An insured building is damaged by fire or other casualty. The owner files an insurance claim and hires a contractor to make repairs, promising to use the insurance proceeds for that purpose. The contractor does the work before the insurance proceeds are received. When the insurance check arrives, it is payable to both the owner and the owner’s mortgage lender – who refuses to allow it to be disbursed to pay the contractor despite the pleas of the owner. When the owner can’t pay him, the contractor puts a mechanic’s lien on the property – and sues both the owner for breach of contract and the mortgage company for “unjust enrichment,” “constructive trust” and a host of other legal theories they teach in law school. Who wins?
Because a property and casualty insurance policy is personal to the policyholder and does not run with the insured property, a mortgage holder is not entitled to insurance proceeds simply because of its mortgage on the insured property. The mortgagee does, however, have an "insurable interest" in the property (i.e., something of value to protect, without which the law regards an insurance policy as an illegal gambling contract), and it is common for mortgages to require mortgagors to obtain casualty insurance on the property payable to the mortgagee as “loss payee.”
This same principle of personal contract rights as opposed to rights running with the land means that lien priorities with respect to the property do not determine the priority of competing claims to insurance proceeds. See, e.g., Midland Lumber & Supply, Inc. v. J.P. Builders, 265 N.J.Super. 246, 626 A.2d 89, 91 (1993) (“Because of the personal nature of a contract of insurance, if an insurance policy is made expressly payable to a second mortgagee, the second mortgagee is entitled to the policy proceeds in preference to the holder of a first mortgage who is not listed as a loss payee under the policy.”). Thus, resolving whether the mechanic’s lien or the mortgage has first dibs against the property won't determine who has first dibs on the insurance proceeds.
Even though the insurance check is made payable to the mortgagee, the nature of insurance can tip the scales here. Property insurance contracts are contracts of indemnity, and to the extent they result in a monetary benefit beyond reimbursement for the peril insured against – which is what happens once repairs have been made but aren’t paid for – they are pure windfalls. A Maryland case, Cottman Co. v. Continental Trust Co., 169 Md. 595, 601-02, 182 A. 551 (1936), explains:
“It cannot be denied that if the restoration of the security, at the expense of the debtor, to the value it had before the loss or damage, leaves the parties in statu quo, then the retention of the insurance money by the creditor, mortgagee, or trustee, as additional security, would put the holder in a better position than he had originally bargained for. The theory of insurance, however, does not contemplate a resulting profit to the insured, or his mortgagee or other creditor. The interest of the mortgagee is to maintain the equilibrium of debt and security; and if, by the application of the insurance money to the upkeep of the security, that parity would be continued, it is not inequitable to require the payee of the fund to transfer the same to the debtor for that purpose, upon properly safeguarding its application to that end.”
If our courts take this approach, the mortgagee in our hypothetical has indeed been unjustly enriched contrary to the purposes of insurance, and should be required to hold the proceeds for the benefit of the contractor rather than apply them to the mortgage indebtedness. There is every reason to think that our courts would require exactly that. “An equitable lien may be imposed to prevent unjust enrichment in an owner whose property was improved, for the increased value of the property.” Iacomini v. Liberty Mutual Ins. Co., 127 N.H. 73, 78 (1985). It is no stretch at all to deem the mortgagee to be the “owner” for such purposes.
Who wins? Bet on the contractor.
Because a property and casualty insurance policy is personal to the policyholder and does not run with the insured property, a mortgage holder is not entitled to insurance proceeds simply because of its mortgage on the insured property. The mortgagee does, however, have an "insurable interest" in the property (i.e., something of value to protect, without which the law regards an insurance policy as an illegal gambling contract), and it is common for mortgages to require mortgagors to obtain casualty insurance on the property payable to the mortgagee as “loss payee.”
This same principle of personal contract rights as opposed to rights running with the land means that lien priorities with respect to the property do not determine the priority of competing claims to insurance proceeds. See, e.g., Midland Lumber & Supply, Inc. v. J.P. Builders, 265 N.J.Super. 246, 626 A.2d 89, 91 (1993) (“Because of the personal nature of a contract of insurance, if an insurance policy is made expressly payable to a second mortgagee, the second mortgagee is entitled to the policy proceeds in preference to the holder of a first mortgage who is not listed as a loss payee under the policy.”). Thus, resolving whether the mechanic’s lien or the mortgage has first dibs against the property won't determine who has first dibs on the insurance proceeds.
Even though the insurance check is made payable to the mortgagee, the nature of insurance can tip the scales here. Property insurance contracts are contracts of indemnity, and to the extent they result in a monetary benefit beyond reimbursement for the peril insured against – which is what happens once repairs have been made but aren’t paid for – they are pure windfalls. A Maryland case, Cottman Co. v. Continental Trust Co., 169 Md. 595, 601-02, 182 A. 551 (1936), explains:
“It cannot be denied that if the restoration of the security, at the expense of the debtor, to the value it had before the loss or damage, leaves the parties in statu quo, then the retention of the insurance money by the creditor, mortgagee, or trustee, as additional security, would put the holder in a better position than he had originally bargained for. The theory of insurance, however, does not contemplate a resulting profit to the insured, or his mortgagee or other creditor. The interest of the mortgagee is to maintain the equilibrium of debt and security; and if, by the application of the insurance money to the upkeep of the security, that parity would be continued, it is not inequitable to require the payee of the fund to transfer the same to the debtor for that purpose, upon properly safeguarding its application to that end.”
If our courts take this approach, the mortgagee in our hypothetical has indeed been unjustly enriched contrary to the purposes of insurance, and should be required to hold the proceeds for the benefit of the contractor rather than apply them to the mortgage indebtedness. There is every reason to think that our courts would require exactly that. “An equitable lien may be imposed to prevent unjust enrichment in an owner whose property was improved, for the increased value of the property.” Iacomini v. Liberty Mutual Ins. Co., 127 N.H. 73, 78 (1985). It is no stretch at all to deem the mortgagee to be the “owner” for such purposes.
Who wins? Bet on the contractor.
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