’s word, as damage such as mold or corrosion might not be apparent. Though the insurance would exclude any damage known to have happened during the lapse period, already damaged property may have other losses unknown on the day the bank bought the force-place insurance. The bank must protect its interests, hence the backdating; and the insurer takes the risk of loss having already happened, hence the premium for the lapse period.
At bottom, any injury to mortgagors is the mortgagors’ fault. They failed to insure the property as they promised. They then failed to buy insurance more to their liking upon learning of the force-place insurance. (When they do so, they get a full refund of the force-place premium charged while their own insurance was in force. 12 U.S.C. § 2605(l)(3)(B). Surely an insurer presented with undamaged property would be pleased to sell backdated insurance.) As to all claims in law, the mortgagors failed to mitigate damages. As to all claims in equity, they are equally at fault or come to court with unclean hands. Whatever the claim, mortgagors should lose in court. Mortgagors’ lawsuits are simply the wrong devices for changing banks’ and insurers’ practices as to force-place insurance.
Relative to the other branches of government, generalist courts are ill-suited to determine the reasonableness of the rates set for force-place insurance or of the commissions insurers pay banks. Banking is regulated by the federal government, and insurance is regulated by the states. In the past year or two, the regulators have acted on force-place insurance.
The Seventh Circuit’s opinion in Cohen v. American Security Insurance Co., No. 11-3422 (7th Cir. Nov. 4, 2013) is here, and the district court’s opinion in Simpkins v. Wells Fargo Bank, No. 12-cv-768 (S.D. Ill. Aug. 26, 2013) is here.