By David A. Shaneyfelt
Mortgage lenders who survived the residential mortgage meltdown must now brace for repurchase demands from their third-party investors -- and for the refusal of their liability insurers to defend and indemnify them against these demands. Mortgage lenders should be prepared to protect themselves against such denials of coverage.[IMAGE]
*Claims Under Contract? Restitution?*
Insurance companies often deny coverage for repurchase demands by invoking the common exclusion for claims arising under contract. This argument should not fly. Repurchase demands typically accuse the mortgage lender not only of breaching the terms of the agreement, but of having sold loans ""negligently."" The lender's negligence typically did not ""arise from the contract,"" but arose during underwriting and origination of the loan Ã¢â‚¬" for example, failing to follow buyer eligibility guidelines, or failing to do due diligence concerning property value, income history, credit worthiness, or employment background. These are acts of lender negligence that insurance typically protects against.
More problematic is an exclusion for restitution. Insurance covers ""loss"" -- but not amounts one is required to give back. Insurers say that repurchase demands fall in that category.
It's not that simple. Repurchase demands are not really demands for the return of the mortgage loan. Nor are they demands to rescind the deal. Instead, these demands specify the damages the buyer has sustained because of the allegedly defective mortgage, which may well be more than the value of the original loan, given interest, penalties, resale discounts, and other costs and expenses incurred. In many cases the defective mortgage has already been resold and there is no demand to ""take it back."" In short, a repurchase demand is often not a demand to rescind the deal, but a detailed assessment of the losses the third-party incurred because of the loan sale. In that case, the repurchase demand is seeking legal damages that, all else being equal, fall squarely within an insurer's coverage obligations.
Also potentially troublesome is an exclusion in some mortgage lenders' policies specifically for repurchase demands: ""any claim arising out of or resulting, directly or indirectly, from any insured's actual or alleged obligation to repurchase a loan."" One lender recently tried to avoid application of this exclusion, claiming it was ""ambiguous."" The court disagreed.
Perhaps the better argument (not raised in that case) is that the exclusion renders the policy's coverage illusory. An insurance policy cannot promise terms of coverage, and then rob the policyholder of exactly the same coverage through an exclusion. Yet some policies promise to cover a mortgage lender for negligence in ""selling"" residential loans, and then purport to exclude from coverage all ""repurchase demands."" For mortgage lenders whose primary business is the selling of residential loans, such an exclusion may mean that, for its primary business interest, the lender has no coverage for its only meaningful liability exposure.
When faced with a denial on these grounds, the lender should first check whether its policy has a repurchase exclusion. If so, it should discuss with its broker whether and to what extent the policy delivers value. Second, the lender should scrutinize any repurchase demand carefully, distinguishing between ""inquiries"" and actual claims. ""Claims"" typically must be reported to the insurance company. If notice is delayed until the demand ripens into a lawsuit, the insurance company may argue that the ""claim"" arose before the policy period and is not covered. The lender should give the insurance company as much information as it can regarding the demand, not only whether and to what extent employee negligence occurred in the initial procurement of the loan, but the specific items of damage claimed, and how and why they are not restitutionary amounts.
Above all, the lender should not raise any white flag if its insurance company claims that none of these repurchase demands are covered. Usually, the lender will have much to argue about and plenty of room for negotiation and settlement.
_David A. Shaneyfelt ([email protected]) is a shareholder with Anderson Kill Wood & Bender, P.C., where he represents policyholders in claims against insurance companies._