Subrogation Rights Under A Standard Mortgage Clause In Canada

A. What is A Standard Mortgage Clause?

First-party property insurance policies usually contain one of two types of mortgagee clauses: i) a loss-payable clause; or ii) a standard mortgage clause.

i)          The Loss-Payable Clause: This type of clause merely provides that insurance proceeds shall be paid to a mortgagee as "its interests may appear." Under a loss-payable clause, a mortgagee’s right to recovery is dependent upon the insured mortgagor’s compliance with policy obligations. That is to say, a mortgagee has no better position than the insured (mortgagor) to recover under the policy and is therefore subject to any act, neglect, omission or misrepresentation of the insured which might void or breach coverage under the policy. 

 ii)       The Standard Mortgage Clause: The Standard Mortgage Clause is the standard vehicle by which mortgagees insure their interest in encumbered property. The standard mortgage clause was incorporated into policies because the “loss payable” clause did not adequately protect the mortgagee’s interest in the insured property. Under the standard mortgage clause, a mortgagee is entitled to direct payment for a loss to the extent of its interest at the time of the loss, independent of whether the named insured mortgagor has complied with its policy obligations. Once the mortgagee has been paid for a loss to the extent of its full interest in the property, the insured mortgagor is entitled to payment for the remainder of the amount of loss, if any.

B. A Standard Mortgage Clause is an Independent Contract

A policy that contains a Standard Mortgage Clause contains, in essence, two contracts:

(1) a contract between the insurer and the insured mortgagor (such as a homeowner), and

(2) a contract between the insurer and the mortgagee (for example, a bank).

The separate contract between the insurer and the mortgagee remains in force even when the policy itself has been voided by an act, neglect, omission or misrepresentation attributable to the mortgagor, owner or occupant of the property. Thus, when the insured mortgagor voids the policy, for example, by doing something that materially changes the policy risk, the Standard Mortgage Clause protects the mortgagee by maintaining the insurance of the mortgagee’s interest in force. The insurer must pay the mortgagee’s loss to the extent of the policy limits even when the mortgagor has voided the policy.

C. Example of a Standard Mortgage Clause

The Standard Mortgage Clause, as approved by the Insurance Bureau of Canada, has two parts:

IT IS HEREBY PROVIDED AND AGREED THAT:

1. BREACH OF CONDITIONS BY MORTGAGOR, OWNER OR OCCUPANT

This insurance and every documented renewal thereof – AS TO THE INTEREST OF THE MORTGAGEE ONLY THEREIN – is and shall be in force notwithstanding any act, neglect, omission or misrepresentation attributable to the mortgagor, owner or occupant of the property insured, including transfer of interest, any vacancy or non-occupancy, or the occupation of the property for purposes more hazardous than specified in the description of the risk;

PROVIDED ALWAYS that the mortgagee shall notify forthwith the Insurer (if known) of any vacancy or non-occupancy extending beyond thirty (30) consecutive days, or of any transfer of interest or increased hazard (not permitted by the policy) shall be paid for by the Mortgagee – on reasonable demand – from the date such hazard existed, according to the established scale of rates for the acceptance of such increased hazard, during the continuance of this insurance.

2. RIGHT OF SUBROGATION

Whenever the Insurer pays the Mortgagee any loss award under this policy and claims that – as to the Mortgagor or Owner – no liability therefore existed, it shall be legally subrogated to all rights of the Mortgagee against the Insured; but any subrogation shall be limited to the amount of such loss payment and shall be subordinate and subject to the basic right of the Mortgagee to recover the full amount of its mortgage equity and in priority to the Insurer; or the Insurer may at its option pay the Mortgagee all amounts due or to become due under the mortgage or on the security thereof, and shall thereupon receive a full assignment and transfer of the mortgage together with all securities held as collateral to the mortgage debt.

SUBJECT TO THE TERMS OF THIS MORTGAGE CLAUSE (and these shall supersede any policy provision in conflict therewith BUT ONLY AS TO THE INTEREST OF THE MORTGAGEE), loss under this policy is made payable to the Mortgagee.

As you can see above, the first part of the Clause contains the language that provides that the policy remains in force as to the interest of the mortgagee despite any act, omission or misrepresentation of the mortgagor or any change in use that increases the risk.

The second part of the Clause provides that when its requirements are met, the insurer becomes legally subrogated to all the rights of the mortgagee against the insured to the extent of the payment it has made to the mortgagee.

D.  Can an insurer exercise its right of subrogation against an insured mortgagor under a standard mortgage clause without establishing that a policy is void?  

On a literal reading, the subrogation portion of the standard mortgage clause appears to suggest that an insurance company can simply allege that coverage has been vitiated by the insured mortgagor in order to exercise these subrogation rights. Thus, the question arises; can an insurer exercise its right of subrogation against an insured mortgagor under a standard mortgage clause without having to prove that the policy coverage has been vitiated?

Surprisingly, this question had received little judicial consideration in Canada until the recent Ontario Court of Appeal decision of Farmers’ Mutual Insurance Company (Lindsay) v. Pinder, 2009 ONCA 831 (CanLII).

A fire occurred at the home of Joyce and Cindy Pinder. Their insurance company denied coverage, alleging that there had been a material change in risk with respect to the installation of a new heating system, and that the Pinders had made willfully false statements regarding their contents claim. The Pinders sued their insurance company seeking a declaration that they were entitled to coverage.

The house was subject to a mortgage with the Bank of Montreal for which the insurance company paid $97,143.97 under a Standard Mortgage Clause.  Upon making the payment, the insurance company then commenced a subrogated action against the Pinders seeking summary judgment for the $97,143 that it paid the bank on the mortgage. The Pinders argued that since the issue of whether their policy was void had yet to be resolved, the Bank had not yet acquired the right of subrogation under the Standard Mortgage Clause.

The Court of Appeal clarified that:

1. First, the insurer must actually make a payment to the mortgagee for its loss. This condition was satisfied when the insurance company paid the bank $97,143.97.

2.  Second, the insurer must establish a claim that it has no liability to the insured mortgagor. In other words, before the insurance company could exercise the right of subrogation under the standard mortgage clause, it had to prove that the Pinders had vitiated coverage under the policy.  This was an issue that would require a trial and so could not be addressed on the insurance company’s summary judgment motion.

Accordingly, the Court held that the issue of whether the insurance company had a right of subrogation under the Standard Mortgage Clause would have to wait until a resolution of the Pinder’s coverage action. The Court ordered that the two actions be tried together.

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