Just Say No

LENDERS ARE TRYING TO GRAB A RIDE ON YOUR CO-OP'S INSURANCE. YOU SHOULD: JUST SAY NO

Beware: when buyers close on their apartment sales at a co-op – technically the transfer of shares from one party to the other – some banks are overreaching. They’re requesting that they be listed as “additional insured” on the insurance policy. Not only is this wrong, it could also create problems for the co-op in the future.

Attorney Theresa Racht says the request has happened often enough at recent closings for her to take notice. “More than one lender’s counsel has asked me to deliver at closing a certificate of insurance naming the bank and its successors and/or assignees as additional insureds on the co-op’s insurance,” she reports.

Other attorneys have fielded similar requests. “We have run across that on several occasions,” admits attorney Stuart Saft, a partner at Holland & Knight. “They asked for it, we told them we wouldn’t give it to them, that granting such a request would just create too many problems, and that they have no right to have it. They backed off.”

What exactly does the bank’s request mean? A call to a banking colleague about its legitimacy directed Racht to the regulations concerning insurance by the Federal National Mortgage Association, commonly known as Fannie Mae. Fannie Mae is the government-backed organization that expands the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities, which allows lenders to reinvest their assets into more lending and, in effect, increasing the number of lenders in the mortgage market by reducing the reliance on locally based savings and loan associations.

Racht had been told by her colleague to review Fannie’s regulations concerning lenders, specifically Section B7-3-08, “Mortgagee Clause for Property and Flood Insurance.” That section requires that when there is a “first mortgage secured by a unit in a condo project or [there is] a co-op share loan,” the “policy must include the standard mortgagee clause and must name Fannie Mae or the servicers for the mortgages/shared loans as the mortgagee.”

“There are a lot of issues with this provision when it comes to co-ops,” warns Racht, who adds that “it underlines the fact that Fannie Mae is not recognizing in its regulations the legal differences between co-op and condo ownership.”

So, what are those legal differences between co-ops and condos as far as the bank is concerned? Although condos often give banks additional insured status on the condo’s master insurance, the situation between a condo and a lender is different from that between a co-op and a lender, primarily because of how ownership is defined. A condo unit-owner has what is called a “fee ownership interest.” Because the unit-owner and the condo have a responsibility to rebuild the unit after a casualty loss, the lender’s interest in the unit needs to be protected in case the unit-owner and the condo fail to rebuild. In that case, the lender must protect its collateral and take on the rebuilding itself, explains Racht.

“In a cooperative, however, the obligation to rebuild is held by the co-op, not the individual unit-owners,” she continues. “The co-op shareholder is only responsible for the furniture, furnishings, built-ins, paint, tiles, carpet, appliances – essentially all those things described as ‘personalty,’ or personal property in the contract of sale. The shareholder is not responsible for rebuilding, thus his lender has no interest to be protected.

“Lenders in co-op transfers are not entitled to be added as additional insureds or certificate holders or anything else,” Racht asserts. “No way should a shareholder’s bank, which has made a personal loan to a shareholder secured by the shares, have any claim on any insurance claims or payouts from the co-op’s master insurance.”

Granting additional insured status to a bank tells the insurance company that there is a business relationship between the co-op and the bank that entitles the bank to certain protections and indemnifications, asserts Racht. This is not the case. A loan to a shareholder is a personal loan. The collateral includes the shareholder’s shares of stock in the co-op and interest in the proprietary lease. The relationship between the bank and the co-op is limited to that described in the recognition agreement.

Adding a shareholder’s bank as an additional insured opens the door for that bank to make claims and intervene in the business of the co-op with its insurance carrier. That is not contemplated by the relationship between banks and co-ops described in the standard recognition agreements or in the proprietary lease provision permitting shareholders to use their apartments as collateral for share loans.

“Say you have a co-op that has had a bad fire,” Racht observes. “Ultimately, a payment is received from the co-op insurance’s co-payable to the co-op and the co-op’s underlying fee mortgage holder. If a shareholder’s lender also is named as an additional insured, that lender may also be co-payable on the insurance payout to the co-op and would therefore have an equal voice with the co-op’s underlying lender as to how that money is spent by the co-op. That’s not a right the shareholder’s lender should have.”

Agrees Saft: “The lender then becomes involved in working through getting any insurance recovery that they really don’t have a right to.”

The shareholder’s bank should only receive from the co-op proof of insurance coverage for the building by a form that does not credit or confer any status of any kind onto the bank, either by copies of the policy declaration pages or a proof of insurance form that states on its face that no rights of any kind are conferred onto the holder.

If Fannie Mae believes it needs to be named in an insurance policy to protect its collateral interest in a co-op apartment, asserts Racht, then Fannie Mae should require all shareholder borrowers to have a co-op homeowner’s insurance policy naming the lender as certificate-holder or additional insured. Such homeowner’s insurance policies protect the shareholder’s personalty – again, those items within the walls of the co-op apartment that belong to the shareholder and are not the co-op corporation’s responsibility to repair or replace. If a toilet or tub overflows and causes damage to an apartment’s wood floors, this homeowner’s insurance policy would cover the repair and replacement, not the co-op corporation’s master policy. That way, a bank’s interests would be protected.

“It is important for transfer agents – the manager or attorney – to say no to lenders that request to be added to an insurance policy,” Racht observes. “This unfortunate new trend is wrong on so many levels – it should not, under any circumstances, be allowed to become the norm. It is also time for Fannie Mae to reflect in its regulations the legal differences between loans on co-op apartments and loans on condo units.”

All the more reason for the co-op’s attorney to be consulted in a transfer. “The lender would have to get a document signed by the co-op in order to accomplish what the bank is requesting,” Saft notes. “That would probably be a side letter or an additional part of the recognition agreement. When the bank requests that document, that’s when the smart managing agent handling the transfer should be going to the co-op’s lawyer to ask, ‘Should we be doing this?’ If they just did the transfer on their own and agreed to the request, that could be a disaster.”