As seen in the DSNews, June 2008

Do you remember about four years ago when a grilled cheese sandwich fetched an astonishing $28,000 bid at a popular Internet auction site? The lunchtime favorite, allegedly depicting an image of the Virgin Mary, was even said to bring about good luck. Apparently, the buyer felt this incredibly high price was a good value for this 'lucky' purchase.

The key word in all of this is value. Somebody knew they were buying a grilled cheese sandwich and still paid good money for it. Maybe it was for the 'miraculous image.' Maybe it was for good luck. Maybe it was to be recognized as the person who spent $28,000 on a half-eaten kid’s meal. The point to all of this is that while many might find a one-time purchase of a $28,000 grilled cheese sandwich absurd, servicers every day are blindly spending much more for much less. Imagine bidding hundreds of thousands of dollars on a house, sight unseen, only to find you are the proud new owner of a flooded home full of black mold or fire charred drywall. This situation has been known to happen regularly, often with dilapidated properties selling for more than $100,000. In a foreclosure sale, lenders 'buy' this type of property all the time, not even realizing they’ve done so. Once realization and knowledge sets in as to what they’ve taken ownership to, the same question seems to arise, 'Can we file an insurance claim?'

The Claim Game
You’d be surprised how many damaged homes are sold back to the mortgagee at foreclosure sale for the total debt due on the loan. The majority of the time the mortgagee isn’t even aware of the damage when the total debt bid is made. 'No problem,' people might think when they discover a property has suffered some kind of damage. 'We’ll just make an insurance claim.' What many don’t know, however, is that the law can be unfavorable when it comes to trying to recoup insurance proceeds after a total debt bid at foreclosure sale. While servicers have the loan servicing process down to almost an exact science, the increase in defaulted loans has forced them to hastily educate themselves about strategies throughout a foreclosure, often leaving some important topics ignored. A significant area that servicers need to familiarize themselves with is property damage and insurance claims during the foreclosure process.

Why Should this Matter?
The ability to make a successful insurance claim and be awarded the proceeds depends on when the property damage occurred as well as the current stage of the foreclosure process. It can’t be stressed enough to servicers that blindly proceeding to foreclosure sale on a damaged property can very well affect your ability to receive a fair value for the asset. Servicers should educate themselves on what to do prior to generating foreclosure bids, how a property’s condition should affect their bid, and how to respond to property damaged after foreclosure sale. Insurance claim issues can affect you at all stages of the foreclosure process. With a little education, you have a better chance at ensuring your investment maintains its value.

Going Once, Going Twice
Properties need to be inspected before they are sold at foreclosure sale. One would be amazed at the amount of damage that can be seen just by simply driving down a street past a house. Fire damage is often visible and obvious. Vandalism can often be apparent as well. Other damage, however, may not be so obvious. Certainly damage inside the home will be concealed, but you may be able to infer the possible existence of specific situations based upon the outward condition of the house. For example, the possibility might be high that mold is present if the roof has caved in and the property is abandoned. Any damage present that could have an instant impact on the value of the asset should be considered immediately. The last thing you should do is to take the property to foreclosure sale, bidding total debt owed, and assume that you will deal with any insurance and property preservation issues subsequent to the foreclosure. Proceeding to sale on a damaged property may have an unwanted affect on your ability to collect insurance proceeds. If a decision is made, however, to proceed to sale, the most important thing you can do is bid accordingly—making certain the bid reflects the current fair-market value of the property in its damaged condition. Not all property is damaged prior to the foreclosure sale. When the asset suffers postforeclosure sale, it is equally important to make every effort to ensure you are protected as a payee on a damage policy. The following two situations will give you a brief overview on how property damage can interfere with your ability to make an insurance claim and maintain the value of your asset. After all, you are not in the business of buying $28,000 grilled cheese sandwiches, and certainly not in the business of buying $100,000 condemnations or health hazards.

Dealing with Presale Damages
Initially, a mortgagee needs to make certain they know the status of the property prior to the foreclosure sale. Is the roof missing? Has there been a fire? Has the property succumbed to water damage or flooding? Any of these can have a significant impact on the value of the home, and the foreclosure bid should be adjusted accordingly. When damage is significant enough to require an insurance claim, you need step back and examine the situation. Don’t try to rush or hurry the foreclosure process because it could end up costing you or your investors thousands of dollars.

Take for example, Countrywide Home Loans v. Allstate Insurance Company, 2007 WL 4481007 (Mo.App.W.D.), S.W.3d (Mo. Ct. App. 2007), where even though the mortgagee was well aware that the property had suffered extensive fire damage prior to making its bid at the foreclosure sale, it still bid the full amount owed on the loan. The court stated that because the debt owed to Countrywide was satisfied by the full debt bid at foreclosure sale, the mortgagee had no interest in any insurance proceeds that resulted from the fire damage. Here, the borrower could potentially walk away with more than $95,000 in insurance proceeds. Had Countrywide intended to apply the funds against the debt or alternatively use the funds to repair the property, it would have needed to bid the fair-market value of the damaged property and either applied the proceeds to the debt or used the funds to repair the property, proceeding with foreclosure only when the repairs had been made. Instead, it ended up extinguishing the borrower’s mortgage, satisfying the borrower’s debt, and taking possession of a property suffering from approximately $105,000 in fire damage. Anytime a property is damaged prior to the foreclosure sale, you must act accordingly. Work with your foreclosing attorney to help develop the best strategy and best possible solution to your particular circumstance.

Assessing an After-the-Sale Situation
There is somewhat of a different result when a property is damaged after the foreclosure sale occurs. In the situation where legal title has vested in the name of the foreclosure deed grantee and the borrower is no longer in possession, there is no real issue. As long as the grantee owner of the property has maintained insurance, they should be able to make a claim and receive any payments based on the claim. The original mortgagor would no longer have an interest in the property or any insurance proceeds resulting from damage to the property.

The real issues occur when a property is damaged while it is still in its redemption period. State redemption periods often vary anywhere from zero to 365 days. The winning bidder at foreclosure sale (usually the mortgagee) should continue to maintain an insurance policy on the property, listing itself as the policy payee. Many states allow the foreclosure deed grantee to add the costs of any insurance premiums to the amount necessary to redeem the property from the foreclosure sale, but this is certainly not the only reason a policy should be maintained. The threat of damage to the property is ultimately the most significant reason for continuing the policy during the redemption period, allowing the winning bidder to be afforded protection in its interest (see Better Valu Homes, Inc., v. Preferred Mutual Ins. Co., 230 N.W.2d. 412). It is always recommended that a servicer maintain a current policy on the property during the redemption period. This could be a servicer’s only means of protecting its investment after a foreclosure sale extinguishes its mortgage lien.

And Now We’re Left With …
The ultimate goal in any foreclosure action is obviously to maximize the return for the investor. The last thing any servicer wants is to have to explain to its investor that the property is worthless because the mortgage debt was satisfied bidding on a burned-down or condemned property while the mortgagor gets to walk away with insurance proceeds. Hopefully, their foreclosure-sale bid will result in a piece of property in excellent condition. But if a $100,000-plus bid buys an uninhabitable and damaged home at foreclosure sale, then maybe, just maybe, the investor will be lucky enough to find an image of some famous historical figure charred into a piece of drywall or two. If a grilled cheese sandwich can net $28,000, then anything is possible. Or is it? Instead of pressing their luck, investors would be wise to exercise caution, do the right research, and think twice before jumping into a potentially risky—and wallet-robbing—situation.

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