As banks play an increasing role in the marketing and sale of property-casualty insurance products, the businesses of banking and insurance are becoming entangled. One place where they intersect is the purchase of lender-placed insurance protecting against floods and other hazards. Uniform mortgage agreements typically give banks a right to “require” their borrowers to maintain certain types of insurance on mortgaged property, and to separately purchase that insurance on behalf of borrowers who fail to honor their commitments. Issues relating to the placement of such insurance have been raised in several dozen putative class actions that are currently pending across the country.
In the last few months, courts have issued preliminary decisions in several of these cases that illustrate the extent to which concepts of banking and insurance law have begun to converge. The discussion in this post will focus primarily on cases involving lender-placed flood insurance, but many of these issues arise for other lender-placed coverages, as well.
Lender-Placed Flood Insurance
Under federal law, properties located in areas that have been designated Special Flood Hazard Areas by FEMA must be covered by flood insurance in order to qualify for public and private financing. Regulations issued by the Office of the Comptroller of the Currency (OCC), under authority of the National Flood Insurance Act (NFIA), require lenders and mortgage servicers to ensure that properties subject to their loans have certain minimum coverage. If the property owner fails to maintain the minimum flood coverage, the NFIA requires the lender to purchase additional coverage on its borrower’s behalf.
Consequently, uniform mortgage agreements typically contain provisions that obligate the borrower to maintain insurance against various hazards, including floods, in amounts, and for such periods of time, “that [the lender] requires.” If the property owner fails to obtain the requisite coverage, the mortgage agreement usually permits the bank to purchase coverage on the borrower’s behalf—and at his or her expense. In most cases, if the borrower has ignored demands to obtain, or increase the amount of, flood insurance, the lender or mortgage servicer will purchase temporary coverage—say, for 30 or 45 days—that will become permanent only if the borrower fails to buy permanent coverage within that time.
These circumstances give the bank’s licensed agency affiliate an opportunity to earn commissions by purchasing insurance from a company whose products it sells. In many cases, the banks contract to buy all their lender-placed coverage from a single carrier. Since the mortgage agreement permits the bank to exercise its own discretion over the selection of the insurer, unhappy borrowers have branded those commissions as “kickbacks.”
On top of that, both the NFIA and OCC regulations require that properties be covered “for the term of the loan.” Because of this “continuous coverage” requirement, carriers include “automatic issuance” provisions in their program agreements, meaning that coverage automatically comes into force whenever required for a property in the loan portfolio. When borrowers are later billed for this coverage, they perceive it as a retroactive purchase of insurance for a period in which they purportedly know no flooding has occurred. In litigation, plaintiffs pejoratively characterize this billing as “backdating” of their insurance.
Then there’s the issue of how much insurance the property needs. On the one hand, the NFIA requires that the amount of insurance be “at least” equal to the lesser of (i) the amount of the outstanding loan or (ii) the maximum limit of coverage that is available for the property under the NFIA. On the other hand, six federal agencies, including FEMA, have issued guidance to mortgage servicers, stating that they should insure each property at the full replacement value of a home or other improvements.
Since the language of a uniform mortgage instrument usually states that insurance must be maintained in the amounts that the lender “requires,” most mortgage servicers elect to follow the federal guidance and insure the full replacement value, even if the outstanding loan balance is smaller. Among other things, some courts have found that replacement value coverage protects the bank from losing a performing loan at a time when interest rates have declined, and from incurring origination costs connected with premature repayment. Lenders justify this election, because both FEMA and FDIC characterize it as “a sound flood insurance risk management approach.” The federal agencies consider flood insurance at full replacement value to be in the best interests of both the property owner and the lender. But the additional insurance also increases the amount of the commission—or alleged “kickback”—earned by the bank’s affiliated agency.
While borrowers always have the option to purchase their own insurance, the plaintiffs’ class-action bar calls lender-placed flood insurance “force-placed insurance,” and the practice has been challenged in lawsuits around the country against banks or (in some cases) both banks and insurers. Most of these cases are still at a preliminary stage. In the last few months, they have produced several decisions on motions to dismiss that address an interesting array of legal issues. (Full disclosure: Jorden Burt represents insurers in several of the cases discussed below.)
The Filed Rate Doctrine
One issue is whether the banks violate either the express terms of the mortgage agreements, or the agreements’ implied covenants of good faith and fair dealing, by selecting insurance at a price that is allegedly “excessive,” because it includes the commissions paid to the banks’ affiliated agents. In several cases, banks have responded to these claims by asserting defenses under the filed rate doctrine—the rule that bars claims against insurers (and other regulated businesses) for charging allegedly unreasonable rates, if those rates have been filed with, and/or approved by, a government authority. That is, the banks have asserted defenses, based on the filing or approval of the rates that they paid for flood insurance.
The banks’ theory was not an immediate success. In rulings on motions to dismiss under Federal Rule 12(b)(6) (in which plaintiffs’ factual allegations were assumed to be true), courts accepted the argument that what plaintiffs put at issue is the bank’s act of selecting an insurer that charges a high rate, not the insurer’s act of charging that rate. Without any substantial analysis as to the relief being sought, the courts found that the filed rate doctrine applies only to the latter. Cannon v. Wells Fargo Bank N.A., No. C-12-1376 EMC (N.D. Cal. Jan. 9, 2013); Gallo v. PHH Mortgage Corp., No. 12-1117 (NLH/KMW) (D. N.J. Dec. 31, 2012) (a case involving hazard insurance); Ellsworth v. U.S. Bank, N.A., No. C 12-02506 LB (N.D. Cal. Dec. 11, 2012); Kunzelmann v. Wells Fargo Bank, N.A., No. 9:11-cv-8173-DMM (S.D. Fla. June 4, 2012).
But the story doesn’t end there. In connection with a subsequent motion to certify a national class, the court in Kunzelmann rejected the plaintiff’s argument that it had “already ‘disposed of’ the filed-rate defense.” Kunzelmann v. Wells Fargo Bank, N.A., No. 9:11-cv-8173-DMM (S.D. Fla. Jan. 10, 2013). Once it was free to consider evidence that the commissions challenged by the plaintiff were incorporated into “the rate filed by the insurance carrier in each state,” the court stated that it “seems apparent that the filed-rate doctrine is an issue that must be addressed.”
The Kunzelmann court went on to find that “differences between the states in their application of the filed-rate doctrine render certification of a nationwide class improper.” Implicit in that ruling was a holding that the bank defendants could validly assert a defense under the doctrine.
The fact that the doctrine may validly be asserted by insurers in cases based on lender-placed insurance had already been established explicitly. E.g., Schilke v. Wachovia Mortgage, FSB, 820 F.Supp.2d 825, 835-37 (N.D. Ill. 2011).
Pre-emption by Federal Banking Laws
On the flip side, some insurers have argued (along with their bank co-defendants) that contract claims arising out of the placement of insurance by mortgage servicers are pre-empted by the National Bank Act (NBA). E.g., Ellsworth v. U.S. Bank, N.A.. The NBA prohibits states from interfering with the exercise, by a federally chartered bank, of any powers granted by that statute, or by regulations of the OCC.
The foundation for the NBA pre-emption argument was laid in a series of decisions in the Schilke case. In those decisions, the Northern District of Illinois dismissed tort and contract claims against a federal savings bank, on the ground that the claims were pre-empted by the Home Owners Loan Act (HOLA) and the regulations of the Office of Thrift Supervision. Schilke v. Wachovia Mortgage, FSB, 705 F. Supp. 2d 932, 936 (N.D. Ill. 2010); 758 F. Supp. 2d 549, 556-58 (N.D. Ill. 2010); 820 F.Supp.2d at 835-37. In reaching that conclusion, the court rejected an argument that a bank that purchases lender-placed insurance engages in “the business of insurance” within the meaning of the McCarran-Ferguson Act or the Gramm-Leach-Bliley Act. 758 F.Supp.2d at 557-58. The court found that the claims against the bank would impermissibly use state laws to impose requirements regarding (i) the bank’s ability to require private mortgage insurance, (ii) its charging of loan-related fees and (iii) its disclosure of loan terms—all of which activities are controlled by the OTS, under 12 C.F.R. § 560.2. 705 F.Supp.2d at 939.
In cases against national banks, however, courts have ruled that claims relating to commissions for lender-placed insurance do not interfere with the banks’ powers, under the NBA, either to set fees or to make real estate loans subject to applicable regulations. Cannon v. Wells Fargo Bank N.A.; Ellsworth v. U.S. Bank, N.A.; Kunzelmann v. Wells Fargo Bank, N.A. See also Williams v. Wells Fargo Bank N.A., No. 11-21233-CIV (S.D. Fla. Oct. 14, 2011).
Because these cases rejected the NBA pre-emption argument, and because the court in Schilke dismissed claims against the insurer under the filed rate doctrine, none of these cases reached the question of whether a valid pre-emption defense would also protect an insurer. (An appeal is pending in the Schilke case, and the Seventh Circuit may address this pre-emption issue under the HOLA.) In the past, courts have held that NBA and HOLA pre-emption extends to agents of national banks, as well as to independent businesses that act on a bank’s behalf in connection with the bank’s authorized functions. E.g., Pacific Capital Bank, N.A. v. Connecticut, 542 F.3d 341, 353 (2d Cir. 2008); State Farm Bank, FSB v. Reardon, 539 F.3d 336, 345-47 (6th Cir. 2008); SPGGC, LLC v. Ayotte, 488 F.3d 525, 532 (1st Cir. 2007).
The reasoning behind these cases is that a state may not regulate the activities of a non-bank in a way that “interferes with national banks’ ability to carry on” an “NBA-authorized activity.” Pacific Capital, 542 F.3d at 353. In particular, the state may not “prohibit non-bank firms from providing national banks with the resources to carry out their banking activities.” SPGGC, 488 F.3d at 533. As the First Circuit explained, “the question here is not whom the [state] statute regulates, but, rather, against what activity it regulates.” Id. at 532 (emphasis in original).
In the context of lender-placed insurance, insurers seem well-positioned to argue that they enjoy federal pre-emption to the same extent as banks, because they provide the banks with the resources to carry out their banking activities.
Claims based on the theory that insurers’ commissions to bank agency affiliates are “kickbacks,” by which the banks breach their implied duty of good faith, have met with mixed success. The bare fact that the banks have an interest in obtaining insurance from companies that pay commissions to their agency affiliates has been held to be insufficient to state a claim for breach of contract or breach of the covenant of good faith. E.g., Feaz v. Wells Fargo Bank, N.A., No. 12-cv-0350-KD-M (S.D. Ala. Nov. 19, 2012); McKenzie v. Wells Fargo Home Mortgage, Inc., No. C-11-04965 JCS (N.D. Cal. Oct. 30, 2012); LaCroix v. U.S. Bank, N.A., No. 11-3236(DSD/JJK) (D. Minn. June 20, 2012).
Other cases, however, suggest that the complaint need not say much in order to state a claim, either for breach of the covenant of good faith and fair dealing, Kolbe v. BAC Home Loans Servicing, LP, 695 F.3d 111, 123-24 (1st Cir. 2012), vacated and on en banc review; Casey v. Citibank, N.A., No. 5:12-CV-820 (N.D.N.Y. Jan. 2, 2013); Ellsworth v. U.S. Bank, N.A., supra; McNeary-Calloway v. JP Morgan Chase Bank, N.A., 863 F.Supp.2d 928, 956 (N.D. Cal. 2012), or for unjust enrichment. Williams v. Wells Fargo Bank N.A., supra.
Yet another issue arises in the case of mortgages that have been acquired by Fannie Mae, but which are serviced by a bank—a circumstance that can cut both ways. In Cannon v. Wells Fargo Bank N.A., the Northern District of California dismissed claims against the mortgage servicer, Wells Fargo, for breach of contract and breach of the covenant of good faith and fair dealing. The could held that Fannie Mae, rather than Wells Fargo, was the successor to the “contracting party.” But in Casey v. Citibank, N.A., the Northern District of New York used the same reasoning to reject the argument of the mortgage servicer, Citibank, that it had a contractual right to set and change the amount of flood insurance required. On that basis, the bank’s motion to dismiss was denied.
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On January 17, 2013, the Consumer Financial Protection Bureau released its new rules for mortgage servicers, which will take effect on January 10, 2014. Servicers are now prohibited from charging for lender-placed insurance without (i) a reasonable basis to believe the borrower has failed to maintain hazard insurance and (ii) providing required notice.
The rules require that charges related to the insurance must bear a reasonable relationship to the cost of providing the service, but this portion of the rules makes an exception for insurance rates approved by state regulatory authorities. The rules are also silent on the central issue of whether servicers may require property owners to carry insurance in amounts that exceed the outstanding amounts of their loans. Most servicer and underwriter programs already comply with the CFPB regulations. The tide of lawsuits, on the other hand, appears to continue rising, with the impact of the Kunzelmann denial of national class certification to be determined.