Member Article

Lenders who take legal charges over real property usually require their interest to be 'noted' on the insurance policy covering the property.

However, this may not give them the protection they require, especially in the current economic climate.

It is quite appropriate that lenders want to be certain that insurance arrangements covering a property used as security are satisfactory. If insurance is inadequate to cover the rebuilding of the property after damage, the value of the lender's security may be affected.

For this reason, a lender's loan agreement typically makes drawdown of a loan conditional upon the lender being satisfied with the insurance arrangements. Also, the legal charge is likely to contain covenants requiring the borrower to keep a suitable insurance policy 'on risk' with confirmation that all premiums have been paid and are up to date.

Notwithstanding these requirements, a lender is also likely to require some form of relationship with the insurer so that it can be kept informed if the policy lapses or if a claim is made. It can then use that information to exert pressure on the borrower under the loan and security documentation.

Depending on the exact terms of the policy, having the lender's name ‘noted' can, in some cases, impose obligations on the insurer to notify the lender if there is a claim or if the policy lapses.

However, it will not usually give the lender an independent right to make a claim on the policy if the borrower fails to do so. This is because noting is not generally regarded as giving the lender a contractual relationship with the insurer. Nor will noting give the lender a right of redress against the insurer, if it fails to give these notifications to the lender. Instead, the lender would need to pursue any claim against the borrower.

Rather than have its name noted, a lender may be afforded a better level of protection if a ‘composite' insurance policy is put in place.

This is a single insurance policy, taken out for both the lender and the borrower, and giving the lender a direct contractual relationship with the insurer. It would enable the lender to make its own claim on the policy (and receive the insurance proceeds direct).

A composite policy is, in some respects, similar to a joint insurance policy. However, unlike a joint policy, a composite policy recognises that the lender and borrower have separate interests in the property.

A breach of a composite policy by the borrower (for instance by failing to disclose a material fact), would not affect the rights of the lender against the insurer. This would not be the case if the lender and the borrower took out a joint policy.

Whilst putting a composite policy in place is likely to be more time consuming and costly than simply getting an interest ‘noted', it is something that a prudent lender should consider.

The additional costs involved (i.e. higher premiums) could be passed on to the borrower, and the additional time and effort may be a price worth paying given the better protection it affords the lender.

This is of particular importance in the current climate, when insurers are increasingly using minor breaches of insurance policies to avoid paying out on claims.