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Composite insurance: the importance of a separate interest

30/11/2017

At a glance

In most debt finance transaction where the Lender is securing their interest over property, the Lender will usually require that the insurance policy for that property is amended and historically Lenders have been satisfied with being noted on a Borrower’s insurance policy. However, recently there has been a shift in the readiness of Lenders to accept the noting of their interest and a marked increase in the requirement for a Lender to be composite insured and named as the first loss payee on any policy.

Noting and Composite – what’s the difference?

If a Borrower requests that a Lender’s interest is noted on their insurance policy, the insurer will simply be required to inform the Lender (subject to the terms of the policy) if the policy is cancelled or not renewed by the Borrower and, occasionally whether there have been any material amendments to key aspects such as cover limits and policy types. Noting a Lender’s interest does not give a Lender any direct contractual rights to claim against the insurance policy nor any say (other than under the facility agreement) as to the distribution of the proceeds of any claim made.

Composite insurance provides the Lender with a separate, distinct right of claim against the insurer which is segregated from any rights of claim the Borrower may have. The insurance contract will allow a Lender to recover even in the event the Borrower and policy holder has breached its terms (particularly in respect of fraud or non-disclosure under the Insurance Act 2015). The Lender may therefore bring claims under the insurance separately to the Borrower.

Composite (or co-insured) is not however, the same as a joint insurance contract. A joint insurance contract will mean the policy is held in both the names of the Borrower and Lender, therefore an insurer can avoid the whole contract if fraud or non-disclosure is found to have been committed by one of the policy holders. It would be deeply unsatisfactory if, in the event a Borrower fails to disclose material facts to an insurer and the insurer was subsequently able to avoid any payment under the policy of insurance, and the Lender was left exposed.

First loss payee and refinancing – potential pitfalls

On a recent REF development refinance transaction a Lender had required composite insurance and to be named as first loss payee, however the standard form of lease already in existence for the developed units had specific provisions around the use of insurance funds by the Borrower to re-instate or repair the relevant units. The property was part-developed and therefore the lease had been entered into by a number of existing lessees. In this instance and given the short term nature of the funding, both Borrower and Lender agreed that it would be most time and cost effective to remove the requirement for the Lender to be entered as first loss payee however the provisions of existing leases on the refinance of development lending and indeed those of a standard form where the transfer of units has not yet commenced should be carefully checked for clauses such as these which may afford the Lender less protection in the event of an insurance claim by the Borrower.

Memery Crystal is well placed to advise on your property finance and banking transactions. Memery Crystal are listed as a leading firm for property finance in Legal 500 2017.

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