With so many legal stipulations to bear in mind, deserted dwellings are anything but an open-and-shut case.
As foreclosure resolution time frames swell, servicers and investors must maintain property preservation standards for longer periods of time. Properties at the highest risk of loss or damage are vacant properties. Vacancy presents a host of problems to servicers and investors in managing their foreclosure inventory. Paramount among those concerns is vandalism.
Many servicers and investors are proactively addressing vandalism in vacant, abandoned properties by employing progressive methods of securing and monitoring them. However, in the event of an incident of vandalism (or incidents), a claim may be filed by the mortgagee if there is a policy of insurance in force. Even where a mortgagee has yet to take title, a borrowers' insurance policy still provides some protection against loss. These insurance proceeds are intended to protect the subject property as the security interest of the mortgagee. A lienholder must be aware, though, that an insurance policy secured by the borrower, and still in force while the property is vacant, may contain exclusions that can severely limit the coverage available to the mortgagee.
The vacancy exclusion present in most standard-line insurance policies, particularly as the exclusion pertains to fire—or, more specifically, arson—is an area of some confusion. Legal precedent differs in the interpretation of the terms "vandalism" and "arson" as they are applied under the vacancy exclusion. A servicer or investor should be aware of the limitations in coverage under a borrower's insurance policy for vacant properties that suffer losses from arson.
The standard mortgage document requires a borrower to carry an insurance policy that covers the dwelling, listing the mortgagee as lienholder, as a condition of the mortgage. In the event of delinquency, many mortgage documents, and most every insurance policy, provide the mortgagee the opportunity to maintain said coverage as lienholder. Many mortgage servicers elect to maintain the policy originally issued to the borrower as the named insured. However, as most mortgagees are aware, once the borrower no longer resides at the property, the risk underwritten by the standard line carrier changes considerably.
Most standard-line policies contain language limiting the types of losses covered after a property has been vacant for a stated period of time. Why? Quite simply, a vacant property has an increased risk of damage. Many policies set that period of vacancy at 30 days, although some will extend the vacancy clause to 60 or 90 days. After the property remains vacant for said period of time, certain perils will no longer be covered. The most common exclusion is vandalism.
Vandalism is a broad term, and in the context of an insurance contract, is rarely defined. This lack of definition can lead to confusion as to what occurrences may be covered as "vandalism" and what occurrences may be excluded. There is a split in legal precedent as to whether the definition of vandalism is ambiguous, what actions actually constitute "vandalism or malicious mischief," and whether those actions also include “arson." In reviewing the conflicting decisions, a servicer or investor can assess risk exposure and the important steps to take in order to limit that risk.
Generally, the interpretation of an insurance policy, like other contracts, is a question of law. Ambiguous terms in an insurance policy are commonly given their plain and ordinary meaning unless the parties have expressed a contrary intent. In most states, any ambiguity is construed against the insurer as the drafter of the policy and in favor of the insured. When addressing a vacant, vandalized property with damage from an occurrence of arson, the coverage afforded the mortgagee rests on the interpretation of the term "vandalism." Please note, insurance policies differ in contract language and definition, so application of legal precedent is contingent on the similarities and/or the differences in the language of the policy governing the loss.
In Estes v. St. Paul Fire and Marine Insurance Company, a Kansas federal court held that in an insurance policy that excluded vandalism from coverage, if the home was vacant for 30 days or more, "vandalism" included arson. The court pointed out in the decision that vandalism is commonly defined as "the willful or malicious destruction or defacement of things of beauty or of public or private property," citing Webster's Third New International Dictionary. The court also noted that arson is defined as "the willful malicious burning of or attempt to burn any building, structure, or property of another with criminal or fraudulent intent." The court reasoned that arson of a private dwelling was clearly within the plain and ordinary meaning of vandalism.
In Battishill v. Farmers Alliance Insurance Company, a claimant in New Mexico suffered a fire loss, which was determined to be intentional, to a rental home that had been vacant for more than 30 days. The insured filed a claim for loss, only to have the insurer deny, arguing the loss was excluded under the vacancy clause. The insurer maintained the fire was an act of vandalism and malicious mischief. The subject insurance policy did not define the term vandalism or malicious mischief, nor did it mention specifically the term "arson."
The New Mexico Supreme Court reasoned the common and ordinary meaning of an undefined term should be based upon contemporary usage, where possible, because the issue is how a reasonable insured would understand the term at the time of purchase. The court noted that "the ancient connotations of 'vandalism' have given way, in modern usage of the term, to a very broad meaning of the word that includes the destruction of property generally." The court then concluded that "it can be inferred that fire, vandalism, and malicious mischief are covered, unless they fit within an explicit exception. Therefore, even though arson is a form of fire, to which no exception applies, it is encompassed within the definitions of vandalism and malicious mischief, to which an exception does apply."
In contrast, other courts have held that the term "vandalism" is ambiguous, and when left undefined in the insurance policy, should be construed in a light most favorable to the claimant. In American States Insurance Company v. Rancho San Marcos Properties, LLC, the Washington Court of Appeals held that arson was not "vandalism" under the vandalism exclusion in a property insurance policy. The court held that, "This policy does not exclude arson. Not all arson is an act of vandalism. So when the vandalism exclusion is read strictly (as we must), arson is covered. Moreover, coverage here should not turn on esoteric, semantic, or nice distinctions. Vandalism describes the motive for an event, not the event." In its summation, the court stated succinctly, "Ultimately, the question (at least in Washington) is whether the average person purchasing insurance would believe that he or she assumed the risk of an arson fire under an all-risk policy where the policy excluded coverage for vandalism … The answer to that question is no."
Under similar circumstances, the Maryland Court of Appeals held, in Mutual Fire Insurance Company of Calvert County v. Ackerman, that the subject insurance policy was, "independently ambiguous because ‘fire’ and 'vandalism' are listed as separate perils insured against for property coverage … because of the separate listing of these perils, two different meanings could be inferred." Because of the ambiguity, the court remanded the case back to the trial court so that the parties could present evidence outside the terms of the contract (or extrinsic evidence) to support their "vandalism" interpretation.
To add to the contrast of opinion, and also to the confusion, many jurisdictions have no legal precedent regarding the terms vandalism and arson as they pertain to a contractual vacancy exclusion. Many state courts have yet too specifically, or tangentially, address the issue. So where does that leave the servicer or investor? What steps can be taken to address the issue?
As the case law suggests, insurance contracts vary greatly in terms and definitions. If confronted by a claim denial involving the vacancy exclusion and fire (arson), the first objective is to obtain a copy of the policy. Why? The mortgagee should determine if any ambiguity exists in the policy with regard to the terms vacancy, vandalism, fire, and arson. Most standard-line insurers cite or include policy language in correspondence explaining or denying benefits, but this will not give the servicer or investor all the relevant information. A claimant must first determine what terms, if any, are included in the policy and how those terms are defined, if at all. This information can only be obtained via a copy of the insurance policy.
Absent an analysis of the terms and definitions of the insurance policy, and the possible placement of these variables in the contract, what other options does a servicer or investor have? The documentation created as part of the ordinary business of property preservation may be helpful as well. Vandalism has become so routine in particular ZIP codes, or particular municipalities, that public services agencies may have no incident reports to document when it occurred. A servicer or investor should be diligent in reviewing any available documentation it possesses to determine if the date and time of the vandalism incident indeed matches the date and time of the fire loss. Inspection reports, preservation documentation, and in some cases documentation from the applicable fire department will provide a chronology that can refute an assumption that the fire occurrence was contemporaneous to the vandalism occurrence. If the vandalism pre-dated the fire (or was documented after a fire loss), then an exception is not triggered with regard to fire. Although the vandalism claim may be denied, the fire claim would not.
In addition, servicers and investors can lower the risk exposure for denials based on vacancy exclusions through coverage endorsements on existing lender-placed policies. The blanket policies that cover real estate owned properties (REO) and/or properties in the default cycle likely have coverage options that bridge the gap created through the vacancy exclusion under the borrowers' standard-line policy. These endorsements provide certainty and peace of mind, but usually at a hefty cost. Servicers and investors must weigh the risks associated with vacant properties against the cost of insuring against so many unknown variables.
Servicers and investors are best served in assessing risk when aware of all the variables that could impact its interests in a property. In assessing risk on vacant properties, the exclusions contained in insurance policies should be understood in construction and application. When these coverage limitations are understood, servicers and investors can begin making decisions to best preserve the common interest of both the borrower and the organization: the subject property.
This select print feature, originally appeared in the November 2014 issue of DS News magazine.