Insurance Coverage and the SubprimeCrisis: A Broad Overview

by Matthew L. Jacobs, Lorelie S. Masters and Daniel I. Weiner

- Matthew L. Jacobs and Lorelie S.

Masters are partners and Daniel I. Weiner is an

associate in the Washington office of Jenner &

Block, LLP. This article reflects their views, and

none of the views or statements in this article is

to be attributed to any of the clients of Jenner &

Block, LLP. The authors would like to thank

Alistair McVan, a Jenner & Block project

assistant, who provided extremely helpful

research and technical editing assistance.

Introduction

Within the past 10 years, the business and legalcommunities were rocked by a series of accountingand securities fraud scandals known primarily by thenames of the companies involved, such as Enron,Tyco and WorldCom. These disruptions had nationaland worldwide economic implications, and mostgenerated costly, ongoing legal battles that in turnimplicated a wide array of insurance coverageissues. They barely had subsided when a new finan-cial crisis appeared on the horizon, this time centeredon a single industry, mortgage lending and securiti-zation, but again with implications throughout theworld economy. This new series of financial disrup-tions has come to be known collectively as the‘‘subprime meltdown.’’ In contrast to scandals likeEnron, Tyco and WorldCom, which centered on alle-gations of accounting fraud, the subprime meltdownis the product of a complicated set of economicfactors. While allegations of flawed decision-making abound, at this juncture there is little agree-

ment on which actors, if any, bear primaryresponsibility. Given the amount of money at stake,however, the subprime meltdown, like past financialcrises, will almost certainly generate extensive litiga-tion targeting a wide array of covered persons andentities.

In this article, we first provide a brief overview ofthe subprime meltdown and its possible causes. Wethen chart some of the specific litigation trends emer-ging in the wake of the impairment of the subprimereal estate market. Third, we describe several of themost clearly applicable types of insurance coveragethat are likely to protect individuals and entitiesinvolved in various mortgage lending and securitiza-tion processes. Fourth, we discuss possible defensesthat carriers may raise to limit their coverage obliga-tions. Finally, in the remaining sections, we discussthree specific insurance issues, the duty to defend,severability, and default, which tend to be ofspecial importance to covered individuals and enti-ties, and are likely to play important roles in thisparticular context as well.

The ‘‘Subprime Meltdown’’

Subprime mortgage loans are high interest loansmade primarily to borrowers with high credit risk,either because of a low credit score or a high debt-to-income ratio. In 2005 such loans accounted for 20percent of all mortgage loans, up from approximately5 percent a decade ago.1 The vast majority (approxi-mately 90 percent) of these loans carry hybridadjustable interest rates—i.e., a low fixed rate forthe first two or three years, followed by periodicresets to substantially higher rates.2 In 2003-2004,when interest rates were relatively low and property

COMMITTEE ON INSURANCE COVERAGE LITIGATION

Section of Litigation

American Bar Association

John E. James and Laura A. Foggan, Committee Cochairs

Editor in Chief: Erik A. Christiansen

Published by LexisNexis Volume 18, Number 4, July/August 2008

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values were booming nationwide, hundreds of thou-sands of borrowers who might not otherwise havebeen able to buy into the market did so by obtainingsubprime financing.3 Hundreds of thousands moreborrowed against their rapidly appreciating realestate to obtain cash for a variety of other purposes.Between 2003 and 2007, the raw total of subprimedebt outstanding increased almost threefold, from$332 billion to almost $1.3 trillion.4

Then, in 2006 and early 2007, in the face of higherinterest rates and a slump in certain sectors of theeconomy, the housing market began to cool, andsubprime borrowers like other homeowners beganto see their equity depreciate significantly. Whenthe low introductory rates attached to loans made in2003 and 2004 expired, many borrowers’ monthlypayments jumped beyond their ability to pay, butmany individuals were unable to refinance or evensell their property. The result was a nationwide spikein foreclosures; the rate increased by 90 percent from2006 to 2007.5 In the third quarter of 2007, it washigher than it had been any time since 1972.6 Risingforeclosure rates have, in turn, driven real estateprices even lower, further exacerbating the plight ofmany homeowners, particularly those with highadjustable rate mortgages.7 As of late 2007, it wasprojected that as many as half of those borrowerswhose adjustable rates were due to reset in the firstthree months of 2008 eventually would lose theirhomes to foreclosure.8 In the meantime, manysubprime lenders have declared bankruptcy.9

The effects of the subprime meltdown have spreadwell beyond the subprime lending industry and highcredit risk borrowers. Most obviously, falling houseprices have reduced the wealth of millions of home-owners regardless of their credit risk, and they nolonger have sufficient equity in their homes tofinance a variety of other pursuits like consumerspending and education.10 As one commentatornoted, cash-strapped home owners are likely tomake mortgage payments a priority over paying offother types of debt.11 For this reason, the effect on thewider credit industry may be particularly severe. Injust the first five months of 2007, late credit cardpayments rose 30 percent.12

The damage caused by the subprime meltdownadditionally has been compounded because manysubprime mortgages (about 63 percent in 2006) aresecuritized.13 The securitization process involvespooling loans with similar characteristics togetherfor sale to investors as mortgage-backed bonds, ormortgage-backed securities (MBS). These bondstypically are conveyed by the original lender to atrust entity, which in turn sells them to individualand institutional investors through an underwriter/

placement agent (often an investment bank). Otheractors in the process include credit rating agenciesthat rate the bonds, loan servicers (i.e., companieshired to collect loan payments from the borrowerand deal with delinquencies and foreclosures), andcredit risk insurers who provided credit enhancementcoverage to increase the rating, and therefore thevalue, of the bonds.14 In 2003, when propertyvalues were booming, subprime MBS appeared tobe an extremely attractive investment for all ofthese parties because they offered the prospect of afixed-income and little risk, like all MBS, combinedwith higher returns due to the high adjustable ratesand the fact that many of the underlying loans carriedprepayment penalties that were intended to insurelonger payback periods (and therefore more overallinterest paid).15 In reality, however, the marketunderestimated the likelihood of default by manysubprime borrowers. Estimates as of late 2007projected that investors around the world wouldlose $300-$400 billion.16

Along with erroneous market projections, anothercause of the subprime meltdown may have been thegovernmental bias in favor of individual homeownership that prevailed throughout the 1990s, oneof whose most notable adherents was the formerFederal Reserve Chairman, Alan Greenspan.17 Thisattitude arguably abetted the relaxation of under-writing standards across the board, for examplethrough reduced documentation requirements andthe use of automatic screening, which ultimatelyallowed many under-qualified borrowers to obtainloans they could not afford.18 The nature of the secur-itization process itself also contributed to the problemby segmenting and ‘‘packaging’’ relatively riskymortgage debt in such a manner that some investorsdid not understand what they were buying.19 Finally,some borrowers have alleged that they were eithermisled about the feasibility of paying back theirmortgages or simply did not understand their obliga-tions because nobody explained the agreements theysigned (although many may also have shared thesame unrealistic expectations of the housing marketprevalent in the rest of the economy).20

Even at this preliminary stage, the subprimemeltdown already has generated severalhundred distinct lawsuits and governmentinvestigations, and the number is expandingrapidly.

In short, unlike the financial accounting scandalsof several years ago, most of which centered on

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massive allegations of fraud, the root causes of thesubprime meltdown may have more to do with theinevitable consequences of widespread but highlyunrealistic expectations about the capacity of thehousing market to sustain long term gains, perhapscombined with some degree of carelessness and duediligence failures on the part of many differentactors, including ordinary home purchasers, mort-gage lenders, financial institutions, and the U.S.government. The degree to which blame can beshared among many different individuals and enti-ties has, unfortunately, resulted in more, not less,litigation, as all actors seek to assign blame else-where and minimize their own exposure. The morediffuse character of the subprime meltdown and itseffects—combined with ongoing sharp debatesregarding its consequences—mean that, while thereare certainly significant parallels between thecoverage issues it raises and those which surfacedin past financial scandals, there is also a pressingneed for a fresh analysis.

Litigation Trends

Even at this preliminary stage, the subprime melt-down already has generated several hundreddistinct lawsuits and government investigations, andthe number is expanding rapidly. Navigant, arespected, experienced consulting firm, has estimatedthat the litigation fallout from the crisis is likely tosurpass even that of the S&L crisis in the early1990s.21 The majority of these actions have beencommenced by or on behalf of subprime borrowers,investors in MBS, or shareholders in the various enti-ties involved in the mortgage securitization process.That said, a variety of other parties also havecommenced litigation, including lenders, under-writers and the beneficiaries of ERISA retirementplans that have lost money due to the subprime melt-down. We do not intend here to provide an exhaustivesurvey of all litigation related to the subprime crisis,but simply to explore several different types of litiga-tion matters that are likely to give rise to coveredclaims.

Borrower Lawsuits:

As of early 2008, approximately 140 to 170 lawsuitsand investigations had been commenced by or onbehalf of aggrieved subprime borrowers, makingthis category the most numerous of subprime-related litigations. Primarily, borrowers have suedmortgage lenders and other participants in the realestate closing process like title insurers (who maybe implicated by the lenders themselves even ifthey are not named by the plaintiffs).22 Some ofthese actions have already settled. For example, in

June 2007 the mortgage lender NovaStar paid $5million to settle a borrower class action allegingthat it violated Washington consumer protectionlaws when it failed to disclose to prospectiveborrowers that it paid ‘‘yield spread premiums,’’which are premiums paid to mortgage brokers whenthey negotiate interest rates that are higher than therate for which a borrower would otherwise be quali-fied.23 Borrower class actions also have alleged avariety of other ‘‘predatory’’ lending practices,including failure to make required disclosures andthe alleged use of otherwise misleading loan docu-ments,24 other allegedly misleading representationsby mortgage brokers,25 alleged fabrication of creditinformation,26 alleged schemes to inflate homevalues,27 the collection of supposedly illegal or other-wise improper interest,28 various alleged overchargesfor settlement services,29 and the alleged payment ofillegal kickbacks and referral fees by lenders to titleinsurance agents.30 Many of these suits state claimsfor relief under state consumer protection and realproperty laws as well as federal statutes like theTruth in Lending Act (TILA), the Real Estate Settle-ment Procedures Act (RESPA), RICO, and evenfederal antitrust laws (in the case of some allegedconspiracies to inflate home values). A number ofsuits against lenders also have alleged that lowincome African American and Hispanic customerswere particular targets of risky or inappropriateloans, which, if true, might violate the federal FairHousing and Equal Credit Opportunity Acts.31

In addition to lawsuits brought directly byborrowers, a number of subprime-related consumerprotection actions also have been initiated by stateattorneys general. For example, the attorney generalof Ohio has sued 10 mortgage lenders, accusingthem of pressuring real estate appraisers to inflatethe value of homes.32 Likewise, the attorneygeneral of New York has brought a similar actionagainst First American, a title insurance company,33

and is investigating a number of other corporations inconnection to the same allegations.34 The attorneygeneral of Massachusetts has sued FremontGeneral, a savings and loan, alleging that it chargedexcessive broker’s fees and induced consumers totake out loans they obviously could not afford,35

while the attorney general of the District of Columbiahas sued New Century Financial for allegedly takingpart in an ‘‘equity stripping’’ conspiracy to rob finan-cially distressed homeowners through bogusrefinancing deals.36 Three cities, Baltimore, Cleve-land and Buffalo, also have brought actions againstlenders. Baltimore alleges violations of the FairHousing Act by lenders targeting minority residentsfor inappropriate loans, while both Cleveland andBuffalo allege that negligent, irresponsible lending

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practices in general led to the abandonment of housesacross each city due to foreclosure, resulting in urbanblight and violations of state nuisance and other lawsconcerning the use of real property.37 Finally, therealso has been at least one criminal case, involving thelocal U.S. attorney in Miami, who has charged agroup of local brokers, sellers and appraisers withparticipating in a fraud ring to inflate home prices.38

Finally, while most consumer protection-typelawsuits on behalf of subprime borrowers havetargeted lenders and other participants in the settle-ment process, at least two actions have targeted majorfinancial institutions such as Lehman Brothers andMerrill Lynch, on the theory that they aided andabetted allegedly predatory behaviors by subprimelenders through their participation in the mortgagesecuritization process.39

In the long run, the types of allegations at issue inlitigations commenced by or on behalf of aggrievedborrowers may have significant staying power, evenrelative to some of the other types of subprime-related litigation discussed below. For example, of32 motions to dismiss filed by defendants in suchcases last year, only about a third were successfulin dismissing all claims (compared to two thirds inthe context of securities litigation, for example).40 Atthis stage, it is too soon to say how many of theselawsuits will actually be successful, but it is clear thatsubprime-related litigation by or on behalf ofborrowers is likely to be a significant cost of doingbusiness for many different parts of the mortgage-lending and housing industries for the foreseeablefuture.

Investor Lawsuits:

A second group that alleges harm as a result of thesubprime meltdown and has turned to litigationconsists of investors in subprime mortgage-backedsecurities. To date, investors or those seeking toprotect their interests have commenced approxi-mately 50-55 lawsuits and investigations. The mostobvious target for these actions consists of the finan-cial institutions from whom many investorspurchased subprime MBS. The most high profilecase thus far has been a suit brought by Banker’sLife Insurance against Credit Suisse First Boston(CSFB) and several of its subsidiaries and affiliates,who sold Banker’s Life MBS.41 Banker’s Lifealleges that the securities it purchased from CSFBalmost immediately declined in value to almostzero due to credit rating downgrades by Moody’s.Banker’s Life further alleges that it was induced topurchase these securities by defendants’ representa-tions that they were ‘‘safe,’’ low-risk, fixed incomeproducts.42 Its Complaint goes on to claim that, evenif the defendants did not intentionally misrepresent

the level of risk, had they performed the requisite duediligence on the loans in question, they would nothave marketed them as safe investments. Banker’sLife seeks recovery for negligent misrepresentation,common law fraud, breach of the duty of care, viola-tion of various federal and state securities disclosurelaws, and civil conspiracy.43

Banker’s Life is certainly not the only case of itstype.44 Moreover, as of early 2008 allegations thatinvestors were misled by major financial institutionsabout the risks associated with subprime MBS alsohad triggered dozens of investigations of major finan-cial institutions by the SEC,45 the United Statesattorneys for the Southern and Eastern Districts ofNew York,46 the attorneys general of New Yorkand Connecticut, and the Massachusetts secretary ofstate.47 Several states also have commenced litiga-tion against underwriters on behalf of their ownemployees, some of whose pension funds have lostmoney due to the subprime crisis.48

What makes Banker’s Life particularly interestingrelative to the above matters is the fact that Banker’sLife not only sued the financial institution that sold itMBS, but also various other companies, includingTriad Guarantee Insurance, the insurer that provided‘‘credit enhancement’’ coverage for the securities,and Bank of New York, which acted as trustee forthe underlying mortgage loans.49 As with many otherMBS, those purchased by Banker’s Life were backedby a credit enhancement insurance policy designed toshield investors from losses in the event that a certainpercentage of the underlying loans entered intodefault. As in most cases, however, the actual policy-holders were not the investors but the trustee andlender, who had fiduciary and contractual duties topursue coverage on the investors’ behalf. Alongsidethe alleged misrepresentations by Credit Suisse andits affiliates, a key allegation in Banker’s Life is thatafter Triad denied coverage on the grounds that losseshad exceeded policy limits, Bank of New York didnot vigorously challenge Triad’s decision and thusbreached its contractual obligations to Banker’sLife as the third party beneficiary of the Triadpolicy.50 The decision to name Triad itself, as analleged coconspirator and in the breach of contractclaim,51 may be a further indication of investors’desire to recover on insurance policies obtained fortheir protection but whose enforcement was assignedto other entities.

Thus far, this strategy has met with mixed success.On April 22, 2008, U.S. District Judge ElizabethKovachevich dismissed all of the claims of Banker’sLife against Triad, along with its civil conspiracyclaims against all defendants, but upheld theremainder of Banker’s Life’s claims and alsogranted it leave to amend.52 An Amended Complaint

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was filed on May 6, 2008, in which all of the afore-mentioned allegations were re-alleged.53

A final set of parties who may draw investors’ ireare the credit rating agencies. Commentators havesuggested that the agencies, who are already beinginvestigated by the SEC54 and the attorneys generalof Ohio and New York,55 may be vulnerable to theextent that they helped fuel the growth of the marketfor subprime mortgage-backed securities by under-stating the risk these securities posed. Theagencies’ vulnerability here may be enhanced bythe fact that they have admitted to working activelywith many issuers during deal processes to help themachieve desired ratings for various types of mort-gage-backed bonds. Having supposedly taken suchan interactive role in many deals, it is thought thatthe agencies may now be vulnerable to charges ofnegligence and self-dealing when they try to assertthat they did nothing more than offer neutral opinionsas to credit worthiness.56

Shareholder Lawsuits:

A third important category of subprime relatedlawsuits and investigations are those that have beenbrought by or on behalf of shareholders, of whichthere are currently around 100. To date, mortgagelenders,57 financial institutions that served as under-writers,58 providers of credit enhancementinsurance,59 companies that invested in subprimeMBS,60 and the credit rating agencies, and/or theirtop executives, all have been targeted by their ownshareholders in class action lawsuits.61 The allega-tions in most of these suits are broadly similar,namely that the companies and/or named executivesviolated various federal securities laws and regula-tions by inaccurately portraying the extent or natureof the company’s involvement with subprime mort-gage lending in SEC filings and other publicdocuments, thereby causing stock values to be artifi-cially inflated. For example, the class action lawsuitfiled against the mortgage lender Countrywide, itsCEO and its CFO, alleges that the company down-played the extent of its subprime lending activities ina series of filings and press releases until July 2007,when its losses due to mounting foreclosures finallybecame apparent and its stock plummeted.62 Asimilar lawsuit against the investment bank UBSand its three top executives alleges that, as of lateas March 2007, the bank intentionally overvaluedits subprime-related assets, even though valuationsof similar assets were being slashed by its hedgefund unit, Dillon Read.63 Even the class actionlawsuit filed against the CFO of the credit ratingagency Moody’s follows this same basic pattern, alle-ging that the defendant ‘‘misrepresented or failed todisclose that the Company assigned excessively high

ratings to bonds backed by risky subprimemortgages . . .’’.64

In addition to shareholder suits, the plaintiffs’ baralso has started to target other parties it claims shareblame for overvaluation of companies’ subprime-related assets. For example, the auditor Deloitte &Touche was named as a defendant in an actionconnected to a secondary offering of four millionshares by American Home Mortgage, which wascompleted on April 30, 2007, less than four monthsbefore the company went bankrupt. The complaintalleges that Deloitte certified certain reports andstatements used in the offering materials that werematerially inaccurate.65 Transactional lawyers maybe another potential target, to the extent that theytoo are thought to have been involved in overvaluingsubprime-related assets.66

Apart from shareholder class actions, many of theSEC investigations regarding the overvaluation ofsubprime mortgage-related assets also implicatealleged injury to shareholders.67 As of early 2008,there were also over a dozen criminal investigationsin progress, again focusing on allegations that com-panies fraudulently inflated the value of their assets, aswell as allegations that individual executives withknowledge of the impending meltdown sold stock inviolation of insider trading restrictions.68

While shareholder-related litigation has prolifer-ated in the wake of the subprime meltdown, suchactions face considerable obstacles, perhaps evengreater than those in other areas, notably becausethere is generally so little evidence of consciouswrongdoing (like insider sales of large quantities ofstock—the aforementioned exceptions notwith-standing). It may also be difficult, given the overalleconomic slow down, to pin the cause for plaintiffs’losses on eventual disclosures related to companies’subprime holdings.69 Accordingly, it is not entirelysurprising that only about one out of three securities-related subprime lawsuits filed last year survived aruling on a motion to dismiss (although a numberwere also consolidated). Moreover, no putative plain-tiff class in this area has yet been certified.70 Thenumerosity of such lawsuits thus may have artifi-cially inflated preliminary perceptions of theirultimate significance, though of course even rela-tively frivolous suits may still carry significantdefense costs.

ERISA Beneficiary Lawsuits:

A fourth category of lawsuits consists of class actionsbrought on behalf of beneficiaries of ERISA retire-ment savings plans, of which there are currently atleast 30 to 40. These suits generally have targeted thetrustees of company-sponsored retirement plans(usually either company executives or third party

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financial institutions). The principal allegation hasbeen that the plan trustees invested recklessly insubprime mortgage-backed securities, therebyfailing to manage plan assets prudently in compliancewith their fiduciary duties under ERISA.71 Althoughmost of these suits have involved plans benefitingemployees of mortgage lenders and financial institu-tions, some have been connected to companyretirement plans in entirely unrelated industries,further proof of the wide sweep that the subprimemortgage crisis is taking through the economy.72

Buyback Lawsuits:

A small fifth category of subprime-related lawsuitsconsists of actions initiated by underwriters and inves-tors against lenders who refused to buy back defaultedloans, allegedly in violation of their contractual obli-gations.73 Most agreements for the sale of mortgageloans by lenders to underwriters contain ‘‘buy back’’provisions obligating the lender to repurchase mort-gages under certain circumstances. These provisionsvary considerably, however, making it difficult togeneralize regarding the probable exposure generatedby these types of litigations.

Applicable Insurance Coverage

The lawsuits and types of claims described aboveimplicate at least four types of insurance coverage:directors and officers (D&O) liability coverage,errors and omissions (E&O) liability coverage, fidu-ciary liability coverage and credit risk coverage.D&O, E&O and fiduciary liability coverage applyto alleged wrongful acts committed by individualsand entities in the course of various business activ-ities. A key component of D&O and E&O coveragein particular is the defense obligation found in suchpolicies. As we discuss in a later section, the defenseobligation is likely to be critical in the presentcontext, as it was in litigation arising out of pastfinancial disruptions. Credit risk coverage, on theother hand, serves quite different purposes. Ratherthan protect against litigation-related liabilities, it isintended to help absorb the underlying financiallosses. The key question in this regard will bewhether carriers will, in fact, be able to honor theirpolicy obligations.

D&O and E&O Coverage:

D&O and E&O coverage are forms of liability insur-ance covering business entities and individuals. D&Ocoverage in particular is familiar from many of thefinancial accounting scandals. It is intended to coverlosses resulting from claims based on allegedwrongful acts by individuals committed in their capa-city as directors or officers, or the entity under certain

circumstances. There are three basic types of D&Ocoverage: Side A, Side B and Side C, or ‘‘entity’’coverage. Side A covers the cost of defendingagainst, settling or satisfying a judgment in connec-tion with a claim for which a director or officer is notindemnified by the corporation. Side B providesreimbursement coverage for the corporation whereit has provided indemnification to individual direc-tors and officers (as is usually the case). Finally,claims against the company itself are covered bySide C, or ‘‘entity,’’ coverage. Shareholder claimsalleging violation of disclosure requirements infederal securities law and regulations are an exceed-ingly common type of D&O covered claim.74

Virtually all of the lawsuits and investigationsdiscussed above allege some type of ‘‘wrongfulact’’ by directors, officers or professionals.

Like D&O coverage, E&O—or professional liabi-lity coverage—protects against claims derived fromalleged wrongful acts, in this case committed in thecourse of delivering ‘‘professional’’ services. E&Ocoverage protects those who provide such services,including mortgage lenders, bankers, lawyers andauditors, as well as the professional business entitiesfor which such individuals work. It typically coversmost claims of negligence, recklessness or othermisconduct.75 In contrast to the typical D&Opolicy, a typical E&O policy explicitly obligatesthe insurer not only to reimburse the insured forcovered losses, but also to defend the insured inany litigation implicating a covered claim.76

Because those insured under a typical D&O policyusually are entitled to have defense costs advanced tothem, this distinction tends to matter much less thanmight first appear to be the case (an issue discussed atgreater length below).

Virtually all of the lawsuits and investigationsdiscussed above allege some type of ‘‘wrongfulact’’ by directors, officers or professionals. The vastmajority of these acts, such as negligent or recklessmisrepresentations about companies’ subprime activ-ities, the use of ‘‘predatory’’ lending tactics, andfailures to perform adequate due diligence, are neces-sarily committed during the course of individuals’professional or managerial duties, making it likelythat all or part of these litigations are covered bythe defendants’ D&O or E&O policies.

Fiduciary Liability Coverage:

Another form of coverage that is likely to be calledupon in response to the many claims described hereinis fiduciary liability insurance. Companies with

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ERISA and other employee benefits plans typicallypurchase such policies, which afford coverage forERISA plan trustees in connection with acts, errorsor omissions allegedly committed while adminis-tering a trust or benefits plan.

A typical definition of ‘‘wrongful act’’ in a fidu-ciary liability policy states that the term means:‘‘With respect to any trust or plan, any breach ofthe responsibilities, obligations or duties imposedupon fiduciaries of the trust or plan by the [ERISA]of 1974 . . . or any negligent act, error or omission inthe administration of any trust or plan.’’ As with mostE&O and D&O policies, this definition is broadenough to encompass many subprime-relatedclaims. Notably, there are many claims being madeby plan participants who have alleged in variouspending lawsuits that plan trustees breached theirfiduciary duties, or acted negligently, when theydecided to invest the plan’s funds in mortgage-backed securities that involved subprime mortgages.Plan trustees have also been accused of failing toexercise due diligence, or invest prudently, whenmaking investments in supposedly low-risk productsthat were marketed as being as liquid an investmentas cash, such as ‘‘safe’’ collaterized debt obligationsor even Auction Rate Securities, some of whichproved to be significantly more risky than they atfirst appeared.77

Thus, when an ERISA plan and its trustees aresued by plan participants, a company should reviewits fiduciary liability coverage to determine if theallegations potentially could trigger coverage.

Credit Risk Coverage:

A final type of coverage meriting discussion is creditrisk coverage. Credit risk coverage (sometimes called‘‘accounts receivable’’ coverage) was not a signifi-cant issue in earlier financial disruptions, but it mayprove to be a major factor in the fallout from thesubprime meltdown. This type of coverage usuallycovers losses due to default by a borrower on aloan.78 For example, many high risk borrowers arerequired to purchase private mortgage insurance(PMI), a type of credit risk coverage that protectsthe lender in the event that an individual borrowerdefaults.79 Another type of credit risk coverage isbond insurance. Bond insurance traditionally hasbeen used to increase the credit rating of municipalbonds by guaranteeing against default by the issuer.80

In the last 10 years, however, bond insurers began tomarket their product to lenders and underwriters as acredit enhancement for MBS. Rather than protectingagainst default by one entity, a typical mortgage bondinsurance policy guarantees a certain return based onthe projected rate of default among all the borrowerswhose loans back the insured security—if more loans

than expected default, the insurer absorbs thelosses.81 In the prime market, this role traditionallyhad been filled by government-sponsored entities(GSEs) like Fannie Mae and Freddie Mac, but theexponential increase in subprime lending has led toa proliferation of private label credit enhancementpolicies.82

Private label credit enhancement policies couldmitigate the fallout from the subprime meltdown.Mortgage lenders may be able to collect on PMIpolicies purchased by individual borrowers, and onbond insurance policies purchased as credit enhan-cers. In both cases, they will be expected to use theproceeds to satisfy the claims of investors, for whoseprotection such policies were generally purchased.83

In the case of bond insurers, however, there areworrying signs that some carriers either will beunable or unwilling to meet all of their obligations.In the Banker’s Life case discussed above, forinstance, the insurer Triad asserted that all investors’claimed losses exceeded the policy limit of approxi-mately $21.1 million, and therefore deniedcoverage.84 More broadly, as discussed below, therecent spate of ratings downgrades calls into questionthe ability of bond insurers to cover even the commit-ments they do not dispute.

Potential Defenses to Coverage

Although many of the claims being asserted againstthe various participants in the subprime meltdown areundoubtedly covered by D&O, E&O or credit riskpolicies, some insurers likely will attempt to denycoverage based on a number of defenses, many ofwhich were, and are still being, raised in the largesecurities fraud lawsuits brought earlier in thedecade. We would hope, however, that fewerclaims will be denied in the wake of the presentcrisis, given that most of the wrongful conductalleged to date clearly falls within the scope ofmost D&O, E&O or credit risk policies. Under thedoctrine of contra proferentem, ambiguities in suchpolicies must be interpreted in favor of the insured, solong as the result reflects the purpose of the policy,the insured’s reasonable expectations of coverage,and ‘‘common sense.’’85 As always, a carrier bearsthe burden of proving any defense.86

Potentially Excluded Claims:

The most basic defense to coverage is that a parti-cular claim is explicitly excluded from the relevantpolicy. For example, virtually all D&O and E&Opolicies contain some form of exclusion for claimsresulting from the insured having realized improperpersonal profit, or having engaged in intentionally

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fraudulent or dishonest conduct. Many policies alsoexclude coverage for any claim based upon awrongful act that the insured knew or could reason-ably have foreseen could lead to a claim (this issometimes referred to as the ‘‘prior acts’’ or ‘‘priorknowledge’’ exclusion).87 Many policies alsoexclude ‘‘insured v. insured’’ claims, i.e., claimsarising out of suits brought by one insured againstanother, although there are typically several excep-tions, including one for derivative suits.88 Some E&Opolicies (but not D&O policies) also exclude claimsarising out of criminal acts by the insured; acts ofdiscrimination on the basis of race, gender, creed ordisability; and securities or ERISA violations.89

Finally, certain types of damages, like punitivedamages and restitution, are uninsurable in somejurisdictions and contexts.90

In the context of litigation arising out of thesubprime disruption, the exclusion that is likely tobe asserted most often is that for intentional fraudand dishonesty that may have contributed to theinsured’s losses. As noted above, the real cause ofthe collapse in the subprime market appears to beunreasonable expectations regarding the housingmarket, perhaps combined with failures to performdue diligence in some instances. Nevertheless,certain types of suits, like the many shareholderactions against lenders, underwriters and other parti-cipants in the mortgage securitization process,feature allegations of intentional fraud. Note,however, that this type of exclusion almost alwayscarries an ‘‘in fact’’ or ‘‘final adjudication’’ require-ment, meaning that the insurer may not denycoverage until the fraud has been established by afinal adjudication in a court of law (at which pointit can demand retroactive reimbursement for theinsured’s defense costs).91 For example, BernardEbbers, WorldCom’s CEO who was convicted ofconspiracy, securities fraud and false regulatoryfilings and sentenced to up to 85 years in prison,continued to receive D&O insurance coverage untilthe day he was found guilty.92

Moreover, it is highly doubtful that the fraudexclusion as it currently appears in many policiescan even be asserted in respect to many allegedsubprime-related misrepresentations. Shareholderactions make up 47 percent of all D&O liabilityclaims affecting for-profit organizations in theUnited States; most of these actions involve someallegation of securities fraud.93 If the fraud exclusionwere applied broadly—inconsistent with black-lettercoverage principles—to many of these suits, therewould be little left to many companies’ coverage,which is contrary to the reasonable expectations ofthe policyholders when they purchased broad liabilitycoverage. Thus, courts have concluded that only

knowing misrepresentations, rather than those thatare reckless or negligent, can serve as a properbasis for excluding a claim.94 Because even thosesecurities actions that allege intentional misrepresen-tation generally also allege reckless or negligentmisrepresentation, it is remote that insurers wouldbe able to deny coverage entirely in these cases, ifat all, and carriers certainly cannot avoid theirdefense obligations merely due to allegations ofintentional misconduct.

Another exclusion that will be asserted in somecases is the personal profit exclusion.95 That exclu-sion applies only to gains to which the insured is notlegally entitled. Because allegations of insidertrading and other self-dealing have been relativelyrare in the subprime-related cases to date, this exclu-sion is less likely to arise than in past scandals.Carriers may also try to assert the ‘‘prior knowledge’’or ‘‘prior acts’’ exclusion applicable to claims alle-ging wrongful acts the insured could have reasonablyforeseen and prevented.96 Finally, in the case ofshareholder lawsuits other than derivative suits,carriers may seek to assert the ‘‘insured v. insured’’exclusion, although the underlying purpose of thisexclusion—the prevention of collusion betweeninsureds—is rarely an issue in shareholder actions,making courts reluctant to apply it in this context.97

The common exclusions listed above are found inmany policies, but of course the actual exclusions acarrier may attempt to apply to deny a particularclaim will be highly case-specific. Credit risk policiesin particular vary greatly based on the contractualterms, which may include or exclude specific typesof borrower insolvency, like forced liquidations orprotracted disputes, that greatly affect the totalpayout to the insured.98

Rescission:

Another defense to coverage is the extreme reactionof rescission—cancellation, retroactively, of theentire insurance policy. The most commonly citedbasis for rescission is a material misrepresentationin the insurance application and supporting mate-rials—i.e., a misrepresentation but for which theinsurer would not have issued the policy (orcharged a higher premium or issued an endorsementunder some state law). As with common exclusionslike fraud, rescission is not available to the insurer asa unilateral remedy. Circumstances justifying rescis-sion must be proven in court.99 Moreover, mostpolicies permit rescission only for intentional misre-presentations, and contain ‘‘severability ofapplication’’ provisions that do not permit rescissionwith respect to all potential insureds under a policysolely because of intentional dishonesty by one.100

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As discussed below, the broader the severabilityprovision, the greater the protection for ‘‘innocent’’directors and officers in the face of an attempt torescind.

Another rescission issue that may arise concernsthe definition of ‘‘application.’’ In an effort to avoidhaving to defend certain claims, some insurers havetaken the position that the insured’s applicationincludes all financial statements ever filed with theSEC.101 Some courts have accepted this position withrespect to statements submitted along with an insur-ance application,102 but others have not.103

We anticipate that rescission will again beasserted only in those rare cases, primarilybecause the underlying subprime litigationsgenerally do not involve allegations ofwidespread intentional fraud.

Because it renders an entire policy void from itsinception, rescission is a drastic remedy that isexceedingly difficult to obtain. Although it was threa-tened repeatedly in the late trading/market timing andrelated financial scandals, relatively few policieswere actually rescinded. We anticipate that rescissionwill again be asserted only in those rare cases,primarily because the underlying subprime litigationsgenerally do not involve allegations of widespreadintentional fraud.

Other Defense Issues:

A number of other issues pertaining to defenses tocoverage also are likely to be raised in coverage liti-gation or ADR proceedings following on thesubprime meltdown. They include:

Notice: Both D&O and E&O policies are primarily‘‘claims-made’’ policies, meaning that they applyonly to claims first made against the insured duringthe policy period. Moreover, such policies rarelycover claims made after the end of the policyperiod, unless the insured has paid an additionalpremium for an extended reporting period.104 D&Oand E&O policies also require that claims be reportedto the carrier during the policy period. Claims-madepolicies also permit the insured to place the carrier onnotice of ‘‘circumstances that would eventually resultin a claim.’’ Once the claim is eventually madeagainst the insured it will relate back to the policyperiod in which the notice of circumstances wasgiven. Some older policies may be ‘‘occurrence’’policies, which cover losses arising out of mattersthat took place or ‘‘occurred’’ during the effectivedate of the policy, regardless of when a claim isfiled against the insured.

Even more than D&O and E&O policies, creditrisk policies frequently provide very short deadlinesfor filing claims for loss and proof that the loss iscovered, making notice a particularly challengingissue in that context.105

Claim: In the D&O and E&O contexts, disputessometimes arise regarding the definition of whatconstitutes a ‘‘claim’’ against the insured. Althoughsome policies define a claim narrowly, most contain adefinition that is at least broad enough to encompassnot only civil proceedings in court and formal admin-istrative hearings, but also written demands formonetary compensation and investigations bygovernment agencies or self-regulating bodies (suchas a stock exchange) regarding alleged violations oflaw.106 On the other hand, it is unclear whetherinternal investigations brought about by the threatof a likely government investigation or private suitare covered, although there is a growing trend torequire insurers to pay pre-notice defense costswhere doing so does not prejudice the carrier anddefending the matter promptly to reduce liability isthe proper action to take.107

Loss: D&O policies cover ‘‘loss’’ resulting fromcovered claims against the insured. Loss is oftenexpressly defined as the total amount that aninsured becomes legally obligated to pay onaccount of each claim for a wrongful act for whichcoverage applies, including damages, judgments,settlements, costs and defense costs. The policymay contain added caveats affording the carrier abasis for excluding certain types of settlements,however. For instance, the insured may want toavoid settling a regulatory investigation throughpayment of ‘‘fines and penalties,’’ which are some-times excluded from the definition of loss. Theinsured should also avoid characterizing any settle-ment payment as ‘‘restitution’’ or ‘‘disgorgement’’because most carriers contend that such categoriesof payment cannot constitute covered loss bylaw.108 When the insured has been ordered oragreed to pay sums of money that the insured hadbeen earning through its regular business operations,it has paid ‘‘damages.’’

Duty to Defend

In addition to defenses to indemnification, one of themost important coverage-related issues likely to ariseout of the subprime disruption, as in the past, willundoubtedly be the duty to defend. When aninsured is sued for at least one covered claim, itsinsurance carrier has two separate obligations:indemnification for all settlements and paymentsarising from covered claims, and defense of anypotentially covered claims or allegations. The duty

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to defend is triggered whenever a complaint, noticeof hearing, or notice of investigation alleges factssuggesting a ‘‘reasonable potential for coverage.’’109

As a matter of basic black-letter law, the duty todefend is inherently broader than the duty to indem-nify, because the duty to defend is only avoidedwhere a carrier has shown no conceivable basis forcoverage.110 Claim expenses can only be deductedonce a possible exclusion is proven in fact, usuallybased on developments in the underlying case.111

Most E&O policies explicitly require the carrier toprovide the insured with a defense for the entire liti-gation, including those aspects that involveuncovered claims or allegations. In contrast, D&Opolicies generally require the carrier to reimburse(or, more favorably, advance) defense costs that arereasonably related to covered claims.112 As a prac-tical matter, however, this is a distinction without adifference, and most courts have held that the duty toadvance defense costs is as broad as the duty todefend.113 Also, as long as a potentially covered—and liability-inducing—claim results in a lawsuit, thecarrier must afford a defense to the entire lawsuit. Inrecent years, courts also have rejected carrierdemands that insureds allocate defense costs exante between covered and noncovered claims.114

Instead, the carrier’s remedy is to seek reimburse-ment at the conclusion of litigation for those costsit can show were not reasonably related to coveredclaims.115

In the financial accounting scandals, which gener-ated immense litigation expenditures, the issue ofavailability of defense costs, and for whom, literallytook on constitutional proportions in some cases.116

From an insurance coverage perspective, the numberof meritless claims filed against companies, and thesheer complexity of even those suits that arguablyhad some basis in fact, make the carrier defense obli-gation absolutely vital. This remains particularly truein jurisdictions where certain types of damages,including punitive damages and restitution forwrongfully acquired gains, are uninsurable as amatter of law.117 In all such cases, the carrier’sdefense obligation is of immense value to the insured.

Thus, carrier defense obligations will onceagain be a primary source of value to coveredentities and they are critical to preserving thelong-term financial health of many companies.

The proliferation of lawsuits and investigationsfollowing in the wake of the subprime meltdownincludes many large consumer protection and share-holder class actions involving thousands of plaintiffs.Thus, carrier defense obligations will once again be a

primary source of value to covered entities and theyare critical to preserving the long-term financialhealth of many companies.

Severability

Severability is another important coverage-relatedissue, although perhaps less so here than in past finan-cial scandals. Severability provisions in policiesprotect innocent insureds from losing coveragebecause of actions taken by their coinsureds. Themost common and valuable type of severabilityprovision, a ‘‘full-severability’’ or ‘‘severability ofapplication’’ provision, protects innocent insuredswhen an insurer attempts to rescind or declare apolicy void based on alleged misrepresentations oromissions in the insurance application caused by acoinsured.118 The second type of severability provi-sion, a ‘‘severability of exclusions’’ provision,prevents insurers from imputing to all insureds exclu-sions that may apply to one insured because of his orher wrongdoing.119 That claims against one indivi-dual are severable due to his or her wrongful actsdoes not obviate the carrier’s duty to defend theentire litigation. Rather, the carrier’s remedy is toseek reimbursement after the underlying litigationis concluded.120

It goes without saying that inclusion of a broaderseverability provision will benefit the insured.121

Conversely, the failure to include a broad severabilityprovision can have serious consequences because itmay allow the carrier to seek to cut off coverage forall ‘‘innocent’’ directors and officers based on awrongful act committed by a single individual.Severability was very important in the Enron andWorldCom litigations, where regulators and plain-tiffs sought to make examples of individualdirectors by seeking recovery from their personalassets. In the WorldCom case, the position of theseindividual directors was arguably weakened becausethe company’s D&O policy lacked a broad sever-ability provision, which made it easier for insurersto threaten rescission of the entire policy unless thedirectors contributed some of their own money.These directors ended up contributing $18 millionof their own funds to the eventual settlement.122

Even with broad severability provisions, coveredentities should take care to insure that they do notaccept provisions that are ambiguously worded.Although ambiguities in insurance agreements are tobe interpreted in favor of the insured, a poorly wordedseverability provision may nevertheless leave roomfor a court to side with an insurer and deny coverageby imputing one individual’s acts to all coinsureds, ashappened in the recent case of Cutter & Buck, Inc. v.Genesis Ins. Co. in the U.S. District Court for theWestern District of Washington.123 The contrary

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result reached in another case, In re HealthSouthCorp., where the court refused to impute one indivi-dual’s misrepresentations to all other innocentinsureds, illustrates the benefits of a carefullyworded severability provision.124

In the context of litigation arising out of thesubprime meltdown, there are some allegations ofthe type of intentional wrongdoing that insurers mayassert as a basis to apply dishonesty, fraud and inten-tional wrongdoing exclusions. In some cases, insurersmay also attempt to argue, based on alleged misrepre-sentations in financial statements regardingcompanies’ subprime-related activities, that thereare grounds for rescission. It would appear so farthat the alleged wrongful acts that are most at issuein subprime related cases, however, have more to dowith careless, reckless or inappropriate decisions andfailures to perform due diligence than with wide-spread fraud and personal profiteering. For thesereasons, the applicability of certain conduct exclu-sions or contract rescission will be more difficult forinsurers to demonstrate, and severability may likewiseprove to be less of a concern.

Risk of Default

A final coverage issue is the risk of default, a concernparticularly relevant to the subprime crisis because ofthe widespread use of bond insurance. On one level,bond insurers are somewhat more removed than otherinsurers from the subprime fallout because, asdiscussed above, their policyholders tend to be otherparties besides the actual policy beneficiaries (i.e.,investors—although, as we note above, some investorshave attempted to reach credit risk policies throughtort and third party breach of contract allegations).125

At the same time, unlike most other carriers, creditrisk insurers acted in many instances as first partyparticipants in the subprime mortgage securitizationprocess when they actively sought to move out oftheir traditional fields of operation. Because ofrecent ratings agency downgrades of MBS, thestock of credit risk insurers already has plummeted.For example, the value of stock in the bond insurerACA Capital was down over 90 percent for the year2007.126 Naturally, shareholder lawsuits havefollowed—three had been filed as of late 2007,against ACA Capital, Security Capital Assurance,and the Radian Group, all alleging that the companiesmaterially concealed the level of their involvement inthe subprime market.127 Worse still, the major creditrating agencies are considering downgrading manyinsurers’ ratings,128 as they already had for theinsurers MGIC, Triad Group and Ambac as of early2008. A ratings downgrade throws into doubt aninsurer’s ability to guarantee debt, triggering achain reaction that vastly increases the ultimate risk

of default. For example, Ambac now faces seriousquestions about its ability to stay afloat—reflectedin its one-day 52 percent stock plummet. Anotheragency, Moody’s, plans to review its rating notonly for Ambac, but also MBIA, the nation’slargest bond insurer.129 One particularly outspokenpublic official, now retired, dubbed the consequencesof this wave of downgrades a potential ‘‘financialtsunami.’’130

Of course, because many different types of compa-nies, including other insurance carriers, invested inmortgage backed securities, the risk of defaultresulting directly from the subprime meltdown isnot necessarily unique to credit risk insurers. Theyare, however, far more likely to be among the melt-down’s first victims. Moreover, to the extent thatcredit risk insurers are unable to meet their obliga-tions to cover losses suffered by investors who didnot think they were buying high risk assets, the latternaturally will look elsewhere for compensation. Theend result could be increased exposure for othermortgage lending and securitization actors, and ulti-mately for D&O and E&O carriers.

Conclusion: What the Future Holds

Looking ahead, the slump in housing prices showsfew signs of abating soon, meaning that it is unlikelythat borrowers quickly will recoup the equity theyhave lost—bad news also for investors holdingbillions of dollars in subprime debt. At this juncture,the most likely factor to mitigate losses is some formof government-sponsored intervention. As of early2008, the Bush administration already had brokereda deal with the mortgage industry to help up to 1.2million financially distressed subprime borrowersavoid foreclosure. Under the terms of the deal,certain borrowers experiencing financial difficultymay be eligible to have their adjustable rates frozenfor a period of five years.131 The deal excludes allborrowers whose homes are already in foreclosure,however, as well as those with high credit scores(who have been deemed more equipped to negotiateon an individual basis with creditors). The adminis-tration also has made clear that it has no plans to helpbail out investors.132 Both of the leading Democraticcontenders for the presidency have promised toprovide greater assistance, at least to homeowners.Separately, Congress also has moved, with tentativeWhite House support, to loosen restrictions onFederal Housing Administration (FHA)-backedloans, which are generally cheaper than privateloans but governed by more stringent terms. Moreof these loans may now become available todistressed subprime borrowers looking to refi-nance.133 It goes without saying that the more thegovernment takes responsibility for helping to

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mitigate subprime-related losses, the more thevolume of litigation resulting from these losses willfall, as will the volume of resulting insurance claims.

Another potential source of relief may be the use ofADR to resolve coverage disputes, although this is atbest a mixed blessing for many covered entities.ADR through mediation or binding arbitration ismandated under many D&O and E&O policies, butusually according to terms that potentially make itunfairly disadvantageous to policyholders relativeto traditional litigation, specifically by the elimina-tion of widely accepted common law insuranceprinciples like contra proferentem and the reasonableexpectations of coverage doctrine.134 On the otherhand, ADR may also emerge as a means to resolvesome of the underlying lawsuits initiated by subprimeborrowers and shareholders.135 To the extent that the

use of ADR pares down the costs of underlyingsubprime-related litigation, both carriers andcovered entities will again benefit.

Ultimately, the total liability to which carriers arelikely to be exposed as a result of the subprime crisisis too difficult to assess, even leaving aside the poten-tial that some credit risk insurers may not be able tomeet all of their obligations. Estimates of D&O liabi-lity, for instance, have ranged from $3 billion peryear for the next three years, to as much as $15billion.136 A great deal depends on the terms of indi-vidual policies, for which it is too soon for any type ofsystemic analysis.137 Because the pace of litigationtends to lag behind the actual economic develop-ments that precipitate it, it may be some timebefore the full coverage implications of the subprimemeltdown are known.

1 Faten Sabry & Thomas Schopflocher, ‘‘The Subprime Meltdown: A Primer,’’ June 21, 2007, at 1, available at http://www.nera.

com/image/SEC_SubprimeSeries_Part1_June2007_FINAL.pdf.2 See Centre for Responsible Lending, ‘‘A Snapshot of the Subprime Market’’— http://www.responsiblelending.org/pdfs/snapshot-of-

the-subprime-market.pdf, Nov. 28 2007, at 1 [hereinafter ‘‘Snapshot Report’’].3 For Federal Reserve interest rates, see http://federalreserve.gov/releases/h15/; see also Snapshot Report, at 1 (describing increases in

overall subprime lending).4 Snapshot Report, at 1.5 Snapshot Report, at 3.6 See Michael Phillips, et al., ‘‘Battle Lines Form Over Mortgage Plan,’’ Wall St. Journal, Dec. 7, 2007, at 1.7 See Phillips, et al., at 1.8 See Phillips, et al., at 1.9 See RTTnews.com, ‘‘Almost 150 Mortgage Companies Were Casualties in 2007,’’ Jan. 22, 2008, available at http://www.rttnews.-

com/forex/economicnews.asp?date=01/22/2008&item=21.10 See Phillips, et al., at 1.11 See Kevin LaCroix, ‘‘Subprime Contagion: Where will the Litigation Wave Spread Next?,’’ D&O Diary, Dec. 3, 2007, at

http://dandodiary.blogspot.com/2007/12/subprime-contagion-where-will.html.12 See Kevin LaCroix, ‘‘Subprime Contagion: Where will the Litigation Wave Spread Next?,’’ D&O Diary, Dec. 3, 2007, at

http://dandodiary.blogspot.com/2007/12/subprime-contagion-where-will.html.13 Sabry & Schopflocher, at 4.14 Sabry & Schopflocher, at 4–8.15 See Center for Responsible Lending, ‘‘Prepayment Penalties in Subprime Loans: When Qualifying for a Better Mortgage Doesn’t

Pay Off,’’ June 18, 2004 (updated Mar. 16, 2005), at http://www.responsiblelending.org/pdfs/ib008-PPP_in_Subprime_Loans-0604.pdf.16 See John Glover, ‘‘Subprime Losses May Reach $400 Billion, Analysts Say’’ (Update 5), Bloomberg.com, Nov. 12, 2007, at

http://www.bloomberg.com/apps/news?pid=20601087&sid=a3fCFxLIgT2s&refer=worldwide.17 See Edmund L. Andrews, ‘‘Fed Shrugged as Subprime Crisis Spread,’’ N.Y. Times, Dec. 18, 2007, at A1.18 Sabry & Schopflocher, at 10.19 See Thomas Musil, ‘‘Subprime Mortgage Risks Were Recognized Too Late,’’ Pitt. Post-Gazette, Feb. 17, 2008, at P8.20 See, e.g., ‘‘Feeling Misled on Home Price, Buyers Sue Agent,’’ N.Y. Times, Jan. 22, 2008, at A1.21 See Press Release, Subprime Mortgage Litigation Outpacing Saving and Loan Crisis of the Early 1990s, According to Navigant

Consulting Study, Feb. 14, 2008, available at http://biz.yahoo.com/bw/080214/20080214005906.html?.v=1.22 See Christopher E. Kentra, ‘‘Caught in the Wake of Mortgage Suits,’’ Chicago Daily Law Bulletin, Nov. 21, 2007, at 5.23 See Phuong Cat Lee, ‘‘Mortgage Lender NovaStar to Settle Suit,’’ Seattle Post-Intelligencer, June 23, 2007, at C1; Pierce v.

NovaStar Mortgage, Inc, 05-CV-05835 (W.D. Wash.) (Voluntarily Dismissed).24 See, e.g., Rodriguez v. Capital One Home Loans LLC, No. 08-CV-1723 (N.D. Il.) (Complaint Filed); Reichert v. UB Mortgage LLC,

et al., No. 08-CV-158 (E.D. Ark.) (Complaint Filed); Poland v. Downey Savings & Loan, No. BC381724 (Cal. Sup. Ct. Los Angeles)

(Dismissed).25 See, e.g., Jordan v. Wells Fargo Bank, N.A., et al., No. 08-CV-1394 (N.D. Il.) (homeowners allegedly promised lower rate if they

refinanced but were actually locked into high interest subprime loans) (Complaint Filed); Boisjolie v. SBMC Mortgage, No. 07-CV-5521

(C.D. Cal.) (homebuyers allegedly promised low fixed rates but induced to sign agreements for high adjustable rate mortgages)

Coverage–12

(Complaint Filed); Romero v. First Magnus Financial Corp., 07-CV-4491 (C.D. Cal.) (same) (Dismissed); Megitt v. Indymac Bank FSB,

No. 07-CV-3018 (D. Mass.) (lender failed to provide notice of right to rescind) (On Appeal).26 See, e.g., Tingley v. Beazer Homes Corp., No. 07-CV-176 (W.D.N.C.) (alleged falsification of loan applications for unqualified

buyers) (Dismissed); Morris v. First Franklin Financial Corp., No. 07-CV-614 (N.D. Ga.) (alleged falsification of credit reports) (Motion

to Dismiss Filed).27 See, e.g., Wilson, et al. v. D.R. Horton, Inc., et al., No.08-CV-592 (S.D. Cal.) (Complaint Filed); Bolden v. KB Homes, et al., No.

BC385040 (Cal. Sup Ct. L.A. Cty.) (Complaint filed).28 See, e.g., Chrisman v. Countrywide, No. 07-CV-333 (E.D. Tenn.) (improper application of mortgage payments to maximize interest

paid) (Complaint Filed); Long v. Wells Fargo Corp. Holdings Corp., No. 07-CV-9551 (S.D.N.Y.) (collection of illegal interest on Co-op

refinances) (Motion to Dismiss Denied).29 See, e.g., Partell v. Lawyer’s Tit. Ins. Corp., No. 08-CV-166 (W.D.N.Y.) (excessive title insurance fees) (Complaint Filed);

Fernandes v. Southland Title Corp., No. 07-CV-6690 (C.D. Cal.) (excessive ‘‘email’’ and ‘‘notary’’ fees) (Complaint Filed); Dorsey v.

EMC Mortgage Co., No. 07-CV-3903 (E.D. Pa.) (excessive attorney fees) (Dismissed); Wooten v. Quicken Loans, No. 07-CV-478 (S.D.

Ala.) (unearned ‘‘loan discount fee’’) (Dismissed).30 See, e.g., Alexander v. Washington Mutual, Inc., et al., No. 07-CV-4426 (E.D. Pa.) (Motion to Dismiss Filed); Moore v. GMAC

LLC, et al., 07-CV-4296 (E.D. Pa.) (Motion to Dismiss Denied).31 See, e.g., Cobb v. Chevy Chase Bank, No. 08-CV-2474 (C.D. Cal.) (Complaint Filed); Chavers v. Option One Mortgage, No. 07-

CV-4916 (N.D. Ill.) (Complaint Filed); Sanchez v. Washington Mutual, No. 07-CV-5542 (C.D. Cal.) (Motion to Dismiss Filed); Ventura

v. Wells Fargo Bank, No. 07-CV-4309 (N.D. Cal.) (Complaint Filed); Miller v. Countrywide Bank, No. 07-CV-11275 (D. Mass.)

(Complaint Filed); Rodriguez, et al. v. Bear Stearns, et al., No. 07-CV-1816 (D. Conn.) (Motion to Dismiss Filed); NAACP v. Ameriquest

Mortgage, et al., No. 07-CV-0794 (C.D. Cal.) (Complaint Filed).32 Dann v. Apex Mortgage Services, et al., No. 07-cv-1996 (Ohio Ct. Com’n Pl. Belmont Cty.) (Complaint Filed).33 People of the State of New York v. First American Corp., No. 07-cv-10397 (N.Y. Sup. Ct. N.Y. Cty.) (Removed to Federal Court).34 See, e.g., Press Release, New York Attorney General Andrew Cuomo Sends Letters of Notice and Demand to Freddie Mac & Fannie

Mae, available at http://www.oag.state.ny.us/press/2007/nov/nov7a_07.html.35 Kimberly Blanton, ‘‘Subprime Lender Under Predator Law,’’ Boston Globe, Oct. 6, 2007, at 10C; see also Commonwealth of

Massachusetts v. Fremont Investment & Loan, et al., No. 07-4373 (Mass. Sup. Ct. Suffolk Cty.) (Preliminary Injunction Granted).36 District of Columbia v. Metropolitan Money Store, No. 2007 CV 006023B (D.C. Sup. Ct.) (Complaint Filed).37 See Christopher Maag, ‘‘Cleveland Sues 21 Lenders Over Subprime Mortgages,’’ N.Y. Times, Jan. 12, 2008, at A9 (describing

Baltimore and Cleveland suits); see also Mayor and City of Baltimore v. Wells Fargo Bank, N.A., et. al., No 08-cv-00062 (D. Md.)

(Complaint Filed); City of Buffalo v. ABN Amro Mortgage Group, Inc., et al., No. ___ (N.Y. S. Ct. Erie Cty.) (Complaint Filed); City of

Cleveland v. Deutsche Bank Trust Co., et al. No. CV 08 646970 (Ohio Ct. Cm. Pl. Cuyahoga Cty.) (Complaint Filed).38 See Carrie Johnson, ‘‘Mortgage Probes Face Big Hurdles,’’ Wash. Post, Dec. 27, 2007, at D1.39 Baumgartner v. Lehman Brothers, Inc., No. 07-CV-4038 (D. Minn.) (Voluntarily Dismissal Without Prejudice); see also Maag, at

A9 (noting that Cleveland suit names underwriters as well as original lenders).40 See Amir Efrati, ‘‘Subprime Crisis Lawsuits 2008: By the Numbers,’’ WSJ Law Blog, Apr. 24, 2008, at http://blogs.wsj.com/

law/2008/04/24/subprime-crisis-lawsuits-2008-by-the-numbers/ [hereinafter Efrati, ‘‘Subprime Crisis Lawsuits 2008. . .’’].41 See Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).42 See Complaint 14-36, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).43 See Complaint 74-135, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.). On April 22, 2008, the court

dismissed the Plaintiff’s common law fraud allegations pursuant to Fed. R. Civ. P. 9(b), but granted Plaintiff leave to amend. See Slip Op,

at 9–10. Banker’s Life re-alleged its common law fraud allegations in its Amended Complaint, filed May 6, 2008, along with all of its

other fraud and negligence allegations. See generally Second Amended Complaint, 37-88.44 For instance Metro PCS Communications, another investor in subprime mortgage backed securities, has leveled similar charges

against Merrill Lynch. See MetroPCS Communications v. Merrill Lynch & Co., et al., No. 07-12430 (Dist. Ct. Tx. Dallas Cty.)

(Complaint Filed). Another recent target is Bear Stearns. The collapse of two mortgage-related hedge funds resulted in two arbitration

claims being filed against its subsidiaries. See ‘‘Bear Stearns Hedge Fund Losses Lead to Arbitration Claims,’’ Marketwatch, Dec. 5, 2007,

at http://www.marketwatch.com/news/story/bear-stearns-hedge-fund-losses/story.aspx?guid=%7B193F9E0C-8933-41E7-B8CE-

757406F5A481%7D.45 See Reuters, ‘‘SEC Eyes Disclosure in Subprime Probe,’’ Feb. 9, 2008, at http://www.reuters.com/articlePrint?articleId=

USN0919055220080209; Paritosh Bansal, ‘‘SEC Probing Three Dozen Subprime Cases,’’ Boston Globe Online, Dec. 21, 2007, at

http://www.boston.com/business/articles/2007/12/21/sec_probing_three_dozen_subprime_cases_source/.46 Karen Freifeld and David Scheer, ‘‘NY, Connecticut Probe Wall Street Loan Disclosures,’’ Bloomberg.com, Jan. 12, 2008, at

http://www.bloomberg.com/apps/news?pid=20601087&sid=a8ry4S5dGsFs&refer=home.47 See Vikas Bajaj & Jenny Anderson, ‘‘Inquiry Focuses on Withholding of Data on Loans,’’ N.Y. Times, Jan. 12, 2008, at A1; Ross

Kerber, ‘‘Galvin Wants Data on Subprime Lenders,’’ Boston Globe, Mar. 14, 2007, at F1.48 See Press Release, Attorney General Mark Dann Sues Freddie Mac on Behalf of Ohio Public Employees Retirement Fund, available

at http://www.ag.state.oh.us/press/08/01/pr080122.pdf; Mark Jewell, ‘‘State Street Sued Over Bond Fund Losses,’’ USA Today Online,

Coverage–13

Nov. 1, 2007, at http://www.usatoday.com/money/economy/2007-11-01-2787099883_x.htm (describing similar suit on behalf of Alaska

public employees).49 See Complaint 37, 116–120, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).50 See Complaint 116–120, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).51 See Complaint 116–120, 132–35, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).52 See Slip Op., at 11–12, 19, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).53 See generally Second Amended Complaint, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).54 See Stephen Labaton, ‘‘Debt-Rating Agencies Under Scrutiny by SEC,’’ N.Y. Times, Sept. 27, 2007, at C4.55 ‘‘Ratings Agencies Not Off the Hook: AG,’’ N.Y. Post Online, Feb. 8, 2008, at http://www.nypost.com /seven/02082008/business/

rating_agencies_not_off_hook__ag_290635.htm (describing investigation by Attorney General Cuomo of New York); Katie Banner &

Adam Lashinsky, ‘‘Subprime Contagion?’’, CNN.com, July 5, 2007, at http://money.cnn.com/2007/07/05/news/economy/subprime.

fortune/index.htm (describing investigation by former Attorney General Dann of Ohio).56 LaCroix, ‘‘Ratings Agencies and the Subprime Lending Meltdown,’’ D&O Diary, May 13, 2007, at http://dandodiary.blogspot.

com/2007/05/rating-agencies-and-subprime-lending.html (citing Joseph Mason & Joshua Rosner, ‘‘Where Did the Risk Go? How

Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions,’’ available at

http://www.hudson.org/files/publications/Hudson_Mortgage_Paper5_3_07.pdf).57 See, e.g., Casey v. Nat’l City Corp., No. 08-209 (N.D. Ohio) (Complaint Filed); Adcock v. NetBank, No. 07-cv-02298 (N.D. Ga.)

(Consolidated in Case No. 07-2631); In re: Beazer Homes USA, Inc. Securities Litigation, No. 07-cv-00725 (N.D. Ga.) (Complaint

Filed); Pappas v. Countrywide Financial, No. 07-CV-05295 (C.D. Cal.) (Consolidated in Case No 07-725); Reese v. Indymac Financial,

No. 07-CV-01635 (C.D. Cal.) (Amended Complaint Filed); Boyd v. NovaStar Financial, No. 07-CV-0139 (W.D. Mo.) (Motion to

Dismiss Filed); Gold v. New Century Financial, No. 07-cv-00931 (C.D. Cal.) (Consolidated in Case No. 07-931); Atlas v. Accredited

Home Lenders, No. 07-CV-0488 (S.D. Ca.) (Motion to Dismiss Denied in Part, Granted in Part); Greenberg v. American Home Mortgage,

No CV-07-3152 (E.D.N.Y.) (Complaint Filed); Freudenberg v. E*Trade Financial Corp., No. 07-CV-8538 (S.D.N.Y.) (Complaint Filed).58 See, e.g., Reese v. O’Meara, No. 08 C 1119 (N.D. Ill.) (suit against Lehman Bros.- Voluntary Dismissal); Stratte-McClure v. Lynch,

No. CV08-00963 (C.D. Cal.) (suit against Morgan Stanley- Complaint Filed); Cohen v. Bear Stearns, No. 07-CV-10453 (S.D.N.Y.)

(Complaint Filed); Nelson v. Washington Mutual Inc., No. 07-CV-1809 (W.D. Wash.) (Consolidated in No. 08-1919).59 See, e.g., Clark v. Security Capital Assurance Ltd., No. 08-CV-00158 (S.D.N.Y.) (Complaint filed); Rose v. ACA Capital Holdings,

Inc., No. 08-CV-00253(RWS) (S.D.N.Y) (Complaint Filed); Cortese v. Radian Group, S.A., No. 07-CV-3375 (E.D. Pa.) (Complaint

Filed).60 See, e.g., Cornwell v. Credit Suisse Group, No. 08 CIV 3758 (S.D.N.Y.) (Complaint Filed); Wesner v. UBS AG, No. 07-CV-11225

(S.D.N.Y.) (Complaint Filed); Life Enrichment Foundation v. Merrill Lynch & Co., No. 07-CV-9633 (S.D.N.Y.) (Complaint Filed);

Briarwood Investments, Inc. v. Care Investment Trust, Inc., No. 07-CV-8159 (S.D.N.Y.) (Complaint Filed); Kornfield v. Opteum, Inc.,

No. 07-CV-14278 (S.D. Fla.) (Complaint Filed).61 See, e.g., Nach v. Huber, No. 07-CV-4071 (N.D. Ill) (Transferred to S.D.N.Y. Case No. 08-1536); Teamster’s Local 282 Pension

Trust Fund v. Moody’s Corp., No. 07-CV-8375 (S.D.N.Y.) (Complaint Filed); Reese v. Bahash, No. 07-CV-1530 (D.D.C.) (Complaint

Filed).62 Complaint 1-2, Pappas v. Countrywide Financial, No. 07-CV-05295 (C.D. Cal.).63 Complaint 1-5, Wesner v. UBS AG, No. 07-CV-11225 (S.D.N.Y.).64 See Complaint 4, Nach v. Huber, No. 07-CV-4071 (N.D. Ill).65 See Marlin v. Citigroup Global Markets, et al., No. 07-3580 (E.D.N.Y.) (Consolidated in No. 07-1898).66 See Marc Tracy, ‘‘With CEO Heads Rolling, Lawyers May Be Next,’’ Financial Services Law 360, Nov. 5, 2007. The article does

note that lawyers appear to have played less of a role in causing the subprime meltdown than they did in certain financial scandals, such as

those related to options-backdating.67 Johnson, at D1.68 See Associated Press, ‘‘FBI Probes Fourteen Companies in Subprime-related Mess,’’ Jan. 30, 2008, at

http://www.msnbc.msn.com/id/22903197.69 LaCroix, ‘‘Dismissal Granted in Subprime-related Securities Law Suit,’’ D&O Diary, Dec. 4, 2007, at http://dandodiary.blogspot.

com/2007/12/dismissal-granted-in-subprime-related.html; see also, e.g., Motion to Dismiss, Tripp, et al. v. Indymac Bank Corp., No. 07-

cv-01635 GW VDK (C.D. Cal.).70 Efrati, ‘‘Subprime Crisis Lawsuits 2008. . .’’.71 See, e.g., Howard v. The Bear Stearns Companies, Inc., No, 08-2084 (S.D.N.Y.) (Complaint Filed); Bussey v. Washington Mutual,

Inc., No. 07-CV-1879 (W.D. Wash.) (Complaint Filed); Esposito v. Merrill Lynch & Co., No. 07-CV-10687 (S.D.N.Y.) (Complaint

Filed); McCoy v. Plan Comm., No 07-CV-2693 (C.D. Cal.) (Consolidated in No. 07-2693); Unisystems Profit Saving Plan v. State Street

Bank & Trust Co., No. 07-cv-9319 (S.D.N.Y.) (Consolidated in No. 07-8488); Patterson v. Countrywide Financial Corp., et. al., No. 07-

CV-1141 (C.D. Cal.) (Complaint Filed); see also Greenberg Traurig LLP, ‘‘Subprime Mortgage Crisis Impacts ERISA Plan Investment in

Employer Stock,’’ January 2008, available at http://www.gtlaw.com/pub/alerts/2008/0100j.pdf.72 See generally, e.g., Complaint, Unisystems, Inc. Employee Profit Sharing Plan v. State Street Bank & Trust, No. 07-CV-9319

(S.D.N.Y.) (case involves publishing company).

Coverage–14

73 Aurora Loan Services LLC v. Fieldstone Mortgage Co., No. 07-CV-1892 (D. Co.) (Dismissed); DB Structured Products v. Imperial

Lending LLC, No. 07-CV-4105 (S.D.N.Y.) (Complaint Filed); DLJ Mortgage Capital, Inc. v. Netbank, Inc., No. 07-CV-15211 (S.D.N.Y.)

(Dismissed); Morgan Stanley Mortgage Capital, Inc. v. Baltimore American Mortgage Corp., Inc. No. 07-CV-723 (D. Md.) (Judgment for

Plaintiff).74 See Matthew L. Jacobs & Erika Kane, ‘‘PLI Insurance Law: Understanding the ABCs: Basic Principles of Professional Liability

Insurance,’’ PLI Order No. 11214 (July 2007) § II [hereinafter Jacobs & Kane].75 Paul D. Krause, ‘‘Professional Liability Insurance Including E&O and D&O Policies,’’ PLI Order No. H0-00H7 (April 2002), § I.76 Krause, § V.77 See Notes 71-72 and accompanying text; LaCroix, ‘‘Auction Rate Securities: The Next Subprime Litigation Wave?,’’ D&O Diary,

Feb. 13, 2008, at http://www.dandodiary.com/2008/02/articles/subprime-litigation/auction-rate-securities-the-next-subprime-litigation-

wave/.78 Dickstein Shapiro LLP, ‘‘Insurance Coverage for Subprime Lending Losses, Litigation, and Investigations,’’ August 2007,

available at http://www.dicksteinshapiro.com/files/Publication/25cd85c7-c4c6-4937-a187-01ea61e019c6/Presentation/Publication

Attachment/22fe1763-82b3-4e22-96d100973f882edc/Subprime_Lending_Alert%2010.2.2007.pdf [hereinafter Dickstein Shapiro,

‘‘Insurance Coverage for Subprime Lending. . .’’].79 Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . .’’.80 Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . .’’.81 Sabry & Schopflocher, at 4–5.82 Sabry & Schopflocher, at 4–5.83 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . .’’.84 Complaint 37, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.).85 See, e.g., In re: HealthSouth Corp. Ins. Litigation, 308 F.Supp.2d 1253, 1269 (N.D. Ala. 2004).86 See, e.g., Bell Lumber and Pole Co. v. U.S. Fire Ins. Co., 60 F.3d 437, 441 (8th Cir. 1995).87 Matthew L. Jacobs & David T. Case, ‘‘Insurance Coverage Alert: Insurance Coverage for Subprime Lending Lawsuits and

Investigations,’’ March 2007, available at http://www.klgates.com/newsstand/Detail.aspx? publication=3702 [hereinafter Jacobs &

Case].88 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . .’’.89 Krause, § IV.90 Krause, § V; see also Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 10 A.D.3d 528 (N.Y. App. Div. 2004) (‘‘The risk of being

directed to return improperly acquired funds is not insurable. Restitution of ill-gotten funds does not constitute ‘damage’ or a ‘loss’ . . .’’).91 Jacobs & Case.92 Brooke A. Masters, ‘‘WorldCom’s Ebbers Convicted,’’ Wash. Post, Mar. 16, 2005, at A01.93 Krause, § VI(A).94 See., e.g., Faulkner v. American Cas. Co. of Reading Pa., 584 A.2d 734 (Md. Ct. App. 1991).95 Jacobs & Case.96 Jacobs & Case.97 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . .’’.98 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . . .’’.99 John D. Green, ‘‘Check Your Policy: Does your D&O Insurance Cover Backdating Issues?,’’ Dec. 20, 2006, available at

http://www.fbm.com/index.cfm/fuseaction/publications.detail/object_id/a20194d2-b396-4991-8fe9-84405d75dc04/CheckYouPolicy-

doesyourDOinsurancecoverbackdatingissues.cfm.100 See, e.g., In re: HealthSouth Corp. Ins. Litigation, 308 F.Supp.2d 1253, 1280 (N.D. Ala. 2004).101 William Kapell, ‘‘Directors & Officers Securities Coverage, Insurer Rescission Claims,’’ N.Y. Law Journal, Nov. 22, 2006,

available at http://www.winston.com/siteFiles/publications/Kapell_NYLawJournal.pdf [hereinafter Kapell, ‘‘Directors and Officers

Securities Coverage. . .’’].102 Kapell, ‘‘Directors and Officers Securities Coverage. . .’’].103 See HealthSouth, 308 F.Supp.2d at 1281.104 Jacobs & Case.105 See Dickstein Shapiro, ‘‘Insurance Coverage for Subprime Lending. . .’’.106 Jacobs & Case.107 See, e.g., Liberty Mut. v. Black & Decker, 383 F. Supp.2d 200 (D. Mass. 2004); Smith & Nephew, Inc. v. Fed. Ins. Co., 2005 U.S.

Dist. LEXIS 31309 (W.D. Tenn., Nov. 10, 2005).108 Jacobs & Case.109 Brown v. Am. Int’l Group, Inc., 339 F. Supp.2d 336, 346 (D. Mass. 2004).110 See, e.g., Slip. Op., Sun-Times Media Group, Inc., et al. v. Royal SunAlliance Ins. Co. of Canada, et al., No. 06-11-108 (Del. Super.

June 20, 2007); Fireman’s Fund Ins. Co. v. Bradley Corp., 660 N.W.2d 666, 674 (Wis. 2003).111 See, e.g., Sun-Times, No. 06-11-108 (Del. Super. June 20, 2007); Fireman’s Fund Ins. Co. v. Bradley Corp., 660 N.W.2d at 674.

Coverage–15

112 Jacobs & Case; see also Pan Pacific Retail Properties v. Gulf Ins., 471 F.3d 961, 970 (9th Cir. 2006).113 See, e.g., Slip Op., at 20, Acacia Research Corp., et al. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, No. 05-cv-501 (C.D. Cal.,

Feb. 8, 2008); Hurley v. Columbia Cas. Co., 976 F. Supp. 268, 275 (D. Del. 1997); Shapiro v. Am. Home Assurance Co., 616 F. Supp.

906, 913 (D. Mass 1985); Am. Chem. Soc’y v. Leadscope, Inc., 2005 Ohio App. LEXIS 2428 (Ohio Ct. App., Franklin Cty., May 24,

2005).114 See. e.g., Slip Op., Sun-Times, No. 06-11-108 (Del. Super. June 20, 2007) (refusing to force allocation of defense costs based on

applicability of exclusions).115 See, e.g., Slip Op., Sun-Times, No. 06-11-108 (Del. Super. June 20, 2007).116 See, e.g., United States v. Stein, 435 F. Supp.2d 330 (S.D.N.Y. 2006).117 See, e.g., Level 3 Comm., Inc. v. Fed. Ins. Co., 272 F.3d 908, 911 (7th Cir. 2001); Granite State Ins. Co. v. Aamco Transmissions,

Inc. 57 F.3d 316, 320 (3d. Cir. 1995); Executive Risk Indemnity, Inc. v. Pacific Educational Services, Inc., 2006 US. Dist. LEXIS 61101,

at * 8 (D. Haw. August 25, 2006); Krause, § V.118 The following is a typical example of a severability of application provision in a typical D&O policy:

‘‘Coverage under this policy shall be void as to the following:

(1) any insured person who knew, as of the inception date of the policy period, the facts that were not accurately and completely disclosed in the application;

(2) the company to the extent it indemnifies any insured person who knew that facts were not accurately and completely disclosed as of the inception date of

the policy period; and

(3) the company if any past or present chief executive officer, chief financial officer or chief operating officer of the organization knew, as of the inception

date of the policy period, the facts that were not accurately and completely disclosed in the application.’’119 The following is a typical example of a severability of exclusions provision in a typical D&O policy:

‘‘For the purpose of determining the applicability of Exclusions 4(a) through 4(c) and 4(f) [personal profit; illegal remuneration; dishonest, criminal, or

fraudulent acts; wrongful acts occurring prior to the continuity date that one could reasonably foresee could lead to a claim] the facts pertaining to or

knowledge possessed by any Insured Person shall not be imputed to any other Insured Person.’’120 See Note 111.121 Jacobs & Kane, § III(A).122 See Thomas M. Reiter & Roberta D. Anderson, ‘‘A Timely Lesson from the WorldCom and Enron Settlements: Make Sure Your

D&O Program is Adequate,’’ January 2005, available at http://www.klgates.com/files/Publication/d263ed22-0e16-4fa1-98ab-

29c412df7c90/Presentation/PublicationAttachment/00d6d217-5bee-497c-bf49-35e39e320291/ica0105a.pdf.123 See Cutter & Buck, 306 F.Supp.2d 988, 1011–12 (W.D. Wash. 2004), aff’d, 144 F. App’x 600 (9th Cir. 2005).124 See HealthSouth, 308 F.Supp.2d 1253, 1281 (N.D. Ala. 2004).125 See, e.g., Second Amended Complaint, 89-96, Banker’s Life v. Credit Suisse First Boston, No. 07-cv-00690 (M.D. Fla.) (third

party breach of contract allegations against Triad).126 LaCroix, ‘‘Subprime Litigation Wave Hits Bond Insurer, Freddie Mac; Larger Problems Loom,’’ D&O Diary, Nov. 22, 2007, at

http://dandodiary.blogspot.com/2007/11/subprime-litigation-wave-hits-bond.html.127 See Note 59.128 Christine Richard & Matt Miller, ‘‘ACA Capital May Get ‘Thrown to Wolves,’ JP Morgan Says,’’ Bloomberg.com, Nov. 21, 2007,

at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aL_bJEd3m9Tc.129 Tomoeh Murakami Tse, ‘‘Insurer Of Bonds Loses Top Rating,’’ Wash. Post, Jan. 19, 2008, at D01.130 See Dan Wilchins (Reuters), ‘‘Bond Insurer Woes Could Become Market Tsunami: Spitzer,’’ Wash. Post Online, Feb. 14, 2008, at

http://www.washingtonpost.com/wp-dyn/content/article/2008/02/14/AR2008021400013.html.131 Phillips, et al., at 1.132 Phillips, et al., at 1.133 ‘‘Senate Passes Bill Easing Home Loan Rules,’’ N.Y. Times, Dec. 16, 2007, at C8.134 Most of these provisions instead mandate that the insurance policy be construed in an ‘‘even-handed’’ fashion — despite the fact

that the policy is almost never drafted by both parties.135 See Linda DeBene, ‘‘Viewpoint: Navigating the Crisis,’’ Origination News, Dec. 1, 2007, at 4.136 LaCroix, ‘‘About Those Subprime D&O Loss Estimates,’’ D&O Diary, Feb. 10, 2008, at http://www.dandodiary.com/2008/02/

articles/d-o-insurance/about-those-subprime-d-o-loss-estimates/.137 In the last few years, for example, many financial institutions have only purchased Side A D&O coverage. Given the prevalence of

indemnification in suits against directors and officers, the absence of Side B coverage is likely to reduce carrier exposure significantly, but

many of the higher estimates of total D&O liability do not take this fact into account.

Coverage–16