It seems as though we go over these things every couple of months, but a recent case caught our attention. In May, The US Court of Appeals for the 5
Circuit ruled against the lessor in
Sierra Equip., Inc. v. Lexington Ins. Co.
The case itself is not all that earth-shaking, but the topic is one that has potentially serious ramifications for the less-than-careful lessor.
Sierra, the lessor did not get a standard insurance certificate from its lessee, stating that it was an additional insured (liability, if not both policies) and loss payee (fire, theft and casualty policy). In fact, the lease required only that the lessee insure the equipment with a policy in form, in terms, in amount and with carriers reasonably acceptable to the lessor.
The lessee did, in fact, obtain insurance on the leased equipment before the lessee filed for bankruptcy. The policy made no mention of the lessor. On inspection, the lessor found that the equipment had been damaged and tried to recover insurance proceeds. Let's stop here for a moment.
In theory, if the lessee sent its policy to the lessor and the policy did not indicate that the lessor was a loss payee, the lessor could have demanded that the policy be reissued or that an endorsement be prepared. (At lease in the case of liability insurance, an endorsement is much, much better than a mere certificate, because the certificate is not binding on the insurance company according to several court cases).
The lessor, however, did not demand to see the insurance policy. Thus far, the law is pretty clear: the lessor has no rights under the lessee's policy. If the lessor was named an additional insured, it could file a claim. As a loss payee, when the claim was filed by the lessor or the lessee, the lessor would be paid.
What makes the
Sierra case unusual is that its lawyers tried a creative argument: that the bankruptcy court should impose a lien on the insurance proceeds, so that instead of going into the lessee's bankruptcy estate they are held for the lessor's benefit as if it were a secured party for whom the insurance proceeds were collateral.
That may well have worked if the lease clearly required the lessee to name the lessor as additional insured. If so, there were cases in which the lessor, like a mortgagee, had the right to enforce insurance policies taken out for its benefit. While "everybody knows" the insurance was intended by the lessor for that purpose, the lease only said that the insurance would be satisfactory to the lessor.
If we take a step back, there are two reasons a lessor might want a lessee to have insurance: to (1) protect the lessee and its creditworthiness, and thus to protect the lessor as the lessee's creditor generally and (2) to protect the lessor as to the specific assets that are its property or collateral. In equipment finance we always look for reason (2) primarily. An unsecured creditor would look only for reason (1).
What the court was saying was that the equitable lien would only be imposed where reason (2) could be seen in the lease itself, not by implication. In fact, there is even more at issue here.
First, the lessor's rights will be limited to what is on the certificate. If the insurance certificate says that the lessor is additional insured for $1,000,000 of liability coverage, the insurer is not obligated to provide more even if the lessee has a $5,000,000 policy. Before accepting "acceptable" coverage, it may pay to find out what the lessee carries.
Second, in case there is any doubt, unless the lessor is named as loss payee, the insurer does not have to send the lessor a check. Another question is whether the lessor is the Sole loss payee - joint checks can be a problem. What you want today is to be "lender loss payee" which, we are told covers this and a host of other issues, such as waiver of misrepresentation by the lessee and notification of cancellation.
Third, only the insured and additional insured can file a claim on any insurance - liability or casualty. We have heard of oddball situations where the lessee refused to file the claim, preferring to be sued by the lessor under its indemnity. And be sure that the lessee is obligated to indemnify and to pay for damage to the equipment because just having insurance without the obligation raises issues and possible defenses.