A recent decision of the Court of Appeals of New York highlights the need of a secured party to protect its security interest in insurance proceeds by having itself named loss payee or additional insured in the insurance contract of its debtor.
B&F Supermarket, Inc. (the "Debtor"), the lessee and operator of a supermarket, granted a security interest to its landlord, plaintiffs Elpidio and Irma Badillo (the "Secured Party"), in all insurance proceeds in respect of the leased premises for the purpose of securing its obligations as lessee. The Secured Party filed UCC-1 financing statements describing its security interest in the insurance proceeds. Less than a year later, a fire destroyed the supermarket. At the time of the loss, the Debtor carried casualty insurance on the premises under a policy issued by Tower Insurance Company of New York (the "Insurance Company"). The policy, however, did not name the Secured Party as loss payee or otherwise mention its interests. The Debtor submitted proof of loss to the Insurance Company and was subsequently paid the loss proceeds under the policy, amounting to approximately $70,000. Four months later, the Secured Party notified the Insurance Company of its security interest in the insurance proceeds and learned that the Insurance Company had already paid the claim. The Secured Party, who never received any of the proceeds from the Debtor, sued the Insurance Company for the $70,000, alleging that the UCC-1 financing statements gave the Insurance Company constructive notice of the Secured Party's interest in the loss proceeds and that therefore, the Insurance Company had converted the funds. Although the trial court denied summary judgment in favor of the Secured Party, the intermediate appellate court reversed and found in favor of the Secured Party.
In a unanimous opinion, however, the New York Court of Appeals rejected the Secured Party's argument and reversed the intermediate appellate court's decision to the contrary, holding that the constructive notice provided by the UCC-1 financing statements, without more, did not obligate the Insurance Company to pay the loss proceeds to the Secured Party, as holders of a security interest in the proceeds. In so doing, the court recognized that the UCC's system of notice filing simply does not apply "to carriers in the context of good faith payment of loss proceeds under insurance contracts." Rather, as the court analogized, an insurance carrier who pays insurance proceeds to the appropriate person under the policy is much like the account debtor who is protected under the UCC when it makes payment to the account creditor without actual notice that the account creditor has assigned its interest in the account and that payment is to be made to the assignee. To hold otherwise, the court noted, would require insurance carriers to perform UCC searches prior to making loss payments, thereby complicating and delaying the payment of claims.
Consequently, to protect a security interest in insurance proceeds, it is not enough for a secured party to file UCC-1 financing statements in the appropriate filing offices. Rather, a secured party must have itself named in the insurance contract as loss payee or additional insured to ensure that the proceeds are actually paid to the secured party. Otherwise, as this case illustrates, the benefits of obtaining a perfected security interest in insurance proceeds may be lost.
Badillo v. Tower Insurance Company of New York, No. 29, 1999 N.Y. Lexis 43 (Ct. App. February 23, 1999).
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