The U.S. Court of Appeals for the First Circuit recently considered two putative class-action lawsuits involving alleged unauthorized charges or demands for increased flood insurance coverage.
Although the terms of the mortgages in the two cases differed appreciably -- one explicitly gave the lender discretion to determine the amount of flood insurance, while the other did not contain an explicit grant of discretion -- the First Circuit reached the same conclusion as to both actions, holding that the lower courts' dismissals must be vacated due to ambiguity "as to the lender's authority to increase the coverage requirement" for flood insurance.
We refer to the former matter as the "Lass litigation," and the latter as the "Kolbe litigation," after the names of the respective plaintiffs. Copies of the opinions are available at:
http://www.ca1.uscourts.gov/pdf.opinions/11-2037P-01A.pdf (Lass litigation)
and
http://www.ca1.uscourts.gov/pdf.opinions/11-2030P-01A.pdf (Kolbe litigation).
A bank sent letters to borrowers Lass and Kolbe, requiring them to obtain additional flood insurance on their homes. Both letters provided that if the borrowers did not do so voluntarily, the bank would obtain insurance on their behalf and charge them accordingly.
Lass' mortgage provided that the amount of flood insurance was to be determined by the lender. In addition, Lass received a document at the time of her closing that notified her of the amount of flood insurance she was to obtain, and further provided that "[t]his insurance will be mandatory until the loan is paid in full" (the "notification").
Kolbe's mortgage included a paragraph titled "Fire, Flood and Other Hazard Insurance," which provides as follows: "Borrower shall insure all improvements on the Property...against any hazards, casualties and contingencies, including fire, for which Lender requires insurance. This insurance shall be maintained the amounts and for the periods that Lender requires. Borrower shall also insure all improvements on the property...against loss by floods to the extent required by the Secretary [of HUD]."
Kolbe bought the insurance that the bank required. Lass did not, and the bank purchased additional flood insurance on her behalf. The insurance certificate was supposedly "backdated" to provide coverage for two months' prior to the purchase. The bank allegedly purchased Lass' insurance through an affiliated company.
Both borrowers filed putative class actions. Lass argued that the bank had improperly forced her to purchase excessive amounts of flood insurance, and had improperly profited through supposed "kickbacks, commissions or 'other compensation'" paid in connection with the same. Kolbe brought a breach of contract claim, arguing that his mortgage did not give the bank authority to demand increased flood insurance coverage.
In both instances, the bank moved to dismiss the complaint, which the lower courts granted. Both Lass and Kolbe appealed.
On appeal, Kolbe raised two arguments: first, that the general hazard insurance provision and the provision regarding flood insurance in his mortgage are mutually exclusive; and second, in the alternative, that his preferred construction was one of two reasonable constructions of the mortgage. Thus, Kolbe argued that the provision affording the lender with discretion to determine the amount of insurance required did not apply to flood insurance, such that the lender could only require that Kolbe obtain insurance to the extent required by the HUD Secretary.
The First Circuit began by scrutinizing the terms of the mortgage. It noted that the relevant paragraph "is structured to address two different categories of insurance, with the first and third sentences containing identical introductory language..." This structure, according to the First Circuit, "arguably denotes two parallel statements of coverage..." The Court also emphasized that the title of the paragraph specifically mentions "fire" and "flood" insurance in its title, which "further supports the view that the flood coverage was handled by the separate, linguistically parallel third sentence."
The bank argued that the contract should be interpreted such that the "extent required by the Secretary" clause imposes only a floor, but not a ceiling, on the discretion afforded to the lender. The First Circuit disagreed, noting that had that been the intention of the drafter of the contract, it "arguably" would have been framed as such. Instead, the sentence as drafted "is not framed as a qualification on the previous sentence, but as an independent, further requirement."
The bank further argued that the "any hazards, casualties and contingencies" language in the contract must be read to include flood insurance, under any reasonable understanding of those terms. The First Circuit acknowledged that this argument had some force, but opined that the borrower's construction of the same terms was also reasonable. Therefore, having found the mortgage to be ambiguous, the First Circuit considered the relevant extrinsic evidence to determine the meaning of the provision in question.
The First Circuit found that the relevant extrinsic evidence bolstered Kolbe's position. Specifically, the Court observed that HUD's handbook for the administration of mortgages "treats hazard insurance and flood insurance separately." Further, the Court found that HUD's treatment of flood insurance indicated Congress' finding that floods "were not customarily among the hazards protected by standard homeowners' insurance policies." Because HUD documents show that the agency "routinely treats hazard and flood insurance separately," the First Circuit concluded that "a rational jury could construe [the relevant provision of the mortgage] in favor of either Kolbe or the Bank."
The First Circuit also considered Kolbe's allegation that the bank violated the covenant of good faith and fair dealing. The Court observed that requiring additional insurance company, without more, would fall short of constituting bad faith. Under the facts at issue here, however, the First Circuit held that the bank's behavior could constitute bad faith if it could be shown that the bank required Kolbe to obtain additional insurance in order that it could profit financially.
Accordingly, the First Circuit reversed the judgment of the lower court in the Kolbe case, and remanded the matter for further proceedings.
The facts alleged in the Lass litigation differed from those alleged in the Kolbe litigation in that Lass' mortgage explicitly gave the mortgage lender discretion to determine the required amount of flood insurance, and in that the bank obtained lender-placed flood insurance on Lass' property. Nevertheless, the First Circuit reached similar conclusions in both matters.
On appeal, Lass challenged the lower court's dismissal of her claims for breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, and breach of fiduciary duty. She argued that regardless of whether the mortgage gave the lender discretion to determine the amount of flood insurance, the notification created an ambiguity as to whether the bank could require more flood insurance than the notification provided for.
The First Circuit began by considering Lass' breach of contract claim. Lass emphasized the notification's provision that the flood insurance required at the time of the closing "will be mandatory until the loan is paid in full." She contended that the notification indicated that the amount of flood insurance would be fixed for the duration of the loan. The bank countered that the notification merely established a minimum amount of insurance, and did not include any language indicating that the bank would never increase the insurance obligation.
As it did in the Kolbe litigation, the First Circuit held that the language in the mortgage and notification was ambiguous. It reached that conclusion by first rejecting the bank's contention that the notification should not be considered part of the contract, because it did not bind both parties and required only Lass' signature. The Court's view was that "the Notification was an essential part of the transaction because it represented the exercise" of the discretion afforded to the lender by the mortgage.
Next, the First Circuit found that the mortgage and notification, taken together, could be read in two ways. First, the notification could be construed to provide that the specified amount of flood insurance obtained by the borrower was "the amount of insurance Lass was to maintain until she paid off her loan." The First Circuit also found the reading urged by the bank to be plausible, finding that the notification could be read to "highlight the duty under federal law to maintain an amount of insurance linked to the principal balance of the loan..."
With that determination in place, the First Circuit determined that the lower court erred in rejecting Lass' construction of those agreements as unreasonable.
The First Circuit continued to consider Lass' good faith and fair dealing claim. The Court held that the Lass' claims that (1) the bank demanded insurance coverage greater than it was permitted to under the mortgage and related documents; (2) and that the bank improperly backdated the insurance coverage it obtained on Lass' behalf; and (3) alleged self-dealing related to the bank's payment of commission to a related entity, if proved, were sufficient to state a claim.
Lass' claim of unjust enrichment proceeded along similar lines to her good faith and fair dealing allegations. The bank countered these allegations by arguing out that claims for breach of contract and unjust enrichment are mutually exclusive, and that an unjust enrichment claim was inappropriate where, as here, the parties' expectations are governed by a contract. The First Circuit acknowledged that the bank's argument had some force, but nevertheless rejected it on the grounds that the lower court "will be in a better position once the record is more developed to determine whether the unjust enrichment claim should survive."
Finally, the First Circuit considered Lass' claims that the bank breached its fiduciary duty to her. Using similar reasoning as described above, the First Circuit again determined that the lower court improperly dismissed this claim.
Accordingly, the First Circuit again reversed the judgment of the lower court in the Lass case, and remanded the matter for further proceedings.
Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
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Chicago, Illinois 60602
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Email: RWutscher@mtwllp.com
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