Standard Mortgage Clause Effects on Vacancy Restrictions in Homeowner Policies Under Minnesota Law

Generally there are two types of mortgage clauses contained within homeowner policies: (1) a standard mortgage clause; and, (2) an open form mortgage clause.

Standard mortgage clauses specify that “the insurance with respect to the mortgagee shall not be invalidated by the mortgagor’s acts or neglect.” American National Bank & Trust Co. v. Young, 329 N.W.2d 805, 810 n.1. (Minn. 1983). The Minnesota Courts have observed that the legal effect of a standard mortgage clause is to make a new and separate contract between the mortgagee and the insurance company thereby creating a separate insurance for the interest of the mortgagee which is dependent for its validity solely upon the course of action of the insurance company and the mortgagee.

The standard mortgage clause leaves the mortgagee unaffected by any act or neglect of the mortgagor. Under the terms and conditions of the insurance policy in which the standard mortgage clause is contained, the terms and conditions of the policy apply equally to both the loss payee and the insured except that, under the standard mortgage clause, the loss payee is only liable for the loss payee’s own breaches. A typical standard mortgage clause provides that if the insurance company denies the owner’s claim because of the owner’s acts or because the owner has failed to comply with the terms of the policy, the mortgage holder still has the right to receive loss payment. Standard mortgage clauses also specify that the insurance with respect to the mortgagee shall not be invalidated by the mortgagor’s acts or neglect.

The Minnesota courts have repeatedly held that the words “any acts” used in a standard mortgage clause are not limited merely to acts prohibited by the contract or to failure to comply with the terms of the contract, but “literally embrace any act of the mortgagor.” American National Bank & Trust Co. v. Young, 329 N.W.2d at 810 n. 1. See also, H.F. Shepherdson Co. v. Central Fire Ins. Co., 220 Minn. 401, 405-06 19 N.W.2d 772, 775 (1945); see also, Magoun v. Fireman’s Fund Ins. Co., 86 Minn. 486, 490-91 91 N.W. 5, 7 (1902) (holding that a standard mortgage clause is an independent contract of insurance not invalidated by act, neglect, omission or default of mortgagor); Bast v. Capital Indem. Corp., 562 N.W.2d 24, 28 (Minn. App. 1997) (holding that “when an insurance policy establishes an independent contract between the insurer and the loss payee through use of a standard form mortgage clause, the loss payee is entitled to notice of any material change resulting in a substantial reduction in coverage, notwithstanding the acts of the insured”); and, Farmers State Bank v. Western National Mut. Ins. Co., 454 N.W.2d 651, 653 (Minn. App. 1993) (holding that when an insured misrepresented material facts to the insurer, the contract was nevertheless not void as to the loss payee because the contract included a standard mortgage clause protecting the loss payee.)

Recently, the Minnesota Court of Appeals in Commerce Bank v. West Bend Mut. Ins. Co., 853 N.W.2d 836 (Minn. App. 2014) found, as a matter of first impression, that denial of coverage based on a vacancy exclusion did not apply to a mortgagee who was protected by a standard mortgage clause. In Commerce Bank, the bank loaned $3.2M to an LLC which was the owner of the insured property. Under the loan agreement, Commerce Bank secured a mortgage on the property. At that time the owner had an insurance policy with The Hartford, which was West Bend’s Mutual Insurance Company’s (West Bend’s) predecessor in interest. Under the Hartford policy, there was coverage for “loss of or damage to buildings or structures to each mortgageholder.” The policy had a standard mortgage clause. The policy also excluded coverage in cases of vacancy.

The policy specifically described what vacancy was. The description of vacancy indicated that the building would be considered vacant at the policy’s inception unless at least 31 percent of its total square footage was rented to a lessee or sublessee and used by the lessee or sublessee to conduct its customary operations and/or used by the building owner to conduct customary operations, or was under construction or renovation. The policy also indicated that if the building was vacant for more than 60 consecutive days before loss or damage occurred, the insurance company would not pay for any damage or loss caused, in part, by vandalism.

The record indicated that prior to the issuance of the policy and prior to the bank loan being issued, the building was vacant and the police had responded to numerous break-ins that resulted from vandalism. In 2010, the property sustained damage from vandalism at which time the owner submitted an insurance claim to The Hartford under the policy.

The Hartford denied the vandalism claim under the policy indicating that the vandalism damage had occurred over a period of time from December 2007 through the date that the loss was reported. The Hartford asserted that the vandalism stemmed from the building’s tenant abandoning the building without completing renovations that had been started and that the building was vacant from December 2007 up through the report of the loss.

Because the owner had difficulty making loan payments to Commerce Bank the loan was in default in the Fall of 2010. The Hartford had listed Commerce Bank as the mortgagee and as an additional insured under the policy effective February 21, 2011. At that time, Commerce Bank did not have control of the building, but it did have access to enter the property and had contracted with a third-party to manage various building-related issues such as winterization, electricity, security, insurance claims, lawn care, and snow removal regarding the building’s condition. Pursuant to this arrangement, the third-party visited the property in August 2011, while the building was still vacant, to assess the needs of repairs and refurbishment. In September 2011, the building was vandalized again incurring significant damage which resulted in the loss that was at issue in Commerce Bank v. West Bend Mut. Ins. Co.

In December 2012, Commerce Bank submitted an insurance claim to West Bend for the September 2011 loss. The claim was denied on the basis that the loss was excluded from coverage because the building had been vacant since at least 2010, more than 60 days prior to the loss. Further, there was no evidence that the building was under construction or renovation prior to the loss. Thereafter, Commerce Bank sued West Bend.

The District Court held that the building was vacant and was not under construction and that the policy’s vacancy provision created a circumstance of non-coverage rather than an exclusion to coverage. The Court granted summary judgment in favor of Commerce Bank. West Bend appealed. On appeal, the Court held that the Minnesota Supreme Court in American Bank & Trust Co. v. Young, had unequivocally established that under a standard mortgage clause “the insurance with respect to the mortgagee shall not be invalidated by the mortgagor’s acts or neglect.” 329 N.W.2d at 810 n.1. The Court of Appeals in Commerce Bank found the foregoing principle applied, not only when the mortgagee’s acts were prohibited by the contract, but also because of the mortgagor’s failure to comply with the terms of the contract and literally embraced any act of the mortgagor. The undisputed record facts demonstrated that while Commerce had knowledge that the owner had left the property vacant for more than 60 days prior to the September 2011 loss, and had access to the property during that relevant time period, Commerce Bank did not have possession or control of the property, and had no legal right to remedy the vacancy until January 2012, when it received title to the property. Under controlling Minnesota law, the Court of Appeals found that the insurance coverage with respect to the mortgagee was not invalidated by the mortgagor’s acts or neglect. Therefore, the Court held that Commerce Bank did not breach the policy and that the policy’s vacancy provision did not apply to Commerce Bank.

In ruling in favor of Commerce Bank, the Court rejected West Bend’s argument that allowing Commerce Bank to recover would render the vacancy provision meaningless. Although the owner of the building had failed to occupy the property or secure a tenant that gave rise to the vacancy and, therefore, had no coverage under the policy for those violations, Commerce Bank had a separate and independent policy with West Bend, and the vacancy provision would only apply to Commerce Bank if Commerce Bank was guilty of breaching the policy. The Court noted that the indemnity of the mortgagee was not placed at the whim of the debtor and was subject only to breaches for which the mortgagee was itself guilty of.