Claims And Issues

The Moral Hazard in Federal Financial Crisis Insurance.

When the Federal Government bailed out Citigroup in 2008, "it did more than reassure troubled markets -- it encouraged high-risk behavior by insulating risk-takers from the consequences of failure."

Report to Congress of Hon. Neil Barofsky, Special Inspector General for the Troubled Asset Relief Program ("TARP"), quoted by Gretchen Morgenson, "Fair Game/A Bank Crisis Whodunit, With Laughs and Tears" p. 1, col. 2 (New York Times Nat'l ed., "SundayBusiness" Section, Sunday, January 30, 2011).   

   Last Thursday, January 27, the Financial Crisis Inquiry Commission released its report on the causes of the financial crisis and how the crisis played out for key regulators, financial institutions, and Federal Taxpayers.  Here is a page from the FCIC's website that will allow you to download all or part of the report.

   Lots of recent loose talk about "moral hazard" may actually be hitting the mark, but perhaps not as the shooters intended.  The players in the financial crisis took huge risks with other people's money, made great amounts of personal profits while doing that, and then walked away and left the Federal Taxpayers to pay for the consequences when it all came apart.

   When Taxpayer-funded Insurance is in place for any financial risk, where is the incentive to follow morality?  Why would a financial institution or a regulatory agency not burn down the financial building if the only consequence to them is a large payout?

   At least one significant cause of the financial crisis, then, truly appears to be "moral hazard":  The Insurance in this instance, in the form of Federal Taxpayer payments, should never have been issued without far more careful underwriting by regulation, in a nutshell.

   In addition to Ms. Gretchen Morgenson's column linked above, here are more newspaper reporters and columnists commenting on the FCIC report's analysis, conclusions, and stunning dissents:  Sewell Chan, "Crisis Panel's Report Parsed Far and Wide" p. B1, col. 5 (New York Times Nat'l ed., "Business Day" Section, Friday, January 28, 2011); Joe Nocera, "Inquiry is Missing Bottom Line" (New York Times Online on Friday, January 28, 2011 and in print on Saturday, January 29, 2011); Jim Puzzanghera, "Financial Crisis Panel Finds Many at Fault" (Los Angeles Times Online, Thursday, January 27, 2011).

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Bad Faith Claim Handling Evidence Irrelevant to Insurance Coverage Questions.

   In the case of Download 1550 Brickell Associates v. QBE Insurance Co. (S.D. Fla. Case No. 07.22283, Order Filed Dec. 22, 2010) PUBLIC ACCESS, also published as 2010 WL 5392654 (S.D. Fla. Dec. 22, 2010)(authorized password required to access Westlaw), the Federal District Judge entered an Order with a very long but highly descriptive name:  Order Granting in Part Defendant's Motion in Limine to Preclude Evidence of, or References to, Claims Handling Practices, Bad Faith or Good Faith and Fair Dealing.

   A Bad Faith Claim in that Case was stayed.  The Order of Stay was on Appeal.  The Federal Judge held in the linked decision that "Bad Faith" Claims Handling Evidence is irrelevant to the Insurance Coverage Issues to be tried in that case.  "This case involves Plaintiff's attempt to collect the proceeds of an insurance policy underwritten by Defendant after Hurricane Wilma severely damaged a pair of insured buildings near downtown Miami."  Id. at *1.

   The Online Docket of this Case on PACER reflects that the Case was Dismissed With Prejudice pursuant to the Stipulation of the Parties announced in Open Court as a part of their publicly stated Settlement, on January 7, 2011.

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No Theft Coverage to Alabama Corporation For Florida Flipping.

   In Hartford Fire Ins. Co. v. Mitchell Co., Download Hartford Fire Ins. Co. v. Mitchell Co. (S.D. Ala. Order Filed Dec. 15, 2010) PUBLIC ACCESS, also published as 2010 WL 5239246 (S.D. Ala. Dec. 15, 2010)(authorized password required to access Westlaw), Hartford sued its named Insured, The Mitchell Company ("TMC") and one Campus, "an employee and officer" of TMC, for Declaratory Judgment under a Crime Shield Policy which Hartford issued to TMC.

   TMC claimed a covered "Theft Loss" under the Policy.  Its original Proof of Loss listed $5,418,767.00 in damages and TMC filed a later, amended Proof of Loss claiming $4,735,567.00.

   The claimed "Theft Loss" was described by TMC in its Proof of Loss as the result of "flipping".  TMC is a corporation in Alabama; Campus is a resident of Florida.  TMC's description of the loss has purchasers associated with Campus buying land and then quickly reselling ("flipping") the same land to TMC.   Had Campus "acted in good faith as an employee and officer" of TMC, then TMC would have purchased the properties at a lower price and would not have overpayed by the amounts which TMC claimed for indemnity from Hartford.  Hartford Fire Ins. Co. v. Mitchell Co., 2010 WL 5239246 at *2.

   The parties' lawyers were not skimpy on the length and number of their submissions to the Federal Court in this case, apparently.  "However, despite the approximately 4160  pages of substantive briefing and voluminous exhibits submitted by the parties, this case is decided by the first [or Insurance Coverage] issue:  whether Campus' alleged misconduct constitutes 'theft' as defined in the Policy such that it is a covered claim."  Id. at *4.  [Emphasis by the Court.]

   The Federal Court held that this was not a covered "Theft Loss" under the Policy at issue.  Although it was clear on the record of that case that Mr. Campus "received money" from transactions in which TMC purchased properties and that Campus "did not disclose to TMC his financial interest in the properties[,] ... this behavior cannot be characterized as theft as defined in the policy."  Further, "[w]hile Campus' acts were certainly dishonest, they do not constitute theft of money by Campus."  Id. at *5.  The Federal District Court accordingly granted Hartford's Motion for Summary Judgment of No Coverage in this case.  The PACER Online Federal Court Docket reflects that a Notice of Appeal was filed in this case on January 12, 2011.

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Insurance Agents, Expert Witnesses, and Standard of Care.

   In many jurisdictions, such as Iowa, the standard of care for Insurance Agents is established by Statute concerning the procurement of Insurance.  The parties will also be given an opportunity to present Evidence of their particular contractual relationship in the given case.  See Download Langwith v. American Nat'l Gen. Insurance Co. (Iowa, Opinion Filed December 30, 2010) PUBLIC ACCESS, also published as 2010 WL 5393493 (Iowa, December 30, 2010)(authorized password required to access Westlaw).

   Expert Witnesses, however, are not permitted to establish the Insurance Agents' standard of care in such jurisdictions.  This is the case at the very least in lawsuits filed against Insurance Agents for their alleged conduct in the procurement of Insurance.  Instead, Expert Witness Testimony is allowed in Evidence to address the scope of the Legal Duty.   Langwith v. American National General Insurance Co., 2010 WL 5393493 at *5 - *6.

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Damage to "Work" Caused by Subcontractors: No Arkansas CGL "Occurrence".

   In a decision which has confronted many Courts in recent cases, the Eighth Circuit Court of Appeals has held that damage to the Insured's "Work" that is caused by a subcontractor is not a covered "Occurrence" under a CGL Policy under Arkansas Law.  However, so-called consequential damage or "collateral damage" -- i.e., damage to property of others -- can be a covered CGL "Occurrence" under Arkansas Law.  Download Lexicon, Inc. v. Ace American Ins. Co. (8th Cir. Case No. 10.1100, Opinion Filed Dec. 28, 2010) PUBLIC ACCESS, also published as 2010 WL 5293808 *3 (8th Cir. Dec. 28, 2010)(authorized password required to access Westlaw).

   As noted, this precise Insurance Coverage issue has been presented in many recent cases.  Many cases are collected in Dennis J. Wall, "Litigation and Prevention of Insurer Bad Faith" § 3:107 (West Publishing Company 2010 Supplement).

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The United States Honors One of Its Sons: Dr. Martin Luther King, Jr.

January 15 is the birthday of Dr. Martin Luther King, Jr.  Happy Birthday, Dr. King and God Bless the United States of America which was graced by your presence and is graced now by your memory!

D&O Insurance Coverage: Bank Director's Defense Against Criminal Charges?

   A Director's and Officer's Liability Insurance Carrier's Duty to Defend will be determined as an issue of fact on remand in Wintermute v. Kansas Bankers Surety Co., 2010 WL 31531 (8th Cir. Case No. 09-2806, Opinion Filed January 6, 2011)(authorized password required to access Westlaw).  A Liability Insurance Company's Duty to Defend is ordinarily held to be determined by the allegations in the complaint against the Insured.  See Dennis J. Wall, "Litigation and Prevention of Insurer Bad Faith" § 3:48 (Shepard's/McGraw-Hill Second Edition, West Publishing Co. 2010 Supplement).

   The D&O Policy involved in the Wintermute case, however, required the Courts to look at facts to see whether two Exclusions applied under Arkansas law to defeat the Duty to Defend, or not.

1.  Personal Profit Exclusion.

   The Trial Court in Wintermute granted a Summary Judgment of No Duty to Defend based in part on a "Personal Profit Exclusion":

Exclusion 2 provides that KBS [the D&O Carrier] shall not be liable for payment or defense of any claim for Loss made against a Director "based upon or attributable to the Director[ ] ... gaining in fact any personal profit or advantage to which [she was] not legally entitled."

Id. at *6.  The Court of Appeals reversed.  It held that the actual language of the Insurance Policy Exclusion required proof of facts, not merely reliance on allegation in the underlying complaint against the Insured in that case.  "The term 'in fact' means 'actual or real' or 'resulting from the acts of parties rather than by operation of law.'"  Id. at *8.

2.  Dishonesty Exclusion.

   The Trial Court also based its grant of Summary Judgment of No Duty to Defend on a so-called "Dishonesty Exclusion" in the Policy at issue:

   Exclusion number 11 provides that KBS shall not be liable to make payment or provide any defense in connection with any claim for Loss against a Director "brought about or contributed to by the dishonesty of the Directors....  This exclusion shall not apply to any protection provided for any Director ... under the terms of this policy who was not involved in the dishonest acts."

Id. at *9.  Again the Court of Appeals reversed the District Court and opted instead for an examination of the facts which it held is required by the actual language of this particular Policy provision.  "We conclude that the last sentence of the dishonesty exclusion serves the same purpose as the "in fact" language contained in the personal profit exclusion.  The last sentence must be given some meaning."  Id. at *10.

   The Court of Appeals' examination of the requirements imposed by the actual language of the Policy at issue is focused on the case before the Court rather than on the application of general principles that may have no meaning in the particular case.  Whether other Courts follow this approach will be known over time.

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Foreclosure Failures Raise Insurance Coverage Issues, To Be Determined.

   In an action filed by servicing companies or banks on behalf of securitized trusts ("foreclosers"), the highest Court in Massachusetts affirmed lower court decisions and held itself that the Plaintiffs were not entitled to a declaration of perfection.  The Plaintiffs requested a judicial declaration that their real estate titles were perfected.  Instead, the Courts unanimously held that the foreclosers failed to obey the Law which allows nonjudicial foreclosures.   Download U.S. Bank National Association v. Ibanez (Mass., Opinion Filed January 7, 2011) PUBLIC ACCESS SLIPSHEET OPINION STATED SUBJECT TO REVISION.  You can also try this link for the Public Access Official Opinion:  http://weblinks.westlaw.com/result/default.aspx?action=Search&cnt=DOS&db=MA=ORS, or do an internet search for "Massachusetts Supreme Judicial Court" and click on decisions or opinions.

   Other aspects of this decision are posted on Insurance Claims and Bad Faith Law Blog. 

   There is potential resulting from this decision for a number of Insurance Coverage Issues under Director's and Officer's Liability Insurance Coverage and under Commercial General Liability Insurance Coverages, to name two examples.

   Further, as the Concurring Justice noted in this case:

   What is more complicated, and not addressed in this opinion, because the issue was not before us, is the effect of the conduct of banks such as the plaintiffs here, on a bona fide third-party purchaser who may have relied on the foreclosure title of the bank and the confirmative assignment and affidavit of foreclosure recorded by the bank subsequent to that foreclosure but prior to the purchase by the third party, especially where the party whose property was foreclosed was in fact in violation of the mortgage covenants, had notice of the foreclosure, and took no action to contest it.

   This decision, which clearly has landmark potential, is also the subject of reporting by, for example, E. Scott Reckard, "Foreclosure Ruling Could Be Setback for Banks" (Los Angeles Times Online, Friday, January 7, 2011), and by Gretchen Morgenson, "Massachusetts Ruling on Foreclosures is a Warning to Banks" p. A1, col. 1  (New York Times Nat'l ed., Saturday, January 8, 2011).

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Representations, Warranties and Settlements, Continued ... Settle Them and Seal Them.

   Hard on the heels of yesterday's post on the Insurance Claims Bad Faith Law Blog comes news of a settlement by Bank of America with the Federal Government's Fannie Mae and Freddie Mac.  See Ben Protess and Eric Dash, "Bank of America Buys Back $2.5 Billion in Mortgage Debt" p. B3, col. 5 (New York Times Nat'l ed., Business Section, Tuesday, January 4, 2011).

   BOA is reportedly negotiating settlements of "so-called put-back claims from insurance companies and more than a dozen private investors that bought roughly 160 troubled mortgage securities from Countrywide [since acquired by BOA]."  Id.  These are the sort of claims which BOA successfully settled with Fannie and Freddie.

   This seems to be the first wave of BOA's settlement strategy to reduce or eliminate all such claims, which involve alleged representations and warranties given by Countrywide to each and all of the investors that the mortgage securities met Countrywide's Underwriting standards or Countrywide would buy the mortgage securities back if they did not meet its Underwriting standards, as was posted on the Insurance Claims Bad Faith Law Blog yesterday.

    BOA appears to be singling out Fannie and Freddie first, not simply because of the size of the debts being settled, but because the Federal Government (such as the S.E.C., for recent public examples) does not present much expertise in settling claims with large financial institutions, for whatever reason.

   Once BOA settles with Fannie and Freddie -- and the point behind the present reports is that BOA has successfully settled with Fannie and Freddie -- it should become easier for BOA to reach other settlements with other investors who have less at stake than Fannie and Freddie -- i.e., the Federal Taxpayers -- did.  That would leave only those claims of warranties and representations, i.e., "put-back claims," which cannot be settled and must continue to be litigated or even tried.

   This apparent strategy also raises Insurance Coverage Questions, including:

1.  What sorts of Insurance Policies might BOA contend provide it with Coverage for these settlements or, in the event any such claims actually go to judgment, for judgments in cases presenting these claims?

2.  Aside from the question of Insurance Policies, what sort of "cover" has BOA undoubtedly arranged for these payments -- and who is really at risk to pay them?

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Chinese Drywall: Homeowner's Insurance Coverage But For Two Exclusions.

   In a ground-breaking decision, a Federal Judge in Louisiana has held that there is Insurance Coverage for the Chinese Drywall Damages alleged, under the Insuring Agreements of at least two of the many Homeowner's Insurance Policies at issue in In re Chinese Manufactured Drywall Products Liability Litigation, Download In re Chinese Manufactured Drywall Prod. Liab. Litigation (E.D. La. MDL 2047, Order and Reasons Filed December 16, 2010) PUBLIC ACCESS, also published as 2010 WL 5288032 *8 (E.D. La. December 16, 2010)(Multi-District Litigation, Louisiana substantive law; authorized password required to access Westlaw).  Under the ASI Lloyds and Allstate Homeowner's Policies at issue there, the Chinese Drywall Damages alleged in that case constitute "covered 'accidental, sudden,' 'physical,' 'loss.'  These Plaintiffs' allegations indicate that the damage caused by the Chinese drywall was 'unexpected,' 'unknown,' and 'unusual.'  The Court must accept these allegations as true for purposes of the present issue [presented by 8 Motions to Dismiss and 2 Motions for Judgment on the Pleadings]."  In re Chinese Manufactured Drywall Products Liability Litigation, 2010 WL 5288032 at *8.  There was a big "but," however.

   The many Homeowner's Insurance Policies in that case also contained "faulty materials" Exclusions and "corrosion" Exclusions, which barred all Coverage for the Chinese Drywall Damages alleged.  Id. at *17-*21.

   On the other hand, the Federal Court held in that case that three Exclusions did not apply under Louisiana substantive law, and that the "ensuing loss" exemption (or Exclusion, depending on one's viewpoint and the wording of a particular Policy) did not apply under Louisiana substantive law, either:

1.  Not the Policies' Latent Defect Exclusions, id. at *12;

2.  Not the Policies' Pollution or Contaminant Exclusions, id. at *15;

3.  Not the Exclusion for Dampness or Temperature contained in one of the Homeowner's Insurance Policies at issue, id. at *17; and

4.  Not the "ensuing loss" provision found in the Homeowner's Insurance Policies at issue.  Id. at *24-*25.

Exclusions for similar Catastrophe Claims are addressed by Dennis J. Wall in Chapter 2 of "CATClaims:  Insurance Coverage for Natural and Man-Made Disasters" (Thomson Reuters West 2010 Supplements).

The Chinese Manufactured Drywall Products Liability Mutli-District Litigation Case was posted for its Bad Faith features on Thursday, December 30, 2010 on Insurance Claims Bad Faith Law Blog.

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