Mortgagee not required to repair damage prior to recovery under a Standard Mortgage Clause

A Standard Mortgage Clause is a common element of insurance policies in respect of mortgaged real property. Lenders will typically require the inclusion of such a clause in a borrower’s insurance policy as a condition precedent to providing a loan. While the coverage afforded to the insured mortgagor under such a policy relates to the property itself, the Standard Mortgage Clause operates to protect the mortgagee’s security interest in the property. This “two contract” theory was recently reconfirmed by the Ontario Superior Court of Justice in Portage.¹ The Standard Mortgage Clause was found to permit a mortgagee to make an insurance claim for the balance owing on its mortgage after the sale of a fire-damaged property, without any obligation to repair that property in advance of the sale.

In Portage, the borrower/mortgagor, Mr. Bell, had insured his residential property with the defendant insurance company, Portage La Prairie Mutual Insurance Co. (PLP). The insurance policy contained a Standard Mortgage Clause in favour of the mortgagee on the property, Equitable Trust Co. (Equitable). During the term of the insurance policy, the property was damaged by fire that PLP alleged was started by Mr. Bell. Shortly thereafter, Mr. Bell defaulted under the mortgage and Equitable proceeded to sell the property on an “as is” basis since neither Mr. Bell nor Equitable wanted to repair the damage prior to sale. After applying the sale proceeds to the mortgage loan, the shortfall amount required to fully discharge Equitable’s mortgage was over $98,000, which Equitable claimed from PLP under the insurance policy.

PLP denied Equitable’s claim for the shortfall, arguing that Equitable was obligated to take steps to repair the property before selling it. PLP contended that Equitable was only entitled to the “Actual Cash Value” of the cost to repair the damage. Since Equitable had sold the property for more than the Actual Cash Value of the damage, PLP took the position that Equitable was not entitled to any recovery.² PLP also raised a number of arguments against Mr. Bell, including allegations of arson and misrepresentation, in an attempt to deny any recovery under the policy.

In deciding the matter, the Court referred to an American article³ which summarized the “two contract” theory of Standard Mortgage Clauses that has been accepted in Canadian jurisprudence.⁴ The Court cited with approval the following key elements from that article:

• A Standard Mortgage Clause allows a mortgagee to recover under a policy regardless of the actions of the mortgagor;
• A mortgagee’s right to recover is limited by the amount of the remaining debt secured;
• A mortgagee’s interest in the policy is in respect of its security interest in the property, not the property itself; and
• A Standard Mortgage Clause creates a separate contract of insurance between the insurer and the mortgagee and thus the acquisition of the property by the mortgagee actually increases the mortgagee’s interest.

In accordance with the “two contract” interpretation, the Court held that any arguments PLP may have had against the insured could not be used against Equitable. Given that the Standard Mortgage Clause created a separate insurance contract between Equitable and PLP, Equitable’s insured interest was, in fact, the amount of the shortfall it realized following the sale of the property. Equitable was awarded the amount of its shortfall as Equitable was not obligated, contractually or otherwise, to make any repairs before selling the property.

This decision serves as a reminder to lenders of the importance of including a Standard Mortgage Clause in insurance policies over mortgaged real property in order to obtain the primary benefits of a separate contract of insurance between the insurer and the mortgagee. It also provides a useful summary of the nature of the relationship between a mortgagee and an insurer created by a Standard Mortgage Clause.