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Liberty Mutual Fire Insurance Company v. Alexander

374 N.J. Super. 340, 864 A.2d 1127 (App. Div. 2005)

FORECLOSURE; INSURANCE—When a fire causes damage to a foreclosed property during the redemption period but the deed is erroneously delivered during that time, the insurance proceeds are to be paid to the foreclosing lender to the extent of the debt and the borrower is entitled to a credit for the value of the property received in the foreclosure sale.

A homeowner defaulted on its mortgage. The mortgagee bought the property at the resulting foreclosure sale but did not seek a deficiency judgment. The house was then destroyed by a fire during the redemption period but after the deed inadvertently was delivered to the mortgagee. The homeowner’s insurance company then filed a complaint seeking a declaratory judgment to determine how the $175,000 insurance proceeds were to be allocated. The mortgagee argued that it was entitled to the full amount of the insurance proceeds because it had obtained title to the property before the fire. The owner claimed that its right of redemption negated the erroneous transfer of title by sheriff’s deed to the mortgagee and that the mortgage merged with the lien. The lower court held that the mortgagee was entitled to $128,081, leaving $47,818 for the owner.

The Appellate Division affirmed the lower court’s decision, holding that the mortgagee was entitled to an award of the insurance proceeds to the extent of the mortgage debt, and that the owner was entitled to a credit for the value of the damaged property that the mortgagee had obtained from a subsequent purchaser. According to the Court, a judicial sale without an actual transfer of title is merely a contract for sale that does not extinguish the insured’s interest in its homeowner’s fire insurance policy. Therefore, the mortgage debt remains, and the owner is entitled to use the property to pay off the debt. In effect, the owner remains the title owner of the property, and in the absence of any agreement to the contrary, a mortgagee has the right to apply fire insurance proceeds to the outstanding debt. Unless a mortgage contains a provision to the contrary, a mortgagee cannot not be forced to convert a mortgage loan into a construction loan or to become a mortgagor’s partner in rebuilding a structure. Instead, the mortgagor’s debt is reduced by an amount equal to the reduction in value of the building caused by the fire so that the parties retain the same position they held prior to the fire.

Once a mortgagee acquires a property through foreclosure, it may recover, under an owner’s insurance policy, for the losses incurred after it acquired title without regard to either the amount of the loan secured by the property or the amount of the debt owed by the owner at the time of acquisition.

In this case, the facts were unusual because the deed was mistakenly delivered during the redemption period, and the owner never moved to rescind the delivery. Despite that, the Court disagreed with the lower court that the result would have been the same even if the owner had been deemed to be the title owner to the property. The owner had the right of redemption at the time of the fire. The available proceeds would have been applied to the amount of the mortgage debt, in which case the owner would have been left with the land. Here, the land had been sold to a third party for its market value. Therefore the owner was put in the same position it would have been had it received the deed in exchange for extinguishment of the mortgage by payment of the insurance proceeds to the mortgagee.

The Court rejected the owner’s contention that the mortgagee had to either accept the deed to the damaged property in satisfaction of the mortgage debt and give the owner the full insurance proceeds, or accept the proceeds but return the deed. The Court’s reasoning was that the mortgage debt was secured by land with an undamaged house; therefore, the mortgagee was not required to accept a deed that represented land with a destroyed house in satisfaction of the debt. Furthermore, the owner failed to explain how it would have been entitled to the insurance proceeds on land it did not own. As to the owner’s alternate theory, that the mortgagee was required to accept the insurance proceeds but return the deed, the effect of the lower court’s decision was that the mortgagee accepted the insurance proceeds in full satisfaction of the debt, while the owner was awarded the equivalent value of the deed as measured by the sale of the property to a third party. By crediting it with the value of the property, the lower court’s decision placed the owner in the same financial position it would have been if it hadn’t received the damaged property itself. For that reason, the Appellate Division affirmed the lower court’s distribution of the insurance proceeds.


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