In a reported opinion, Celink v. Estate of William R. Pyle, 258 Md. App. 512 (2023), 2023 Md. App. LEXIS 493; 2023 WL 4782784, the Appellate Court of Maryland determined that a foreclosure of a reverse mortgage did not extinguish the Lender’s right to insurance proceeds for a casualty loss that had occurred presale, up to the amount of the remaining unpaid balance. In doing so, the Court applied the “loss before foreclosure rule” to the reverse mortgage, notwithstanding the reverse mortgage’s prohibitions against collection of a deficiency judgment. Accordingly, in a dispute between the Lender and the Borrower’s Estate, the Court held that where the proceeds of the foreclosure sale of the reverse mortgage were insufficient to satisfy the debt in full, the Lender could recover up to the remaining balance of the loan, with the excess to be paid to the Estate.
A copy of the opinion is available here:
Background – The Reverse Mortgage
Lender had advanced a reverse mortgage loan to the Borrower that was secured by a deed of trust on residential property. Op. at 3 (citing Section 3 of the Deed of Trust). Under a reverse mortgage, funds are advanced during the Borrower’s lifetime, and are then repaid upon a triggering event such as death or the sale of the property. Thus, as noted by the Court, “[b]ecause repayment can usually be deferred until death, reverse mortgages function as a means for elderly homeowners to receive funds based on their home equity.” Op. at 2, n. 1.
In this case, the deed of trust provided that the debt could only be enforced through the sale of the property, and expressly prohibited the Lender from obtaining a deficiency judgment in the event of a mortgage sale. Op. at 3 (citing Section 10 of the Deed of Trust).
The terms of the loan and deed of trust also required the Borrower to maintain insurance to protect against losses due to fire. Id. (citing Section 3 of the Deed of Trust). Those provisions provided that upon a loss, if restoration or repaid or the property is not economically feasible, the insurance proceeds would be applied to the balance due under the loan, with the excess to be paid to the “entity legally entitled thereto.” Id.
Following a fire at the property, the Borrower died, triggering the loan becoming due. Op. at 3. The Property was thereafter sold, and purchased by Lender for $175,000, leaving an unpaid balance of approximately $208,000 due under the loan. Id.
As a result of the fire loss, the insurance company issued a check payable jointly to the Estate and Lender. Op. at 4. Both Lender and the Estate then claimed the insurance proceeds.
Borrower’s Estate then filed a declaratory judgment seeking a determination that it was entitled to all of the insurance proceeds, and asserting that Lender failed to obtain a deficiency judgment in the foreclosure proceeding. Id. The trial court determined that by foreclosing upon the property, Lender “eliminated the indebtedness secured by the Deed of Trust, thereby eliminating any right or claim to the insurance proceeds” and ordered that Lender endorse the check so that it could be paid to the Estate. Id. Lender appealed.
Discussion
As an initial matter, the Court rejected the Estate’s assertion that Lender had failed to preserve a right to seek a deficiency judgment under applicable Maryland law. Although the Court noted that Lender had expressly waived the right seek a deficiency judgment under the deed of trust, the Court distinguished seeking a deficiency judgment from seeking a declaration of rights to the proceeds of an insurance policy. Op. at 6.
The Court then determined that Lender was entitled to an amount of the proceeds up to the unpaid balance due on the loan, consistent with the “loss before foreclosure rule,” which is applied when an insurable loss occurs prior to a foreclosure sale. Id. In such cases, the secured party has a claim to the policy proceeds up to the difference between the amount realized at the sale and the balance due on the secured indebtedness. Op. at 6-7. The borrower is entitled to the remainder. Op. at 7.
The Court provided an overview of the development of the rule, which originated in Maryland in Thomas' Adm'rs v. Vonkapff's Ex'rs, 6 G. & J. 372, 1834 WL 2000 (1834). Like the present case, the Thomas’ decision involved a dispute over insurance proceeds between a lender and borrower, involving a mortgage which required the proceeds to be used to rebuild a structure damaged by fire, and which did not give the lender an enforceable right to the proceeds. The Thomas’ Court determined that
(1) a covenant in a mortgage requiring the borrower to provide fire insurance for the secured property was for the benefit of the lender and its assignees,
(2) any claim by the borrower or his successors-in-interest to the policy proceeds was "subject to the [lender's] equity,"
(3) the lender had the right to enforce its interest, and
(4) the lender's right to do so stemmed from fundamental principles of equity and fairness. 6 G. & J. at 380-81.
Op. at 7-8 (citing Thomas, 6 G. & J. at 380-81).
Consequently, under Thomas’:
[A]lthough a lien existed, it gave [the lender] no right to the possession of the fund . . .; the design being to apply it for the purpose of reinstating the premises. But the facts show that the lien cannot in the terms of the contract be specifically enforced, owing to the sale of the mortgaged premises. A court of equity, however, is not on this account powerless. It must administer relief, in the only manner in which it can now be done. As the leading object in effecting the insurance, was exclusively a beneficial one to the [the lender], its great spirit and object will be effectuated by decr[e]eing him the fund. The mode only, of giving relief, will be changed.
Op. at 8-9.
The Court then discussed Rollins v. Bravos, 80 Md. App. 617, 565 A.2d 382 (1989), which characterized the “majority view” regarding the loss foreclosure rule to allow insurance proceeds for a loss occurring prior to a sale to be applied to any deficiency arising from the sale:
[W]here the insured premises are damaged before foreclosure proceedings have been instituted or, if after they have been instituted, prior to the sale being held, and the mortgagee purchases the property at the foreclosure sale, the mortgagee is permitted to retain the insurance proceeds pursuant to a mortgage clause requiring insurance, to the extent of any deficiency between the amount brought at foreclosure and the amount of the debt. The remainder of the proceeds is payable to the mortgagor.
Op. at 10 (quoting Rollins, 80 Md. App. at 69).
Further, the Court noted that in Wheeler & Co. v. Factors' & Traders' Ins. Co. of New Orleans, 101 U.S. 439, 25 L. Ed. 1055 (1879), the U.S. Supreme Court, recognizing Thomas’ as the leading case on the matter, characterized the mortgagee clause as creating an equitable lien upon the insurance proceeds in favor of the lender:
[I]f the mortgagor is bound by covenant or otherwise to insure the mortgaged premises for the better security of the mortgagee, the latter will have an equitable lien upon the money due on a policy taken out by the mortgagor to the extent of the mortgagee's interest in the property [is] destroyed.
Op. at 10 (quoting Wheeler, 101 U.S. at 442).
The Court found these principles consistent with Nationwide Mut. Fire Ins. Co. v. Wilborn, 291 Ala. 193, 279 So. 2d 460 (1973), which it identified as the leading “modern case” on the topic:
Where. . . the [property damage] loss precedes the foreclosure, the rule is [that the mortgagee] may satisfy the mortgage indebtedness by two different means. He may look to the insurance company for payment as mortgagee . . . and may recover, up to the limits of the policy, the full amount of the mortgage debt at the time of the loss. In this event he would have no additional recourse against the mortgagor for the reason that his debt has been fully satisfied.
The second alternative available to the mortgagee is satisfaction of the mortgage debt by foreclosure. If the mortgagee elects to pursue this latter option, and the foreclosure sale does not bring the full amount of the mortgage debt at the time of the loss, he may recover the balance due under the insurance policy as owner. If the foreclosure does fully satisfy the mortgage debt, he, of course, has no additional recourse against the insurance company, as his debt has been fully satisfied.
Op. at 11 (quoting Wilborn, 279 So. 2d at 463-64).
The Court also found the reasoning of the loss before foreclosure rule consistent with the Restatement (Third) of Property (Mortgages) (2007) §§ 4.7 – 4.8.
Although no opinion had expressly applied the rule to reverse mortgages, the Court determined that the legal principles underlying the loss before foreclosure rule were no less applicable, given that the Borrower’s residence, “together with the fire insurance policy that he was required to maintain to protect the lender’s interests, was security for repayment of the loan.” Op. at 14. Accordingly, the Appellate Court reversed the trial court, and remanded the case for an order declaring that the Lender was entitled to payment from the insurance proceeds to satisfy the remaining balance of the loan.