PowerPoint to support discussion regarding developments in insurance coverage disputes and ensuing litigation arising from the financial crisis.

1. Unintended Consequences :: An Update
on the Impact of the Financial Crisis on
Your Insurance Coverage Practice
MICAH SKIDMORE
AMY ELIZABETH STEWART
16TH ANNUAL INSURANCE LAW INSTITUTE
NOVEMBER 3-4, 2011
AUSTIN, TEXAS

2. The Financial Crisis
Litigation arising out of the “Financial Crisis”:
 Securities litigation
 Bankruptcy litigation
 Regulatory/government enforcement
actions
 Insurance coverage litigation

3. Securities Litigation
“Credit Crisis” Related Securities Litigation:
 2007—40 (20%)
 2008—103 (41.7%)
 2009—58 (26.7%)
 2010—36 (15%)
Source: NERA Economic Consulting, Recent Trends in Securities Class Action Litigation: 2011 Mid-Year Review

4. Securities Settlements
 Settlements of subprime and credit crisis
litigation have been few, but large
 As of September 2011, settlements totaled $3.4
billion
 Average $116 million per settlement
Source: Kevin LaCroix, The D&O Diary, http://www.dandodiary.com/.

5. Staggering Settlements
 Countrywide shareholders settlement —
$624m
 Wachovia bondholders settlement —$627m
 Merrill Lynch shareholders settlement —
$475m
 WaMu—$208.5m
 Wells Fargo mortgage backed securities —
$125m
 National City—$168m
 Lehman Brothers—$9om
Source: Kevin LaCroix, The D&O Diary, http://www.dandodiary.com/.

6. Defense Costs Estimates
 In many cases, defense costs alone may exceed the
limits of the defendants’ D&O coverage or other
available insurance
Source: J. Robert Brown, US v. Stockman and the Burn Rate on the D&O Policy,
THERACETOTHEBOTTOM.ORG (June 2, 2008), available at www.theracetothebottom.org/stockman/us
-v-stockman-and-the-burn-rate-on-the-do-policy.html (detailing the exhaustion of a $50 million tower of
D&O insurance through defense costs accruing at a rate of $1.67 million per month).

7. Corporate Bankruptcy
Business Bankruptcy Filings:
 2007—28,322
 2008—43,546
 2009—60,837
 2010—56,282
Source: American Bankruptcy Institute, U.S. Bankruptcy Filings 1980-2010 (Business, Non-Business, Total)

8. Failed Bank Litigation
 Total bank failures since Jan 2008—406
 87 bank failures this year alone
 FDIC has initiated 15 lawsuits to date
 FDIC has authorized lawsuits involving 34 failed
banks and 308 directors and officers for liability of
at least $7.3M
 Litigation expected to increase
Source: Kevin LaCroix, The D&O Diary, http://www.dandodiary.com/.

9. Regulatory Enforcement
SEC ENFORCEMENT ACTIVITY 2007 2008 2009
Investigations Opened 776 890 994
Cases Filed 656 671 664
Source: SECURITIES AND EXCHANGE COMMISSION, PERFORMANCE AND ACCOUNTABILITY REPORT 36 (2009).

10. Insurance Coverage Litigation
 Derivative of underlying “financial crisis”
litigation
 Direct actions on first-party financial
guaranty insurance, i.e., mortgage insurance,
trade credit insurance

11. Coverage Issues
 The “fortuity doctrine,” “known loss” or “loss in
progress” defense
 Rescission and the “fraud in the application”
defense
 Priority of payments among insured defendants
 Coverage for non-traditional “claims”

12. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
 Insured $96.5 million in loans to film production
company
 No foreign distribution required by Chase
 Coverage for default denied as not “fortuitous”

13. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
Q. If the terms of the financing transaction were equally
known to the insurer, is the “fortuity doctrine” a
defense?
A. No.

14. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
“Given the underlying basis of the doctrine, and the right
of the parties to agree to cover existing losses, it has been
recognized that the known loss doctrine does not apply if
the insurer also knew of the circumstances on which it
bases the defense.”

15. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
Q. Does the “fortuity” defense apply to risks that were
not investigated prior to issuance of the policy?
A. Probably not.

16. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
 N.H. waived voluntary disclosure for Chase.
 Other cases have inconsistently addressed the
insurer’s obligation to investigate potential risks as a
prerequisite to the “fortuity” defense.

17. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
Q. If the insured subjectively was unaware but
objectively should have known of a “loss in
progress,” will the “fortuity” defense apply?
A. It depends on the jurisdiction.

18. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
 In Texas, “the fortuity doctrine precludes coverage for
known losses and losses the insured knows, or should
know, are ongoing at the time the policy is issued.”
 In other jurisdictions, the standard is “subjective”
only.

19. Fortuity Doctrine
CASE STUDY:
Chase Manhattan Bank v. N.H. Insurance Company
Q. Is the “fortuity” doctrine inconsistent with or
preempted by statutory provisions addressing
“fraud” in an insurance application?

20. “Fraud in the Application”
Texas Insurance Code Section 705.004
 Policy provisions voiding coverage on the basis
of false statements in an application
 No effect and will not bar coverage, unless:
 Shown at trial
 Material to the risk
 Contributed to the event for which coverage is sought

21. “Fraud in the Application”
CASE STUDY:
Suntrust Mortgage, Inc. v. AIG United Guaranty Corp.
 Master mortgage insurance policy
 Insured Combo 100 loans
 AIG denied coverage defaults and rescinded the
policy
 Allegations that ST misrepresented the underwriting
standards for the subject loans

22. “Fraud in the Application”
CASE STUDY:
Suntrust Mortgage, Inc. v. AIG United Guaranty Corp.
Q. Will knowledge of past “misrepresentations” or a
failure to investigate impair the insurer’s “fraud”
defense?
A. Yes.

23. “Fraud in the Application”
CASE STUDY:
Suntrust Mortgage, Inc. v. AIG United Guaranty Corp.
“Armed with a sweeping right to audit ST’s loans and
being in possession of information that would have
alerted a reasonable insurer (especially a sophisticated
insurer like UG) to the prospect of material, wide-scale
misrepresentations by ST years before UG raised its
fraud defense, UG cannot now claim that it was duped
by ST into covering the loans.”

24. “Fraud in the Application”
CASE STUDY:
United Guaranty Mortgage Indemnity v. Countrywide Fin. Corp.
 Master mortgage insurance policy
 Claim for rescission as to all insured loans
 Allegations that Countrywide misrepresented the
underwriting standards for some loans

25. “Fraud in the Application”
CASE STUDY:
United Guaranty Mortgage Indemnity v. Countrywide Fin. Corp.
Q. Do “misrepresentations” as to some loans justify
rescission of coverage for all loans?
A. No.

26. “Fraud in the Application”
CASE STUDY:
United Guaranty Mortgage Indemnity v. Countrywide Fin. Corp.
“United Guaranty cannot articulate any limiting principle
for when misrepresentations as to some loans would
entitle it to global rescission for all loans. . . . [T]he
parties spelled out the procedures and remedies for
misrepresentation or fraud—and those procedures apply
on a loan-by-loan basis.”

27. Numerous Claimants ::
Limited Proceeds
CASE STUDY: IndyMac Bank
 16 insurance policies
 $160 million in policy proceeds
 Bank’s failure prompted numerous lawsuits
 IndyMac subsidiary sued the insurers
 Sought declaration regarding priority of
proceeds
 Asked court to determine its entitlement

28. Numerous Claimants ::
Limited Proceeds
CASE STUDY: IndyMac Bank
 Case dismissed
 D&O policies with ABC coverage prioritized payment to
individuals before entities
 Individuals’ entitlement could not be determined prior
to adjudication of the claims against them
 Subsidiary did not have an adequate injury; so, no
justiciable dispute
 Subsidiary had no interest in proceeds of Side-A
policies

29. Numerous Claimants ::
Limited Proceeds
CASE STUDY: Lehman Brothers
 Claims arising out of the largest bankruptcy in
American history ($691 B)
 $250 million insurance program
 Single primary D&O policy; 16 layers of excess
 Substantial defense costs eroding policies

30. Numerous Claimants ::
Limited Proceeds
CASE STUDY: Lehman Brothers
 August 2011—former CEO and other D&Os reach
$90 million settlement funded entirely by insurance
 Would nearly exhaust remaining limits
 D&Os of a different Lehman entity also facing
significant litigation/exposure
 Objection to settlement—inequitable
 Court approved settlement October 19, 2011

31. Numerous Claimants ::
Limited Proceeds
CASE STUDY: Creative Problem Solving
 Coverage defenses => leverage for negotiating
reduced settlement
 Saving partial limits (consider impact)
 Release policy (consider impact), except carve-back
for SEC/DOJ defense costs—could ultimately erode
policy completely notwithstanding coverage
defenses
 When there’s not enough money, outcome will be
short of perfect

32. Coverage for Non-
Traditional “Claims”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
 Bond insurer seeking coverage for regulatory
investigations and follow-on shareholder litigation
 Three challenged transactions
 $29.5 million in defense costs

33. Coverage for Non-
Traditional “Claims”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Q. Does a regulatory subpoena constitute a “Claim”
as defined by the subject policies?
A. Yes.

34. Coverage for Non-
Traditional “Claims”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
A subpoena is an “order” or “similar document”
triggering the policies’ coverage for “a formal or
informal administrative or regulatory proceeding
or inquiry commenced by the filing of a . . . formal
or informal investigative order or similar
document.”

35. Coverage for Non-
Traditional “Claims”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Q. Is coverage for the investigation of a shareholder
derivative demand limited to the costs incurred
until the demand is accepted or rejected?
A. No.

36. Coverage for Non-
Traditional “Claims”
CASE STUDY: MBIA, Inc. v. Federal Ins. Co.
Costs incurred to investigate, and if necessary reject, the
shareholders’ demand are covered, but further costs
expended by the Special Litigation Committee to continue
to investigate the shareholders’ claims are also covered
irrespective of the primary policy’s $200,000 sublimit for
investigation costs on account of all Shareholder
Derivative Demands.

37. Questions?

38. Unintended Consequences :: An Update
on the Impact of the Financial Crisis on
Your Insurance Coverage Practice
THANKS!
16TH ANNUAL INSURANCE LAW INSTITUTE
NOVEMBER 3-4, 2011
AUSTIN, TEXAS