What Is a Loss Payable Clause?
A Loss Payee Must Have an Insurable Interest in Insured Property
A loss payee is a person or entity who's eligible to receive payment under an insurance policy if property, in which they have an interest, is damaged by a covered peril. A loss payee may be a property owner, a lender, or a seller. Loss payees are often added to commercial property policies via a standard endorsement entitled Loss Payable Provisions. The endorsement contains four clauses, each designed for a specific type of loss payee. The first two clauses are used most often. They are the Loss Payable Clause and the Lender's Loss Payable Clause.
What Is a Loss Payable Clause?
The Loss Payable clause protects a property owner against loss or damage to the property while it's in the insured's possession. The loss payee may own all or a portion of the insured property.
For example, Fred owns Fantastic Furniture, a furniture manufacturing company. Fantastic Furniture is buying a new laser cutting machine from Lasers-R-Us. The machine costs $120,000, and Fantastic will pay the seller $40,000 per year for three years. Until the machine is paid off, both Fantastic Furniture and Lasers-R-Us will have an insurable interest in it. Fantastic has insured the machine under a commercial property policy. The sales agreement requires Fantastic to include Lasers-R-Us as a loss payee under Fantastic's property policy.
The Loss Payable Clause does not give the loss payee the rights that are afforded by the Lender's Loss Payable Clause.
At Fred's request, Fantastic's insurer adds the Loss Payable Provisions endorsement to the company's property policy. The insurer includes Lasers-R-Us' name and address as well as a description of the laser machine in the endorsement schedule. If a fire breaks out in Fantastic's factory and the laser machine is destroyed, Fantastic's insurer will pay for the loss to Fantastic and Lasers-R-Us jointly, as their interest may appear. This means that either or both parties will be compensated for a loss based on their insurable interest in the insured property.
If Fantastic owns 30% of the machine at the time of the loss, its share of the insurance payment should be $36,000 (not counting the deductible). Lasers-R-Us' share should be $84,000. The insurer may pay the entire $120,000 to both parties jointly.
How Does a Lender's Loss Payable Clause Work?
The Lender's Loss Payable Clause is used to cover a creditor whose interest in insured property is stated in a written document such as a mortgage, warehouse receipt, or bill of lading. For example, suppose that Fred (in the previous example) decides to pay Lasers-R-Us the full purchase price of the laser machine upfront. Fred finances the purchase by obtaining a $120,000 business loan from the Benevolent Bank. The loan is secured by the laser machine.
Under the Lender's Loss Payable Clause, the insurer will make a loss payment directly to the lender if property in which the lender has an interest is damaged by a covered peril.
As a condition of the loan, Fantastic must insure the bank as a loss payee under the Lender's Loss Payable Clause. This clause protects the lender in three important ways.
First, the Lender's Loss Payable Clause ensures that the loss payee can receive payment for a loss even if it has initiated a foreclosure action on the covered property. For example, suppose Fantastic Furniture has missed several payments on its business loan so the Benevolent Bank begins foreclosure proceedings. Two days later, the laser cutting machine is destroyed by a windstorm. The bank is entitled to receive payment for the loss of the machine under Fantastic's property policy even though it has foreclosed on the loan.
Acts Committed by the Insured
Secondly, the Lender's Loss Payable Clause protects the lender in the event the insured commits certain acts that cause the insurer to deny its claim. The lender retains its right to receive loss payments even if the insured's claim has been denied, say because the insured has failed to comply with the terms of the policy.
For example, suppose that the laser cutting machine has been destroyed by a fire at Fantastic Furniture's manufacturing plant. At the time of the fire, Fantastic has paid off half of its loan to the Benevolent Bank. Fantastic files a claim for its share of the loss. However, the insurer denies Fantastic's claim because Fred refuses to provide a proof of loss or to communicate with the adjuster.
The Benevolent Bank can still receive compensation for its share of the loss if it pays any outstanding premium (if any is due) and submits a signed, sworn proof of loss (since Fred hasn't submitted one). The lender must also notify the insurer if the ownership of the insured property has changed (such as the loss payee has repossessed the property).
A third protection provided to the lender under the Lender's Loss Payable Clause is notification if the insurer cancels or non-renews the policy. If the insured has failed to pay the premium, the insurer will provide 10 days' notice that it intends to cancel the policy for nonpayment. The insurer will provide 30 days' notice if it cancels the policy for any other reason. If the insurer decides to non-renew the policy, it will notify the loss payee 10 days before the policy expires.