Mortgagee not escrowee of insurance proceeds but homeowner stated breach of contract action where mortgagee did not demonstrate that repairs were not economically feasible before applying the proceeds to the mortgage balance

After the mortgaged property in Avila v. CitiMortgage, Inc., No. 14-1949 (7th Cir. Sept. 4, 2015) was damaged by fire, and the mortgagee received insurance proceeds, it paid some the money to the homeowner to get the restoration underway. It later inspected the work and found it needed to be redone, but by that time the homeowner had missed several mortgage payments. The mortgagee then applied the remaining insurance proceeds from the insurance payout toward the homeowner’s outstanding mortgage loan and the home was never repaired. The homeowner brought a class action asserting claims for breach of contract and breach of fiduciary duty based on the mortgagee’s use of payout from the homeowner’s insurance policy to pay down the loan rather than repair the damaged house. The district court dismissed concluding that the mortgagee owed no fiduciary duty and the homeowner was precluded from bringing a breach-of-contract claim because his default preceded the mortgagee’s alleged breach. The Seventh Circuit affirmed in part and reversed in part. The Court determined that the terms of the mortgage contract precluded the fiduciary duty claim because it allowed the mortgagee to do what it did. The Court rejected the homeowner’s argument that because the insurance proceeds were placed in the hands of the mortgage it created an escrow under Illinois law. The mortgage did not explicitly create an escrow and the mortgagee did not affirmatively accept the role of escrow agent. The function of an escrow agent is to serve as intermediary to deliver the escrowed property in conformity with the parties’ instructions. But that was not the mortgagee’s role. The insurer was not party to the mortgage and thus could not be the grantor in any escrow created by the mortgage. The Court also noted that the mortgagee is vested with title to the insurance proceeds under the loss payee provision of the policy, unlike a typical escrow agent. By contrast, other provisions in the mortgage are explicit in creating an escrow for taxes and insurance. Under those provisions, the mortgagee’s function is simply to possess the funds and disburse them in accordance with the escrow instructions; it does not have an independent property interest in the funds. On the breach of contract claim, however, the court found the homeowner pled a plausible claim. The mortgage said that the insurance money shall be applied towards the property’s repair if it was economically feasible and mortgagee’s security is not lessened. But the mortgagee never indicated that repairing the house was economically infeasible or would harm its security interest. The mortgagee said it was excused from making this election because the mortgagor had defaulted. Section 22 of the mortgage describes the mortgagee’s remedies in the event of a default, and because it establishes a specific process for dealing with a default, the homeowner’s first default would not make the mortgage agreement thereafter wholly unenforceable. While the mortgagee could have accelerated the loan in response to the default, applying the insurance proceeds to pay down the loan balance was not a remedy for missed payments.

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