Subprime Fallout: Insurance Coverage Battles: Part One
Reidy, Andrew M., Risk Management
While the nation's widely known mortgage lenders and issuers of mortgage-backed securities (MBS) are already facing government investigations and numerous lawsuits, the nature of these actions-and the defendants facing them--are expanding every day. Actions have already been filed against subprime lenders, brokers, appraisers, loan issuers, homebuilders, investment funds, bond raters and public companies who invested in MBS. Allegations run the gamut from breach of fiduciary duty, negligent misrepresentation, common law fraud and breach of contract claims to claims of discrimination, civil conspiracy and violations of the Securities Acts of 1933 and 1934, and the Employee Retirement Income Security Act (ERISA).
As varying claims emerge and the number of defendants increases, companies and individuals facing potential liability will look to their insurers for protection. Given the enormous exposure for the insurance industry and the complex factual setting relating to the securitization of subprime loans, there inevitably will be a large number of disputes about the availability of insurance. Because of the size of the claims, many will end up in litigation or arbitration. Some of the most impacted coverages will be directors and officers insurance, errors and omissions insurance, fiduciary liability insurance and commercial general liability insurance. The following are the questions every company should ask.
When Does a Claim Arise?
Most D&O, E&O and fiduciary liability policies are claims made policies requiring a claim during the policy period to trigger the policy obligations. There is a wide variety of definitions of "claim," but most require a written demand or document be presented to the insured. The securities class actions, derivative actions and ERISA actions arising out of the subprime crisis will constitute claims. The most common disputes will be whether inquiries from governmental entities or customers constitute claims.
The first place to look to determine whether an investigation or customer complaint constitutes a claim is the specific definition of claim in the policy. If that does not provide clarity, one should look at the case law. Importantly, the facts of any action must be carefully analyzed. For example, in National Stock Exchange v. Federal Insurance Company, the court held that an SEC "Order Directing Private Investigation and Designating Officer to Take Testimony" issued to the company was a claim against individuals because the definition of "company" was broad and included directors and officers.
Is a Wrongful Act Alleged?
D&O, E&O and fiduciary liability policies also require that a "wrongful act" be alleged. One definition of "wrongful act" in D&O and E&O policies is "an actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission or act." A typical definition of "wrongful act" in fiduciary liability policies is a "breach of responsibilities, obligations or duties imposed upon the fiduciaries of any plan by ERISA or the common law or statutory law of any jurisdiction governing such plan."
Insurers have reserved rights with respect to whether certain subprime cases allege wrongful acts. The insurers have raised issues such as whether the policies cover intentional acts, whether the alleged acts were done in the individual's insured capacity and whether the conditional language of investigative orders (e.g., "may have" committed) constitutes a wrongful act. Each of these defenses should be relatively easy to overcome. These policies unequivocally cover intentional acts. Although whether an act is performed in an individual's insured capacity is an issue that will depend upon the facts of the particular claim, the vast majority of subprime cases allege claims arising out of conduct taking place in an insured capacity. Finally, the conditional language of an investigative order should be sufficient to constitute a wrongful act. …