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In the aftermath of the January 1994 earthquake in Northridge, California, a wave of delinquencies and foreclosures occurred in the areas affected by the quake. It was a certainty that litigation would arise between Borrowers and Lenders over which party was entitled to recover the proceeds of earthquake insurance.

A June 1995 decision of the Court of Appeal has determined this issue in favor of the Borrowers, based on the language of the loan documents and the specific facts of the case.

In Ziello v. Superior Court (First Federal Bank of California), Ziello, the Borrower, obtained a mortgage loan from First Federal Bank, the Lender, to finance the purchase of a home in Northridge. The promissory note was secured by a deed of trust which required that the Borrower maintain certain fire and hazard insurance coverage but did not require earthquake coverage. The deed of trust also required the Lender to be named as "loss payee" under the insurance policy.

The Borrower obtained a policy of insurance with the coverage required by the Lender. Subsequently, the Borrower purchased earthquake insurance coverage for the property at her own expense.

The Insurer added earthquake insurance coverage to the existing policy and also included the Lender as loss payee for that coverage, without consulting the Borrower.

In January 1994, the Borrower's home was seriously damaged as a result of the Northridge earthquake. Beginning in February 1994, the Borrower began to fail to make her mortgage loan payments, and in May 1994 the Lender recorded a Notice of Default to commence non-judicial foreclosure proceedings.

That same month, May 1994, the Insurer informed the Borrower that it was prepared to issue a check for the earthquake damage caused to her home and, since the Lender was the loss payee under the policy, the Insurer made the check jointly payable to the Borrower and the Lender.

The Lender refused the Borrower's request to endorse the earthquake insurance proceeds over to her, and she filed suit seeking a declaration from the Court that she alone was entitled to the earthquake insurance proceeds.

The trial court ruled that the Lender was entitled to the earthquake insurance proceeds and granted summary judgment to the Lender (a means of obtaining a judgment by written request to the court without the necessity of a complete trial). Subsequently, the Lender completed its non-judicial foreclosure proceedings and acquired title to the property.

The Court of Appeal partially vacated, and partially affirmed, the trial court's summary judgment. The Court held that, absent any requirement by the Lender in its loan documents that the Borrower obtain earthquake insurance, or any broad provision as to the application of all insurance proceeds to repair the property or reduce indebtedness under the loan, the Borrower was entitled to the earthquake insurance proceeds.

In that regard, the fact that the Lender was named as loss payee on the earthquake insurance did not resolve the issue of entitlement to the proceeds in favor of the Lender.

The Court's decision in the Ziello case was and is specific to the facts of the case and the particular language of the loan agreement between the Borrower and Lender. However, the decision can provide a basis for affected Borrowers to claim the right to earthquake insurance proceeds where similar language is contained in the loan documents.

Analogous situations could easily arise in connection with the properties in Sacramento County and Placer County which were damaged by the flooding from the rains of the Winter of 1994-1995. The authority of the Ziello decision could give affected Borrowers a right to claim the proceeds of flood insurance, at least where the language of the loan documents was similar and the Lenders commenced and/or completed non-judicial foreclosure proceedings against the property.

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