David James believes lender clauses are dangerous and must be handled with care

Lenders clauses are a series of variations to coverage that extend insurers' liability - often in unexpected directions. They include: confirming non-vitiation extensions, notification commitments to third parties on key dates (such as following changes in terms), confirming that adequate disclosure has been given and to whom (and how quickly) a loss should be paid. These notification commitments can sometimes be triggered simply by underwriters becoming aware of a particular fact or circumstance, eg the right to take a point on non-compliance with a policy term or condition. Ascertaining when an underwriter's awareness was sufficient to trigger the provision is, in practice, very difficult to determine.

These clauses are increasingly common in property and terrorism markets. We should expect banks' advisers to increasingly push for their adoption. In the past insurers have signed loss payee clauses - simply directing the flow of claims monies to the financiers - but these new clauses go a lot further.

The breadth and possibly explosive potential of such clauses will only be properly felt when the first major "unexpected" loss occurs as a result of one of these clauses being agreed. They are serious variations of the standard terms that insurers have relied upon for the last hundred or more years - basic concepts such as disclosure are overridden without any consideration.

In practical terms, if assureds want to get such clauses agreed we would ask two things. The first thing is timing. Let your underwriters know what clause you need early - ideally before coverage is bound. The second thing is communication. Involve your broker early.

The effect of most lenders' clauses is effectively to circumvent the protections put in place by underwriters in the policy by enabling the lender to recover in circumstances where the insured has breached a term of the policy, such as a condition or warranty. Their consequences may therefore be far reaching.

These clauses are dangerous and should be treated as what they are: a significant variation of the key contractual terms.

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