Andy owns A-1 Appliances, a company that sells home appliances. Andy's company has just purchased a new warehouse with a mortgage it obtained from Lucky Lending.

The loan A-1 obtained from Lucky Lending is secured by the warehouse. Thus, Lucky Lending has an insurable interest in the property. To protect Lucky's interest, the loan agreement requires A-1 to insure the warehouse against damage by fire and other perils under a commercial property policy.


The contract states that the policy must include a standard mortgage clause.

Standard Mortgage Clause

Most commercial property policies contain a clause in the policy Conditions section that addresses the rights of mortgageholders (lenders). Mortgageholders are also called mortgagees. Many policies contain the standard mortgage clause found in the ISO commercial property policy. The provisions of this clause are summarized below.

Interests

The mortgage clause applies to the mortgageholder named in the declarations. The lender is covered for loss or damage to the building or structure that serves as collateral for the loan.

If multiple lenders are listed in the policy, they are covered in order of precedence. For example, suppose that a policyholder has purchased a building via two mortgages (a first and a second).  If the building burns down, the lender listed on the first mortgage will be paid. After the first lender has been compensated, the lender on the second mortgage will receive payment.

The mortgage clause states that lenders will receive payment "as their interests may appear." That is, the amount each lender will receive depends on the extent of damage to the insured building and the unpaid balance (principal and interest) of the loan. Suppose a fire destroys A-1 Appliances' warehouse. At the time of the fire A-1 owes Lucky Lending $750,000 in principal and accrued interest. Lucky Lending receives an insurance payment of $750,000 (its interest in the property).

The amount the insurer will pay for a loss is subject to the limit on the policy. For instance, if the warehouse is insured for $1.5 million, the insurer will pay no more than $1.5 million to all covered parties (the insured and all lenders).

In some states lenders secure their loans via deeds of trust rather than mortgages. Thus, the term mortgageholder in the standard mortgage clause includes a trustee.

Foreclosure

The lender's right to recover for a loss under the borrower's property policy is not affected by any foreclosure action the lender has initiated against the property owner prior to the loss. For example, suppose that Lucky Lending issues a notice of default to A-1 Appliances. One month later the warehouse is destroyed by a fire. The default notice will not affect Lucky's right to receive payment for the loss under the policy.

Acts of Policyholder

The mortgagee has a right to recover for a loss under the policy even if the policyholder has violated a condition of the insurance contract. For example, suppose that A-1 Appliances' warehouse is destroyed by a fire. A-1 files a claim with its property insurer for damage to the building and its contents. However, A-1 refuses to let an adjuster onto the property to evaluate the damage. The insurer ultimately denies A-1's claim due to the policyholder's failure to comply with the policy's conditions.

If Lucky Lending fulfills certain conditions, its right to recovery under the policy will not be affected by A-1's actions. The lender must:

• Pay any outstanding premium due that the policyholder has failed to pay
• Submit a proof of loss (if the policyholder has failed to submit one) within 60 days of receiving a notice that a proof of loss is due
• Notify the insurer if the lender is aware of any change in the building's ownership or occupancy or if  the risk has changed substantially

Once the lender has fulfilled these conditions, the property policy will apply to the lender.

Transfer of Rights

In the previous example, A-1 Appliance was denied payment under the policy because it failed to comply with the terms of the insurance contract. Suppose that Lucky Lending has received an insurance payment of $700,000 for its interest in the damaged warehouse. The fire was caused by a defect in an electric dryer stored in the warehouse. If Lucky Lending had not received compensation for its interest in the damaged building, the lender would have the right to sue the dryer manufacturer for property damage.

Because A-1's property insurer has indemnified the lender (made it whole) for the loss, the lender's right to sue the manufacturer for compensation is transferred to the insurer. The insurer now has the right to subrogate against (seek compensation from) the manufacturer for the amount of the payment the insurer has made to Lucky Lending.

The insurer may choose to pay the lender the principal amount on the mortgage plus any accrued interest. The policyholder is then obligated to pay the remaining debt to the insurer.

Cancellation and Non-renewal

The mortgage clause requires the insurer to notify the mortgageholder in writing if the insurer cancels the policy or refuses to renew it. If the insured has failed to pay the premium, the insurer must notify the lender ten days in advance before cancelling the policy. If the insurer cancels the policy for any reason other than non-payment of the premium, it must provide 30 days advance notice to the lender. Should the insurer decide not to renew the policy, it must provide the lender ten days' notice.

These cancellation conditions may be modified by state law. For instance, a particular state may require insurers to notify a lender at least 45 days in advance if a policy is cancelled for any reason other than non-payment of premium.