Flood Insurance Contents Coverage and Lessors

Inquiry/Issue

The Bank has commercial loans in its portfolio secured by real property located in special flood hazard areas and by a security interest in the contents of the buildings. Both the mortgages on the properties and the security interest are given by the borrower. The buildings are leased, however, and the contents actually belong to the lessors. Is flood insurance for contents still required? Can the Bank keep its UCC filing on contents even if there are no contents covered by it?

Response Summary

If the Bank has taken a security interest in the contents of buildings located in special flood hazard areas securing loans, then flood insurance is required for the buildings and any contents stored in them that is subject to a security interest. If the contents are owned by the lessors, however, such would only secure the loans to the borrowers if the lessors either pledged them as collateral or hypothecated them to the borrowers to pledge as collateral. Otherwise, the security interest given by the borrowers would not attach to the contents owned by the lessors and the contents would not secure the loans. In such case, flood insurance would not be required for the contents.

Response Detail

Under the flood rules, flood insurance is required for the building securing a loan located in a special flood hazard area and any contents stored in them in which a security interest has been given 12 CFR §339.3(a). The amount of contents coverage required will depend on a number of factors, including the value of the contents actually securing the loans.

The Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”) provide the example of a $200,000 commercial loan secured by a warehouse, with an insurable value of $150,000, and inventory in the warehouse worth $100,000. Flood insurance coverage must be obtained for the lessor of the outstanding balance of the loan or the amount of coverage available under the NFIP. The maximum amount of insurance available is $500,000 for each category. In this example, Federal flood insurance requirements could be satisfied by placing $150,000 worth of coverage on the warehouse, thus insuring it up to its insurable value, and $50,000 of coverage on the contents, thus providing total coverage in an amount equal to the outstanding principal amount of the loan. The result would be the same even if the contents were worth $200,000. Interagency Q&A, Question 39.

What is instructive in this example is how the value of the contents is related to the amount of coverage required. As in situations where a loan is secured by several buildings located in a special flood hazard area, if there is a building and contents securing a loan, and the total value of the collateral or the amount of coverage available is greater than the amount of the loan, each category of collateral does not have to be insured up to its insurable value, so long as each category has some coverage.

In the present situation, the Bank will have to perform the same type of analysis in determining the flood insurance coverage required. With regards the contents of the building, however, the Bank will have to determine not only their value, but whether they have actually been pledged as security for the loan. For example, if a building located in a special flood hazard area secures a loan and the contents of the building belonged to the borrower but were not pledged as collateral, the Bank would not be required to obtain proof of flood insurance coverage for the contents. Likewise, if the borrower gave a security interest in contents, but the contents of the building did not belong to the borrower, the security interest would not attach to them. It would be as though the borrower had never given a security interest in the contents of the building, since the actual contents of the building do not secure the loan. The contents would secure the loan only if the owner of the contents—that is, the lessor—had either pledged them as collateral or hypothecated them to the borrower to pledge.

For each building, then, the Bank must determine the value of the contents actually securing a loan and document that valuation for the file. There must be some contents coverage on file, unless the Bank is able to demonstrate that there are no contents in the buildings with any value that is securing the loan. If the Bank is going to keep the security interest in contents given by the borrower, it must also be able to demonstrate, at any particular time, the actual worth of the contents belonging to the borrower in any of the buildings, and that the flood insurance requirements have been satisfied with respect to that collateral.

 

This entry was posted on Monday, January 11th, 2016 at 2:00 pm.