Insurance Proceeds Payable to Tenant Diverted to Pay for Property Owner’s Back Taxes

May 19, 2017

The Third Circuit Court of Appeals sitting in Pennsylvania recently issued a precedential decision that interpreted the definition of a “named insured” under a tax delinquency statute to encompass tenants of a property even though the property owner, not the tenant, owed the delinquent taxes. In re: The Trustees of Conneaut Lake Park, No. 16-2516 (3d Cir. May 2, 2017). The Court held that the statute made receipt of insurance proceeds conditional on first satisfying the delinquent taxes owed on the property regardless of the insured’s ownership interest.

Park Restoration operated a 1-acre venue known as the Beach Club under a management agreement at a 55-acre park owned by the Trustees of Conneaut Lake. When the beach club was destroyed by a fire, the insurer required Park Restoration to obtain a certificate from the local municipal treasurer stating whether back taxes were owed on the property in accordance with 40 Pa. Stat. § 638. The statute prohibits insurance companies from paying a claim of a “named insured” for fire damage exceeding $7,500 unless the insurer is furnished with the appropriate certificate from the municipal treasurer. To the surprise of Park Restoration, the certificate stated that the Trustees owed $478,260 in back taxes to local and state authorities on the entire 55—acre plot of land dating back to 1996, well before Park Restoration rented the venue.

The Third Circuit held that Section 638 does not require that the named insured referenced in the statute be the owner or limit the imposition of the tax proceeds to only the entity liable for the tax debt. In other words, the tax runs with the property and the tax claim is attached to any fire insurance proceeds payable to any named insured. The Court determined the taxing authorities were entitled to the full payment of the back taxes irrespective of the lack of Park Restoration’s ownership interest, and that Park Restoration was entitled to the remaining balance. The public policy underlying the statute, which is to prevent property owners from profiting from arson, applies equally to tenants. 

Although the Pennsylvania Supreme Court has not ruled on this issue, the Third Circuit predicted how the Supreme Court would decide. Several public policy concerns are raised by this ruling. First, under long-standing Pennsylvania law, an insurer’s obligations run only to the insureds named in the insurance policy. However, this ruling requires an insurer to satisfy tax delinquency owed by a property owner that was not a party to the insurance contract. 

Further, the tenant obviously obtained the insurance policy to ensure the 1—acre parcel where its business was located without consideration of whether tax delinquency was owed on the entire 55—acre plot. Since the majority of the $611,000 in insurance proceeds went to the tax authorities, the tenant will be without sufficient funds to repair the fire damage. The Court found the interest of the tax authorities to be paramount but did leave open the door for Park Restoration to make a claim for equitable relief against the property owner.

The takeaway here is that a prospective tenant should research any back taxes owed on a property before making a substantial investment.