When lending money to businesses, lenders typically require borrowers to provide evidence that the collateral securing their loan is adequately insured. Not only does the borrower need to have the correct type of coverage and the correct amount of coverage, but lenders also need to work with borrowers and their insurance agents to ensure lenders are properly named on those policies. In the event of a loss, a lender’s status on the applicable insurance policy can become an important factor in their ability to obtain the proceeds of the policy.

The proper type of insurance coverage can vary from borrower to borrower, but in most cases, lenders will want to ensure their borrowers have liability insurance and property insurance (including business personal property and real estate, as applicable). Depending on the borrower’s business, they may also need additional coverage, such as workers’ compensation insurance, business interruption insurance, liquor liability insurance, or professional malpractice insurance. The best practice for lenders is to ensure all this coverage is in place by the time their loan closes.

The proper amount of coverage can also vary from borrower to borrower and often depends on the type of collateral involved. Depending on the value of the collateral and the size of the loan, a lender may choose to require a borrower to obtain certain levels of liability and property coverage. In many cases, for policies that cover real property or personal property, lenders will require borrowers to obtain full replacement cost coverage or, if such amount is unavailable, coverage for the maximum insurable value.

Once lenders confirm their borrowers have the correct type and amount of coverage, they need to take the crucial next step of being named on their borrower’s policies. This allows a lender to recover directly from the insurance company in the event of a loss. Typically, for liability insurance, lenders should be named as Additional Insured, and for property insurance that covers real estate, lenders should be named as Mortgagee.

When it comes to business personal property, there are usually two options for lenders to be named on their borrower’s policies – they can be named as Loss Payee or Lender’s Loss Payee. While these two terms are very similar and sometimes erroneously used interchangeably, there is a key difference that is important for lenders. If a lender is named as Loss Payee and there is a covered loss, the insurance company would make the check payable to the lender and the borrower. However, if there was any reason why the insurance company would not be required to make a payment to the insured (borrower), such as a breach of the policy terms by the borrower, then the lender would also not receive payment. The option that affords the lender more protection is being named as Lender’s Loss Payee. Being named as Lender’s Loss Payee entitles lenders to payment, even in situations where the insured may not be entitled to payment due to their non-compliance with the terms of the policy.

Finally, when collecting documentation to verify adequate collateral insurance, it is important to remember that while the commonly used ACORD forms can provide a succinct summary of a borrower’s coverage, the ACORD forms are only issued as a matter of information and they confer no rights upon the certificate holder. Therefore, best practice is to verify that the borrower’s coverage and the lender’s certificate holder designation are truly as expected by obtaining additional supporting documentation.

If your lending institution has any questions about ensuring its collateral is properly insured, please reach out to Jellum Law, PA , Your SBA Legal Department®.