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MORTGAGE COMPANY<br />
Professional<br />
Liability<br />
Coverage<br />
www. gordonrees. com
CONTENTS<br />
Scope of Coverage.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3<br />
The Insuring Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4<br />
Scope Of Coverage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8<br />
Defense And Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10<br />
Exclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13<br />
Common Endorsements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17<br />
CONTACT<br />
Randall I. Marmor<br />
Gordon & Rees<br />
One North Franklin, Suite 800<br />
Chicago, IL 60606<br />
phone: 312.980.6778<br />
email: rmarmor@gordonrees.com<br />
Craig Jacobson<br />
Gordon & Rees<br />
One North Franklin, Suite 800<br />
Chicago, IL 60606<br />
phone: 312.980.6784<br />
email: craig.jacobson@gordonrees.com
MORTGAGE COMPANY<br />
PROFESSIONAL LIABILITY COVERAGE<br />
INTRODUCTION<br />
A professional liability policy insures professionals against loss arising from claims brought against them<br />
by persons for whom the insured provides professional services. The policy typically provides a defense<br />
and indemnity in connection with claims alleging errors and omissions. It is insurance that protects the<br />
professional activities of those who have specialized knowledge or skills through education or experience.<br />
Historically, such policies were issued mainly to professionals such as accountants, attorneys, doctors or<br />
engineers, but the coverage can also apply to persons engaged in other specialized fields who desire<br />
coverage for their wrongful acts<br />
The Mortgage Company Professional Liability Policy (“MCPL policy”) provides errors and omissions<br />
coverage to professionals and companies working in the real estate finance industry, such as mortgage<br />
bankers and mortgage brokers. The policy provides defense and indemnity protection from claims that<br />
may be brought by borrowers or other third parties for whom the insureds have provided services, such<br />
as arranging, documenting and/or servicing mortgage loans. The coverage is provided for claims arising<br />
from any alleged failure by the professional to perform, or to adequately perform, professional services<br />
in connection with such work. The following is an overview of the coverage under the MCPL policy.<br />
PROFESSIONAL LIABILITY COVERAGE · 4
THE INSURING AGREEMENT<br />
The Insuring Agreement of the MCPL policy states as follows:<br />
The Company will pay on behalf of the Insured Loss in excess of the Retention stated in Item 4 of the<br />
Declarations which the Insured shall become legally obligated to pay as a result of any Claim first made<br />
against the Insured during the Policy Period for a Wrongful Act that occurred on or after the Retroactive<br />
Date stated in ITEM 6 of the Declarations.<br />
Under the Insuring Agreement, the MCPL policy provides a defense and indemnity to any “Insured” who sustains a<br />
“Loss” from a “Claim” made during the policy period for a “Wrongful Act” that occurred on or after the retroactive<br />
date as set forth on the declarations page of the policy. The terms “Insured,” “Loss,” “Claim” and “Wrongful Act”<br />
are defined in the MCPL policy, and those definitions must be considered when evaluating coverage. A discussion<br />
of these key definitions as they relate to coverage follows below.<br />
A. WHO IS AN INSURED?<br />
As defined in the MCPL policy:<br />
“Insured” means the individual, partnership, corporation or other entity named in Item 1 of the Declarations<br />
and shall include all persons who were, are or shall become: 1) directors, officers, partners or employees of the<br />
Insured while acting within the scope of their duties as such; and 2) the executors, heirs, legal representatives<br />
or assigns of each Insured otherwise insured herein in the event of his or her death, incompetency, insolvency<br />
or bankruptcy.<br />
Coverage under the MCPL policy applies to both the named insured and to its management and employees, but<br />
only while they are acting within the “course and scope” of their duties. To the extent Claims involve deceased,<br />
incompetent or insolvent insureds, those parties’ successors or legal assigns are also covered.<br />
The foregoing definition may be extended by endorsement to include other specifically named (or described) entities.<br />
For example, coverage may be extended by endorsement to “independent contractors” retained by an insured.<br />
B. WHAT CONSTITUTES A LOSS?<br />
As defined in the MCPL policy:<br />
“Loss” means money damages, settlements, and Defense Costs. Loss shall not include: 1. punitive or exemplary<br />
damages or the multiplied portion of a multiplied damages award; 2. criminal or civil fines or penalties<br />
imposed by law; 3. taxes; 4. matters that may be deemed uninsurable under the law pursuant to which this<br />
Policy shall be construed.<br />
Loss is commonly construed as an amount that insureds are either financially liable or legally obligated to pay.<br />
As defined in the policy, a “Loss” is limited to damages, settlements and Defense Costs (which is a separately<br />
defined term). It does not include:<br />
• Restitutionary awards, such as an order requiring the insured to repay excessive fees that were<br />
improperly charged;<br />
• Fines or penalties imposed by law, e.g., a fine levied by a governmental agency for regulatory violations;<br />
• Non-monetary remedies, such as Claims seeking injunctive relief;<br />
• Awards of punitive or criminal damages, or multiplied damage awards;<br />
• Tax losses;<br />
• Other matters deemed uninsurable. For example, in some jurisdictions, including California,<br />
Claims for punitive damages are uninsurable as a matter of law.<br />
5 · PROFESSIONAL LIABILITY COVERAGE
C. WHAT ARE DEFENSE COSTS?<br />
The MCPL policy covers Loss as a result of a Claim, and Loss, as defined in the policy, includes Defense Costs. The<br />
policy provides the following definition of Defense Costs:<br />
“Defense Costs” means reasonable and necessary legal fees and expenses incurred with the approval of the<br />
Company in connection with the investigation, adjustment, settlement, defense or appeal of a Claim made<br />
against an Insured for a Wrongful Act, and shall include the cost of attachment or similar bonds. Payment of<br />
Defense Costs by the Company shall reduce, and may exhaust, the Limit of Liability under this Policy.<br />
“Defense Costs” shall not include salaries, wages, fees, overhead, overtime, or benefit expenses incurred by<br />
or associated with the Insureds.<br />
Legal Fees and Expenses. Defense Costs include legal fees and expenses that are incurred in connection with the<br />
investigation, adjustment, settlement, defense or appeal of a Claim. They do not include fees or costs incurred<br />
by the insured for other purposes, such as costs incurred in analyzing the potential for coverage under the policy<br />
or the availability of other insurance. Internal costs, such as salaries, fees, overhead or overtime, also do not<br />
constitute Defense Costs.<br />
Reasonable and Necessary. Defense Costs compensable under the policy are limited to those fees and expenses<br />
that are “reasonable and necessary.” The reasonableness of fees and expenses depends on the nature and venue<br />
of the Claim. Rates must be commensurate with the location in which the litigation is pending and the complexity<br />
or special knowledge required under the circumstances. The necessity of fees and costs likewise depends on<br />
the case, but generally Underwriters will pay for only one firm to defend the Claim and will not pay for travel<br />
expenses incurred if the firm is not located in the venue where the action is pending.<br />
Approval of the Company. Under the policy, Defense Costs may be incurred only with the approval of Underwriters.<br />
Underwriters will often give deference to an insured’s choice of counsel, subject to approval of the firm’s rates,<br />
qualifications and geographic proximity to the case. Costs incurred before an insured gives notice of Claim are<br />
not incurred with Underwriters’ approval and therefore cannot satisfy the applicable retention or be considered<br />
for coverage under the policy.<br />
Defense Within Limits. Defense Costs are part of, and not in addition to, the limit of liability under the policy. The<br />
payment of any Defense Costs reduces, and may entirely exhaust, the limits of liability and Retention amount in<br />
the MCPL policy.<br />
PROFESSIONAL LIABILITY COVERAGE · 6
D. WHAT CONSTITUTES A CLAIM?<br />
The Insuring Agreement of the MCPL policy applies to “Loss…which the Insured shall become legally obligated<br />
to pay as a result of any Claim…” A “Claim” is defined as:<br />
a written demand for money damages received by an Insured, including service of suit and the institution of<br />
administrative or arbitration proceedings.<br />
Types of Claim. As so defined, a Claim may include a legal proceeding, i.e., (a) a suit that has been served on<br />
the insured or (b) an administrative or arbitration proceeding that has been instituted against it. However, a legal<br />
proceeding is not required to constitute a Claim. Any written demand made upon the insured for the payment of<br />
money damages may be considered a Claim, e.g., a letter sent to the insured demanding damages.<br />
Money Damages. Not all suits or demand letters necessarily constitute a Claim. The MCPL policy covers demands<br />
for payment of damages. Thus, a demand that seeks reimbursement of allegedly improper charges imposed by<br />
the insured does not seek money damages and is not a Claim. Likewise, the following categories of demands or<br />
suits do not qualify as a Claim if they do not include a demand for payment of damages:<br />
• A suit that seeks equitable relief, such as injunctive or declaratory relief,<br />
if it does not include a demand for money damages;<br />
• A mere accusation of wrongdoing;<br />
• Disciplinary proceedings;<br />
• News accounts or other public reports of an insured’s professional misconduct.<br />
Governmental Investigations. An insured may tender notice of a subpoena or other investigation by a<br />
governmental entity, such as a regulatory agency. Subpoenas and other investigations generally do not qualify<br />
as a Claim under the policy definition. The policy does not afford the insured a defense to such proceedings, nor<br />
indemnify the insured for the cost of its response.<br />
A Claim typically does not include a governmental agency’s order requiring the insured to comply with regulations,<br />
to pay fines or penalties or to pay restitution. Such orders are not demands for payment of damages. However,<br />
even if a governmental action qualified as a Claim, any resulting Loss is expressly excluded under the terms of<br />
the policy.<br />
Repurchase Demands. The MCPL policy is frequently issued to mortgage lenders who originate mortgage loans<br />
to borrowers and then sell the loans to third party investors. The loan sale contracts governing the sale of the<br />
loans require the insured, as seller, to repurchase the loans it sold in the event of an early payment default or if<br />
loans do not meet specific quality standards. When the loan buyer sends a letter that demands “repurchase,” it<br />
usually does not demand payment of damages, but rather seeks adherence to the terms of the parties’ contract.<br />
Such demands generally are not “Claims” within the meaning of the MCPL policy.<br />
Repurchase demand letters typically are potential Claims, rather than actual Claims. If the loan buyer eventually<br />
files a lawsuit seeking, for example, damages for breach of contract, the repurchase demand may become a<br />
Claim. In such cases, however, other exclusions of the MCPL policy often apply to preclude coverage.<br />
Class Action Complaints. Class action complaints may include damages allegations that trigger a duty to defend<br />
under the policy. Defense Costs can be high, but frequently only a small portion of the resulting civil judgments<br />
or settlements are attributable to Claims seeking recovery of damages. The larger component of class action<br />
awards tend to be based on restitution or civil penalties that are more easily awarded on a class-wide basis. That<br />
portion of class action judgment awards are not within the scope of the coverage.<br />
7 · PROFESSIONAL LIABILITY COVERAGE
E. WHAT CONSTITUTES A WRONGFUL ACT?<br />
The insuring clause of the policy applies to “Loss… as a result of any Claim first made against the Insured … for a<br />
Wrongful Act….” The MCPL policy states:<br />
“Wrongful Act” means any actual or alleged negligent act, negligent error or negligent omission committed<br />
by the insured solely in the performance of or failure to perform professional services for others in the<br />
Insured’s Profession as stated in Item 1.A. of the Declarations.<br />
Negligent Act, Error or Omission. Coverage under the policy applies to a “Wrongful Act,” defined as a “negligent<br />
act, negligent error or negligent omission” by the insured. This condition does not necessarily limit coverage to<br />
Claims that assert a “negligence” cause of action. Courts generally hold that the phrase “negligent act” implies<br />
that the conduct giving rise to the alleged liability must be inadvertent or unintentional in some sense. The cause<br />
of action may be based on a contractual relationship, statutory violation or a tort that does not require intentional<br />
conduct. The specific tort at issue should be evaluated to determine whether “intent” is an element.<br />
The Claim allegations against the insured must “sound in” negligence. In practice, that means that many lawsuits<br />
superficially alleging only intentional conduct or that do not describe the defendant’s “intent” may trigger<br />
coverage if the liability might arise from a negligent act.<br />
Performance of or failure to Perform Professional Services for Others. Coverage applies only when the alleged<br />
negligent act, error or omission arises from the performance of or failure to perform professional services for<br />
others in the insured’s profession. The insured’s profession is typically identified in the policy declarations.<br />
“Professional services” has generally been interpreted to mean that there must be some service performed for<br />
another. Thus, for example, under this condition professional liability coverage does not apply to employment or<br />
partnership disputes, or to conflicts with competitors alleging theft of proprietary customer information, since<br />
the Claims do not involve the performance of professional services for others.<br />
In one case, an attorney’s conduct of a lawsuit in which he represented himself did not constitute a “professional<br />
service” as it did not involve services performed for another, namely a client. Also, general administrative activities<br />
are not considered to be “professional services” because they do not involve expertise related to performance<br />
of a particular profession.<br />
The professional services requirement has not been as uniformly enforced. In a recent case, the court held that<br />
fraudulent conduct by lawyers arose out of the rendering of professional services because had defendants<br />
not been acting as attorneys they would not have been able to commit the alleged fraudulent acts. While the<br />
insurance company was correct that the definition of legal services typically does not (and should not) include<br />
the commission of fraud, the acts alleged in the underlying complaint qualified as professional services because<br />
they bore a substantial nexus to professional services sought.<br />
PROFESSIONAL LIABILITY COVERAGE · 8
SCOPE OF COVERAGE<br />
A. CLAIMS MADE COVERAGE<br />
Coverage under the MCPL policy applies only to Claims that are first made against the insured during the policy<br />
period. Coverage under the policy is not triggered when a Wrongful Act occurs, but rather when a “written<br />
demand for money damages” is made to an insured within the policy period.<br />
Future Claims. An insured might become aware, during the policy period, of a Wrongful Act or other circumstances<br />
that it believes may give rise to a future Claim against an insured, but an actual Claim has not yet been made.<br />
In that event, if the insured provides written notice to Underwriters, and identifies the Wrongful Act, potential<br />
claimants and damage that may result, then any future Claim arising from those circumstances shall be deemed<br />
to have been made at the time such written notice was given. (Condition VI.B.).<br />
Matters that Preceded the Policy Period. The MCPL policy excludes coverage for events and circumstances that<br />
were the subject of a Claim or notice under a prior policy. (Exclusion O.1). It also excludes coverage for any Loss<br />
that results from any events or circumstances, known to the insured prior to the policy’s “Coverage Date,” that<br />
would cause a reasonable person to believe that a Claim for a Wrongful Act may be made. (Exclusion O.3). The<br />
“Coverage Date” is set out in the Policy declarations. The date typically coincides with the inception date of the<br />
first policy issued to the insured by Underwriters. An insured is not excused from giving notice on the basis that<br />
it thought the Claim lacked merit. The insured must give notice of circumstances if a reasonable person would<br />
believe that a Claim may ensue<br />
Underwriters also request that applicants disclose in the policy application any circumstances that they are<br />
aware of prior to policy inception that could lead to a Claim. If an applicant is aware of circumstances and facts<br />
prior to policy inception that ultimately lead to a Claim during the relevant policy period—but fails to disclose<br />
those facts or circumstances in the policy application—the insurer may deny coverage or possibly rescind the<br />
policy. Courts often rely upon both the insurance application and policy language when ruling that the prior<br />
knowledge exclusion defeats coverage for the named insured based on knowledge of a single insured who failed<br />
to identify facts or circumstances in the policy application that could lead to a Claim.<br />
Interrelated Wrongful Acts. The MCPL policy provides that Claims arising out of “a single Wrongful Act or<br />
Interrelated Wrongful Acts shall be treated as single Claim…and such Claims shall be subject to the same Limit<br />
of Liability.” (Condition V.C.). The Policy defines “Interrelated Wrongful Acts” as Wrongful Acts that have “as a<br />
common nexus any fact, circumstance, situation, event or transaction or series of facts, circumstances, situations,<br />
events or transactions.” (Condition III.G.).<br />
To the extent two Claims arise from Interrelated Wrongful Acts, they are treated as a single Claim, and each single<br />
Claim is considered first made when the earliest of the Claims was first made. The Claims are subject to the same<br />
Limit of Liability and to a single Retention amount. (Condition V.C.).<br />
Whether two or more Claims arise from Interrelated Wrongful Acts depends on the facts alleged. For example, a<br />
letter from a claimant demanding payment and a subsequent suit brought by the same claimant to enforce the<br />
payment obligation would likely be deemed to arise from Interrelated Wrongful Acts. Also, multiple suits brought<br />
against the insured by different claimants based on a common scheme or pattern of alleged wrongful conduct<br />
by the insured may also be interrelated.<br />
Class action complaints may raise issues of interrelatedness, i.e., that Claims asserted by the respective class<br />
members are interrelated and thus subject to a single limit of liability.<br />
9 · PROFESSIONAL LIABILITY COVERAGE
B. NOTICE OF CLAIMS<br />
The MCPL Policy requires the insured to provide notice of a Claim “as soon as practicable, but in no event later<br />
than sixty (60) days after the date such Claim is first made.” (Condition VI.A).<br />
Some professional liability policies provide “Claims made and reported” coverage. Under such policies, as a<br />
condition precedent to coverage, the Claim must be made against the insured, and notice of Claim must be given<br />
to the insurer, during the policy period. In contrast, the MCPL policy requires notice as soon as practicable not to<br />
exceed 60 days from the date of the date of the Claim. Also, the notice provision is not conspicuously identified<br />
as a “condition precedent” to coverage, either in the initial grant of coverage or at the beginning of the policy.<br />
Thus, although the notice provision states that compliance is a “condition precedent” to coverage, many courts<br />
will hold that the notice provision is not and, therefore, apply the notice prejudice rule to any violations of notice<br />
provision by the insured.<br />
Courts construe notice requirements as imposing a requirement of reasonable notice under the circumstances or<br />
substantial compliance. In a majority of states, an insurer is required to show that it was substantially prejudiced<br />
by an insured’s untimely notice before coverage can be denied on notice grounds. Prejudice will depend on the<br />
particular facts and circumstances, but is typically a high burden for the insurer to satisfy and late notice is thus<br />
not an absolute bar to coverage absent a showing of prejudice.<br />
C. RETROACTIVE DATE<br />
Coverage under the MCPL policy applies only to “Loss…as a result of any Claim…for a Wrongful Act that occurred<br />
on or after the Retroactive Date” specified on the policy’s declarations. The MCPL policy is often subject to<br />
graduated retroactive dates. Higher limits may be afforded for Claims that result from Wrongful Acts that occur<br />
on or after later retroactive dates.<br />
A retroactive date that is closer in time to the inception of the policy period can greatly reduce the scope of<br />
coverage. Claims under the MCPL often relate to problem loans, which may not become evident until the loan<br />
has been in existence for a period of time.<br />
D. RETENTION<br />
The MCPL policy applies to Loss in excess of the Retention amount stated in the policy Declarations. The<br />
Retention is the amount of the otherwise covered loss that is uninsured and must be borne by insured. The<br />
insured bears responsibility to pay the entire Retention amount before Underwriters have any duties to make<br />
payments. (Condition V.D).<br />
PROFESSIONAL LIABILITY COVERAGE · 10
DEFENSE AND SETTLEMENT<br />
A. DUTY TO DEFEND<br />
The MCPL policy provides that Underwriters<br />
have the right and duty to defend any Claim to which this insurance applies, even if any of the allegations of<br />
the Claim are groundless, false or fraudulent.<br />
Scope of Duty to Defend. The policy imposes on Underwriters the duty to defend the insured as long as there is<br />
the potential for coverage for a Claim against an insured, even if the Claim is groundless, false or fraudulent. This<br />
duty is referred to as the “potentiality standard.”<br />
The duty to defend is broader than the duty to indemnify and is determined by the allegations in the Claim.<br />
In a duty to defend policy, the insurer provides an attorney and assumes the defense of a Claim against the<br />
insureds under the policy. The insurer’s obligation to defend a Claim is triggered whenever the facts alleged by<br />
the claimant could even potentially result in a judgment within the scope of coverage. The insurer is required<br />
to provide a full defense to all Claims, even if some allegations would be uncovered. A suit containing any<br />
potentially covered allegations must be defended even when it is unlikely that a settlement or judgment will fall<br />
within the indemnity coverage.<br />
If the allegations in the underlying complaint are vague or contradictory, the insurer must assume that the duty<br />
to defend has been triggered as long as the Claim contains allegations that “sound in” negligence. Although the<br />
policy covers only negligent acts, a Claim that apparently alleges only intentional acts, or that does not describe<br />
the insured’s intent, may trigger a duty to defend if there is any possibility that liability might arise from a<br />
negligent act. In one case, a court held that an insurer had a duty to defend a lawsuit alleging intentional conduct<br />
by an employer who decided to terminate an employee benefit plan and deny benefits to plan participants.<br />
The court concluded that the coverage for negligent acts may include decisions which are discretionary and<br />
intentionally made, but may also nonetheless be negligent decisions.<br />
Options of Insurer. On presentation of Claims, an insurer generally has three options:<br />
1. Accept Coverage and Defend. If the insurer accepts coverage, it generally retains counsel to defend<br />
the insured, pays defense counsel, controls the Claim defense and pays amount of any settlement or<br />
judgment, subject to the policy Retention amount.<br />
2. Deny Coverage. If the insurer denies coverage and refuses to defend the Claim, the insured has the<br />
right to retain defense counsel, control the Claim defense and settle without consent of the insurer or<br />
take the Claims against the insured to judgment. In some jurisdictions an insurer that denies coverage<br />
must promptly initiate a declaratory judgment action seeking a declaration of no coverage in order to<br />
preserve its defenses.<br />
3. Defend under a Reservation of Rights. The insurer may reserve its right to challenge both its defense<br />
and indemnity obligations by agreeing to defend the Claim under a reservation of rights. The insurer<br />
notifies the insured in writing that it will defend the insured, but that it is reserving its rights under the<br />
policy to challenge at a later time whether it owes a duty to defend or a duty to indemnify. If an insurer<br />
reserves such rights, the insurer may conduct an insured’s defense in good faith without waiving its<br />
right to assert any policy defenses, provided it gives the insured notice of any potential defenses in the<br />
reservation of rights. In some cases, an insurer defending under a reservation of rights may be able to to<br />
recoup defense costs in the event that the Claim is ultimately determined not to be covered.<br />
Independent Counsel. Underwriters have the right to control the defense of its insured, based on policy wording<br />
that grants Underwriters “the right and duty to defend any Claim.” The relationship between policyholder, insurer<br />
and insurer-retained defense counsel is a tripartite relationship in which the defense counsel has two clients—<br />
11 · PROFESSIONAL LIABILITY COVERAGE
the policyholder being defended and the insurer that retains and pays counsel. Having multiple clients creates the<br />
possibility of a conflict of interest for defense counsel when the insurer has reserved its right to deny coverage.<br />
An insurer under a duty to defend policy cannot control the defense or select counsel if doing so creates a<br />
potential conflict with the insured’s interests. A conflict of interest exists when an insurer reserves its rights on<br />
a coverage issue and the outcome of that coverage issue can be controlled or influenced by defense counsel<br />
retained by the insurer. For example, when a complaint contains allegations of both intentional and negligent<br />
conduct by the insured, it may be possible for defense counsel to steer the defense away from a finding of any<br />
negligent conduct.<br />
When such a conflict has been identified, the insured generally has the right to select independent counsel. If<br />
the insurer also retains counsel, both counsel provided by the insurer and independent counsel selected by the<br />
insured are allowed to participate in all aspects of the litigation. If multiple insureds are defendants in the same<br />
matter, the conflict analysis must be performed separately for each insured. The right to select independent<br />
counsel can be waived by the insured.<br />
Breach of Duty to Defend. The consequences of breaching the duty to defend vary from state to state, but can<br />
be substantial. Once the duty to defend has been triggered, the insurer may be subject to “bad faith” exposure<br />
for any failure to provide a defense. Specifically, if the insured is unable to defend the action without the insurer’s<br />
assistance, the insurer may be liable for any settlement or default judgment resulting from the action, even if the<br />
settlement or judgment includes elements that would otherwise be beyond the scope of coverage. Depending<br />
on the jurisdiction, an insurer who denies a duty to defend and is ultimately found to have a duty may be<br />
deemed to have waived all of its other defenses, including the policy limits. In addition, the insurer may be held<br />
responsible for any attorney fees incurred by the insured during the defense of the Claim, any attorneys fees<br />
incurred attempting to persuade the insurer to change its erroneous coverage determination, any other damages<br />
(such as business or reputational losses) caused by the insured’s inability to defend itself from the underlying<br />
lawsuit, as well as punitive damages.<br />
B. THE RIGHT TO DEFEND<br />
The policy not only imposes on Underwriters a duty to defend a Claim, it also gives to Underwriters the right to<br />
defend. Underwriters have the right to control the defense of the action against its insured, including selection of<br />
counsel. Defense Costs incurred without Underwriters’ approval are not covered by the policy and do not erode<br />
the applicable Retention.<br />
In furtherance of the right to defend, the policy requires the insured to provide assistance and cooperation to<br />
Underwriters. The policy requires that the insured, upon request, among other things, to submit to an examination<br />
under oath, to attend hearings and depositions, to assist in effecting settlement, or securing witnesses and<br />
evidence, and otherwise to aid in the investigation and defense of the Claim, all without charge to Underwriters.<br />
(Condition VII.E).<br />
C. THE RIGHT TO SETTLE<br />
The Policy also provides that Underwriters have “the right to negotiate the settlement of any Claim….” (Sec. II). An<br />
insured may not settle any Claim or admit liability without Underwriters’ consent. Failure of an insured to abide<br />
by this condition may be a defense to coverage. Underwriters may not commit the insured to any settlement<br />
without its consent. If the insured refuses to consent to any settlement recommended by Underwriters to which<br />
the claimant has agreed, the insured may continue defense of the Claim in the legal proceeding at the insured’s<br />
expense. Underwriters’ liability for the Claim is limited to the amount in excess of the Retention which they would<br />
have contributed had the insured consented to the settlement.<br />
PROFESSIONAL LIABILITY COVERAGE · 12
D. THE DUTY TO SETTLE<br />
When a Claim triggers the insurer’s duty to defend, it also triggers a corresponding duty to settle. Courts find<br />
that an “implied covenant of good faith and fair dealing,” inherent in all policies, requires the insurer to accept<br />
reasonable settlement demands within policy limits when doing so would avoid exposing the insured to liability<br />
in excess of the policy limits or would otherwise prevent some injury to the insured’s interests. The breach of that<br />
duty may expose insurers to bad faith liability.<br />
Considerations related to the duty to settle arise only when the insured may be injured in some way by the<br />
insurer’s failure to settle. Although the potential injury is frequently a verdict in excess of the policy limits, courts<br />
have also held that the possibility of other consequential damages (e.g., damages to the insured’s reputation or<br />
future business prospects) may support a bad faith claim against the insurer.<br />
The duty to settle does not mean insurers are obligated to settle every case regardless of circumstances or<br />
reasonableness of the claimant’s demands. Rather, insurers are obligated to use the resources at their disposal in<br />
a reasonable manner to protect their insureds’ interests. The potential for bad faith liability applies only where the<br />
insurer refuses a “reasonable” settlement demand. In evaluating the reasonableness of a settlement demand the<br />
insurer must determine, in the light of the claimant’s damages and the probable liability of the insured, whether<br />
the ultimate judgment is likely to exceed the settlement offer. Whether the eventual loss has produced an excess<br />
verdict is determined without reference to non-covered losses such as punitive damages.<br />
The insurer should not allow coverage considerations to influence its evaluation of a settlement demand. Even if<br />
the insurer’s substantive coverage position is reasonable and would not subject the insurer to bad faith liability,<br />
the decision to reject a reasonable settlement demand must also be reasonable (without regard to coverage<br />
issues) to avoid bad faith liability in the event coverage applies.<br />
Insurers are allowed a reasonable time to consider a settlement demand. Settlement demands that are withdrawn<br />
before the insurer has had a reasonable opportunity to examine them or where the information necessary to<br />
make an informed decision is unavailable to the insurer are not reasonable demands. Conversely, an insurer may<br />
not unreasonably delay acceptance of a settlement offer.<br />
An “excess judgment” merely provides an inference which is favorable to the insured’s “bad faith” claim. Such<br />
evidence may be rebutted or overcome by other evidence showing that the insured’s estimate of liability was<br />
reasonable at the time it was made. On the other hand, in the absence of an excess verdict, an insurer may be<br />
liable for refusal to accept a reasonable settlement demand if the resulting verdict (although itself not in excess<br />
of policy limits) reduces the limits available to address other claims.<br />
The legal rules governing settlement are complex in theory, and often more so in practice. The required decision<br />
to settle or refuse to settle arises when none of the parties know what the result of the litigation will be, and no<br />
one knows for sure whether a demand is “reasonable.”<br />
13 · PROFESSIONAL LIABILITY COVERAGE
EXCLUSIONS<br />
A. IMPROPER BENEFIT EXCLUSION<br />
The policy excludes coverage for Loss that is<br />
based upon or directly or indirectly arising out of or resulting from an Insured gaining in fact any personal<br />
profit or advantage to which the Insured is not legally entitled.<br />
The foregoing provision is typically referred to as the personal profit exclusion. A person is not legally entitled<br />
to an advantage or profit resulting from his violation of law. Courts have generally found, therefore, that loss<br />
under an insurance policy cannot be held to include restoration of an ill-gotten gain. Courts have reasoned<br />
that allowing an insured to receive coverage for such loss would encourage insureds to intentionally engage in<br />
unlawful activity with the purpose of reaping a benefit from such activity through insurance. Application of this<br />
exclusion requires not only that the individual director or officer personally benefitted from his actions, but that<br />
he was not entitled to the benefit he gained. (Exclusion A).<br />
B. CRIMINAL ACTS EXCLUSION<br />
The policy applies only to negligent acts or omissions. The policy therefore excludes coverage for Loss “that<br />
results in a judgment or final adjudication that any Insured has committed any criminal, dishonest, intentionally<br />
malicious, or fraudulent act, error or omission.” This exclusion is not commonly utilized as a bar to coverage<br />
because it requires a judgment or final adjudication to apply. (Exclusion B).<br />
C. PERSONAL INJURY AND PROPERTY DAMAGE EXCLUSION<br />
Coverage under the policy is limited to economic damages. The policy thus excludes coverage for Loss based on<br />
bodily injury, sickness, mental anguish, emotional distress, disease or death, or to loss of or damage to tangible<br />
property.(Exclusion C).<br />
The policy also excludes coverage for Loss or injury resulting from (1) false arrest, malicious prosecution, abuse<br />
of process, false detention or false imprisonment; (2) assault and battery; (3) libel, slander or defamation of<br />
character; (4) wrongful entry or eviction; or (5) invasion of any right of privacy. (Exclusion G).<br />
D. INSURED VERSUS INSURED EXCLUSION<br />
The policy excludes coverage for Claims brought by one insured against a co-insured, except where the Claim<br />
arises from failure to perform professional services for the claimant as a client. This exclusion originated to<br />
prevent collusion in support of claims tendered under D&O policies. Insurers sought to preclude coverage for<br />
collusive suits in which a corporation would sue its officers and directors in an effort to recoup business losses,<br />
thus converting the liability insurance policy into business-loss insurance. The policy is intended to protect against<br />
Claims by outsiders, not intracompany Claims. (Exclusion D).<br />
While the exclusion is more prevalent with regard to D&O insurance, it occasionally applies to Claims under the<br />
MCPL policy. In that context, application of the exclusion sometimes turns on whether professional services are<br />
being rendered to the claimant insured.<br />
PROFESSIONAL LIABILITY COVERAGE · 14
E. WARRANTY AND GUARANTEE EXCLUSION<br />
The policy applies to Loss as a result of a Claim based on a negligent act or omission. Consistent with that scope<br />
of coverage, the policy excludes coverage for Loss resulting from the breach of an express warranty or guarantee.<br />
Claims for breach of warranty and guarantee typically do not fall within the insuring agreement because they<br />
are based on contractual obligations rather than on negligence, which is the basis for coverage under the MCPL<br />
policy. (Exclusion K).<br />
F. NON-MONETARY RELIEF EXCLUSION<br />
The policy covers the insured’s Loss, which is defined to include money damages. Consistent with that scope of<br />
coverage, the policy also excludes coverage for loss related to injunctive relief, or redress in any form other than<br />
money damages, including disciplinary proceedings. Under the MCPL policy, Claims may be brought against<br />
insureds, for example, by claimants seeking equitable remedies such as restitution or declaratory relief rather<br />
than damages. The exclusion bars coverage for such Claims. (Exclusion J).<br />
G. TERMINATION EXCLUSION<br />
Coverage under the policy applies only to Claims first made against the insured during the policy period. The<br />
policy therefore expressly excludes coverage for facts, circumstances, situations, events and transactions that<br />
were the subject of a Claim or notice on a prior policy, or that would cause a reasonable person to believe that a<br />
Claim for a Wrongful Act might have been made during a previous period. (Exclusion O).<br />
H. CIVIL RIGHTS EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from any violation of any<br />
civil rights laws, including but not limited to discrimination by the Insured on the basis of age, color, race, creed,<br />
sex, size, national origin or marital status.” (Exclusion P).<br />
This exclusion is implicated under the MCPL policy, for example, by Claims by minority borrowers who allege<br />
that mortgage lenders engage in discriminatory practices or by elderly claimants who claim that lenders have<br />
exploited them based on age.<br />
I. CONTRACTUAL INDEMNITY EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from any actual or alleged<br />
assumption by the Insured under any contract or agreement of the liability of others, unless such liability would<br />
have attached to the Insured in the absence of such a contract or agreement.” Coverage under the policy does<br />
not apply when the insured’s alleged liability arises from its contractual agreement to assume the liability of a<br />
subsidiary company or other entity. (Exclusion Q).<br />
J. ADVERTISING EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from any actual or alleged<br />
advertising or solicitation activities of an Insured.” This exclusion commonly applies to Claims by borrowers<br />
alleging misrepresentations by the insured in advertising for or soliciting business, Claims between mortgage<br />
brokers alleging unfair competition or Claims alleging violations of the Telephone Consumer Solicitation Act. The<br />
exclusion bars coverage for any such advertising or solicitation Claims. (Exclusion T).<br />
15 · PROFESSIONAL LIABILITY COVERAGE
K. GOVERNMENTAL ACTION EXCLUSION<br />
The policy excludes coverage for Claims “brought for or on behalf of any governmental authority, quasigovernmental<br />
authority or other regulatory authority or agency, except when acting in the capacity of a customer<br />
or client of the Insured or on behalf of a customer or client of the Insured and when such CLAIM arises from<br />
Professional Services rendered or that should have been rendered to such authority or customer or client.”<br />
This exclusion is implicated when governmental or quasi-governmental entities file actions against the insured for<br />
violations of rules and regulations, or target the insured for investigation, e.g., an SEC subpoena for documents.<br />
Agency subpoenas are not covered because they are not a Claim, do not seek damages, and involve governmental<br />
action barred from coverage by this exclusion. (Exclusion V).<br />
L. LOAN SERVICING EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from (1) collecting, receiving<br />
or recording payments on mortgage loans, (2) establishing or administering tax or insurance escrow accounts on<br />
mortgage loans, (3) managing real property owned by or under the supervision or control of an Insured, or (4)<br />
performing any other acts related to (1), (2) or (3).”<br />
This exclusion is standard on the MCLP Policy form, but the coverage is frequently bought back by endorsement<br />
when coverage is provide to mortgage bankers who also engage in the loan servicing business. (Exclusion W).<br />
M. LOAN REPURCHASE EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from any actual or alleged<br />
duty to repurchase a loan.”<br />
The loan repurchase exclusion was added to the MCPL policy to address a high volume of Claims by investors<br />
who purchased subprime loans from insured mortgage lenders. It applies, for example, when investors claim<br />
that insureds are obligated contractually to repurchase loans based on early payment defaults or alleged nondisclosure,<br />
misrepresentation, fraud or other acts by the borrowers. This exclusion excludes coverage for Claims<br />
based on such repurchase obligations. (Exclusion X).<br />
N. LOAN SALES CONTRACTUAL INDEMNITY EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from any actual or alleged<br />
breach by an Insured of an agreement to hold harmless or indemnify an investor, purchaser or lender in connection<br />
with a loan originated, made, held or sold by an Insured as mortgage broker or mortgage banker.”<br />
This exclusion was added to the MCPL policy crisis to address the flood of contractual demands from purchasers<br />
of subprime mortgage loans. When investors demand that the insured indemnify the investor from loss due to<br />
breach of the terms of the loan purchase agreement, the exclusion precludes coverage. (Exclusion Y).<br />
O. INVESTMENT LOSS EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from depreciation (or the<br />
failure to appreciate) in value of any investment transaction, including real property, securities, commodities,<br />
currencies, options and futures, or any actual or alleged representation, advice, guarantee or warranty provided<br />
by or on behalf of an Insured with regard to the performance of such investment.”<br />
The policy applies Claims for money damages resulting from negligent acts or omissions. It does not apply to<br />
claims for depreciation or losses in real estate values, or in other investments such as securitized mortgages. The<br />
exclusion bars coverage for such investment losses. (Exclusion AA).<br />
PROFESSIONAL LIABILITY COVERAGE · 16
P. TILA EXCLUSION<br />
The policy excludes coverage for loss<br />
directly or indirectly arising out of or resulting from any actual or alleged (1) non-disclosure, concealment,<br />
misrepresentation, misstatement or falsification of any terms of a loan, or of any rights or information required<br />
to be disclosed or revealed under TILA; or (2) improper, excessive, illegal or unauthorized fees, penalties or<br />
costs, including but not limited to prepayment penalties. The term “TILA” means, for the purposes of this<br />
Exclusion, the Truth-in-Lending Act of 1968, Title I of the Consumer Credit Protection Act as amended (15<br />
USC § 1601 et seq.) or Regulation Z (12 CFR Part 226).<br />
Mortgage borrowers seeking to prevent foreclosure sometimes assert retaliatory Claims alleging predatory<br />
lending practices. Such Claims, which were especially prevalent during the subprime mortgage crisis, typically<br />
allege fraudulent misrepresentations of loan terms and violations of statutes, such as TILA. TILA claims are<br />
advantageous for insureds because they did not require proof of intent to establish liability. The exclusion<br />
effectively bars coverage for such Claims. Such Claims are no longer prevalent given substantial changes in<br />
the real estate lending market since the sub-prime crisis. Also, portions of TILA which permit the recovery of<br />
damages are subject to a one year statute of limitation. (Exclusion BB).<br />
Q. REAL PROPERTY OWNERSHIP EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from any transaction (1)<br />
involving real property in which any Insured or any affiliate of any Insured has or acquires a direct or indirect<br />
ownership or financial interest, or (2) involving a lease or property in which any Insured or affiliate of any Insured<br />
has a direct or indirect ownership or financial interest.” The coverage applies to negligent acts or omissions by<br />
the insured, not to Claims involving the insured’s investment in or interest in real estate. (Exclusion EE).<br />
R. BANKRUPTCY EXCLUSION<br />
The policy excludes coverage for loss “directly or indirectly arising out of or resulting from the insolvency or<br />
bankruptcy of any Insured or of any other entity including but not limited to the failure, inability, or unwillingness<br />
to pay Claims, losses, or benefits due to insolvency, liquidation or bankruptcy of any such individual or entity.” The<br />
bankruptcy exclusion in commonly invoked under D&O policies, since shareholder actions are often triggered by<br />
bankruptcy. It is not commonly implicated under the MCPL policy. (Exclusion FF).<br />
17 · PROFESSIONAL LIABILITY COVERAGE
COMMON ENDORSEMENTS<br />
In addition to the standard exclusions, the MCPL policy often incorporates endorsements that further define the<br />
scope of coverage provided. The following are common endorsements that supplement the MCPL policy form.<br />
A. YIELD SPREAD ENDORSEMENT<br />
This endorsement excludes coverage for loss arising from: (1) yield spread premium; (2) kickback; (3) improper<br />
split of charges; and (4) improper payment of compensation for the referral of settlement service business in<br />
connection with any mortgage lending transaction. The endorsement bars coverage for losses arising from such<br />
actions because they arise not from allegedly negligent acts, but rather are based on deliberate acts that are<br />
excluded from coverage throughout the policy.<br />
B. DISCOUNTED LOAN LOSS ENDORSEMENT<br />
This endorsement modifies the loan repurchase exclusion (Exclusion X). It allows limited coverage for “discounted<br />
loan loss,” where:<br />
(1) the insured sold and is legally liable to repurchase the loan as a result of a Claim within the policy period<br />
and after the retroactive date, and<br />
(2) the insured repurchases and the resells the loan.<br />
However, the endorsement excludes coverage it the applicable loan is in default or foreclosure, or payments are<br />
not current, or any loans where the insured has not “made diligent efforts and taken all reasonable actions to<br />
correct any problem with the loan that is the subject of the Claim.”<br />
The endorsement defines the “discounted loan loss” as the original loan principal amount less: (a) all payments<br />
that have or should have been applied to the principal, and (b) the sale price received by the insured upon<br />
reselling the loan, excluding costs incurred to correct loan problems and resell the loan. The endorsement also<br />
limits coverage (usually $100,000) for the entire policy period, regardless of the number of Claims.<br />
PROFESSIONAL LIABILITY COVERAGE · 18
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