By Michael McNeil, Esq.

Powers Kirn, LLC *

USFN Member (NJ, PA)

A New Jersey appellate court in Wilmington Savings Fund Society, FSB v. Daw, --- A.3d --- (N.J. Super. Ct. App. Div. October 22, 2021), held that a lender and its servicer owe a borrower an implied covenant of good faith and fair dealing in determining whether to apply insurance proceeds to pay down the debt or to release the proceeds to the borrower to fund repairs to the collateral.  In practice, this means that after receiving adequate information to determine how to dispose of the proceeds, the lender must clearly advise the borrower of its decision within a reasonable period of time.  In addition, the lender must not deprive the borrower of fair use of the proceeds by making its decision in an arbitrary or capricious manner.  The court further held that trial courts may enforce the implied covenant by exercising their inherent equitable power to abate interest accrued during any period of unreasonable delay by the lender in deciding how to dispose of the proceeds.  Finally, the Court held that the lender must deposit the proceeds in a segregated, interest-bearing account upon receipt until it determines how the funds are to be used.

In Daw, the mortgaged property was badly damaged during Superstorm Sandy, which struck New Jersey in October 2012.  In September 2014, the borrowers were awarded a $150,000 grant from the New Jersey Department of Community Affairs through its Reconstruction, Rehabilitation, Elevation and Mitigation (“RREM”) program.  The grant funds could be used for repairs but were conditioned upon the borrowers elevating the property and residing there long term.  Additionally, in May 2015, the borrowers’ flood insurance claim was approved and insurance proceeds in the amount of $149,847.71 were delivered to the plaintiff pursuant to the terms of the loan documents and policy.

The mortgage in this case included standard provisions regarding disposition of insurance proceeds.  Namely, the proceeds would be used to repair the collateral, unless the repairs were economically infeasible or would lessen the mortgagee’s security, in which case the proceeds would be used to pay down the debt.  The borrowers requested the proceeds be used to repair the property.  In support of this request, the borrowers sent the plaintiff information regarding the RREM grant, an itemized list of needed repairs, and estimated costs.  At the same time, the plaintiff obtained a BPO that showed a mere $10,000 increase in the value of the property if the proposed repairs were completed.  The plaintiff ultimately elected not to apply the proceeds to repair the property.

In the meantime, the plaintiff commenced a foreclosure action against the borrowers after they fell behind in their mortgage payments.  In November 2016, the borrowers opposed the plaintiff’s final judgment motion because, among other things, the plaintiff had not applied the insurance proceeds to pay down the debt.  The trial court agreed and denied the plaintiff’s motion.  Thereafter, the parties engaged in loan modification discussions, but the plaintiff insisted on holding back $100,000 of the proceeds as part of any modification.  The borrowers objected to the holdback, as they needed the entirety of the proceeds and RREM grant to complete all necessary repairs and not lose eligibility for the grant.  Thus, a deal was not reached.

In September 2019, the trial court entered final judgment in favor of the plaintiff after it had applied the proceeds to pay down the debt.  In so doing, the court rejected the borrowers’ opposition in which they argued the plaintiff had unfairly held the proceeds for over three years without applying them to the debt, costing approximately $40,000 in additional interest.  The borrowers appealed this decision.

The appellate court recognized that lenders are not required to “throw good money after bad.”  However, the court looked to, among other things, the Third Restatement of Property (Mortgages), in holding that a lender must act reasonably and fairly in determining how to utilize insurance proceeds.  The court ultimately remanded the matter back to the trial court to conduct additional fact finding and to evaluate those facts in light of this opinion.  In particular, the trial court is to look at whether the plaintiff’s holdback demand was reasonable, whether the plaintiff’s analysis of economic feasibility was sufficient, how the BPO factored into that analysis, if at all, and if so, whether it should be dispositive given the passage of time and ensuing changes in the real estate market.

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USFN Report - Winter 2022