If a Small Business Administration ("SBA") loan is secured with a lien on equipment, fixtures or inventory, the SBA requires that the borrower's business personal property insurance policy contain a lender's loss payable clause in favor of the secured lender.  Although most lenders are aware of this requirement, it is important to recognize the difference between a "lender's loss payee" endorsement and a "loss payee" endorsement.  In addition to the fact that a lender's loss payee endorsement is an SBA requirement, there are also practical benefits and protections associated  with being named a lender's loss payee and real consequences associated with being named merely as a loss payee on an insurance policy.

If a lender is designated as a  loss payee on a borrower's insurance policy, the lender is entitled to receive insurance proceeds if a covered loss occurs, but only if the insured borrower is entitled to payment under the policy.  Although this may sound like sufficient coverage, if the insured borrower fails to make premium payments, intentionally destroys insured property, fails to file a claim in a timely manner, commits fraud under the policy or commits any other act which is deemed a breach of the policy thereby causing the policy to be void, a loss payee will not have a right to receive insurance proceeds.  A loss payee's rights are only as good as the insured's rights.  Therefore, a loss payee can not enforce the terms of a policy once the policy has been voided.

This point was recently illustrated in Westfield Ins. Co. v. Talmer Bancorp, 545 Fed. Appx. 402 (6th Cir.2013).  In that case, a lender was named a loss payee on its borrower's personal property insurance policy.  When the borrower's inventory was allegedly stolen, the borrower did not disclose the lender's security interest in the inventory to the insurance company.  In fact, the borrower affirmatively indicated to the insurance company that no lender held a security interest in the stolen inventory.  Borrower's fraudulent misrepresentation caused the insurance policy to be voided.  Because a loss payee's rights are derived from the insured's coverage (which coverage was no longer in place), the Court held that the lender was not entitled to receive insurance proceeds for the stolen inventory.

The case above may have had a different outcome if the lender had been designated as a lender's loss payee.  Most lender's loss payable endorsements allow a lender's loss payee to collect insurance proceeds even when the insured borrower has not complied with the terms of the policy and the policy has otherwise become void.  A lender's loss payee also typically receives 10 days' prior notice of cancellation of the policy for nonpayment, 30 days' prior notice of cancellation of the policy for other reasons and 10 days' prior notice of non-renewal of the policy.  A mere loss payee is not given these protections.  Another benefit of being named a lender's loss payee is that a lender retains its right to receive insurance proceeds even when the lender has commenced foreclosure proceedings against the borrower.

If a loan is secured with a lien on equipment, fixtures or inventory, it is important for the lender to obtain a copy of the borrower's insurance policy and a proper lender's loss payable endorsement and to review both to ensure the lender has sufficient rights under the policy.  

For questions regarding insurance coverage for SBA and conventional commercial loans, contact Katie at 267-470-1207 or kobrien@starfieldsmith.com.