Flood Insurance for Loan Secured by Lease-Hold Interest

Question/Issue

The Bank has loan secured by a Collateral Assignment of Rents, Income, Profits, and Leases pertaining to improved commercial real estate located in a special flood hazard area. The assignment is not recorded and the consent of the landlord to the assignment was not obtained. The loan is also secured by a security interest in the contents of the property. Is flood insurance required?

Response Summary

A lender is required to obtain flood insurance for improved real estate securing a loan if the loan is a designated loan for flood insurance purposes. A loan secured by the assignment of an interest in improved real estate, such as an Assignment of Rents, is a designated loan. If the building and its contents both secure the loan, and the building is located in a SFHA, flood insurance is required for the contents as well as the building.

Response Detail

The Flood Rules and Regulations (“Flood Rules”) implementing the Flood Disaster Protection Act provide as follows:

A bank shall not make, increase, or renew any designated loan unless the building or mobile home and any personal property securing the loan is covered by flood insurance for the term of the loan [12 CFR §339.3(a)].

A “designated loan” is a loan secured by a building or mobile home that is located or to be located in a special flood hazard area (“SFHA”) in which flood insurance is available under the Act. A “building” is a walled and roofed structure that is principally above ground and affixed to a permanent site, and a walled and roofed structure while in the course of construction, alteration, or repair [12 CFR §§339.2(c), (d)].

Is flood insurance then required for the building in this case?

The building must secure the loan, but otherwise the Flood Rules do not identify the type of security interest being given, the type of estate covered by the security interest, or the type of ownership of the property. The Flood Rules only refer to the nature of the property and its location.

The Interagency Q&A gives an example of a loan that is not secured by real estate, but has been made on the condition of a personal guaranty by a third party, which is secured by an interest in improved real estate that is located in a SFHA. The conditions that a personal guaranty be obtained and secured by real property was deemed by the regulators to tie the property to the loan so closely that it was considered a designated loan for flood insurance purposes [Interagency Q&A, Q. 43].

While the type of security interest in the example is not the same as the security interest obtained by the Bank, the point is that a condition tying the repayment of a loan to property located in a SFHA is sufficient to make the loan a designated loan.

In this case, an assignment has been made of a leasehold interest in improved real estate located in a SFHA. While such an assignment does not cover an estate as broad as a fee simple estate, it does create a collateral interest in the building. Since the Flood Rules do not address the nature of the security interest or any other aspect of it, but only that there be a security interest in a building located in a SFHA, the assignment of a leasehold interest in a building located in a SFHA satisfies the definition of a designated loan.

As for the security interest in the contents of a building, if the building and its contents both secure the loan, and the building is located in a SFHA, flood insurance is required for both the building and its contents. On the other hand, if there is a security interest in the contents of a building located in a SFHA, but the building does not secure the loan, flood insurance would not be required for either the building or the contents [Interagency Flood Insurance Questions and Answers (“Interagency Q&A”), Qs. 38, 39]. Since the building secures the loan through the Assignment of Rents, and since a security interest has been taken in the contents of the building, the flood insurance obtained must cover the contents as well as the building.

This entry was posted on Friday, December 12th, 2014 at 10:21 pm.