Texas Court Holds No Duty to Defend Under Mortgage Broker E&O Policy

In its recent decision in AXIS Surplus Lines Ins. Co. v. Halo Asset Management, LLC, 2013 U.S. Dist. LEXIS 139065 (N.D. Tex. Sept. 27, 2013), the United States District Court for the Northern District of Texas had occasion to consider whether an underlying complaint alleged conduct falling within the scope of coverage afforded under a miscellaneous errors and omissions policy.

AXIS insured Halo Management under a professional liability policy, providing coverage for damages arising out of Halo’s performance of “insured services,” a term defined by the policy as:

Mortgage broker services consisting of counseling, taking of applications, obtaining verifications and appraisals, loan processing and origination services in accordance with lender and investor guidelines and communicating with the borrower and lender. Debt settlement and credit services including arbitration and negotiations; real estate sales and brokerage services. …

While the policy was in force, Halo was named as a defendant in a lawsuit regarding its participation in an investment vehicle involving the purchase of at-risk residential mortgages for repackaging as a new security.  Halo was to have processed and serviced the mortgages as part of this scheme.  The claimant alleged, however, that the underlying mortgages were never purchased and that his initial $5 million investment was never returned.  The complaint alleged that Halo failed to perform due diligence on the entity that was supposed to have purchased the mortgages, and that Halo failed to inform the claimant that the mortgages, in fact, were not being purchased as intended.  AXIS denied coverage to Halo on the basis that the underlying complaint did not allege misconduct arising out of “insured services.”

On motion for summary judgment, AXIS argued that the underlying complaint did not involve any of the services identified in the policy definition of “insured services,” and that definition provides an “exhaustive definition” of the term.  Halo, on the other hand, argued that by employing the phrase “consisting of” following the words “mortgage broker services,” the definition of “insured services” was only intended to provide examples of covered professional services.  Halo further argued that the non-legal definition of the term “broker” is broad and that as such, the concept of “insured services” should be broadly construed. 

The court rejected Halo’s reliance on a lay dictionary, noting that Black’s Law Dictionary has a specific definition of “mortgage broker,” which is an entity that markets mortgage loans and brings lenders and borrowers together, but that does not originate or service mortgage loans.  The underlying complaint, observed the court, related solely to Halo’s role in processing and servicing loans that were to have been purchased by a third party.  As such, the court concluded that:

The allegations in the underlying action are fundamentally based on the Halo defendant's misuse of the Claimant defendant's invested funds, not in mortgage broker services. Taking the allegations in the petition as true, none of the funds even went to purchase mortgages.  The fact that the proposed investment scheme was supposed to involve mortgages does not overshadow the fact that the allegations ultimately stem from fraud and misappropriation of funds.

Accordingly, the court agreed that AXIS had no duty to defend the underlying complaint.  The court, however, denied AXIS’ motion on the duty to indemnify, noting that under Texas law, the duty to indemnify cannot be determined based on the allegations in the complaint, but instead depended on facts that would be considered at trial.