Flood Insurance Contents Coverage When There Aren’t Contents

Issue/Inquiry

The commitment letter for a loan to be secured by a commercial warehouse requires a security interest in the contents of the premises. The warehouse is empty. Is flood insurance coverage for contents required?

Response Summary

There are various approaches towards answering the question, but basically, if there are no contents, then flood insurance is not required, whether or not the Bank took a security interest in contents.

Response Detail

The Flood Rules provide the following:

An FDIC-supervised institution shall not make, increase, extend, 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. The amount of insurance must be at least equal to the lesser of the outstanding principal balance of the designated loan or the maximum limit of coverage available for the particular type of property under the Act. Flood insurance coverage under the Act is limited to the building or mobile home and any personal property that secures a loan and not the land itself. 12 CFR 339.3(a).

With respect to contents coverage, this means that there are two questions:

1. Did the Bank take a security interest in the contents?
2. What is the appropriate amount of coverage?

With respect to the security interest, the commitment letter refers to the requirement for “[a] valid fully-perfected first lien on the chattels, fixtures, personal property and equipment appurtenant to the Premises.” This in turn raises additional questions:

1. Is there is a security agreement covering contents or does the mortgage create a security interest in it?
2. Is there such personal property in the warehouse?

If the Bank did not obtain a security agreement covering contents or if the mortgage did not create a security in contents, then the contents do not secure the loan, and therefore flood insurance is not required.

Under Article 9 of the Uniform Commercial Code as adopted by New Jersey, a security interest becomes enforceable when there is an authenticated security agreement, value has been given, and the debtor has rights in the collateral. N.J.S.A. 12A:9-203. If there are no contents, the security interest is not enforceable and no contents secure the loan. Consequently, no flood insurance would be required. If the borrower subsequently put personal property in the warehouse, the security interest would attach to the personal property and contents coverage would be required.

Likewise, if the Bank obtained a security interest in contents but there were no contents in the warehouse, the amount of flood insurance would be the lesser of the amount of the loan, the value of the contents, or the maximum coverage under the NFIP. If there were no contents (and therefore no value), the amount of flood insurance required would be zero. If the borrower subsequently put personal property in the warehouse, flood insurance would have to be obtained in the appropriate amount.

In this case, if the Bank took a security interest in contents but there are no contents, a memorandum should be put in the file as a matter of best practice, indicating why flood insurance covering contents was not obtained.

In the event that the borrower adds personal property to the premises that is covered by the security agreement, the Bank would be required to follow its force placement procedure, which would apply whenever it determines that collateral is not covered by flood insurance. 12 CFR 339.7(a).

This entry was posted on Monday, July 15th, 2019 at 6:00 am.