After appellants’ home was severely damaged by Superstorm Sandy, they defaulted on their mortgage loan. Their flood insurer paid out $150,000 in benefits for the damage.
Pursuant to the contract terms, the lender’s assignee held the insurance funds in escrow, while it decided whether repairs to the house would be "economically infeasible" or would lessen its security.
Over three years passed before the lender ultimately applied the insurance proceeds to the homeowners' outstanding debt. During that lengthy interval, over $40,000 in mortgage interest accrued.
The homeowners unsuccessfully argued to the Chancery judge they were entitled to a credit on the foreclosure judgment for that portion of the interest, due to the lender’s allegedly unfair conduct.
Consistent with principles of fairness and reasonableness set forth in the Restatement (Third) of Property (Mortgages) (1997), this court holds the lender in such situations owes the borrower an implied covenant of good faith and fair dealing in determining how to dispose of the property or flood insurance funds.
If the lender unreasonably delays making a decision about the proposed use of the insurance funds for repairs, the Chancery judge has the equitable power to abate the mortgage interest that accumulated in the meantime. Additionally, the lender must place the insurance funds in an interest-bearing, segregated account until the proper use of those funds is resolved.
Having announced these governing principles, the court remands this matter to Chancery Division to develop the record more fully and evaluate whether the mortgage company breached the implied covenant.