Certain Underwriters of Lloyds, London v. U.S. Industrial Services, LLC

Citations: 825 F. Supp. 2d 882; 108 A.F.T.R.2d (RIA) 7555; 2011 U.S. Dist. LEXIS 130144; 2011 WL 5593141Docket: Case No. 10-14727

Court: District Court, E.D. Michigan; November 9, 2011; Federal District Court

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The court granted summary judgment in favor of defendants Fifth Third Mortgage and Federal National Mortgage Association (Fannie Mae), while denying the motion for summary judgment from the United States. The case arose from an interpleader action initiated by Certain Underwriters of Lloyds, London, concerning insurance proceeds from a hazard policy on commercial real estate affected by foreclosure proceedings. The property, owned by Maria Kattula and U.S. Industrial Services, LLC, was mortgaged to Fifth Third Mortgage, which was also named as a loss payee on the insurance policy.

Following the default on the mortgage, Fifth Third Mortgage purchased the property at a foreclosure sale and subsequently transferred it to Fannie Mae. Water damage was discovered during the redemption period, leading to competing claims for the insurance proceeds. The court determined that Fifth Third Mortgage could not claim loss payee status as an insured due to lack of interest at the time of loss; however, the assignment of rights to insurance proceeds in the mortgage contract was upheld as surviving foreclosure and superseding the United States tax lien.

As a result, Fifth Third Mortgage and Fannie Mae are entitled to the insurance proceeds up to the unpaid loan balance. The court confirmed the undisputed facts, including details of the mortgage and insurance policy issued, which included specific provisions regarding payment to loss payees.

Denial of a claim due to an insured's actions or non-compliance allows the Loss Payee to receive payment if they fulfill specific conditions: paying any due premiums upon request, submitting a signed proof of loss within 60 days of notice, and informing of any ownership or risk changes. If payment is made to the Loss Payee while denying the insured, the Loss Payee's rights transfer to the insurer up to the amount paid, but they retain the right to recover the full claim amount. 

A federal tax lien was recorded against Robert and Maria Kattula in early 2008, and the mortgage loan on their property defaulted, resulting in foreclosure by Fifth Third Mortgage. The property was sold at a sheriff's sale in August 2009, and subsequently conveyed to Fannie Mae. The redemption period expired without action from Maria Kattula. The property suffered water damage in January 2010, leading to an insurance payout of $84,311.61, with $65,811.62 remaining after satisfying a construction lien. Fifth Third Mortgage, Fannie Mae, and the United States are contesting claims to these insurance proceeds and have filed cross motions for summary judgment.

Under Federal Rule of Civil Procedure 56, summary judgment is appropriate when there is no genuine issue of material fact. The court must view evidence favorably for the non-moving party and determine if a jury could reasonably find in their favor. Material facts influence the lawsuit's outcome, while genuine issues arise when reasonable jury verdicts for the non-moving party are possible. Disputes that are irrelevant do not constitute genuine issues of material fact, and a complete record must not lead a rational fact-finder to support the non-moving party's position.

In Michigan Paytel Joint Venture v. City of Detroit, the court emphasizes that a factual dispute must be substantial to oppose a motion for summary judgment. Here, both parties agree there are no material facts in dispute, making summary judgment appropriate as the issue is strictly legal. The Fifth Third defendants assert that their insurance policy names them as the loss payee, granting them rights to insurance proceeds for damage occurring post-foreclosure sale but pre-redemption period. They argue that the mortgage contract dictates that insurance proceeds post-sale belong to the lender, and that the United States, having a lien only on the taxpayer's right to redeem, lacks claim to the insurance proceeds. The United States counters that Fifth Third's loss payee status did not survive the foreclosure and that the mortgage and its rights were extinguished at sale. The U.S. claims its tax lien on the insurance proceeds takes precedence over other claims. Generally, federal law dictates the priority of tax liens, while state law defines the property interest involved; thus, Fifth Third's rights to the insurance proceeds depend on Michigan law. Michigan courts interpret insurance contracts based on their language, considering the policy as a whole and giving terms their ordinary meaning, avoiding overly technical interpretations.

Fifth Third Mortgage is identified as a loss payee on a hazard insurance policy for the premises. There are two types of loss payable clauses relevant to lienholders: the ordinary loss payable clause, which requires payment to the lienholder before the insured, and the standard mortgage clause, which protects the lienholder from insurer defenses against the insured. The ordinary clause does not create a contract between the lienholder and the insurer and is subject to breaches by the insured. In contrast, the standard mortgage clause offers greater protection, allowing the lienholder to collect insurance proceeds even if the mortgagor fails to meet policy conditions or causes damage.

The court disputes the United States' claim that the Lloyd's contract's loss payable provision is an ordinary clause, affirming that it acts as a standard mortgage clause under Michigan law. This classification is supported by the provision's language, which allows Fifth Third Mortgage to receive payment regardless of the mortgagor's inability to recover due to their actions or non-compliance with policy terms.

Consequently, Fifth Third's rights to insurance proceeds extend beyond the foreclosure sale. Michigan law recognizes that a standard mortgage clause establishes a separate contract between the insurer and mortgagee, shielding the latter from most defenses applicable to the mortgagor. Even after foreclosure, the mortgagee retains coverage rights under the policy's standard mortgage clause, though this coverage typically does not extend beyond the mortgagor's redemption period.

Michigan courts do not view it as an unfair burden for insurers to maintain coverage at homeowners' rates while a mortgagor retains the possibility of redeeming property. In this case, water damage occurred before the mortgagor's right of redemption expired, maintaining the rights of the mortgagee under the Loss Payable provision. The issue arose from Fifth Third Mortgage's transfer of rights to Fannie Mae via a quitclaim deed after foreclosure but prior to the loss. Fifth Third contended that the quitclaim deed was insignificant since Fannie Mae's rights only materialized once the sheriff's deed was finalized post-redemption period. However, the quitclaim deed effectively transferred any rights Fifth Third held at that time, as Michigan law dictates that a quitclaim deed conveys all interests in the property.

Furthermore, Michigan case law requires that if a mortgagor transfers property to a third party, a new insurance contract must be negotiated or the insurer must be notified of the ownership change, failing which the insurance policy becomes void. Consequently, when Fifth Third quitclaimed its interest to Fannie Mae, it lost any insurable interest, which is essential for claiming insurance proceeds. The Loss Payable provision stipulates that Lloyd's will compensate for losses to each Loss Payee according to their interests at the time of loss, which was void for Fifth Third as it had no interest at the time of the water damage.

Additionally, to determine Fifth Third's entitlement to insurance proceeds, the court must assess: (1) whether the mortgagors, Maria Kattula and U.S. Industrial Services, LLC, had an insurable interest at the time of the water damage, and (2) whether the mortgage contract transferred that interest to Fifth Third.

The government’s tax lien is assessed for its priority over Fifth Third’s interest in insurance proceeds. Under Michigan law, mortgagors retain an insurable interest in the property during foreclosure proceedings and the subsequent redemption period. This interest allows them to maintain coverage at homeowner rates until the redemption opportunity expires, which is six months post-foreclosure sale. It is acknowledged that damage occurred during this redemption period, affirming the mortgagors' insurable interest at that time.

Fifth Third argues that the mortgage explicitly assigns insurance proceeds to the mortgagee in the event of foreclosure. The United States contends that the mortgage was extinguished by the foreclosure sale, placing its tax liens above Fifth Third’s claim. Both parties reference *Emmons v. Lake States Insurance Company*, where the Michigan Court of Appeals ruled that an assignment clause for insurance proceeds created an equitable assignment that survived foreclosure, serving as collateral security for the mortgage debt. The ruling indicated that although the bank's interest in insurance proceeds vested at the time of the damage, it expired upon the bank’s satisfaction of the debt through the foreclosure sale.

However, in the current case, a portion of the debt remains post-foreclosure, contrary to *Emmons* where the debt was satisfied. The concern of double recovery identified in *Emmons* is not present here, as Fifth Third purchased the property for significantly less than the remaining debt, while the insurance proceeds total $65,811.82. The United States claims that the *Emmons* ruling on assignment survival is obiter dictum, but the Court maintains that this determination was essential to the prior decision and finds no contradictory authority presented by the United States.

Michigan courts would likely uphold that an assignment of insurance proceeds in a mortgage survives a foreclosure sale, allowing Fifth Third to claim the proceeds as collateral security for an unpaid debt related to undamaged property. This assignment right was also assignable to Fannie Mae. The United States attempts to differentiate this case from Emmons, arguing that the bank's interest must vest prior to foreclosure for the assignment to survive. However, the Emmons court implied that the assignment serves as collateral security for debts not satisfied during foreclosure, explicitly stating that the assignment survived the foreclosure.

The mortgagors had an insurable interest at the time of damage, which allowed Fifth Third to receive insurance proceeds per the mortgage contract, as the foreclosure did not fully satisfy the debt. Regarding tax lien priority, the United States's tax lien attached to all property of Maria Kattula and U.S. Industrial Services, LLC, but Fifth Third's recorded mortgage predates the lien, giving it priority. Federal tax liens do not inherently supersede all other liens, and priority follows the common law principle of "first in time, first in right."

The United States contends that the assignment of insurance proceeds was a contractual right that arose post-loss, occurring after the tax lien. However, this perspective overlooks that the assignment functioned as collateral for the original debt, suggesting it was established alongside the mortgage. Therefore, Fifth Third's interest in the insurance proceeds takes precedence over the United States's interest. This interpretation aligns with Michigan law, specifically Article 9 of the UCC, which affirms Fifth Third's right to insurance proceeds from the mortgaged property, as their security interest predates the tax lien.

The defendant, Tarver, initially had an insurance claim for property damage denied but later won a jury verdict against the insurance company. Before he could collect the insurance proceeds, the Warners filed to foreclose on a land contract and a secured note related to Tarver’s business property, asserting rights to the insurance proceeds. Other secured creditors also claimed a share. Tarver's attorney argued for a superior attorney's lien, but the court ruled that the Warners' security interests in the real property extended to the insurance proceeds, making their interest superior to the attorney’s lien due to its priority. The court emphasized that insurance is intended to compensate property owners for losses, noting that an insurable interest must exist at the time of loss to prevent moral hazard. Fannie Mae had a vested interest in maintaining the property's value, and had Fifth Third Mortgage not transferred its interest to Fannie Mae, it would have been entitled to the insurance proceeds. However, Fannie Mae and Fifth Third Mortgage are entitled to the insurance proceeds under the mortgage contract, while the United States’ tax lien does not extend to proceeds assigned to the mortgagee. The court granted the summary judgment motion for Fifth Third Mortgage and Federal National Mortgage Association, while denying the motion for the United States. They are entitled to the remaining funds held in the court’s registry from the insurance claim.