US Bank vs. Insurance Company in Tennessee

U.S. Bank, N.A. as servicer for Tennessee Housing Development Agency v. Tennessee Farmers Mutual Insurance Company

Case Law
No. W2006-02536-COA-R3-CV
December 21, 2007

Robbins bought a home in Gibson County, Tennessee using the loan she secured from U.S. Bank. The loan was secured by a Deed of Trust in favor of the Bank as well as the mortgagee with respect to the insurance coverage.

The policy was obtained by Robbins from Tennessee Farmers Mutual Insurance Company. The policy contained a 'standard mortgage clause.' This clause, in substance imposed the duty on the insurance company to ensure that the mortgagee's interest is protected and that the protection would not be invalidated based on a foreclosure if the Bank did not have knowledge of the same and on the part of the mortgagee, the duty to notify the insurance company of any increases in hazard.

Robbins married Zack Hill. She started missing her mortgage payments. The Bank sent her a notice of foreclosure but failed to notify the insurance company. Before the foreclosure could have been completed, Hill filed for bankruptcy which in effect stayed the foreclosure proceedings. Later, the house was destroyed by a fire.

The Bank as mortgagee notified the insurance company of the loss however, the latter refused to pay for the loss. According to the insurance company, there was a violation of the mortgage clause in the insurance policy, i.e. the commencement of foreclosure proceedings increased the hazard and the failure of the mortgagee to inform and notify them of the foreclosure proceedings.

The Bank filed a case against the insurance company for breach of contract and refusal in bad faith to pay in accordance with Tennessee Code Annotated § 56-7-105(a). The trial court ruled in favor of the Bank.

The insurance company appealed the decision to the Court of Appeals of Tennessee of Jackson. The following issues were raised for the resolution of the Court: a) Whether or not the Bank is required to notify the insurance company of the foreclosure proceedings in accordance with Tennessee Code Annotated § 56-7-804; and b) whether or not the foreclosure proceedings constituted an "increase in hazard.'

The appellate court ruled that the commencement of the foreclosure proceedings constituted an increase in hazard both under the standard mortgage clause and under the Tennessee Code Annotated § 56-7-804. The increase in hazard means increase in the risk of loss insured against. The rationale for its inclusion both in the law and in the mortgage clause is that it is usual that owners of the property mortgaged when not capable to financially meet their obligations or are not mindful of their responsibility such that recourse is made through foreclosure; the property is more likely to be destroyed by fire so that the insurance money will be applied to the loan. The court further explained that there is a high risk that the owner of the property or house is motivated to destroy it so that he can receive a part of the proceeds of the insurance. Thus, the risk starts when foreclosure proceedings are initiated and will end once it is terminated.

Anent the second issue, the Court explained that the Bank had a clear duty to inform the insurance company of the commencement of the foreclosure proceedings. The law protects against invalidation of the policy however, in the instant case it was made contingent on the compliance by the bank of its duty to notify. The decision of the trial court was reversed.

Lesson Learned: This case was first heard by the Circuit Court for Gibson County and was later appealed to Court of Appeals of Tennessee at Jackson.

This case clearly laid down the principle that compliance with the terms of the contract must be observed. The Bank clearly failed to do what it has bound itself to perform under the contract. Failure to comply with the terms stipulated in the contract barred the Bank from receiving the insurance benefits. Additionally, it also establishes a known and recognized fact that property owners have the likelihood and motive to destroy the house so that the insurance proceeds could be applied to its mortgage loan.

Written by Kevin Levonas and Giselle G.