Banks not liable for flood damage

Banks avoided a flood of potential liability a couple weeks ago when the Iowa Supreme Court issued its decision in Bagelman v. First National Bank. The case involved two plaintiffs—the Bagelmans—who were attempting to hold two banks liable for damages to their home during the 2008 floods.

The events leading to the case began in 2001 when the Bagelmans decided to buy a house near the Cedar River in Waverly, Iowa. The Bagelmans approached First National Bank (“FNB”) about financing the purchase. FNB informed the Bagelmans that since the home was so close to the Cedar River it would have to obtain a flood determination pursuant to the National Flood Insurance Act (“NFIA”).

FNB hired an outside firm to make the flood determination. The firm reviewed Federal Emergency Management Administration (“FEMA”) flood maps of the Waverly area. The firm reviewed the 1990 flood maps and concluded that the Bagelmans’ house was in an area that did not require flood insurance. The firm’s conclusion was wrong.

As a result of the firm’s erroneous conclusion, the Bagelmans were advised that flood insurance was not required for their home purchase. Unbeknownst to the Bagelmans, the home they were about to purchase was actually located in special flood hazard area.

The Bagelmans did do some investigation of the home before purchasing it. They hired an engineer to determine the elevation of the property relative to a nearby bridge. They learned that the bridge was slightly lower than the house. They also inspected the crawlspace and verified the accuracy of the information on the seller’s disclosure of property condition form.

The Bagelmans then purchased the house with financing from FNB. At closing, FNB provided the Bagelmans with the erroneous flood determination, and also advised that the home may be close to a hazard zone so the Bagelmans should consider flood insurance.

Two years later, the Bagelmans sought to refinance with FNB in order to remodel the home. FNB obtained another erroneous flood determination from the same firm as before, and again informed the Bagelmans that flood insurance was not required. After refinancing, FNB assigned the loan to Iowa Banker’s Mortgage Company (“IBMC”). IBMC sold the loan to Fannie Mae, but remained the loan servicer.

In March 2008, FEMA issued new flood determination maps. The firm that had previously issued the two erroneous determinations advised IBMC that the Bagelmans’ house was now located in a special flood hazard area. In late May 2008, the firm sent a list to both FNB and IBMC of the houses that now required flood insurance, including the Bagelmans’ house.

On June 10, 2008, the Bagelmans’ house flooded as a result of catastrophic flooding of the Cedar River. On June 12, 2008, IBMC mailed a letter dated June 9, 2008, advising the Bagelmans that their home was now considered to be in a flood zone and that they should now obtain flood insurance. The Bagelmans received this letter on June 14, 2008, four days after their home was flooded.

The Bagelmans filed a lawsuit against FNB and IBMC. The Bagelmans had a number of claims, including a theory of liability premised on FNB and IBMC’s alleged violation of NFIA. The primary question the Iowa Supreme Court eventually decided to review was whether FNB and IBMC could be held liable for alleged violations of the NFIA.

The NFIA requires lenders to notify borrowers when the borrowers’ homes are in high-risk flood zones. Once borrowers are notified they have 45 days to purchase flood insurance. If the borrower fails to do so then the lender is required to purchase the insurance and charge the cost to the borrower.

The Bagelmans argued that FNB and IBMC failed in their responsibility to advise the Bagelmans that their home was in a flood zone. As a result, the Bagelmans argued that FNB and IBMC were responsible for the damages that arose from the 2008 flood. The Iowa Supreme Court disagreed.

The Iowa Supreme Court explained that the NFIA’s purpose was not to give borrowers the ability to pursue claims against lenders. Rather, NFIA is really an effort to shift flood losses from lenders and the government to the private insurance market. It would be inconsistent with the purpose of the statute to provide individual borrowers with the ability to bring claims against lenders. Thus, neither FNB nor IBMC were liable for alleged violations of NFIA.

The case ended there for FNB. However, the Iowa Supreme Court went on to consider whether IBMC may have been liable under state law anyway. The court left open the possibility that IBMC could be liable for failing to disclose the revised flood assessment in a more timely manner.

The court cited a case where a lender intentionally withheld a flood assessment in an effort to induce a borrower to purchase a property. The court did not indicate whether it thought IBMC had engaged in such conduct in this case. As a result, the case was sent back to the district court for additional proceedings to determine whether IBMC could be liable for failing to disclose the changed flood zone assessment. This could have important ramifications for banks in the future, so it will be important to pay close attention to this case as it proceeds forward.

For now, banks can take solace in the knowledge that in Iowa borrowers cannot sue a bank for alleged violations of the NFIA. However, banks should still take their responsibilities under NFIA seriously since failure to follow the statute could have serious ramifications other than lawsuits from borrowers.