With a catastrophic event such as a gas explosion, lenders must hope that their borrower has buildings insurance which complies with their lending requirements. This would, usually, be a standard clause in the mortgage terms and conditions. A failure by the borrower to have such insurance, or to maintain it, will raise a whole set of issues for a lender.
In the event that a lender’s security is destroyed by such an event, the following scenarios must be considered:
- The borrower has invalid or no buildings insurance – If buildings insurance is obligatory in the mortgage terms and conditions, not having it would constitute a breach. This could lead to the loan being recalled.
- Lender security over the freehold or leasehold title – On leasehold properties, insurance is likely to have been taken out by the landlord and the terms governed by the lease. For freehold properties, the lender should consider enforcing its security and/or the borrower’s obligations under the mortgage.
- Possibility of loss mitigation – On leasehold properties, this will depend on the lease terms and negotiations with the landlord. On freehold properties, the lender may consider selling the land for redevelopment.
- Loan recall due to an event of default – If the mortgage conditions stipulate that the buildings insurance payout is held until property is rebuilt and rebuilding does not take place, despite continued mortgage payments, the lender may have an issue. A lender recovery could be difficult when no default under mortgage conditions has occurred. It is fundamental to address these issues when drafting the mortgage conditions.
- Borrower guarantor – Lenders should consider alternative recovery means, including recovery from a guarantor.
- Borrower or landlord successfully claim insurance without rebuilding the property. The insurance monies must be used to rebuild the property. If they are not the mortgage conditions should be scrutinised to find any conditions which will allow the monies to be reclaimed from the borrower. On freehold land, it may be possible to take action against the borrower to enforce the security and/or recover the insurance monies.
- Obligations of borrower/landlord to rebuild the property – For leasehold property, the lease should be scrutinised for an obligation on the landlord to rebuild the property. With freehold property, the mortgage conditions should be considered for any obligations to enforce against the borrower.
- Legal action against the borrower if the insurance monies have not been utilised for rebuilding – With freehold property, action may be taken to recall the loan if the mortgage conditions evidence an event of default. Leasehold properties are more complex but the terms of the Lease should be considered to see where the obligations lie.
Unfortunately, if a property is destroyed by a gas explosion, there may be a number of competing interests between the insurance company, freeholder, borrower and lender. Well drafted terms and conditions, while not fail safe, can go a long way to ensuring that a lender is able to recover its debt without spending significant time, and costs, in potentially having to litigate around the issues.
The cold season, when central heating is in constant use, is a good time for lenders to review their terms and conditions and also perhaps remind their borrowers of their obligations regarding buildings insurance.