Court Rules Lender Can Force Place Terror Insurance

A decision has been rendered on a case involving a dispute between a servicer and a borrower about "force placement" of terrorism insurance, with a United States District Court in New York ruling that a servicer is free to "force place" terrorism insurance if the borrower refuses to get the insurance. This decision could set a precedent since other similar cases have been settled before getting to the end of the legal process, possibly to avoid the expense of long-drawn out legal skirmishes and attendant legal fees. The case was initiated by Dallas-based Omni Berkshire Corp., who had borrowed $250 million in 1998 from Secore Financial, against Wells Fargo, the special servicer on the loan. The loan - secured by five hotel properties in New York, Chicago, Houston, Dallas, and Irving, Texas - is part of a $1.8 billion commercial mortgage-backed securities offering.

Kathryn O'Neall, a managing director with the Wells Fargo commercial mortgage servicing group said that Wells Fargo is "very pleased" with the decision on this matter.

She noted, "We think the judge's decision clarifies an important issue facing the commercial real estate industry post-9/11. A servicer can still require a borrower to carry terrorism insurance under the standard 'other reasonable insurance' provision of the loan documents, despite the insurance industry's decision to routinely exclude terrorism insurance coverage from 'all risk' policies." About whether Omni would appeal this decision, Ms. O'Neall declined to comment, noting that "this is a potentially ongoing legal matter." Omni did not return a call seeking comment, made to the company's general counsel.

While terrorism insurance on the Omni hotel properties was covered in the "all risk" policy prior to the terrorist attacks of 9/11, the insurance industry specifically started excluding terrorism insurance from "all risk" coverage in the aftermath of the attacks.

In July 2002, Wachovia, the master servicer on the loan, asked Omni to comply with the loan documents by getting terrorism insurance, and Omni responded saying that the loan documents did not specifically require terrorism insurance. Omni also said that it had made inquiries about "standalone" terrorism coverage and found that such coverage was extremely expensive at that point.

After that, Wells Fargo, the special servicer, stepped into the picture and asked for $60 million in terrorism insurance coverage on the hotels. Omni then initiated the lawsuit against Wells Fargo in September 2002. The Terrorism Risk Insurance Act was signed in after that in November 2002. Even after that, Omni determined that the annual cost for $60 million in terrorism insurance coverage would be $316,000, which worked out to about 63% of the cost of the company's "all risk" policy. This would be the case for the life of the loan, up to 2008.

In rendering his decision, United States District Judge Denny Chin notes that the terrorism insurance could not be required under the "all risk" policy since that was not specifically mentioned at the time the loan was made. "It was commonly understood that the standard 'all risk' policy had evolved over time and that it could continue to evolve over time. The Y2K, mold, and terrorism exclusions are examples of exclusions that are now commonly found in 'all risk' policies that did not exist some years ago. Under these circumstances, if the parties had intended to require Omni to maintain for the life of the agreement 'all risk' insurance in the form that existed in August 1998, i.e., that included terrorism insurance, they surely would have said so. That the parties did not include such language suggests that the parties intended to require only what the industry generally accepted - knowing that the generally accepted 'all risk' policy might evolve over time."

However, the judge also finds that Wells Fargo "acted reasonably in requiring Omni to purchase terrorism insurance under the 'other insurance' clause" of the loan agreement. According to the judge, the five Omni hotels are located in major cities and "surely there is some risk that they could be targeted." Also, the judge believes that the cost of coverage, at about $300,000 per year, is reasonable and that the cost of terrorism insurance has "dropped significantly" since the time immediately following the terrorist attacks. Besides, the judge points out that the coverage would benefit Omni and relieve them of the charges for legal coverage for continuing with this case.

In conclusion, the judge has ruled in favor of Wells Fargo and given Omni a time period of 30 days from Feb. 25 to obtain $60 million in terrorism insurance coverage.

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