Suit May Set Quake Law Precedent : Courts: Judges will hear appeal by woman, 71, whose bank refuses her access to cash from insurance claim.

Smack at the epicenter of last year’s earthquake, Phyllis Ziello’s temblor-damaged Northridge home now stands in the midst of a longstanding rumble between homeowners and lenders over who should control insurance money paid out on quake-related claims.

Ziello, a 71-year-old widow, claims that First Federal Bank of California unfairly refused to endorse a $62,000 settlement check from her insurance company and then foreclosed on her house. Now she wants the money and thinks her half-million-dollar house ought to be given back as well.

Her suit against First Federal is scheduled for a hearing before the 2nd District Court of Appeal in June. The court’s decision may set new guidelines that will affect thousands of homeowners.

“Cases like this come up once every 10 years, and every time they do, the rules change,” said Geoffrey Bryan, Ziello’s attorney. “I think the Court of Appeal will almost certainly write a published opinion that will set a new precedent on how all of this will work.”

Ziello’s complaint was a common one last spring as property owners discovered, to their dismay, that they could not spend their insurance checks without the approval of their lenders.

Mortgage lenders wanted quake reimbursement checks made out to them as well as the policyholder so the lenders could refuse to release the funds unless homeowners or business operators proved that the money would be spent on repairing their property--which is the loan collateral. Many homeowners, burdened with big quake-related expenses, wanted the freedom to decide when and how to spend the insurance proceeds.

The conflict over control of insurance proceeds has a long history in California, with some relevant case law dating back to the 19th Century. The laws that govern such transactions are ambiguous and dated, according to attorneys for both parties.

“That’s the real benefit of this litigation for the general public--there will be certainty in the law,” said Richard H. Close, an attorney who last year led a homeowners’ campaign to pressure the California Department of Insurance to regulate the disbursement of funds in favor of property owners. “Since there will be future earthquakes, there needs to be some conclusion as to what the law is.”

*

In Ziello’s case, these legal uncertainties were compounded by the difficulties she was facing even before the earthquake struck. Well before Jan. 17, 1994, she was in danger of losing her house to foreclosure.

A widow, Ziello’s main source of income had been a trust fund that relied heavily on income property, said Bryan. As the California real estate market foundered, so did her fortunes, and she fell behind on her mortgage payments.

The quake caused an estimated $100,000 damage to Ziello’s lushly landscaped, five-bedroom home. Safeco Insurance Group ultimately sent Ziello a $62,101 check, made payable to her and First Federal.

But First Federal officials said they would not endorse the check unless she made the repairs or applied the money to her mortgage.

“She wanted to walk away with the money,” said Steven N. Richman, attorney for First Federal. “If she wanted to repair the house, they would have worked with her. But it is unfair for the owner to benefit from a disaster which adversely affects the lender and, in some situations, the taxpayers.”

Richman said Ziello, in several conversations with First Federal employees, indicated that she wanted to take the money but not spend it on repairs or the mortgage.

Bryan said that Ziello never intended to walk away from the loan and that First Federal’s decision not to endorse the check was unlawful. The check now languishes in a Superior Court vault.

“The lending industry has so brainwashed California homeowners that they think everything belongs to the lender,” said Bryan. “The thing is, she asked a legal expert, and the legal answer was that the money belonged to her.”

While the two parties wrangled over the money, the bank foreclosed on Ziello’s home. In October, she put her furniture in storage and moved to Granada Hills, where she now lives with her son.

Bryan has advised Ziello not to comment on the case, but when asked about her current environment during a visit to her former home, her smile quickly faded.

“That was the house that she planned to live the rest of her life in,” said Bryan. “They are not in the greatest financial circumstances right now, but there’s light at the end of the tunnel.”

Ziello filed a suit against First Federal in June, 1994, in Los Angeles Superior Court. Judge Bruce R. Geernaert ruled in favor of the lender in September. Soon after, Bryan appealed the decision on Ziello’s behalf, and, with unusual speed, the appellate court agreed to hear the case.

Bryan believes that if the court rules in favor of his client, the judges could apply a law that would punish First Federal by forcing it to give the house back to Ziello. Richman, however, thinks that is unlikely, and he believes the appellate court will uphold Geernaert’s ruling.

The result of Ziello’s appeal will be watched closely by lenders and property owners around the state, according to Close.

“The same issue arose in the Oakland fire and the Loma Prieta earthquake. That’s the way the law is in an unsettled area,” he said. “If a person gets a $50,000 check, and they only want to put in $15,000 for repairs . . . they should have an ability to choose how much they want to put into the property.”

Insurance Commissioner Chuck Quackenbush agrees with him.

“The commissioner has been very firm in believing that the earthquake proceeds in question should belong to the insured and the bank should have no role in that process,” said Insurance Department spokeswoman Candysse Miller. “We are still trying to assess how we can accomplish that.”

*

In 1994, Quackenbush joined Close’s effort to persuade then-Insurance Commissioner John Garamendi to force insurance companies to start issuing checks solely to property owners.

At first, Garamendi said he would pursue such action, but threats by the banking industry to hold up millions of dollars in insurance settlements quickly curtailed his plans. Garamendi retreated, saying he would work behind the scenes for reform.

If the Insurance Commission were to require insurance companies to make payments only to property owners, that would be anathema to the lending industry, said Dominick Albano of the California Bankers Assn., which represents 400 members.

“I would characterize the industry as being resistant to any legislation that restricts their ability to control the funds,” said Albano. “Why should the bank take the loss? It isn’t her money, per se, because the bank is still legally co-owners of the house until it’s paid off.”