Fire Three Days Before Closing: Who Has the Insurable Interest?
Dana signs a purchase agreement on February 1 to sell her 12,000-square-foot warehouse to Ridgeline LLC, with closing set for March 15. The contract is silent on risk of loss, and Ridgeline will not take possession until closing. Dana's commercial property policy runs July 1 to June 30 with a $500,000 building limit, replacement cost valuation, a $2,500 deductible, and a standard mortgage clause naming First Mesa Bank, which holds a $310,000 mortgage that will be satisfied at closing. On March 2, at Dana's request, her broker agrees to cancel the policy effective March 15. Ridgeline binds its own policy effective March 15. On March 12 a fire destroys the building. Dana files a claim on March 13, and Ridgeline files a claim under its own policy the same day.
1. Does Dana's policy respond to the March 12 loss, and does the agreed March 15 cancellation change the analysis?
Read the worked answer
Yes, Dana's policy responds.
- Timing of cancellation. A cancellation effective March 15 cannot reach backward. On March 12 the policy was still in force; the later effective date is irrelevant to a loss that occurred while coverage was in place.
- Insurable interest is measured at the time of loss. Dana still holds title, still bears the risk of loss under a contract that is silent on the point, and would suffer actual economic loss from the destruction. That is the classic test for insurable interest.
- Indemnity caps the recovery. Dana recovers her actual loss, not the $500,000 limit, subject to replacement cost provisions and the $2,500 deductible. She cannot profit from a loss that extinguishes a planned sale.
- The sale contract does not transfer the policy. Insurance follows the insured's interest; it does not automatically follow the property to a buyer unless assigned with insurer consent.
2. First Mesa Bank has a $310,000 mortgage balance. How is the claim payment allocated, and would the answer change if Dana had intentionally set the fire?
Read the worked answer
The standard mortgage clause makes the bank a loss payee to the extent of its interest, and it operates as separate contractual coverage running to the mortgagee.
- Normal loss: the insurer pays First Mesa Bank the lesser of the mortgage balance ($310,000) or the policy proceeds attributable to the building, and pays the remainder to Dana. The bank's interest is extinguished by the payoff at closing only if the closing actually occurs - it did not.
- If Dana committed arson: the mortgage clause typically survives the insured's acts. The bank would still collect up to its interest, and the insurer would pay Dana nothing on her own interest.
- Subrogation angle: if the insurer pays the bank, it may subrogate against the responsible party. It cannot subrogate against its own insured, which is one reason the mortgagee's independent coverage matters.
3. Ridgeline's claim is filed under its own policy, effective March 15, two days after the loss. Evaluate whether Ridgeline has coverage and whether Dana's insurer can pursue Ridgeline.
Read the worked answer
Ridgeline has no coverage, and subrogation against Ridgeline is unlikely to succeed.
- Ridgeline's policy had not incepted. A policy effective March 15 provides no coverage for a March 12 occurrence.
- No insurable interest on March 12. Ridgeline held no title, no possession, and no contractual risk of loss, so even a retroactive effective date would raise an insurable interest problem. A buyer with only an executory contract and no risk of loss generally has no insurable interest in the building.
- Dana's insurer mostly bears the loss. Subrogation requires a legally liable third party. Ridgeline committed no tort; a fire of unknown origin does not create liability. Pursuing the buyer would also be inefficient, since Ridgeline would simply look to Dana under the contract.
- Better practice: the parties should have coordinated a single policy through closing, or used a buyer's interim binder, rather than letting two policies begin and end around a closing date.