• California Court Denies Coverage Under D&O Policy for Claim Arising From the Offering of Securitized Mortgages
  • March 8, 2013
  • Law Firm: Troutman Sanders LLP - Atlanta Office
  • On February 26, 2013, the U.S. District Court for the Central District of California, in Impac Mortgage Holdings, Inc., et al. v. Houston Casualty Company, et al., granted partial summary judgment to a D&O insurer, finding that D&O coverage was not afforded for liability arising out of a mortgage banker/broker’s securitization of mortgages.

    Until mid-2007, Impac funded, sold, and securitized non-conforming residential mortgages. Houston Casualty Company issued successive D&O policies to Impac beginning in 2008. Impac was named as a defendant in a number of lawsuits alleging, among other things, that Impac made false and misleading statements in offering documents for Impac’s mortgage-backed securities, including misrepresentations regarding Impac’s adherence to underwriting guidelines. Impac also faced liability related to an error in the Pooling and Service Agreement (PSA) for a mortgage-backed security. Impac filed a corrected PSA that changed how the distributions under the security would be paid, and Impac was then sued by a buyer of the security who allegedly lost millions of dollars due to the change.

    Impac submitted these matters for coverage under its D&O policies. Houston Casualty denied coverage, and the dispute proceeded to litigation, with the parties filing cross-motions for summary adjudication. In the course of the decision granting Houston Casualty’s motion, the Court made three particularly significant rulings.

    First, the Court ruled that California’s standard applicable to determining the duty to defend - i.e., whether the suit “potentially seeks damages with the coverage of the policy,” - does not apply to determining whether coverage is afforded under a D&O policy that expressly disclaims a duty to defend and does not compel an “unconditioned payment of expenses.” This ruling followed on, and rejected Impac’s attempt to distinguish two previous cases, Jeff Tracy, Inc. v. U.S. Specialty Ins. Co., and Peterson v. Columbia Cas. Co. Following Peterson and Jeff Tracy, the Court found that, rather than merely showing a potential for coverage in order to trigger payment under the policy, “ Impac must ‘establish that the underlying claims are within the basic scope of coverage.’”

    Second, in what appears to be the first decision directly addressing the issue, the Court ruled that a provision of the policy providing coverage to the entity for claims “alleging, arising out of, based upon or attributable to . . . the purchase or sale of or offer or solicitation of an offer to purchase or sell any securities of the Organization” referred to Impac’s “own securities,” and not to securities that Impac sold as part of its collateralized mortgage obligation business. The Court ruled that the “fact that it would be ‘semantically permissible’ to interpret the Policies’ language as extending coverage to securities Impac bought, sold, or was involved in the creation of is not sufficient to create coverage where none would otherwise exist.” The Court found that extending entity coverage to Impac’s business “would result in the provision of vastly broader coverage when the insured happens to engage in the business of securitizing mortgages and would cause a traditional D&O policy for those particular companies to become a de facto E&O policy, i.e., a professional liability policy for entities.”

    Finally, the Court agreed with Houston Casualty that the claims were barred in any event by the Errors & Omissions (Professional Liability) Exclusion in the policy and arose out of the “special risks inherent in” the practice of Impac’s profession as a mortgage banker/broker.