Appeal by Iaia's Crossroads Restaurant, Ltd. from a July 18, 1986 order of the United States District Court for the Northern District of New York (McCurn, J). that affirmed a January 6, 1986 order of the Bankruptcy Court of the Northern District of New York (Mahoney, J.). The judgment held that defendant Col-Mur had purchased a single benefit fire insurance policy from appellee National Casualty Company and that National was subrogated to its insured's interest in the proceeds of the sale of the insured property. Reversed and remanded.
The subject of this appeal is a restaurant business encumbered originally by a single mortgage to a bank. The owner should the business and took back a mortgage. Shortly thereafter, the purchaser in turn sold the property and also took back a mortgage as part of the purchase price. The third owner then had a restaurant saddled with three mortgages. While such "borrowing" may not have dulled the third owner's "edge of husbandry," it did result in a cash crunch that unsurprisingly rendered the owner unable either to service the mortgages or to pay the fire insurance premiums on the property. After the owner went bankrupt, a fire destroyed the restaurant, bringing about a forced sale of the property, and precipitating the instant litigating contesting the distribution of the proceeds of the sale.
This is an appeal from a July 18, 1986 order of the District Court for the Northern District of New York (McCurn, J.) that affirmed a decision of the bankruptcy court, which had ruled on the disputed claims to the proceeds. The restaurant property had been owned until March 1980 by Col-Mur Enterprises, Inc. (Col-Mur), subject to a first mortgage held by Key Bank. Col-Mur then sold the property to a company now known as Iaia's Crossroads Restaurant, Ltd. (Iaia), the appellant. Iaia took the property subject to the bank's mortgage and gave back a second mortgage to Col-Mur. Under the terms of the second mortgage Iaia promised to keep the property insured against fire for Col-Mur's benefit, and to deliver the insurance policies to and reimburse Col-Mur for the cost of any premiums.
Three years later Iaia sold the property in S.P.G. of Schenectady, Inc. (S.P.G.). S.P.G., in turn, assumed the bank's first and Col-Mur's second mortgages, and gave Iaia a third mortgage for $278,000. In accordance with these mortgages, S.P.G. obtained fire insurance naming Col-Mur and Iaia as the insured. When S.P.G. ran into financial difficulties, it filed a Chapter 11 bankruptcy petition on October 4, 1984, which was later converted into a Chapter 7 proceeding. S.P.G. thereafter defaulted on its mortgage payments and allowed the fire insurance policy that protected Col-Mur's and Iaia's interests to lapse on November 11, 1984.
Observing the heavy economic seas that S.P.G. had encountered -- and its implications for their interests -- Iaia and Col-Mur obtained separate fire insurance policies. Appellant Iaia obtained a $300,000 policy with the United National Insurance Company (United National). Col-Mur's $250,000 policy was written by the appellee, National Casualty Company (National) and designated as the named insureds the "Trustees for the Benefit of the Former Stockholders of Col-Mur Enterprises, Inc." (hereinafter simply called "Col-Mur"). Col-Mur's policy contained a subrogation clause permitting National to be subrogated to Col-Mur's rights, as mortgagee, against S.P.G. As discussed below, whether Col-Mur obtained the insurance for its own, i.e., "single" benefit, or for S.P.G.'s and Iaia's benefit, i.e., "dual" benefit, as well, is the issue we must decide.
Fire destroyed the restaurant on December 26, 1984 and five days later, Col-Mur instituted foreclosure proceedings and later obtained default judgment of foreclosure. With S.P.G.'s equity of redemption gone, the trustee in bankruptcy proposed to sell the property. To accomplish this, he brought an action against, inter alia, Col-Mur, Iaia, National, and United National to compel the two insurance companies to pay their respective policies. The trustee concluded that the insurance payments would reduce the mortgage debts owed by S.P.G. to Col-Mur and Iaia and thus decrease their shares of the sale proceeds. National paid Col-Mur $250,000 and United National paid Iaia $167,000 on their respective policies. The sale of the property produced $325,000. The order of priority for participation in the proceeds was as follows: costs of the sale, Key Bank's first mortgage of approximately $15,000, and the balance due Col-Mur under its mortgage after subtracting the insurance proceeds. The remainder, approximately $200,000, is the subject of this litigation.
In its answer to the trustee's complaint, National asserted that it was subrogated to Col-Mur's lien status and was therefore entitled to the lion's share of the proceeds from the sale of the property. Iaia cross-claimed against National and argued that § 254(4) of New York's Real Property Law required that National's payment to Col-Mur be deducted from the mortgage principal owed by S.P.G. to Col-Mur for which Iaia was secondarily liable. This appeal arose in the bankruptcy court when National moved successfully to dismiss Iaia's cross-claim.
In a Decision and Order dated January 8, 1986, the Bankruptcy Court for the Northern District of New York (Mahoney, J.) found that Col-Mur had obtained the National policy for its own exclusive benefit. The bankruptcy court also held that § 254(4) did not require reduction of the mortgage debt by the amount of the insurance proceeds paid pursuant to National's policy. The district court concluded upon Iaia's appeal and the bankruptcy judge had correctly found Col-Mur's policy to be a single interest policy. It ruled that Real Property Law § 254(4) did not apply and, even if it did apply, § 254(4) did not negate the operation of the subrogation clause in Col-Mur's policy with National. Finally, the district court rejected Iaia's argument that a subrogation clause like the one contained in Col-Mur's policy becomes operative only when there is proof of fraud or of an underlying tort claim, and that it is otherwise inoperative. We now reverse.*fn1
Iaia advances several theories as to why it is entitled to the proceeds. First, it claims that Col-Mur's policy with National was for S.P.G.'s and Iaia's benefit as well as Col-Mur's and therefore, under § 254(4), National is not entitled to subrogation until their interests are fully recovered. Second, Iaia argues that even if Col-Mur's policy with National only covers Col-Mur's interest, § 254(4) operates to nullify the subrogation clause. Third, Iaia claims that the subrogation clause in the policy only becomes operative when there is proof of fraud or of an underlying tort claim. Before taking up these claims, we first examine § 254(4).
A. § 254(4) of the Real Property Law
Section 254 construes several clauses often contained -- but not necessarily required -- in mortgage instruments. See N.Y. Real Prop. Law § 254 (McKinney 1968 & Supp. 1987). In other words, when the parties to a mortgage incorporate the relevant language, that language must then be construed according to the statute. Section 254(4), entitled "Mortgagor to keep buildings insured," construes a covenant*fn2 by the mortgagor that it will insure the mortgaged property against fire.*fn3 ...