IBA: Insurance Practices in Commercial Real Estate Loans

By David Duncan, Bose McKinney & Evans

Requesting appropriate insurance coverages and obtaining certificates of insurance verifying such coverages are in place may be one of the least understood, and thereby, among the most overlooked issues in commercial real estate loan transactions.

In a loan involving commercial real estate, the lender should require the borrower to maintain standard all risk hazard insurance insuring the property against losses from fire, lighting, explosion, windstorm or hail, smoke, impact of vehicles and aircraft, and malicious mischief. If loan proceeds will fund construction activities, the lender should also require the borrower to maintain builder’s risk insurance which affords coverage for similar losses while the insured property is under construction. If the project includes leased real estate, the lender should require the borrower to maintain a loss of rental value endorsement to the property insurance. Otherwise, the lender should require the borrower to maintain a business interruption endorsement. Finally, the lender should also require the borrower to maintain commercial general liability insurance to insure against claims for bodily injury, death, or property damage.

The lender, and its successors and assigns, should be added as a mortgagee and loss payee on the borrower’s commercial property insurance policy. Likewise, the lender should be added as an additional insured on the borrower’s commercial general liability insurance policy. The lender should require that the policy of commercial property insurance contain a standard mortgagee clause which defines the lender as an insured mortgage holder, provides that the lender’s right to the proceeds of insurance will not be invalidated by any act or neglect of the property owner/mortgagor and requires the insurer to provide notice of cancellation to the lender. If the lender is named as a mortgagee under a standard mortgagee clause they are afforded independent contract rights with the insurer, whereas, being named only as a loss payee or additional insured affords no independent contract rights and subjects the lender to the same defenses the insurer would have against the property owner.

Assuming the insurance policies are not available for review prior to closing, obtaining the proper form of certificate of insurance should be given adequate consideration. The insurance industry subscribes to the form certificates of insurance published by ACORD. ACORD 24 and 28 are standard forms to evidence property insurance. ACORD 25 is the standard certificate of insurance for commercial general liability insurance.

ACORD 75 binds coverage for the policies referenced.

Each of ACORD 24, 25 and 28 typically contain language unfavorable to lenders and:

are issued as a matter of information only and confers no rights upon the certificate holder;

do not constitute a contract between the issuing insurer, producer and certificate holder;

are subject to all the terms, exclusions and conditions of the insurance policy;

policy limits may have been reduced by claims; and

notice of cancellation will be delivered in accordance with the policy provisions.

ACORD 75 is issued subject to the terms, conditions and limitations of the policies in current use by the underwriting company, but is an insurance binder for the limited period of time stated therein. Accordingly, ACORD 75 is the only form lenders should rely upon for evidence of binding coverage.

In the past, attorneys have accepted ACORD certificates of insurance marked-up by the issuing agent with handwritten edits. In April 2009, the Indiana Department of Insurance (IDOI) issued Bulletin 170 addressing this practice. In Bulletin 170, the IDOI stated that “certificates generally serve only as an informational summary of insurance in lieu of an actual copy of an insurance policy and should not be used to amend, extend, or alter policy terms . . . .” and made reference to the language contained in the ACORD forms as acceptable to meet the requirements of the IDOI “so long as the forms are not altered to inappropriately modify terms of the policy.”

It is the best practice to obtain a copy of the policy or a policy binder prior to closing on a commercial real estate loan transaction as certificates/evidences of insurance may not bind coverage. Likewise, inaccuracies in the certificates/evidences of insurance and/or reliance upon modifications by the issuing agent may not bind the underwriting insurance company, and may leave the lender with merely a claim against the issuing agent’s errors and omissions insurance. Depending on the limits of such errors and omissions coverage, this could expose the lender to unintended financial risks.•