Unintended Consequences, Impact Of The Financial Crisis On Insurance Coverage
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Transcript of Unintended Consequences, Impact Of The Financial Crisis On Insurance Coverage
M I C A H S K I D M O R E
A M Y E L I Z A B E T H S T E W A R T
1 6 T H A N N U A L I N S U R A N C E L A W I N S T I T U T E
N O V E M B E R 3 - 4 , 2 0 1 1
A U S T I N , T E X A S
Unintended Consequences :: An Update on the Impact of the Financial Crisis on
Your Insurance Coverage Practice
Litigation arising out of the “Financial Crisis”:
Securities litigation
Bankruptcy litigation
Regulatory/government enforcement actions
Insurance coverage litigation
The Financial Crisis
“Credit Crisis” Related Securities Litigation:
2007—40 (20%) 2008—103 (41.7%) 2009—58 (26.7%) 2010—36 (15%)
Securities Litigation
Source: NERA Economic Consulting, Recent Trends in Securities Class Action Litigation: 2011 Mid-Year Review
Settlements of subprime and credit crisis litigation have been few, but large
As of September 2011, settlements totaled $3.4 billion
Average $116 million per settlement
Source: Kevin LaCroix, The D&O Diary, http://www.dandodiary.com/.
Securities Settlements
Countrywide shareholders sett lement —$624m
Wachovia bondholders sett lement —$627m
Merri l l Lynch shareholders sett lement —$475m
WaMu—$208.5m
Wells Fargo mortgage backed securit ies —$125m
National City—$168m
Lehman Brothers—$9om
Staggering Settlements
Source: Kevin LaCroix, The D&O Diary, http://www.dandodiary.com/.
Defense Costs Estimates
Source: J. Robert Brown, US v. Stockman and the Burn Rate on the D&O Policy, THERACETOTHEBOTTOM.ORG (June 2, 2008), available at www.theracetothebottom.org/stockman/us -v-stockman-and-the-burn-rate-on-the-do-policy.html (detailing the exhaustion of a $50 million tower of D&O insurance through defense costs accruing at a rate of $1.67 million per month).
In many cases, defense costs alone may exceed the limits of the defendants’ D&O coverage or other available insurance
Business Bankruptcy Filings:
2007—28,322 2008—43,546 2009—60,837 2010—56,282
Corporate Bankruptcy
Source: American Bankruptcy Institute, U.S. Bankruptcy Filings 1980-2010 (Business, Non-Business, Total)
Total bank failures since Jan 2008—406
87 bank failures this year alone
FDIC has initiated 15 lawsuits to date
FDIC has authorized lawsuits involving 34 failed banks and 308 directors and officers for liability of at least $7.3M
Litigation expected to increase
Failed Bank Litigation
Source: Kevin LaCroix, The D&O Diary, http://www.dandodiary.com/.
Regulatory Enforcement
Source: SECURITIES AND EXCHANGE COMMISSION, PERFORMANCE AND ACCOUNTABILITY REPORT 36 (2009).
SEC ENFORCEMENT ACTIVITY 2007 2008 2009
Investigations Opened 776 890 994
Cases Filed 656 671 664
Derivative of underlying “financial crisis” litigation
Direct actions on first-party financial guaranty insurance, i.e., mortgage insurance, trade credit insurance
Insurance Coverage Litigation
The “fortuity doctrine,” “known loss” or “loss in progress” defense
Rescission and the “fraud in the application” defense
Priority of payments among insured defendants
Coverage for non-traditional “claims”
Coverage Issues
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Insured $96.5 million in loans to film production company
No foreign distribution required by Chase
Coverage for default denied as not “fortuitous”
Fortuity Doctrine
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
Q. If the terms of the financing transaction were equally known to the insurer, is the “fortuity doctrine” a defense?
A. No.
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
“Given the underlying basis of the doctrine, and the right of the parties to agree to cover existing losses, it has been recognized that the known loss doctrine does not apply if the insurer also knew of the circumstances on which it bases the defense.”
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
Q. Does the “fortuity” defense apply to risks that were not investigated prior to issuance of the policy?
A. Probably not.
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
N.H. waived voluntary disclosure for Chase.
Other cases have inconsistently addressed the insurer’s obligation to investigate potential risks as a prerequisite to the “fortuity” defense.
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
Q. If the insured subjectively was unaware but objectively should have known of a “loss in progress,” will the “fortuity” defense apply?
A. It depends on the jurisdiction.
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
In Texas, “the fortuity doctrine precludes coverage for known losses and losses the insured knows, or should know, are ongoing at the time the policy is issued.”
In other jurisdictions, the standard is “subjective” only.
CASE STUDY: Chase Manhattan Bank v. N.H. Insurance Company
Fortuity Doctrine
Q. Is the “fortuity” doctrine inconsistent with or preempted by statutory provisions addressing “fraud” in an insurance application?
Texas Insurance Code Section 705.004
“Fraud in the Application”
Policy provisions voiding coverage on the basis of false statements in an application
No effect and will not bar coverage, unless:
Shown at trial
Material to the risk
Contributed to the event for which coverage is sought
“Fraud in the Application”
Master mortgage insurance policy
Insured Combo 100 loans
AIG denied coverage defaults and rescinded the policy
Allegations that ST misrepresented the underwriting standards for the subject loans
CASE STUDY: Suntrust Mortgage, Inc. v. AIG United Guaranty Corp.
CASE STUDY: Suntrust Mortgage, Inc. v. AIG United Guaranty Corp.
“Fraud in the Application”
Q. Will knowledge of past “misrepresentations” or a failure to investigate impair the insurer’s “fraud” defense?
A. Yes.
“Fraud in the Application”
“Armed with a sweeping right to audit ST’s loans and being in possession of information that would have alerted a reasonable insurer (especially a sophisticated insurer like UG) to the prospect of material, wide-scale misrepresentations by ST years before UG raised its fraud defense, UG cannot now claim that it was duped by ST into covering the loans.”
CASE STUDY:
Suntrust Mortgage, Inc. v. AIG United Guaranty Corp.
“Fraud in the Application”
Master mortgage insurance policy
Claim for rescission as to all insured loans
Allegations that Countrywide misrepresented the underwriting standards for some loans
CASE STUDY: United Guaranty Mortgage Indemnity v. Countrywide Fin. Corp.
“Fraud in the Application”
Q. Do “misrepresentations” as to some loans justify rescission of coverage for all loans?
CASE STUDY: United Guaranty Mortgage Indemnity v. Countrywide Fin. Corp.
A. No.
“Fraud in the Application”
“United Guaranty cannot articulate any limiting principle for when misrepresentations as to some loans would entitle it to global rescission for all loans. . . . [T]he parties spelled out the procedures and remedies for misrepresentation or fraud—and those procedures apply on a loan-by-loan basis.”
CASE STUDY: United Guaranty Mortgage Indemnity v. Countrywide Fin. Corp.
CASE STUDY: IndyMac Bank 16 insurance policies
$160 million in policy proceeds
Bank’s failure prompted numerous lawsuits
IndyMac subsidiary sued the insurers
Sought declaration regarding priority of proceeds
Asked court to determine its entitlement
Numerous Claimants :: Limited Proceeds
CASE STUDY: IndyMac Bank
Case dismissed
D&O policies with ABC coverage prioritized payment to individuals before entities
Individuals’ entitlement could not be determined prior to adjudication of the claims against them
Subsidiary did not have an adequate injury; so, no justiciable dispute
Subsidiary had no interest in proceeds of Side-A policies
Numerous Claimants :: Limited Proceeds
CASE STUDY: Lehman Brothers
Claims arising out of the largest bankruptcy in American history ($691 B)
$250 million insurance program
Single primary D&O policy; 16 layers of excess
Substantial defense costs eroding policies
Numerous Claimants :: Limited Proceeds
CASE STUDY: Lehman Brothers
August 2011—former CEO and other D&Os reach $90 million settlement funded entirely by insurance
Would nearly exhaust remaining limits
D&Os of a different Lehman entity also facing significant litigation/exposure
Objection to settlement—inequitable
Court approved settlement October 19, 2011
Numerous Claimants :: Limited Proceeds
CASE STUDY: Creative Problem Solving
Coverage defenses => leverage for negotiating reduced settlement
Saving partial limits (consider impact)
Release policy (consider impact), except carve-back for SEC/DOJ defense costs—could ultimately erode policy completely notwithstanding coverage defenses
When there’s not enough money, outcome will be short of perfect
Numerous Claimants :: Limited Proceeds
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Bond insurer seeking coverage for regulatory investigations and follow-on shareholder litigation
Three challenged transactions
$29.5 million in defense costs
Coverage for Non-Traditional “Claims”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Coverage for Non-Traditional “Claims”
Q. Does a regulatory subpoena constitute a “Claim” as defined by the subject policies?
A. Yes.
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Coverage for Non-Traditional “Claims”
A subpoena is an “order” or “similar document” triggering the policies’ coverage for “a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a . . . formal or informal investigative order or similar document.”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Coverage for Non-Traditional “Claims”
Q. Is coverage for the investigation of a shareholder derivative demand limited to the costs incurred until the demand is accepted or rejected?
A. No.
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Coverage for Non-Traditional “Claims”
Costs incurred to investigate, and if necessary reject, the shareholders’ demand are covered, but further costs expended by the Special Litigation Committee to continue to investigate the shareholders’ claims are also covered irrespective of the primary policy’s $200,000 sublimit for investigation costs on account of all Shareholder Derivative Demands.
Questions?
THANKS!
16TH ANNUAL INSURANCE LAW INSTITUTE NOVEMBER 3-4, 2011
AUSTIN, TEXAS
Unintended Consequences :: An Update on the Impact of the Financial Crisis on
Your Insurance Coverage Practice