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Iron Horse Auto, Inc. v. Lititz Mutual Insurance Co.

April 27, 2007


Appeal from Shawnee district court; FRANKLIN R. THEIS, judge.


1. A standard mortgage clause, also known as a union mortgage clause, is an insurance policy provision that provides for loss payments to a named mortgagee even if the named insured's claim may be denied because of the named insured's acts or noncompliance with the policy terms. A standard or union mortgage clause creates a separate contract between the insurer and the mortgagee.

2. K.S.A. 40-2,118 does not nullify, abolish, or invalidate standard or union mortgage clauses in this state. Where an insurer has provided an insurance policy containing a standard or union mortgage clause, the named mortgagee is entitled to the benefits of that coverage according to the policy terms. A standard or union mortgage clause does not violate the public policy of this state.

3. The language of an insurance policy is construed from the perspective of what a reasonably prudent insured would understand the language to mean. The test is not what the insurer intended the language to mean.

The opinion of the court was delivered by: Johnson, J.


Lititz Mutual Insurance Company (Insurance Company) appeals from the summary judgment in favor of Capital City Bank (Bank), whereby the district court found that the Insurance Company's commercial insurance policy provided for a loss payment to the Bank, as mortgageholder, notwithstanding the named insured's filing of a fraudulent claim. The Insurance Company contends that K.S.A. 40-2,118(c) excused the payment to the Bank and, further, that the policy provisions and endorsements specifically excluded coverage for the Bank. Disagreeing on both counts, we affirm.

Iron Horse Auto, Inc. (Named Insured) owned improved real estate as part of its used car dealership business operations. It had a commercial insurance policy with Insurance Company providing, inter alia, fire insurance on its office building with a policy limit of $79,500. The policy also identified William Frye as a named insured and listed the Bank as a "Mortgagee Holder" on the insured building.

The Named Insured owed money to the Bank upon two promissory notes secured by real estate mortgages on the dealership's improved commercial property. The mortgages required the Named Insured to procure and maintain a fire and extended coverage insurance policy on the real estate improvements with the specific requirement that the policy have "a standard mortgagee clause in favor of Lender." Further, the mortgage directed that "[e]ach insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Grantor or any other person."

After the Insurance Company denied certain claims, including one for a fire loss, the Named Insured filed suit against its insurer. The Insurance Company defended on the basis that Frye and/or his wife had participated in setting the fire which caused the claimed loss. The Bank intervened and filed a Third Party Petition which included a breach of contract claim against the Insurance Company for failing to pay the Bank's damages pursuant to the mortgageholder provisions in the policy.

Subsequently, the district court granted the Bank's partial summary judgment motion, finding that the Insurance Company had to pay the Bank under the policy's standard mortgage clause, regardless of whether the Named Insured's claim was fraudulent. The Bank did not participate in the ensuing trial, where the jury found in favor of the Insurance Company. The court entered judgment for the Bank against the Insurance Company in the amount of $43,987.15 plus interest. The Insurance Company appealed that judgment, and we granted its motion to transfer the case to this court.


The Insurance Company's overarching theme in this appeal is an attack upon the judicial recognition and application of an insurance policy provision commonly referred to as a "standard mortgage clause" or a "union mortgage clause." Such a clause provides that a mortgagee will be paid for a covered loss notwithstanding the insurer's right to deny the named insured's claim based upon the named insured's acts or noncompliance with the policy's terms. A popular treatise on insurance law provides some insight, as follows:

"Many policies insuring property contain provisions which purport to protect the mortgagee against loss from causes insured against. . . .

"The ordinary mortgage or loss-payable clause merely provides in effect that the proceeds of the policy shall be paid first to the mortgagee as his or her interest may appear; but the so-called 'standard' or 'union' mortgage clause is somewhat more specific, in that it also provides that the mortgagee shall be protected against loss from any act or neglect of the mortgagor or owner, so that it shall not defeat the insurance so far as the interest of the mortgagee is concerned." 4 Couch on Insurance 3d § 65:8, pp. 65-16 to 65-17 (1996).

See 44 Am. Jur. 2d, Insurance § 1049, p. 297.

The union mortgage clause in an insurance policy creates a separate contract between the mortgagee and the insurer. Vargas v. Nautilus Ins. Co., 248 Kan. 881, 887, 811 P.2d 868 (1991); see also Nieses v. Solomon State Bank, 236 Kan. 767, 778, 696 P.2d 372 (1985) ("Kansas follows the majority rule, i.e., that a standard mortgage clause operates as a distinct and separate contract between the insurer and the mortgagee."); Fancher v. Carson-Campbell, Inc., 216 Kan. 141, 144, 530 P.2d 1225 (1975) ("We have been consistent in holding that [a union mortgage clause] creates a new and independent contract which entitles the mortgagee to recover under the policy of insurance, notwithstanding the effect of any act or neglect on the part of the owner or mortgagor of the property."); Wunschel v. Transcontinental Ins. Co., 17 Kan. App. 2d 457, 463, 839 P.2d 64 (1992). The Insurance Company describes this long-standing and well-settled contract interpretation as "an archaic vestige of 19th Century law."

The policy at issue here has a section entitled, "Mortgageholders," which provides, in relevant part, as follows:

"b. We will pay for covered loss of or damage to buildings or structures to each mortgageholder shown in the Declarations in their order of precedence, as interests may appear.

"d. If we deny your claim because of your acts or because you have failed to comply with the terms of this Coverage Part, the mortgageholder will still have the right to receive loss payment if the mortgageholder:

(1) Pays any premium due under this Coverage Part at our request if you have failed to do so;

(2) Submits a signed, sworn proof of loss within 60 days after receiving notice from us of your failure to do so; and

(3) Has notified us of any change in ownership, occupancy or substantial change in risk known to the mortgageholder.

All of the terms of this Coverage Part will then apply directly to the mortgageholder.

"e. If we pay the mortgageholder for any loss or damage and deny payment to you because of your acts or because you have failed to comply with the terms of this Coverage Part:

(1) The mortgageholder's rights under the mortgage will be transferred to us to the extent of the amount we pay; and

(2) The mortgageholder's right to recover the full amount of the mortgageholder's claim will not be impaired.

At our option, we may pay to the mortgageholder the whole principal on the mortgage plus any accrued interest. In this event, your mortgage and note will be transferred to us and you will pay your remaining mortgage debt to us."

An endorsement changed the language of subsection (b) to read:

"4. Paragraph b. in the Mortgageholders Additional Condition in the Building And Personal Property Coverage Form ...

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