A federal appeals court has ruled that banks can requirea homeowner to buy flood insurance covering the fullreplacement value of a home rather than the amount of the mortgageloan.

The First Circuit Court of Appeals made that decision inKolbe v. BAC Home Loans Servicing, LP.

The decision was handed down through a class action lawsuitwhere the named plaintiff, Stanley Kolbe, sued BAC Home LoansServicing for damages alleged to have arisen out of the bank'srequirement that he maintain flood insurance in an amountsufficient to cover the replacement value of his home, $250,000,rather than the amount of the loan, $197,437.

Kolbe contended that the bank cannot require more than thefederally mandated minimum flood insurance, which is the lesser ofthe principal balance of the loan or $250, 000 in special floodhazard areas, and $0 in all other areas.

The court ruled otherwise.

Kolbe owns a home in Atlantic City, New Jersey in a specialflood-hazard area. The loan was guaranteed by the Federal HousingAdministration.

The district court granted the bank's motion to dismiss allclaims, and Kolbe appealed.

A divided panel of the First Circuit later vacated thedismissal. The panel majority held that both Kolbe'sinterpretation and the bank's interpretation of the contract couldbe found reasonable by a trier of fact, and therefore that thedistrict court erred in dismissing the breach of contractclaim.

But, the full court granted a rehearing where it was concludedthat the bank's reading of the text is the only plausible readingin the relevant context, according to Barry Zalma of ZalmaInsurance Consultants.

The full court held that, for contract language mandated by afederal regulation that implicates the federal mortgage insuranceand flood-insurance programs, this context includes the broaderregulatory schemes and the federal policy underlying thoseschemes.

In essence, when this covenant is understood in context againstits purposes and federal-housing policy, the only reasonableinterpretation of this language is that offered by the bank, Zalmasays in interpreting the full court's opinion.

Zalma says, “The result urged by Kolbe would seriously impairfederal housing policy.” He says Kolbe's interpretation wouldprevent lenders from requiring adequate flood insurance,particularly for homeowners with mortgages above $250,000 (themaximum federal requirement) or homes outside of specialflood-hazard areas, where the United States does not require anyflood insurance.