Standards for Lender’s Application of Insurance Proceeds: Wilmington Savings v. Daw

By: Lucas Anderson, Esquire

In Wilmington Savings Fund Society v. Patricia E. Daw and Richard C. Daw, et al., (New Jersey Superior Court, Appellate Division, Docket No. A-0829-19), the court considered the question of what standards govern a lender’s determination of how to apply insurance proceeds following damage to the mortgaged property.  The case concerned the application of insurance proceeds stemming from damage caused by Superstorm Sandy.

In the Daw case, the lender held the insurance proceeds for more than three years before ultimately applying them to the mortgage debt.  The borrowers argued for a reduction in the final judgment based on the lender’s delay.  The Court held that, although the decision of how to apply insurance proceeds is the lender’s, the implied covenant of good faith and fair dealing constrains the lender’s discretion.  The implied covenant of good faith and fair dealing is a doctrine which holds that no party to a contract may act in a manner designed to prevent the other party from realizing the benefits of the contract, nor may they exercise their contractual functions arbitrarily, unreasonably, capriciously, or with an improper motive.  It is well settled that the implied covenant of good faith and fair dealing applies to all contracts governed by New Jersey law.

The Daw Court noted that most loan documents give the lender the authority to determine how to apply insurance proceeds.  Most such provisions require insurance proceeds to be applied to repairing the mortgaged property, unless repairs would be economically infeasible or would impair the lender’s security.  However, although the lender has the right to determine how to apply insurance proceeds, the Daw Court held that the lender must exercise this right consistent with the implied covenant of good faith and fair dealing.  In any given case, the question of whether insurance proceeds were applied appropriately is a fact-specific determination to be made by the trial court.  However, the Appellate Division has announced the following standards which lenders should bear in mind when handling insurance proceeds:

  • Insurance proceeds must be held in a separate, interest-bearing account until the lender determines how to apply them.
  • The lender’s decision as to whether repairs are feasible must be objective and made in good faith. The decision involves an analysis of the projected cost of repair, the projected increase in value which would result from the repair, the estimated length of time required, and the existence and extent of any default by the borrowers.  The lender is entitled to require the borrower to provide certain information (e.g. estimates of repair cost and market value) and is not required to defer to the borrower’s preference.  However, once the lender has received the necessary information, the decision must be made promptly.  If a court finds that a lender has unreasonably delayed the decision of how to apply insurance proceeds, the court has the power to abate the interest which accrued as a result of the delay.  Finally, the lender’s determination must be objectively based on the question of whether repairs are economically feasible.  The lender is not entitled to apply the insurance proceeds to the mortgage debt unless it has made a fact-based determination that repairs are infeasible or would impair the value of the security.
  • The lender must communicate clearly and consistently with the borrower. Regardless of whether the underlying decision of how to apply the insurance proceeds was justified, the Daw court was troubled that the lender in that case sent multiple inconsistent notices to the borrower.  Some of the notices urged the borrower to complete repairs, while others stated that repairs were not economically feasible and that the lender intended to apply the insurance proceeds to the mortgage debt.  Accordingly, while determining how to apply insurance proceeds, lenders should take care to ensure that all communications with the borrower are clear and consistent.  Communications related to the application of insurance proceeds should not make factual claims unless those claims have been verified to be true.  Finally, any notice to be sent should be reviewed to ensure that it does not contradict previous notices or undermine the position the lender intends to assert.

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