Ninth Circuit Holds Section 533 and Financial Services Exclusion Do Not Bar Coverage for Alleged Mortgage Modification Scam

The Ninth Circuit, applying California law, has held that an insurer improperly failed to defend its insured in connection with a lawsuit alleging that the insured engaged in an ongoing mortgage modification fraud scheme, because one count in the lawsuit did not require willful conduct and therefore was not necessarily uninsurable under California Insurance Code § 533. First One Lending Corp. v. Hartford Casualty Ins. Co., 2017 WL 1018305 (9th Cir. Mar. 5, 2019). The court further held that a financial services exclusion did not completely bar coverage because at least some allegations bore an “insufficient causal nexus with financial services,” thus triggering the insurer’s duty to defend.

A non-profit community advocacy and homeownership organization filed a complaint against the insured lending company alleging that it engaged in a fraudulent mortgage modification scam. According to the non-profit, as part of the scheme, the insured made false representations to vulnerable homeowners, including that it was affiliated with the non-profit, in order to “reel in” the consumers and charge exorbitant and illegal fees. The insurer denied coverage, asserting that California Insurance Code § 533 rendered the suit uninsurable and that the policy’s financial services exclusion, which barred coverage for claims “resulting from the rendering of or the failure to render financial services,” precluded coverage.

The district court granted the insurer’s motion for summary judgment, and the insured appealed.  On appeal, the Ninth Circuit sided with the insured, first holding that § 533 did not necessarily bar coverage for the complaint because at least one count – the Lanham Act trademark infringement claim—"did not require a showing of willfulness,” and every other claim was not “so inseparably intertwined with willful conduct as to render the entire action uninsurable.” The appellate court further held that the financial services exclusion did not bar coverage for the entire action because the exclusion did not apply to all of the claims alleged in the complaint. For these reasons, the court determined that the insurer improperly concluded it had no duty to defend the insured.

Notably, the dissent argued that the entire action was uninsurable under § 533 because each claim was “inseparably intertwined with willful conduct.” The dissent also argued that the financial services exclusion should bar the claims alleging reputational harm and loss of goodwill, because those claims were caused by the defendants’ false claims of association with the non-profit organization, in conjunction with their failure to render financial services.