As previously reported in the August 2021 edition of Executive Liability Insights, a mortgage company received a civil investigative demand from the U.S. Attorney’s Office for the Northern District of New York and the U.S. Department of Justice, which alleged False Claims Act violations in relation to the company’s underwriting and issuance of federally-insured mortgage loans. The company ultimately settled the matter and sought coverage for the settlement under its directors and officers liability (“D&O”) insurance. 

The insurance company denied coverage for the settlement, arguing that the D&O policy’s professional services exclusion and breach of contract exclusion barred coverage. The professional services exclusion precluded coverage for claims “alleging, based upon, arising out of, or attributable to any Insured's rendering or failure to render professional services.” The breach of contract exclusion applied to “any Claim alleging, based upon, arising out of, or attributable to the actual or alleged breach of any oral, written, express or implied contract or agreement.” Furthermore, the insurer argued that because the company failed to seek its consent prior to settling the matter, it was under no obligation to contribute to the settlement amount. Coverage litigation ensued.

The insurer maintained that coverage for the settlement was based on the facts revealed in the government’s investigation, and not on the civil investigative demand. Accordingly, since the investigation revealed that the settlement resulted from the company’s “underwriting errors,” rather than “quality control deficiencies,” the professional services exclusion was applicable. The court found that whether the settlement was a result of “underwriting errors” versus “quality control deficiencies” was “a distinction without a difference.” Furthermore, the court found that the wrongful acts alleged were for duties owed to the government, not to the mortgage borrower clients. Accordingly, the court held that the professional services exclusion was not applicable. 

The insurer also maintained that the breach of contract exclusion was triggered because the investigation arose from breaches of loans issued by the company pursuant to agreements with government agencies. Here, the court again sided with the company, finding the exclusion was not intended to extend to regulatory violations. In fact, the court noted that doing so would render the coverage illusory. 

Lastly, the court rejected the insurer’s argument that it was not obligated to contribute to the settlement because the insured failed to seek the insurer’s consent prior to settling the matter. The court noted that once an insurer “wrongfully refuses to defend a claim, the policyholder is permitted to enter a reasonable settlement with the claimant, provided that there is no fraud, collusion, or bad faith, and sue the insurer for indemnity.”

Customers of a credit union filed a class action complaint alleging the credit union failed to issue notices for repossessed collateral and reported false and derogatory credit information to consumer reporting agencies. 

The parties reached a settlement, and the credit union sought coverage for the settlement amount under the “Third-party Harassment Liability” and “Electronic Publishing Liability” insuring agreements of its management liability insurance policy. But the insurer denied the claim, arguing there was no potential for coverage under the policy and thus it had no duty to defend. Coverage litigation ensued. 

The policy defined a “third-party harassment act,” in part, as any actual or alleged: 

a. violation of any … law prohibiting discrimination of any kind; 

b. harassment …; 

c. defamation, libel, slander, disparagement or invasion of privacy; 

d. false arrest, false imprisonment or malicious prosecution; or 

e. bullying of a natural person other than an employee, officer or director and other than as a part of a lending act.

The insurance company argued that the phrase “other than as part of a lending act” modified the entirety of the definition for “third-party harassment act,” and thus, the allegations in the underlying action were not covered by the definition. The court agreed, reasoning that “an ordinary person of average understanding would construe this phrase to be modifying each paragraph in the series.” Thus, the court found that the underlying allegations of defamation or invasion of privacy did not constitute a “third-party harassment act” when part of a lending act. As a result, the court held there was no potential for coverage and dismissed this portion of the complaint.  

The credit union also relied on the “Electronic Publishing Liability” insuring agreement as an avenue for potential coverage. The policy defined “electronic publishing act,” in part, as “libel or slander resulting from the electronic publishing of material that defames a person” or “violation of the right of privacy … by the electronic publishing of material that publicly discloses private facts.” The insurer argued there was likewise no coverage under this insuring agreement because the disclosure was to reporting agencies, not the public. Moreover, because the settlement was for claims for which it had no liability, the insurer contended there was no “loss” incurred by its insured.

The court, however, noted that the insurer’s “argument ignore[d] the Policy’s clear and unambiguous definition of ‘loss,’ i.e., ‘any amount which an insured becomes legally obligated to pay as a result of a … settlement.’” Since the credit union was legally obligated to pay damages to the class members because of the settlement agreement, the court held the credit union provided sufficient facts to “plausibly show a potential coverage.”