Texas: No duty to defend under mortgage brokers E&O policy because suit based on misuse of funds, not “insured services”

by Christopher Graham and Joseph Kelly


In Axis Surplus Ins. Co. v. Halo Asset Mgmt, LLC, et al, Case No. 12-cv-2419 (N.D. Tex. Sept. 27, 2013), the Northern District of Texas held AXIS had no duty to defend its mortgage broker insureds (collectively, “Halo”).

Halo was sued in Texas state court for fraudulent inducement, negligent misrepresentation, fraud, breach of fiduciary duty, among other theories, relating to a scheme by Halo to induce the underlying plaintiffs to invest in the purchase of failing residential mortgage notes that Halo would turn into performing loans.

Halo tendered the defense and indemnity of the underlying suit to AXIS under a professional liability policy. AXIS denied coverage and filed this suit seeking a declaration of no duty to defend or indemnify.

At summary judgment, AXIS argued it had no duty to defend because the underlying claims aren’t “Insured Services” as defined in the policy.

The policy defines “Insured Services” in part, 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. . . .

The court ruled that the underlying allegations “are fundamentally based on [Halo’s] misuse of the [underlying plaintiffs’] 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.”

AXIS, thus, had no duty to defend.

The court denied AXIS’s motion for summary judgment on the duty to indemnify. Under Texas law, the duty to indemnify is based on the facts proven at trial, not the facts alleged in a complaint. The court stated “[A]n insurer may have a duty to indemnify its insured even if the duty to defend never arises” and that “unlike the duty to defend, which turns on the pleadings, the duty to indemnify is triggered by the actual facts establishing liability in the underlying suit, and whether any damages caused by the insured and later proven at trial are covered by the terms of the policy.”

Category: Professional Liability Insurance Digest Comment »

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