This commentary explores the nature of the claims against these market participants, the factors that affect potential recovery against them and the extent to which insurance in the form of errors and omissions coverage may currently be available to soften the blow to these entities. In light of the increased scrutiny and proposed additional regulation under consideration in Washington regarding these market participants, this commentary also explores the extent to which these entities are likely to be able to maintain or procure effective insurance coverage for their operations and under what conditions it will be available.

More specifically, this commentary addresses:

• Who is suing the loan originators and appraisers and why?
• What obstacles do the originators and appraisers face in having their errors & omissions coverage respond to the claims and suits against them?
• Will originators and appraisers be able to obtain coverage in the future and, if not, what are the implications for the broader market?

Regarding the first issue of who is suing the loan originators and appraisers and why, the author writes: “As an initial matter, in exploring the extent to which collateral participants in the subprime mortgage market face liability, there is no getting around the fact that recent legal developments can be expected to have significant influence on who sues whom and the potential outcome of those claims. Although it will take some time before all of its effects are known, the United States Supreme Courts January 15, 2008 decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta Inc., 2008 U.S. LEXIS 1091 (2008) will definitely affect pending and future cases brought against institutions selling or trading securities based on an alleged failure to identify or disclose information about the potential risks of such investments, including securities collateralized by mortgage loan portfolios.”

The author also states: “While it remains to be seen whether the Court s ruling in Stonebridge will have a chilling effect on secondary participant liability in contexts other than securities claims, we can be certain that defendants in suits arising out of the subprime mortgage mess will seek to apply or extend its approach to defeat claims where the claimant either had no contact with or cannot be shown to have relied on any information provided by the individual or entity at issue.”

As concerns the second issue that the commentary addresses with respect to the obstacles that originators and appraisers face in having their errors & omissions coverage respond to the claims and suits against them, the author writes: “In addition to standard exclusions precluding coverage for situations where the originator engaged in fraud or self-dealing, two exclusions will figure significantly in the coverage disputes between originators and their E&O carriers. The first precludes coverage for damages arising out of the failure of any real or personal property to have at any point in time any projected, estimated, represented, warranted, or guaranteed economic value. The second excuses the insurer from having to pay damages for which the originator is held liable [a]rising out of or in any way involving . . . (3) any loan or loans that have been sold by the Insured which have been repurchased or are required to be repurchased by the Insured; however this provision (3) shall not apply to such Claim(s) made against the Insured resulting solely from the rendering of or failure to render Professional Services.”

The author also writes: “In light of the depressed property values plaguing the national real estate market, the fight over how these two exclusions will be applied in practice has the potential to spill a lot of blood (or at least red ink).”

Regarding the final issue of whether originators and appraisers will be able to obtain coverage in the future and, implications for the broader market if coverage is unavailable, the author writes: “Insurance industry analysts are resigned to the fact that insurers will suffer substantial losses related to the subprime mortgage crisis, although they do not expect it to be as dire an event for the industry as some have predicted. Although litigation over a multitude of issues spawned by the subprime mortgage crisis is in its early stages, industry veterans are already projecting that liability insurance losses alone likely will exceed $1 billion. As much as liability underwriters wish they could steeply raise rates for any person or entity with meaningful exposure to the subprime market collapse, other factors affecting the larger insurance pricing cycle suggest that the market for liability insurance generally remains soft. Underwriters therefore are making up for their inability to substantially raise premiums by establishing more stringent guidelines for undertaking the risk and requiring applicants to make substantially more detailed disclosures about the transactions comprising their loan portfolios.”

The author concludes: “One can argue that the experts in the mortgage lending industry, the securities industry, the financial services industry, the insurance industry and the regulators of all of these entities should have seen this debacle coming. Whether true or not, policyholders and insurers alike currently must face the daunting reality that it will be a very long time before the insurance coverage issues this crisis will spawn will be brought to conclusion. If the industry analysts are correct, the subprime mortgage crisis eventually will remembered as a mere blip among other, more adverse liability insurance events such as the savings & loan crisis and corporate looting cases such as Enron and WorldCom. Stay tuned.”

Subscribers can access the complete commentary on lexis.com. Additional fees may be incurred.