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March 31, 2008

Effect of Insured's Bankruptcy on Mortgagee Claim for Fire Insurance Proceeds

Generally, a mortgagee under a fire insurance policy is required to obtain a deficiency judgment in a foreclosure action within ninety days after the delivery of the referee's deed pursuant Real Property Actions and Proceedings Law § 1371(3), in order to maintain its insurable interest to recover insurance proceeds following a fire. Failure to obtain a deficiency judgment results in an extinguishment of the mortgagee's insurable interest, and the mortgage debt is presumed to have been satisfied in full under the rule established by the New York Court of Appeals in Whitestone Savings & Loan Association v Allstate Insurance Company, 28 N.Y.2d 332 (1971) and Moke Realty Corp. v Whitestone Savings & Loan Association, 82 Misc. 2d 396; aff'd, 51 A.D.2d 1005, aff'd 41 N.Y.2d 954 (1977).

Recently, the Appellate Division, Second Department, held that where a Federal Bankruptcy Court order enjoined the mortgagee from bringing any action to recover against the mortgagor personally, the mortgagee was not required to obtain a deficiency judgment in a mortgage foreclosure action in order to proceed directly against the fire insurer to recover the balance due on its mortgage following a fire loss to the mortgaged real property. Washington Mutual Bank v Allstate Insurance Company, 2008 N.Y. App. Div. LEXIS 1321, February 13, 2008.

In Washington Mutual, an order in the insured's bankruptcy proceeding modified the bankruptcy automatic stay to permit Washington Mutual's predecessor to foreclose on the subject real property. While the order permitted the mortgagee to seek leave to enter a deficiency judgment against the mortgagor, even while the bankruptcy proceedings were pending, the Bankruptcy Court instructed the mortgagee not to file any proof of claim in the bankruptcy because there were no assets to pay creditors. Thus, the filing of such a proof of claim in a "no assets" bankruptcy would have been "meaningless and worthless" according to the Court.

Significantly, the foreclosure sale did not occur until more than five years after the date of the final judgment in the bankruptcy proceeding. The Appellate Division noted that an application for a deficiency judgment by the mortgagee "not only would have violated the decree of the Bankruptcy Court, but also, it would have resulted in a judgment that would have been void as it would have been based on an indebtedness from which the mortgagor had already been discharged. Such an application would have violated the general rule that the '[discharged] [mortgagor] cannot be the subject of a deficiency judgment motion'. *** Under these circumstances, we agree with the Supreme Court that the plaintiff's failure to make a timely motion for leave to enter a deficiency judgment, should not relieve the defendant of its contractual obligation that it otherwise would have to pay, the fire loss claim pursuant to the mortgage loss payable clause of the policy."

This case is an exception to the general rule that the failure of the mortgagee in foreclosure to obtain a deficiency judgment will extinguish the mortgagee's insurable interest, and preclude recovery by the mortgagee under a fire insurance policy insuring the mortgagee under a mortgagee loss payable clause.


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