This article continues to discuss Insurance Benefits for Banks as Mortgagees. The first part of this article was published on Chinalawinsight on January 2012.
III. Assignment of Insurance Benefits
In practice, in order to insure the debt, the lender bank often signs an insurance assignment agreement with the borrower, in which the borrower will assign all insurance benefits(1) under the related property insurance policy(2) to the lender bank. The assignment of rights becomes effective at the moment when the assignment contract is signed, or when the borrower defaults on the loan. Meanwhile, the endorsement slip, in which the insured designates the bank as the "first beneficiary" under the insurance policy, confirms the rights of the bank. To evaluate the feasibility of the insurance assignment contract, the fundamental approach from an insurance law perspective is to assess the nature of the insurance benefits assigned.
According to the basic insurance theory under the purview of English Common Law jurisdictions, the rights derived from an insurance contract is the subject matter of case law. Article 136 of the Law of Property Act 1925(3) provides that an assignor can assign in writing any right of claims and other subject matters of litigation under the Common Law. Therefore, this provision is applicable in any right of claims and other subject matters of litigation, including the rights derived from an insurance contract. But, this provision is applicable only to existing litigation matters. Non-existent rights or rights that the assignor is not yet entitled to cannot be assigned. The assignment of contingent rights of claims will only be recognized as an equitable right.
The assignment of rights under an insurance contract should be conducted in accordance with all applicable laws and regulations. The assignment methods include: (1) assigning the rights under an insurance contract as a whole; (2) assigning the right of claims for insurance benefits under an insurance contract. The difference between these two methods is that under the first method, the assignee becomes the insured, and the assignor is no longer a party to the insurance contract; on the other hand, under the second method, the assignor remains the insured. The following is an in-depth analysis of the various risks and benefits of these two assignment methods in light of basic concepts under PRC insurance laws.
A. The Assignment of the Rights under an Insurance Contract as a Whole
In practice, it is uncommon for a borrower to assign the rights under an insurance policy against the mortgaged property to the lender bank in whole. However, we will discuss this kind of assignment because it will ultimately make the bank obtain the rights under an insurance contract.
According to traditional Common Law insurance theory, where an insurance contract is assigned in whole, the nature of the insurance contract determines whether the assignment is prohibited and whether the permission of the insurer is required. In an insurance contract assignment, especially a property insurance contract assignment as discussed above, the assignee must have an insurable interest over the insured property when the assignment contract is signed. Thus, the assignment of rights under a property insurance contract in whole should be combined with the assignment of the insured subject matter. This requirement is premised on the fact that most insured are the owners of the subject matter of the property insurance. In practice, the assignment of the property insurance contract is always accompanied with the transfer of the subject property. It is worth noting that this theory does not signify that the insurable interest of a property insurance contract lies only in the ownership of the insured subject matter. On the contrary, Common Law insurance theory also recognizes that insurable interests can derive from legal relationships of trust, tenancy or security interests.
As a matter of fact, due to the specific relations under a loan contract, the lender bank cannot be the insured and the owner of the subject property under a property insurance contract at the same time. As a result, the issue that arises is whether the lender bank can, without the transfer of the insured subject matter in at property insurance contracts, accomplish the insurance contract assignment in the name of the security right holder or the creditor?
The Insurance Law of the PRC(4) ("Insurance Law") does not address issues relating to the assignment of a property insurance contract, nor does it require the assignee to have an insurable interest over the insured property when conducting the assignment. The Insurance Law only provides that "where an insured subject matter is assigned, the assignee shall be a successor to the rights and obligations of the insured." In a literal sense, this provision allows the assignment of the insured subject matter will result in the assignment of the insurance contract, but the former is not a prerequisite for the latter. We can further analyze the feasibility of the assignment of an insurance contract within the purview the Contract Law of the PRC(5) ("Contract Law"). Article 88 of the Contract Law provides that a party to a contract may assign the whole of its contractual rights and obligations to a third party with the consent of the other party. Therefore, without the transfer of the insured subject, the assignment of the entire interest in an insurance contract requires the consent of the insurance company. Assuming that the nature of the property insurance contract allows the above assignment, the insurance company involved is inclined to care less about the insurable interest of the assignment than about the risks behind the transfer (especially the moral hazard of the bank who is not the owner of the property) when conducting such an assignment. As a result, the bank does not play a dominant role in the assignment. It is also difficult for the bank to demand the insurance company and the borrower to cooperate and accomplish the assignment according to the former agreements among the parties involved. If the insurance company finally agrees to conduct the assignment, the bank, as the insured, will become a party to the insurance contract. The legal status of the bank as the insured has been previously discussed in this article.
B. The Assignment of the Right to Claim Insurance Benefits under an Insurance Contract
This form of assignment is the most common in banking practice. Banks hope to obtain all of the insurance benefits of an insurance policy without assuming obligations of the insurance contract.
In short, this type of assignment does not change the relationship of the parties to an insurance contract, the assignor is still the insured and shall assume obligations under the insurance contract. According to the Common Law insurance law theory, the insured or the assignee shall notify the insurer of the assignment in a timely manner, but the consent from the insurer is not required. Moreover, the insured is still a party to the original insurance transaction after the assignment transaction, and the assignee is not required to have an insurable interest over the insured property.
It is worth noting that even though this type of assignment is theoretically reasonable, it is still risky under the Insurance Law framework. The insurance assignment contract and the endorsement slip issued by the insurance company designate the bank as the "first beneficiary" to the insurance contract. The bank is entitled to obtain the borrower’s insurance benefits under the insurance contract that is due or will be due. However, two major issues arise: (1) is the establishment of the "first beneficiary" by the three parties legitimate during the insurance assignment transaction? (2) recalling the unique nature of an insurance contract that the right to receive insurance benefits is still a contingent claim at the time of assignment, will the actual rights enjoyed by the assignee be weakened when the insurance contract is due?
As to issue (1), the essence of the assignment of the right to claim for insurance benefits is to establish the "first beneficiary" that is entitled to receive the insurance benefits under a property insurance contract. However, if the establishment of an extra-statutory obligee in an insurance contract is illegitimate, the insurance company may argue against the bank’s status as a party to the contract, and still pay the insurance benefits directly to the insured on the grounds that the establishment of the "first beneficiary" is illegal. According to the Insurance Law, parties concerned in a property insurance contract include the policy holder, the insurer, and the insured. The insured means a person who is entitled to claim the insurance proceeds. Moreover, there are risks to assigning a beneficiary in a property insurance contract. Although related laws do not clearly prohibit assigning a third party the right to claim for the insurance benefits, the risk that the insurance company only pays the insurance benefits to the insured still exist in practice.
Before exploring issue (2), the definition of the insurance benefits provided in an actual insurance assignment contract may offer some enlightenment. It can be inferred from this definition that the contents of the insurance assignment contract include the existing right to claim for the insurance benefits that is due as well as the contingent right to claim for the insurance benefits that will be due. According to the Common Law insurance theory, the collection of the creditor’s right that is due is a common legal right, and the assignee can bring a suit in his/her own name. With regard to the judicial practice in China, the assignee of the creditor’s right can bring a suit against the debtor, demanding the debtor to render performance. The above mentioned Shanghai precedents support this as well.
However, a few impediments will prevent the assignee from obtaining the insurance benefits that would be due. Presuming an insured against incident occurs, and the insured is slow to perform his/her duty to notify the insurer, the insurer may not make any active investigations in the accident in order to confirm the amount of indemnity. Under this circumstance, can the assignee directly claim for the insurance benefits against the insurer if the insurer’s obligation to pay the insurance benefits has not become due? According to the Common Law insurance theory, the assignment of contingent creditor’s right is regulated by the principles of equity, what the assignee obtains is not the right to institute legal proceedings, but the right of a "beneficial interest". "After the consent of the assignor, the assignee and assignor can be the co-plaintiffs and bring forward a lawsuit together."(6)We can conclude from the analysis of the above theory that what the assignee obtains is only the right to receive contingent insurance benefits. Since the assigned right does not constitute the subject matter of litigation under common law, the assignee is unable to obtain the corresponding right to bring a lawsuit. The Common Law affords other remedies to the assignees under the assignment of the contingent creditor’s right so that they can bring a lawsuit under certain circumstances.
Under China’s laws, the property insurance contract is ambiguous in nature.What the insured enjoys is a contingent creditor’s right, which is nonexistentuntil the insured-against incidents specified in the contract take place. According to the judicial practice in China, contingent creditor’s rights are assignable, but the legal effect of the assignment will not take effect until the creditor’s right comes into existence. After the assignment takes effect, the assignee has the right to directly claim against the debtor. The insurer’s obligation to pay insurance benefits has yet to be vested at the moment the insurance assignment contract is signed between the bank and the debtor, and thus the assignment of related insurance benefits has yet to take the corresponding effect. According to the nature of the property insurance contract, the insurer pays insurance benefits to the insured only when damages or losses take place due to the insured-against incidents. Thereafter, the assignment of the creditor’s right would take effect. Thus, the insured’s obligation to promptly notify the insurer becomes very important. Article 21 of the Insurance Law specifies that:
"the policy holder, the insured or the beneficiary(7) shall, in a timely manner, notify the insurer after being aware of the occurrence of an incident covered by insurance. Where a policy holder, insured or beneficiary fails to notify the insurer in a timely manner intentionally or out of gross negligence, making it difficult to ascertain the nature, cause, extent of the loss, etc., of the incident covered by insurance, the insurer shall not be liable for indemnification or payment of insurance benefits for the undeterminable part, unless the insurer has known or should have known the incident in a timely manner through other channels."
Therefore, if the insured delays in performing his obligations to notify the insurer when the insured-against incident occurs, the insurer can refuse paying the indemnification or insurance benefits. In such a situation, the assignee can not initiate its independent claims for there is no actual interest contained in the assignment. The judicial practice in Shanghai is signified by the People’s Court’s holding that: "a beneficiary refers particularly to a person who is entitled to claim for the insurance benefits in a personal insurance policy. If a beneficiary is created in a contract of property insurance, the beneficiary can be reimbursed only after the insurance company has indemnified the loss. The beneficiary is not entitled to claim for the insurance benefits.
In summary, the China legal system does not provide a proper mechanism for the parties in a property insurance contract to set up a beneficiary. Consequently, even if there is an assignment of the right to claim for the insurance benefits between the bank and the insured (the borrower), it is difficult for the bank to claim for insurance benefits against the insurer directly at the time the mortgaged property suffers damage or loss. Commonly, the bank can claim the insurance benefits against the insurer with the insured’s assistance. On the other hand, the hypothesis that the bank can be designated as the insured is judicially sustainable, but the designation needs consent from the insurer. In addition, other difficulties also impede the bank in performing the obligations of an insured. Thus, it is rare in practice for the parties in a property insurance contract to designate the bank as the insured. On the contrary, it is a feasible way for the bank to guarantee the bank’s legitimate right to claim for the insurance benefits if the bank and the insured reach an agreement on the end use of the insurance benefits. The bank can only urge and cooperate with the parties of the insurance contract in an active manner to make the key procedures (such as the confirmation of insurance benefits and the final indemnification) to move forward smoothly. Under the current legal system of China, the bank is not entitled to bring a lawsuit against the non-compliant activities in those procedures. This is also a grave risk factor the banks should consider when conducting loan transactions.
1、All the insurance benefits generally refer to all the payments which were due or would be due to the borrower (the insured) under the insurance policy.
2、The related property insurance policies generally refer to those insurance policies relating to the target property under the loan. They also can include insurance policies only pertaining to the assignee.
3、The Law of Property Act 1925 is a statute of the United Kingdom Parliament. The programme was intended to modernise the English law of real property. The Act deals principally with the transfer of property by leas and deed.
4、The Insurance Law of the PRC was adopted at the 14th Meeting of the Standing Committee of 8th National People’s Congress on June 30, 1995, amended in accordance with the Decision on the Amendment of the ‘Insurance Law of the People’s Republic of China’ made at 30th Meeting of the Standing Committee of 9th National People’s Congress on October 28, 2002, and amended at 7th Meeting of the Standing Committee of 11th National People’s Congress on February 28, 2009.
5、The Contract Law of the PRC was adopted at the 2nd Session of the 9th National People’s Congress on March 15, 1999 and came into effect as of October 1, 1999.
6、Malcolm A. Clarke, Insurance Contract Law, p.177
7、The "beneficiary" here refers to a person who, as designated by the insured or the policy holder in an insurance of person, is entitled to claim for insurance benefits.