Texas Case Highlights Need for Mortgage Lenders to Use Caution When Advising on Flood Insurance

11/7/2017

The lack of flood insurance policies in the areas affected by the floods in Louisiana in August 2016 and those in the Houston area in 2017 has spurred much discussion about National Flood Insurance Program requirements for homeowners. With the NFIP set to expire this December, a case recently filed in Houston could add an interesting element to the debate in Congress over whether and how to address the program’s financial challenges.

After his home flooded during Hurricane Harvey, a Houston attorney sued his mortgage lender for allegedly advising him not to purchase flood insurance when the attorney bought his home, raising concerns for similar lawsuits after four hurricanes made landfall in the United States and its territories just this year.

In his complaint—filed in the Southern District of Texas—the attorney alleges that he originally procured flood insurance to cover his home when he purchased it in the summer of 2011. But when the attorney submitted his proof of coverage to his lender, the attorney alleges that the mortgage lender advised him not to buy flood insurance because the home was not in a flood zone. The attorney claims that he relied on the mortgage lender’s advice and cancelled his flood insurance before the loan closing.

In the lawsuit, the attorney claims that the mortgage lender negligently provided “home-insurance advice,” and that the mortgage lender negligently misrepresented that the home was not in a flood zone. The attorney also alleges that the mortgage lender engaged in the unlawful practice of insurance by providing “flood insurance advice and other counseling” during the loan application process.

Generally, the National Flood Insurance Act, which established the NFIP, requires lenders to determine whether property is located in a flood zone and, if so, to notify borrowers and ensure that flood insurance is obtained. And lenders that violate these requirements can be subject to civil penalties under the Act.

In the past, numerous borrowers have filed suit against their lenders for allegedly failing to properly determine whether property is located in a flood zone, but courts have made clear that the Act did not create a private cause of action against lenders who fail to comply with its regulations. Instead, state law controls whether a common law right of action exists against a lender who allegedly fails to properly notify a borrower that property is located in a flood zone.

To date, most courts that have addressed the issue have held that the Act preempts any state law causes of action. That said, the appellate courts of many states have yet to decide the issue. And what makes this recent case novel is that the plaintiff alleges that his lender engaged in the “unauthorized practice of insurance”—an issue that has yet to be addressed in the context of the lending relationship.

Given the recent flooding across the nation, financial institutions should be prepared to address these types of claims and seek to prevent them by focusing on full compliance with the Act and the NFIP.

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