Question:
I purchased a boat with a loan from an established marine lender. My signed loan agreement was called a “Security Agreement, Note and Disclosure Statement.” The boat was documented with the Coast Guard, and the mortgage was recorded with the Coast Guard as a “Preferred Ship Mortgage” when I purchased the boat. A year later, the boat was lost in a fire and unfortunately my insurance company denied my claim. The denial led to a lawsuit against my insurance company which I eventually lost. After the conclusion of the lawsuit my lender filed a “Satisfaction of Preferred Ship Mortgage” with the Coast Guard, and I assumed at that point that the entire matter was finally over. However, several months ago I received a demand letter from a company that had apparently purchased my loan from the original lender, claiming that I still owe a substantial balance on the note. That letter was a shock in light of the “Satisfaction of Mortgage” filed by my original lender. Can they do this? I’m hoping this is a simple matter of an incomplete file being sent to the new lender.
Answer
I’m afraid I don’t have any good news for our reader. His insurance company denied a claim on a boat that was a total loss, but he still owes money on the boat to the new lender. His confusion about the current status of his loan is probably due to a number of misunderstandings, about the relationship between an insurance company and a lender, and the function and legal effect of a mortgage recorded with the Coast Guard.
Most of us have purchased property with the help of a bank loan. And, whether the property is a boat, a car or a home, we accept the fact that the lender will require the property to be insured, and the lender named as “loss payee” on the insurance policy. This protects both the lender and the property owner in the event of a catastrophic loss, since the insurance proceeds will be used to pay off the loan and the owner / borrower won’t be saddled with payments for property that he or she no longer owns. This arrangement works perfectly unless the loss is caused by an act or omission that leads to a denial of insurance coverage.
A marine insurance claim may be denied for a variety of reasons, but most denials are based on a failure of the boat owner to maintain the part or parts that caused the loss. This is not always a straight-forward analysis, since the cause of the loss and the adequacy of the maintenance may both be disputed, and claim denials therefore often lead to litigation.
As noted above, the loss payee listed on an insurance policy enjoys certain benefits from that policy, but the burden that is felt in the event of a claim denial falls solely in the property owner. When our reader’s litigation was unsuccessful and the claim denial was upheld, he had an unpaid balance on his loan and that balance did not go away.
Certain types of insurance coverage may be available, for an additional premium, that would protect against the loss suffered by our reader. A breach of warranty clause (also known as a breach of warranty endorsement) ensures that a lender with a security interest in a vessel is still paid in the event of a covered loss, even if the boat owner’s claim is denied due to a breach of a policy condition. A breach of warranty endorsement is a separate clause added solely for the benefit of a financial institution, to protect their financial interest in the yacht. Unfortunately, these endorsements are typically not available for recreational boat insurance policies, and in any event our reader did not have this coverage.
Our reader’s other area of confusion concerns the function and legal effect of a mortgage recorded with the Coast Guard. A Preferred Ship Mortgage is a legal device that secures an obligation of the vessel owner by encumbering the title of the vessel until the underlying obligations are satisfied. A “Satisfaction of Mortgage” is a document that is filed with the Coast Guard to release the vessel from those obligations, but the document has no bearing whatsoever on the underlying obligations of the boat owner.
When the Satisfaction of Mortgage is filed, the boat is no longer collateral for the loan, but the loan itself does not go away. In this case, since the boat was destroyed and therefore had no value as collateral, the lender may have filed a Satisfaction of Mortgage simply as a housekeeping item to clean up its books. But our reader’s obligations remain unchanged, and he will need to deal with the new owner of the loan.
An insurance claim denial on a boat with an unpaid loan balance is one of the most painful experiences that any boat owner can endure. Insurance policies may not be particularly interesting to read, but most policies are written in relatively plain English, and they should be required reading for every boat owner. Compliance with the provisions of a marine insurance policy is critical, and all boat owners should familiarize themselves with those provisions to avoid a scenario such as the one described above. Contact a maritime attorney if any of those provisions are unclear.
