Insights

In September, the U.S. Court of Appeals for the First Circuit twice reversed dismissals of trial court cases in favor of lenders who each required a borrower to increase his or her flood insurance coverage from the amount of the outstanding principal balance of the loan to the amount of the replacement cost of the property.

In the first case, the First Circuit held that the mortgage document itself was ambiguous as to the amount of flood insurance the borrower was required to maintain. In the second case, however, the First Circuit held that that mortgage unambiguously allowed the lender to require insurance up to the replacement cost of the property, but a supplemental document provided at the closing, titled “Flood Insurance Notification” provided otherwise. Thus, taken together, the mortgage and the notification were ambiguous. In both cases, each lender will have to defend its documentation and force-placed flood insurance practices in further court proceedings.

First, in Kolbe v. BAC Home Loans Servicing, LP, 2012 U.S. App. LEXIS 19935 (1st Cir. (D. Mass.) September 21, 2012), Bank of America, through its subsidiary, Balboa Insurance Company, sent Stanley Kolbe notices stating that he was required to increase his flood insurance to an amount equal to the replacement cost of the property, rather than in an amount equal to his outstanding loan balance. In response, Kolbe sued Bank of America for breach of contract and breach of the implied covenant of good faith and fair dealing. Kolbe’s mortgage tracked the FHA’s Model Mortgage Form, which included a provision requiring the borrower to obtain fire, flood, and other hazard insurance. Under federal law, Kolbe was required to obtain flood insurance in an amount at least equal to the outstanding principal balance of the loan, or $250,000, whichever was less, because his property was located in an area designated as a special flood hazard zone. Bank of America moved to dismiss, arguing that the mortgage provision provided the lender discretion to require insurance equal to the replacement cost of the property. The trial court agreed, and dismissed the case for failure to state a claim. Kolbe appealed.

The U.S. Court of Appeals for the First Circuit reversed. The appellate court held that the provision of the mortgage requiring the borrower to obtain fire, flood, and other hazard insurance was ambiguous as to whether it provided the lender discretion to require insurance equal to the replacement cost of the property. Accordingly, the appellate court resorted to evidence outside of the mortgage to interpret the contractual provision. After a review of HUD’s handbook for administration of insured home mortgages, the appellate court concluded that Kolbe’s contention that the mortgage provision merely required the borrower to obtain flood insurance equal to the outstanding loan balance was reasonable. The appellate court stated that Bank of America’s interpretation that the provision required the borrower to insure the property up to its replacement cost was also arguably reasonable, and that Bank of America would have the opportunity to develop support for its argument upon remand to the trial court.

The appellate court also reversed the trial court’s dismissal of Kolbe’s claim that Bank of America had breached the covenant of good faith and fair dealing. Kolbe alleged that Bank of America warned him that the Bank’s force-placed insurance may be more expensive and likely to provide less coverage than insurance Kolbe could obtain on his own. The appellate court found that a finding of bad faith was supportable because Bank of America’s motivation for demanding additional flood insurance coverage may have been to increase corporate profits by funneling new coverage to its own affiliates. Such allegations of self dealing, according to the appellate court, were sufficient to state a claim for relief.

Second, in Lass v. Bank of America, N.A., 2012 U.S. App. LEXIS 19937 (1st Cir. (D. Mass.) September 21, 2012), as in Kolbe, the borrower, Sharon Lass, alleged that Bank of America wrongfully required her to increase the amount of flood insurance on her home and wrongfully force-placed flood insurance. Bank of America filed a motion to dismiss, arguing that the mortgage unambiguously allowed the lender to increase the amount of flood insurance and to buy that insurance on the borrower’s behalf if the borrower failed to do so. The trial court agreed and dismissed Lass’s claims.

Unlike in Kolbe, the First Circuit held that the mortgage document included a provision that unambiguously required the lender to require insurance up to the level of the replacement cost of the property. However, at closing, the borrower was also provided with a document titled “Flood Insurance Notification” which stated that the borrower was required to provide flood insurance equal to the amount financed, or the maximum amount available, whichever was less. Thus, the appellate court determined that, taken together, the mortgage and the notification were ambiguous as to the lender’s authority to demand increased flood insurance coverage on the borrower’s property. Finally, following the same line of reasoning described in Kolbe, above, the appellate court also reversed the trial court’s dismissal of Lass’s claim that Bank of America breached the covenant of good faith and fair dealing.

Accordingly, mortgage lenders should take care to ensure that its practices with regard to the force-placed flood insurance comply with the borrower’s underlying mortgage and any other supplemental documents provided to the borrower at closing.

Katherine C. Fisher is an associate in the Maryland office of Hudson Cook, LLP. Kate can be reached at 410-782-2356 or by email at kfisher@hudco.com.

Frank H. Bishop Jr. is an associate in the Maine office of Hudson Cook, LLP. Frank can be reached at 207-541-9554 or at fbishop@hudco.com.