Foran Glennon Palandech Ponzi & Rudloff

April 2014

10th Circuit Upholds Broad Interpretation of Exclusion for “Lending Services” in Bank D&O Policy.

John Eggum

D&O Policies issued to lending institutions often contain broad exclusions for both Lending Services and Professional Services.  In a recent case, the Tenth Circuit construed a “Lending Services” exclusion broadly.  It held that the exclusion encompassed not only acts and omissions that were directly related to the lending process (like recording mortgages), but also subsequent acts and omissions that, while not directly part of the lending process, “flow from” the Lending Services provided to a borrower.

The case involved allegations that certain bank officers wrongfully refused to remove allegedly fraudulent liens, the Tenth Circuit upheld a lower court’s determination of no coverage due to a broad Lending Services exclusion.  Although the Insureds argued that the Policy provided coverage because the allegedly wrongful refusal to remove the liens was distinct from the services rendered when the initial loan was made years earlier, the court disagreed.  The applicable exclusion used the phrase “arising out of” in the reference to Lending Services, and the Tenth Circuit agreed with the District Court that this policy language is to be given a broad interpretation.  Since the allegedly wrongful refusal to remove the purportedly fraudulent liens could not have occurred absent the Lending Services provided to the borrower, the Exclusion applied.  Not only was there no coverage, but there was no duty to defend, either.

Factual Background.  Western Heritage Bank and two of its employees (collectively, “Western”) brought an action against its insurer, Federal Insurance Company (“Federal”), asserting that Federal owed them a duty to defend an underlying state court action brought in Texas by Hawkins Boulevard, LLC (“Hawkins”).  The underlying action arose out of a loan transaction between Western and Lujo Investments, Ltd. (“Lujo”).  In 2004, Western loaned money to Lujo to renovate property owned by Hawkins for use as an El Pollo Loco restaurant (the “Hawkins Property” or the “Property”).  According to Hawkins, Lujo’s lease of the Hawkins Property expressly prohibited using the Property as collateral for a loan, and Hawkins alleged that Western was aware of this lease covenant.  Notwithstanding the lease covenant, however, Western accepted a pledge of the Property as collateral for the loan to Lujo, and it recorded deeds of trust against the Property and the improvements on the Property.

Three years after the initial loan to Lujo, Lujo vacated the Property.  Hawkins became aware that Western had recorded deeds of trust against the Property, and sought their removal/release.  Western refused, asserting that it would only release its liens if it were paid hundreds of thousands of dollars.  Approximately 18 months later, however, Western relinquished its liens on the Property, notwithstanding having received no payment from Hawkins or Lujo.  Hawkins brought suit, asserting lost opportunity cost for a long-tem lease with a new tenant, resulting from the delay in removing the alleged improper liens.  Western tendered the suit to Federal under a Policy that provided both Bankers Professional Liability and Director and Officers Liability coverage.  Federal denied coverage.  Western apparently accepted Federal’s position that the Bankers Professional Liability coverage did not apply with regard to Hawkins suit, but contested the denial under the D&O coverage provided by the Policy.

Policy Language.  The Policy provided that Federal would pay, on behalf of each Insured Person, “Loss for which the Insured Person is not indemnified by the Organization on account of any Claim first made against the Insured Person, individually or otherwise, during the Policy Period . . . for a Wrongful Act.”  At issue was whether the Policy’s exclusion for “Loss on account of any Claim . . . based upon, arising from, or in consequence of the performing or failure to perform Professional Services or Lending Services” excluded coverage for Hawkins claims.

The Policy defined Lending Services as “any act performed by an Insured for a Lending Customer of the Organization in the course of extending or refusal to extend credit or granting or refusal to grant a loan or any transaction in the nature of a loan, including any act of restructure, termination, transfer, repossession or foreclosure.”

The Policy defined Professional Services as: “Loan Servicing and only those services performed or required to be performed by an Insured for or on behalf of a Customer of an Insured: a. for a fee, commission or other monetary consideration; a. where a fee, commission or other monetary consideration would usually be received by the Insured but for business or other reasons is waived by the Insured; or c. for other remuneration which inures to the benefit of such Insured.”

Under the Policy, “Loan Servicing” was defined as “the servicing of any loan, lease or extension of credit (whether consumer, commercial, mortgage banking or otherwise, but not including financing for investment banking, or for leveraged management buyouts). . . . Loan Servicing includes the following servicing activities: record keeping, billing and disbursements of principal or interest, receipt or payment of insurance premiums and taxes, credit reported or statements of creditworthiness, determination of the depreciation amount of property (but not projections of or an appraisal for residual or future value of property).”  The Policy also stated that “Loan Servicing shall not include any act of restructure, termination, transfer, repossession or foreclosure, or any act arising out of the operation or control of any entity or property that the Insured acquired as security or collateral for any loan, lease or extension of credit.”

Discussion.  New Mexico law applied under the circumstances, and New Mexico applies fairly traditional principals to the interpretation of insurance policies.  As courts frequently state, the court’s primary objective is to interpret the policy to give effect to the intent of the parties, and the Policy is to be construed as a whole, giving effect to each term and construing clauses in relation to other clauses, as appropriate.

In interpreting the relevant Exclusion, the Tenth Circuit highlighted that the Policy excluded coverage “arising from . . performing or failure to perform Professional Services or Lending Services.”  The use of the phrase “arising from” indicated that the Exclusion was to be interpreted broadly, and it also demonstrated that the parties intended the Exclusion to apply even when the Lending Services (or Professional Services) were not the direct cause of the injury.

The Court, after addressing whether certain qualifications/exceptions to the Exclusion applied, determined that both placing the liens and refusing to remove them constituted Lending Services and therefore the Exclusion applied.  Western placed the liens on the Hawkins Property to secure Lujo’s credit, and therefore it was “incontrovertible” that the liens about which Hawkins complained and demanded release “arose from” and were “in consequence of” Lending Services provided by Western.  Hawkins’ allegation that failure to remove the liens was a separate and distinct injury (and Wrongful Act) was of no consequence to the analysis given the language of the Policy.

Conclusion.  The Western decision highlights that bank D&O Policies with broad lending exclusions are intended to exclude coverage for both alleged acts and omissions that are directly connected to the loan underwriting process, as well as acts and omissions that are incidental to that process, and which flow from the lending activities.  Claimants cannot successfully “plead around” Lending Services and Professional Services exclusions in instances where the Policy language indicates that the Insured and the Insurer intended such exclusions to be broadly interpreted and applied.

The case is: W. Heritage Bank v. Fed. Ins. Co., 13-2077, 2014 WL 903469 (10th Cir. Mar. 10, 2014).