THE MISCHIEVIOUS CLASS ACTION
Home mortgage lenders are always concerned that their security is appropriately protected by insurance. As a result, by the terms and conditions, of the mortgage the lender keeps to itself the right to compel the borrower to buy sufficient insurance. In Stanley Kolbe v. Bac Home Loans Servicing, LP, D/B/A Bank of America, N.A, No. 11-2030 (1st Cir. 09/21/2012) the bank asked that the borrower, Stanley Kolbe ("Kolbe") and Susan Lass v. Bank of America, N.A., and Bac Home Loans Servicing, L.P, No. 11-2037 (1st Cir. 09/21/2012), increase the amount of flood insurance he carried by the amount of $46,000. Kolbe did not allege, and the record is devoid of facts that show how much additional premium he paid, but even if he was paying an egregious 10% rate it would only have cost an additional $460 for the increase in flood insurance.
Kolbe filed on his behalf, and those similarly situated, a class action claiming that they were improperly forced to increase flood insurance coverage on their properties. Kolbe asserted that Bank of America's demand that he increase his flood coverage by $46,000 breached both the terms of his mortgage contract and the contract's implied covenant of good faith and fair dealing. The district court concluded that the pertinent provision of the mortgage unambiguously permitted the lender to require the increased flood coverage and, granted the defendants' motion to dismiss the complaint.
Kolbe borrowed $197,437 from a mortgage company to finance the purchase of his home in Atlantic City, New Jersey. The loan is guaranteed by the Federal Housing Administration ("FHA"), an agency within the Department of Housing and Urban Development ("HUD"), and Kolbe's mortgage in all material respects tracks the FHA's Model Mortgage Form for single-family homes. Paragraph 4 of both the model mortgage form and Kolbe's agreement describes the borrower's obligation to maintain hazard insurance, in pertinent part, as follows:
Fire, Flood and Other Hazard Insurance. Borrower shall insure all improvements on the Property, whether now in existence or subsequently erected, against any hazards, casualties, and contingencies, including fire, for which Lender requires insurance. This insurance shall be maintained in the amounts and for the periods that Lender requires. Borrower shall also insure all improvements on the Property, whether now in existence or subsequently erected, against loss by floods to the extent required by the Secretary [of HUD].
Federal law required Kolbe to obtain flood insurance because his property is located in an area designated as a special flood hazard zone under the National Flood Insurance Act ("NFIA"). The minimum amount of such insurance also is mandated by law. Under the NFIA, the flood coverage for a residential property securing a mortgage issued by a federally regulated lender must be in an amount at least equal to the outstanding principal balance of the loan, or $250,000, whichever is less. Kolbe's complaint states that he purchased coverage in an unspecified amount in excess of the minimum.
Through appellee Balboa Insurance Company, the Bank sent Kolbe notices in October and November 2009 stating that he was required to increase his flood insurance by $46,000 so that the total coverage would equal the replacement cost of his property as identified in his homeowner's insurance policy. The Bank warned that it would purchase the additional insurance itself, at an estimated cost to Kolbe of $237, if he did not acquire the insurance by December 6. The Bank further advised that the insurance it would purchase - commonly known as "force-placed" or "lender-placed" insurance," might cost more and would likely be less comprehensive than coverage Kolbe could obtain on his own. In response to these notices, Kolbe bought the additional $46,000 in flood insurance.
In February 2011, Kolbe filed this action against Bank of America and Balboa on behalf of himself and others similarly situated for breach of the mortgage contract and breach of the contract's implied covenant of good faith and fair dealing. He claimed that his mortgage contract did not permit the Bank to demand increased coverage, and he alleged that the Bank had implemented a nationwide policy of compelling borrowers to maintain greater flood insurance than required by their mortgages or federal law. Kolbe's complaint asserted that the Bank was profiting from this improper policy because it often arranged for force-placed insurance to be purchased through its own affiliated companies and brokers.
In its written decision, the district court agreed that the hazard-insurance provision can only be reasonably interpreted to afford discretion to the lender. The court concluded that the reference to "any hazards" in the first sentence of the paragraph encompasses flooding, and, consequently, it held that the second sentence gives the lender the right to require that flood insurance, like other types of hazard coverage, "be maintained in the amounts and for the periods that [the] Lender requires."
The issue in this case is one of straightforward contract interpretation. Appellant Kolbe asserts that the hazard and flood insurance sentences in the mortgage are independent and mutually exclusive.
Breach of Contract
The paragraph at issue is structured to address two different categories of insurance, with the first and third sentences containing identical introductory language directing the borrower to insure "all improvements on the Property, whether now in existence or subsequently erected."
Floods unquestionably are a type of hazard, and they are thus literally within the scope of the first sentence. Moreover, the third sentence can be reasonably understood to declare the borrower's obligation to obtain flood insurance as required by the NFIA regardless of whether the lender requires any other form of hazard insurance, but not to override the lender's exercise of discretion to require more. Finding that the language is not decisive, we consider what the available extrinsic evidence tells us about the meaning of the provision.
The Extrinsic Evidence
HUD's practice of treating flood coverage separately reflects Congress's specific concern about such insurance, which led to the enactment of the NFIA in 1968. HUD's practice of treating flood insurance independently is pertinent to our interpretation of the FHA's model language.
Lenders may have good reason to require full replacement coverage. Nonetheless, in mandating minimum coverage in an amount "equal to the outstanding principal balance of the loan," Congress in the NFIA appears to have incorporated an assumption that, at times, a more limited amount of flood insurance may be reasonable and appropriate.
The First Circuit concluded that a rational jury could construe the mortgage in favor of either Kolbe or the Bank. Though the text of Paragraph 4 and the extrinsic evidence both provide strong support for Kolbe's interpretation, his reading is not the only reasonable one. Kolbe has therefore stated a plausible breach of contract claim, and, hence, the district court erred in dismissing his complaint on the ground that the mortgage unambiguously permitted the Bank to demand the additional $46,000 in coverage.
The Covenant of Good Faith and Fair Dealing
The allegations plausibly support such a contention of improper motivation: Kolbe alleges that the Bank demanded flood insurance in excess of his obligations under the contract, that it did so in bad faith, and that the Bank or its related entities would profit through the purchase of force-placed insurance. These allegations, in effect, amount to a claim that the Bank's motivation for demanding additional flood insurance coverage was to increase corporate profits by funneling new coverage to its own affiliates.
The First Circuit concluded that the complaint alleges sufficient facts to establish a breach of the covenant of good faith and fair dealing that is plausible on its face. Hence, the claim should not have been dismissed.
Defendants argue that the district court's judgment in favor of Balboa should be affirmed even if the complaint is reinstated against Bank of America. The First Circuit agreed. Balboa's alleged involvement in the matters underlying Kolbe's lawsuit was limited to preparing and sending the letters notifying Kolbe that he needed to purchase additional flood insurance.
For the foregoing reasons, the judgment of the district court was affirmed in part, vacated in part, and remanded for further proceedings consistent with this opinion. Costs are awarded to the appellant.
The dissent argued that "It is one thing to read ambiguous language in favor of the borrower; it is quite another to disregard clear language that has only one sensible reading supported by salient practical reasons for why that reading was intended. Language of the same ilk appears to be common in loan agreements. To let this case proceed will be the source of great mischief."
Class actions allow a plaintiff, like Kolbe, who has very little damages as a result of the actions of the lender, to bring a major lawsuit by combining with all other borrowers similarly situtated. If there is a flood I am certain Mr. Kolbe will be happy that he had full replacement cost insurance and the lender will be happy that their security was fully protected. He just didn't want to pay for it.
The issues were also confused by the action of the United States Congress who, knowing nothing about insurance or the hazards faced by lenders lending money to borrowers in flood zones. As a result of strained wording the class action will go forward and as the dissenting justice noted there will be "great mischief" created by this action.
Lexis.com subscribers can access Lexis enhanced versions of the Kolbe v. BAC Home Loans Servicing, LP, 2012 U.S. App. LEXIS 19935 (1st Cir. Mass. Sept. 21, 2012) and Lass v. Bank of Am., N.A., 2012 U.S. App. LEXIS 19937 (1st Cir. Mass. Sept. 21, 2012) decisions with summaries, headnotes, and Shepard's.
Reprinted with Permission from Zalma on Insurance, (c) 2012, Barry Zalma.
Barry Zalma, Esq., CFE, is a California attorney, insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud. Mr. Zalma serves as a consultant and expert, almost equally, for insurers and policyholders. He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He recently published the e-books, "Zalma on Insurance;" "Murder and Insurance Don't Mix;" "Heads I Win, Tails You Lose - 2011," "Zalma on Rescission in California," "Zalma on Diminution in Value Damages," "Arson for Profit" and "Zalma on California Claims Regulations," and others that are available at Zalma Books. Mr. Zalma can also be seen on World Risk and Insurance News' web based television program "Who Got Caught".
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