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Federal Deposit Insurance Corp. v. Arch Insurance Co.

United States District Court, W.D. Washington, Seattle

November 13, 2017

FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff,
v.
ARCH INSURANCE COMPANY, et al., Defendants.

          ORDER DENYING DEFENDANT ARCH INSURANCE COMPANY'S MOTION FOR SUMMARY JUDGMENT

          Robert S. Lasnik, United States District Judge.

         This matter comes before the Court on “Defendant Arch Insurance Company's Motion for Summary Judgment.” Dkt. # 97. Arch is an excess insurer on a financial institution blended policy issued to Washington Mutual Bank (“WaMu”) starting in May 2006. It seeks a summary determination (a) that the policies do not cover fraudulent mortgages originated prior to the policy period and/or (b) that the claimed losses are indirect and do not trigger coverage under the terms of the policy. WaMu collapsed in 2008, and the United States Office of Thrift Supervision placed it into receivership with the Federal Deposit Insurance Corporation (“FDIC”). The FDIC is pursuing a claim for insurance coverage that WaMu made in 2007. The FDIC opposes Arch's motion and requests that it be denied or, in the alternative, that the Court defer ruling under Fed.R.Civ.P. 56(d)(2).

         Summary judgment is appropriate when, viewing the facts in the light most favorable to the nonmoving party, there is no genuine issue of material fact that would preclude the entry of judgment as a matter of law. The party seeking summary dismissal of the case “bears the initial responsibility of informing the district court of the basis for its motion” (Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986)) and “citing to particular parts of materials in the record” that show the absence of a genuine issue of material fact (Fed. R. Civ. P. 56(c)). Once the moving party has satisfied its burden, it is entitled to summary judgment if the non-moving party fails to designate “specific facts showing that there is a genuine issue for trial.” Celotex Corp., 477 U.S. at 324. The Court will “view the evidence in the light most favorable to the nonmoving party . . . and draw all reasonable inferences in that party's favor.” Krechman v. County of Riverside, 723 F.3d 1104, 1109 (9th Cir. 2013). Although the Court must reserve for the jury genuine issues regarding credibility, the weight of the evidence, and legitimate inferences, the “mere existence of a scintilla of evidence in support of the non-moving party's position will be insufficient” to avoid judgment. City of Pomona v. SQM N. Am. Corp., 750 F.3d 1036, 1049 (9th Cir. 2014); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252 (1986). Factual disputes whose resolution would not affect the outcome of the suit are irrelevant to the consideration of a motion for summary judgment. S. Cal. Darts Ass'n v. Zaffina, 762 F.3d 921, 925 (9th Cir. 2014). In other words, summary judgment should be granted where the nonmoving party fails to offer evidence from which a reasonable jury could return a verdict in its favor. FreecycleSunnyvale v. Freecycle Network, 626 F.3d 509, 514 (9th Cir. 2010).

         Having reviewed the memoranda, declarations, and exhibits submitted by the parties, [1] the Court finds as follows:

         BACKGROUND

         In the early 2000s, WaMu contracted with third parties to have them originate residential real property mortgage loans which WaMu agreed to purchase. In March 2004, WaMu discovered that a mortgage originated by CIP Mortgage Corporation was based on a misstatement regarding the borrower's income: the application showed annual income of approximately $150, 000, but the relevant tax return showed income of less than $15, 000. WaMu brought the problem to CIP's attention and initiated a broader review. By June 2004, WaMu knew of eleven loans, including two made to the Chief Executive Officer of CIP, that were based on false income statements. WaMu's Correspondent Area Risk and Risk Mitigation departments concluded “that the borrowers misrepresented their income and employment.” Dkt. # 173-4 at 3. Persons involved in the loans, including CIP and its CEO, were placed on a list of “Suspect Parties, ” CIP was internally referred for further monitoring, and WaMu repurchased the loans it had sold to Fannie Mae. In July 2004, WaMu notified CitiMortgage that it had identified two more fraudulent loans originated by CIP. WaMu notified CIP of its findings and requested that it repurchase the loans. CIP agreed to do so and fired the processor who originated the loans. At approximately the same time, however, WaMu discovered that CIP's 2003 net worth was less than 1/10th what it had been in 2002, in large part due to a “huge distribution” to shareholders. Dkt. # 99 at 40-41. On September 2, 2004, WaMu notified CIP that its selling privileges for WaMu had been suspended.

         Prior to September 2005, WaMu purchased three fraudulent loans from another mortgage company, Coastal Capital.

         In the spring of 2006, WaMu's insurance broker negotiated changes to the blended policy underlying Arch's excess layer. The underwriters agreed to define the term “Loan Originator” and granted certain specified coverages related to their services, effective May 1, 2006. Pursuant to the policy in place in 2007-2008, the underwriters agreed to indemnify WaMu for “[l]oss resulting directly from dishonest or fraudulent acts committed by an Employee acting alone or in collusion with others.” Dkt. # 1-1 at 25. An “individual and/or company[, ] which originates mortgage loans purchased by the Insured” is an Employee under this coverage provision. Dkt. # 1-1 at 35.

         On September 18, 2007, a defendant in a pending criminal matter notified WaMu that over 100 of the mortgages originated by CIP for WaMu were actually unsecured. WaMu conducted an investigation and found that CIP prepared fraudulent paperwork, including loan applications, mortgages, notes, and title insurance, to make it look like a third party was borrowing money that was secured by real property owned or controlled by CIP's CEO. In fact, the CEO and others involved in the fraud fronted just enough money to get through settlement, then sold the loans to WaMu and pocketed the proceeds without ever recording the mortgage, paying taxes, or purchasing insurance. The CEO and/or his companies would make monthly payments on the loan so that they appeared legitimate. The properties that were supposedly securing WaMu's loan were often sold to end-users, thereby compromising WaMu's position in the chain of title. WaMu concluded that it had purchased 124 fraudulent loans for $53, 344, 641.16. WaMu notified the underwriters of the loss on November 21, 2007.

         ANALYSIS

         The parties agree that the underlying bond is to be interpreted under Washington law. Insurance policies are construed “as contracts, giving them a fair, reasonable, and sensible construction as would be given to the contract by an average person purchasing insurance.” Xia v. ProBuilders Specialty Ins. Co., 188 Wn.2d 171, 181 (2017) (internal quotations marks omitted).[2] Undefined terms are given their plain and ordinary meaning and, if the policy language is clear and unambiguous, it will be applied as written. Id. Where there is an ambiguity coverage provisions are liberally construed in favor of coverage while exclusions are strictly construed against the insurer. Ross v. State Farm Mut. Auto. Ins. Co., 132 Wn.2d 507, 523 (1997). If an insured shows that the loss falls within the coverage provision, the insurer must show that it is excluded by specific policy language. Moeller v. Farmers Ins. Co. of Wash., 173 Wn.2d 264, 272 (2011).

         A. Definition of “Employee”

         Arch argues that the losses at issue do not trigger the obligation to indemnify because, at the time CIP and Coastal Capital sold the fraudulent loans to WaMu, they were not “Employees” covered under the fidelity bond. Arch dedicates a significant amount of its memorandum recounting when WaMu became aware that CIP had sold it bad loans and when it ceased doing business with both loan originators. Based on this time line, Arch obliquely mentions that it would be unfair to force the insurers to cover a loss that was known, but undisclosed, when the coverage first went into effect. The “known loss doctrine” applies in Washington and can, in certain circumstances, bar recovery on an insurance claim for a loss that the insured subjectively knew had already or would occur. See Hillhaven Props. Ltd. v. Sellen Const. Co., Inc., 133 Wn.2d 751, 758 (1997). Arch does not, however, argue that WaMu knew, as a matter of law, that the loan originators had engaged in fraud (as opposed to negligence or recklessness) prior to May 2006. Arch is not, therefore, arguing that there was a known loss, but rather that the fidelity bond covers only losses caused by dishonest or fraudulent acts occurring during the policy period by persons who were then employed by WaMu.

         Insurance coverage can be offered on an occurrence or a claims-made basis. “Occurrence policies generally provide coverage for damage that occurs during the policy period regardless of when the damage is discovered if notification is made within a reasonable time. . . . By contrast, claims-made policies generally provide coverage for claims which the insurer receives notice of during the policy period regardless of when the damage occurred.” Am. ContinentalIns. Co. v. Steen, 151 Wn.2d 512, 517 (2004). Arch is implicitly arguing that WaMu purchased an occurrence policy and that, because the alleged fraud occurred long before the policy period began, there is no ...


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