March 28, 2014
by Kathryn A. Lachowsky
Wilson & Associates, PLLC – USFN Member (Arkansas, Tennessee)
Nationwide Mutual Fire Insurance Co. v. Citizens Bank & Trust Co., 2014 Ark. 20, arose out of a fire that occurred in December 2009 and an insurance company denying the claim of both the insured homeowner and the mortgagee. The homeowner, Danny Ludwick, applied for insurance coverage from Nationwide Mutual Fire Insurance Co. (Nationwide) on his home located in Van Buren, Arkansas. Nationwide relied upon the information supplied in his application and supplemental application, and issued a policy insuring the home and its contents for the period of May 6, 2009, through May 6, 2010. The policy at issue contained a standard mortgage clause.
The home was later destroyed by a fire in December 2009, and Citizens Bank & Trust Co. (Citizens) had a valid mortgage on the home at the time of the application and at the time of the fire. During Nationwide’s investigation of the fire, Nationwide learned of two previous fire losses sustained by the homeowners that had not been disclosed in their application and supplemental application for insurance. According to Nationwide’s underwriting guidelines, Nationwide would not have issued the policy if the prior undisclosed fire losses had been disclosed at the time of the application. Based on this material misrepresentation, Nationwide voided the policy back to its inception and refunded the premiums paid by the homeowners.
Mortgagee Citizens submitted a timely claim to Nationwide, but Nationwide denied the claim — not on the basis of a policy exclusion, but rather on the basis that the policy was void back to its inception. At trial, Nationwide argued that its rescission of the policy voided the policy ab initio and thereby extinguished not only the homeowner’s interest, but also Citizens’ interest as mortgagee. The Crawford County Circuit Court entered its order, without explanation, granting Citizens’ motion for summary judgment and denying Nationwide’s motion. Nationwide appealed and the Arkansas Court of Appeals certified this case to the supreme court as one of first impression that is of significant public interest. The Arkansas Supreme Court affirmed the decision.
On appeal, Nationwide contended that the circuit court erred in its decision because when Nationwide rescinded the policy, the policy was void ab initio and, therefore, there was no policy in which Citizens had an interest. According to Black’s Law Dictionary, the definition of “void ab initio” is: “null from the beginning, as from the moment when a contract is entered into.” Nationwide’s position was simple: If the policy is void and a legal nullity, the mortgagee can have no interest in it. Nationwide further argued that rescission of a contract and cancellation of a contract are two distinctly different remedies based on different grounds. Cancellation takes effect only prospectively, while rescission voids the contract ab initio. Nationwide, 2014 Ark. 20, citing Ferrell v. Columbia Mut. Cas. Ins. Co., 306 Ark. 533, 537, 816 S.W.2d 593, 595 (1991).
Citizens’ argument is based on the parties’ unambiguous stipulation that the mortgage clause in the policy is a standard mortgage clause. Under Arkansas law, a standard mortgage clause serves as a separate contract between the mortgagee and the insurer, as if the mortgagee had independently applied for insurance. Nationwide, 2014 Ark. 20, see, e.g., Farmers Home Mut. Fire Ins. Co. v. Bank of Pocahontas, 355 Ark. 19, 129 S.W.3d 832 (2003). Thus, the rights of a named mortgagee in an insurance policy are not affected by any act of the insured, including improper and negligent acts. The words “any acts” as used in a standard mortgage clause do not refer merely to acts prohibited by the contract or to a failure to comply with the terms of the contract, but literally embrace any act of the mortgagor. Nationwide, 2014 Ark. 20, citing 4 Couch on Insurance § 65:48 (3rd ed.).
In its review, the supreme court acknowledged Nationwide’s argument in reply that rescission voids a policy regardless of whether the policy’s mortgage clause is a standard mortgage clause. Nationwide’s position, however, overlooks the effect of Arkansas law treating the mortgagee as having an independent contract unaffected by the acts of the insured. The justice concluded in his opinion that under Arkansas law, the standard mortgage clause serves as a separate contract between Nationwide and Citizens as if Citizens had independently applied for insurance. As such, Nationwide’s rescission of the homeowner’s policy based on the acts of the homeowner does not affect Citizens’ independent contract with Nationwide. It is important to note that this independent contract with the mortgagee cannot be defeated by any act of the insured. Farmers Home Mut. Fire Ins. Co., 355 Ark. 19, 129 S.W.3d 832. Fraudulent acts by the insured and the rescission of the policy have no affect whatsoever on the independent contract with the mortgagee.
While this issue is one of first impression in Arkansas, the conclusion is consistent with the long-settled law of Oklahoma. In 1958, the Oklahoma Supreme Court similarly held that “a mortgagee’s contract was completely independent of the insured’s rights and would be valid even though the insurance policy was void ab initio.” Nationwide, 2014 Ark. 20, citing Okla. State Union of Farmers’ Educ. & Coop. Union of Am. v. Folsom, 325 P.2d 1053, 1056 (Okla. 1958) (citing Western Assur. Co. v. Hughes, 179 Okla. 254, 66 P.2d 1056) (Okla. 1936)).
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