Insurance Policies and Proceeds as Collateral: The UCC may not be the key

Insurance is a critical component in any secured financing. At a minimum, a lender will require proof of personal property insurance that insures the replacement cost of the collateral and that lender is named lender’s loss payee pursuant to a lender’s loss payable endorsement. These mechanisms help ensure that a lender receive payments of insurance in the event of loss or damage to the collateral for its loan.

But what if a lender requires additional insurance as credit support? Business interruption insurance may be important for a manufacturer or distributor, especially when operations are limited to one or a few locations. Loan underwriting may also require a key man life insurance policy where the principal of the borrower is integral to its business. These types of insurance, while providing additional avenues for repayment, go beyond merely protecting the collateral. How then does a lender gain comfort that in the event a right to payment arises under the policy, the proceeds of the policy will be paid to the lender?

Insurance and the UCC

The Uniform Commercial Code (“UCC”) does not treat all insurance the same.  On one hand, the UCC includes within the framework of Article 9 payments under personal property insurance. The term “proceeds” as defined in the UCC includes “insurance payable by reason of the loss … or damage to the collateral” to the extent the insurance is payable to either the borrower or secured party.[i] In other words, if a lender has a security interest in tangible personal property such as inventory or equipment, then any payments made under the property insurance policy as a result of a loss are “proceeds” of the property and are subject to the UCC’s provisions that apply generally to proceeds.[ii] Under UCC Section 9-315(c), if the lender has a perfected security interest in the underlying collateral (e.g., inventory or equipment), it continues to be perfected in insurance payments made under the insurance policy as proceeds of such collateral.

The UCC’s treatment of insurance payments for other types of insurance differs dramatically. The UCC contains a long-standing and broad exception excluding insurance policies and rights under such policies from the scope of its coverage. UCC Section 9-109(d)(8) provides that Article 9 does not apply to “a transfer of an interest in or an assignment of a claim under” an insurance policy.[iii] One express exception exists with respect to assignments by or to a health-care provider of a health-care-insurance receivable (and any subsequent right to payment), but other types of insurance are not carved out from this exclusion.

Death benefits paid under a life insurance policy are one type of claim contemplated by the UCC’s exclusion.[iv] The event giving rise to payment does not involve the loss of property. As a result, a lender relying on key man life insurance could not characterize payment as a proceed of property and would need to look to state law other than the UCC to create and maintain a lien on such claim and subsequent payments under such claim. 

It is far less obvious whether the UCC’s insurance exclusion applies to payments under a business interruption insurance policy. Indeed, litigation over the years has tested the scope of the exclusion as it relates to such insurance payments. Some aggrieved secured parties have successfully asserted that payments under a business interruption insurance policy are covered by Article 9 and that the secured party’s financing statement perfected its security interest in such payments. For example, in In re Bell Fuel Corp.,[v] a secured party asserted that a claim under a business interruption insurance policy was a form of general intangible. Under common law, an insurance claim is a “thing of action,” and the UCC defines general intangibles to include “things in action.”[vi] The court in Bell Fuel concluded that the payment constituted a proceed of a general intangible and given that general intangibles fall within the scope of Article 9, the payment was a proceed of such collateral.[vii]

In MNC Commercial Corp. v. Rouse,[viii] a secured party successfully argued that claims under a business interruption insurance policy were the proceeds of either a “thing in action” or the debtor’s “business operations” over which the secured party asserted a lien given that its blanket lien encompassed all “tangible income-producing property.”[ix] The court concluded that whether the business interruption insurance proceeds were deemed to be the proceeds of the thing in action or the debtor’s “business operations,” the UCC’s insurance exclusion did not apply.

Notwithstanding these decisions, they represent a minority view. More reasoned (and recent) case law have upheld the broad exclusionary language of Section 9-108(d)(8), finding the exclusion to apply to all types of insurance other than assignments of health-care receivables. The most recent United States appellate court decision, Wheeling & Lake Erie Ry. Co. v. Keach,[x] held that the UCC’s insurance exclusion applies to payments under a business interruption insurance policy. According to the U.S. Court of Appeals for the First Circuit, “the insurance exclusion applies broadly to interests in as well as to claims under an insurance policy…. [T]he assignment of a right to payment under an insurance policy, which is inseparable from the policy itself, falls squarely within the heartland of the exclusion.”[xi] 

In reaching its decision, the court in Wheeler rejected the secured party’s assertions that its security interest was perfected in the insurance claim as a proceed of an “account” or as a “payment intangible,” which is a type of general intangible. As for the first characterization, the court noted that the UCC’s insurance exclusion is specific to carve out as “accounts” only receivables that constitute health-care-insurance receivables. The failure to expressly provide for additional payments under insurance suggests that none were intended to be included. As for the second characterization, the court used the rule of construction that when general and specific provisions of a statute conflict, the specific provisions control. The court concluded that to characterize a payment under an insurance policy as a “payment intangible” would undermine the specific exclusion of rights under an insurance policy as otherwise provided in the UCC.[xii]

Based on the court’s decision in Wheeling, a secured lender’s best approach is to assume that payments under insurance policies other than personal property insurance are not likely to be deemed to be “proceeds” covered by the UCC. This exclusion does not preclude a borrower from assigning its rights under an insurance policy to a lender. It simply means that the assignment must arise under state law other than the UCC.

State Law Variations

Looking beyond the UCC means moving away from the conformity the UCC provides. Some states have codified their laws regarding the assignment of insurance not covered by the UCC, but most have not.  For those states without a specific statute, the governing law is found in state common law as developed over decades of court decisions. A sampling of case law across jurisdictions reveals a multitude of possible steps necessary to obtain an enforceable assignment of a right to payment under an insurance policy. Options include:

• Written assignment of the policy (or claim thereunder) by the policy owner to the assignee;[xiii]
• Written assignment and possession of the policy by the assignee;[xiv]
• Oral assignment;[xv]
• Oral assignment and possession of the policy;[xvi]
• Possession of the policy;[xvii] or
• Written assignment and notice to the insurer.[xviii] 

Given these varied approaches, it can be difficult for a lender to know if it has a first priority lien in the insurance policy and payments, and the outcome under state common law sometimes can be counterintuitive to the rules under the UCC. 

For example, Rose v. AmSouth Bank of Florida[xix] involved multiple written assignments of the same life insurance policy. The first assignee, Rose, had financed the insurance premiums under the policy. However, Rose never notified the insurance company of the assignment. The second assignee, AmSouth, made a loan for which the life insurance policy served as primary collateral. Before extending its loan, AmSouth obtained a representation from the borrower that there were no other assignments and also contacted the insurance company to confirm if any prior assignments existed. Not knowing of the first assignment due to Rose’s failure to notify it, the insurance company responded that there were none. After the policy was assigned to AmSouth, AmSouth sent the assignment to the insurance company, and received an acknowledgment from the insurance company that the assignment had been recorded. 

After the borrower died, Rose sought payment under the policy from the insurance company based on its assignment. The insurance company refused to pay Rose, and instead made payment to AmSouth pursuant to the collateral assignment that had been recorded with it.

Relying on New York common law, the U.S. Court of Appeals for the Second Circuit held in favor of Rose. Quoting existing New York case law, the court noted that New York law provides that “priority in point of time establishes priority of right … without regard to the date of notification to the debtor.”[xx]  The court held immaterial the fact that AmSouth had first notified the insurance company of an assignment.

Rose highlights the potential inequitable result where an equivalent to the “first to file” rule is absent under a state’s common law. Had the applicable law been that of a state where both an assignment and notice to the insurer was required to establish priority, AmSouth would have prevailed. Instead, having attempted to confirm the priority of its lien before extending its loan to the borrower, Rose nonetheless had a right to payment superior to AmSouth. 

Suggestions for Collateral Assignments

Notwithstanding the varying, non-uniform law that governs collateral assignments of insurance, a lender must be ready to consider it as part of its collateral pool when circumstances warrant.  Consequently, it is best to employ a comprehensive approach to minimize the risk that an assignee overlooks a nuance under one state’s law and is held not to have a valid (or first priority) assignment. 

Pre-Assignment Diligence. Prior to extending any financing based on the rights in or proceeds to be paid under an insurance policy or otherwise relying upon an insurance policy as a primary source of repayment, a lender should:

1. Have the insured confirmed that it has not sold or otherwise assigned the policy to another.
2. Contact the insurance company and inquire whether its records indicate that a prior assignment has occurred. This will likely require the assistance of the insured, given that an insurance company is not obligated to share any information with a potential lender seeking to take an interest in the policy.
3. Conduct a cautionary UCC lien search in the applicable jurisdiction to determine whether any person has filed a UCC financing statement asserting an assignment of rights under an insurance policy or other collateral for which the insurance coverage could be asserted to be the proceeds thereof.

Assignment. The best approach to take when accepting a collateral assignment is to take all steps that may possibly be required under any state’s law. Choice of law considerations may not be straightforward, especially where the insured, insurer and lender (and any potential unknown assignee) are located in different jurisdictions. Moreover, public policy considerations could be relevant if the requirements for assignment differ among states. It is conceivable that a court in a forum state of any litigation could find that the policy considerations (e.g., either requiring or not requiring notice to an insurer, or that possession of the policy is or is not required) are relevant to determining a claim of priority among conflicting assignees. As a result, a lender obtaining an assignment should:

1. Have the insured execute a written assignment of rights under the particular policy. If the insurance company has a specific form of collateral assignment, using the insurance company’s form may be the best and most efficient approach. Such forms are common with collateral assignments of life insurance policies.
2. Deliver the assignment to the insurance company. The assignment is best sent by overnight courier or with delivery confirmation so there is independent verification the assignment was received by the insurance company.
3. In some instances, the insurance company may have a mechanism to acknowledge that the assignment has been received and noted in the insurance company’s records. This also is common with collateral assignments of life insurance policies. If no form acknowledgment exists, send a duplicate original of the assignment to the insurance company requesting that a copy of the assignment be signed and returned by the insurance company. The assignment should expressly provide that the insurer’s failure to acknowledge its receipt of notice of the assignment does not affect the validity or enforceability of the assignment. By doing so, the failure to acknowledge should not undermine a claim for proceeds, but the receipt of an acknowledgment would preclude the insurance company from disputing that it had knowledge of the assignment. 
4. Require that the insured deliver the original policy to the assignee to be held at all times while the assignment is in effect. In those states where possession is required, this will also help confirm that a valid assignment has not previously been made.

Nonetheless, it bears caution to note that even the most diligent of assignees may not be protected. As was the case of AmSouth in Rose, the assignee did all it could (other than take possession, which the court held was not a requirement under New York law) to ensure its priority position with respect to the assignment. As such, a secured lender seeking to rely upon an insurance policy as collateral may not be fully assured that its claim will prevail if it seeks to enforce its rights and collect upon the proceeds of its collateral.

[i] UCC § 9-102(a)(64).  

[ii] See PPG Indus., Inc. v. Hartford Fire Ins. Co., 531 F.2d 58, 61 (2d Cir. 1976).

[iii] U.C.C. § 9-109(d)(8). Note that two states, California and Louisiana, have non-uniform provisions of UCC Section 9-109(d)(8).

[iv] The Official Comments to the predecessor section to UCC Section 9-109(d)(8) expressly referenced the exclusion of life insurance policies as not fitting “easily under a general commercial statute” and being “adequately covered by existing law.” Official Comment No. 7, U.C.C. § 9-104 (1972).

[v] In re Bell Fuel Corp., 99 B.R. 602 (E.D. Pa. 1989), aff’d without opinion, 891 F.2d 281 (3d Cir. 1989). 

[vi] U.C.C. § 9-102(a)(42). 

[vii] Bell Fuel, 99 B.R. at 607. 

[viii] MNC Commercial Corp. v Rouse, No. 91-0615-CV-W-2, 1992 WL 674733 (W.D. Mo. Dec. 15, 1992). 

[ix] Id., 1992 WL 674733, at *1.

[x] 799 F.3d 1 (1st Cir. 2015). 

[xi] Id. at 6-7.

[xii] Id. at 9.

[xiii] Fidelity Mutual Life Ins. Co. v. City Nat’l Bank of Fairmont, 95 F. Supp. 276, 282 (N.D.W. Va. 1950); Moorestown Trust Co. v. Buzby, 157 A. 663, 664 (N.J. Ch. 1931); Rabinowitz v. People’s Nat’l Bank, 126 N.E. 289, 290 (Mass. 1920).

[xiv] McAllen State Bank v. Texas Bank & Trust Co., 433 S.W.2d 167, 171 (Tex. 1968); In re Mile High Restaurants, 233 F. Supp. 936, 938 (D. Colo. 1964).

[xv] In re Anchorage Nautical Tours, Inc., 102 B.R. 741, 744-45 (B.A.P. 9th Cir. 1989).

[xvi] Considine v. Considine, 7 N.Y.S. 2d 834, 835-36 (N.Y. App. Div. 1938); Detroit Life Ins. Co. v. Linsenmier, 217 N.W. 919, 920 (Mich. 1928).

[xvii] In re Bickford’s Estate, 38 N.Y.S. 2d 785, 787 (N.Y. App. Div. 1942); Woofter v. Fourth Nat’l Bank of Tulsa, 78 P.2d 683 (Okla. 1938).

[xviii] In re Big Squaw Mountain Corp., 122 B.R. 831, 838-39 (Bankr. D. Me. 1990); Klebba v. Struempf, 23 S.W. 2d 205, 207-08 (Mo. Ct. App. 1930); Patten v. Mutual Benefit Life Ins. Co., 6 S.E.2d 26, 30 (S.C. 1939).

[xix] Rose v. AmSouth Bank of Florida, 391 F.3d 63 (2d Cir. 2004).

[xx] Id. at 67 (quoting Rochester Ropes, Inc. v. Scherl, 121 F.2d 852, 852 (2d Cir. 1941)).