Insurance is a Valuable Asset

Insurance briefing from Debevoise & Plimpton LLP published in the October 2009 issue of The In-House Lawyer

In cases involving teh lending of large sums of money, the use of the borrower's insurance as a security asset is often viewed as the failsafe in the overall security package.1 In the event of a catastrophe giving rise not only to material damage but also to business interruption, or even the loss of a key member of the borrower's management, there may be no other significant asset available for recourse by the lender. It is therefore surprising that so little attention is sometimes paid to the technical requirements that need to be met for the insurance policy to become an asset available to the lender. Indeed, the insurance is sometimes an afterthought. Getting the technicalities right is perhaps more important to the lender of the money, but a small mistake by the borrower can have unintended, and sometimes extreme, consequences.

POSSIBLE PROBLEMS

Problems usually only come to light when a claim is made on the insurance and is disputed by the insurer, who is primarily interested in validly minimising any payment under the policy. The position then becomes simply an untangling of the tripartite legal position – lender, borrower, insurer – rather than any constructive solution between the lender and the borrower to move forward commercially. The following problems in particular can arise:

the policy may be cancelled upon a specified period of notice by the insurer's exercise of a clause in the insurance contract; expiry and non-renewal of the policy before repayment of a loan; policy amendments taking effect upon renewal, at which time a new insurance policy comes into effect; the policy may be avoided ab initio by the insurers for non-disclosure of a material fact or misrepresentation; termination of the policy for breach of warranty (the breach of warranty need not be material to the loss and the termination of the insurance is automatic at the date of breach); and the insured may fail to comply with any ongoing requirements and, in particular, notification requirements in the event of a potential claim. PROTECTION FOR LENDERS

The following areas of protection should therefore be considered by a lender.

BECOMING A NAMED INSURED ON A COMPOSITE POLICY

The simplest method (which would also provide the maximum security) is for the lender to become an insured party, but this gives rise to both commercial and legal issues. Commercially, the addition of the lender is likely to increase the insurance premium, while legal issues will arise concerning the status of each insured, which will impact on its rights under the policy. The key distinction is whether the insurance is placed on a joint or composite basis. In either case each insured will be required to comply with the policy obligations and thus both will be liable for the whole premium. Equally, each insured will have a direct right of action against the insurer.

However, a joint insured is one who has an identical interest with another joint insured, so that a fraud or non-disclosure on the part of one will have serious (and usually terminal) consequences for both. A composite insurance is written where the insured parties' interests are divisible and identifies each insured individually, so that each has its own contract with the insurer. Where banks are concerned it is usually the case, even if not actually specified, that the insurance is written on a composite basis, ie that the lender and the borrower have quite disparate elements of insurance, with the effect that the borrower's peccadilloes will not affect other parts of the insurance. Composite insurance can be expressed by qualifying the parties' insurance as 'each for...