Round one in the Battle of the Titans has gone to Countrywide. On October 6, 2009, the Central District of California handed down its decision on Countrywide’s (now part of Bank of America) Motion to Dismiss in the case of United Guaranty Mortgage Indemnity Co. v. Countrywide Financial, et al., holding that United Guaranty’s (a subsidiary of A.I.G.) tort and statutory claims would be dismissed, and only UG’s claims based on breach of contract and breach of the implied covenant of good faith and fair dealing would survive. The full order is embedded below.
Each of Countrywide, the nation’s former number one lender, and A.I.G., the nation’s largest insurer, have filed lawsuits against one another in the Central District of California (UG filed a third case in federal court in North Carolina, citing forum selection clauses) All eyes are on these cases as a bellweather for future decisions in subprime mortgage litigation, especially litigation related to mortgage insurance. This Order is one of the first to tackle head-on some of the thornier issues surrounding who will bear the losses associated with the mortgage meltdown.
Judge Mariana Pfaelzer’s opinion takes the time to walk through the securitization and mortgage insurance acquisition process, and determines that both UG and Countrywide were sophistocated parties that had substantial experience in securitizations and mortgage insurance policies, despite UG’s arguments that it had “limited experience in the subprime market.” In doing so, the Court showed a willingness to take judicial notice of language in the Policy regarding the parties’ assessment and allocation of risk that it found to contradict UG’s allegations. While ordinarily, for the purposes of a motion to dismiss, a court must accept as true all properly pled allegations of material fact, the Court cited the recent Supreme Court case of Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949-50 (2009) for the proposition that the court need not accept as true “unreasonable inferences” when the complaint is read together with the underlying documents (i.e., the insurance policy and commitment agreements).
In my initial analysis of these cases, I noted the dichotomy between UG’s assertions that it was relatively inexperienced in subprime mortgage insurance and Countrywide’s assertions that UG was a sophisticated market actor in this area. It appears this battle has been decidedly won by Countrywide, with the Court finding that UG negotiated a sophisticated contract that contained remedies for fraud and negligence, and that UG had the means and the knowledge to conduct due diligence on Countrywide’s loans prior to insuring them. These findings seemed to be important factors in the court finding that UG’s claims for fraud and negligence must be dismissed, and that it must pursue contract remedies for any such findings.
The opinion also discusses the concept of delegated underwriting, standard in the mortgage insurance industry, in which the insurer delegates the responsibility for properly underwriting the loans it insures to the lender, which represents and warrants the loans were underwritten properly. In return, the insurance company retains the right to audit the loan files to determine whether they were indeed properly underwritten. This structure is often necessary due to the lender’s superior access to information and the short turnaround time available after the loan is closed but before it is sold into securitization.
Judge Pfaelzer noted that this “delegated model makes sense when engaging in bulk mortgage insurance transactions: the applicant represents material information about the mortgage, then the insurer prices and issues the policy based on that information.” However, her Order goes on to find that, “any reasonable mortgage insurer that (1) was doing multibillion-dollar bulk transactions and (2) had an express right to audit or sample the underlying loan files before the transactions closed, would engage in some degree of auditing or sampling of the underlying loan files to be insured.” Thus, the Court found that UG could not have reasonably relied upon any misrepresentations Countrywide may have made to induce UG to provide insurance.
The Court also discredited UG’s “global rescission” argument – that these misrepresentations as to some loans entitled it to rescind coverage as to all loans in a pool. Thus, to succeed in its case, UG will have to go forward on its contract claims and demonstrate, on a loan-by-loan basis, that Countrywide breached the terms of the policy or commitment agreements for each.
