The Second Circuit Court of Appeals affirmed on February 3 that Residential Funding Company cannot tap its professional liability coverage for two class action settlements stemming from allegedly unlawful mortgage fees that the company never actually collected itself.
The case offers a masterclass in how exclusionary language can work in insurers' favor, particularly when policies include what's known as a deemer clause that extends certain definitions to cover third parties.
RFC operated as General Motors' mortgage subsidiary, buying loans from originating banks and then packaging them for resale or securitization. The company didn't originate mortgages or pocket any of the fees that borrowers paid at closing. Those went straight to the originating banks.
But under federal law, specifically the Home Ownership and Equity Protection Act, anyone who purchases a mortgage steps into the shoes of the original lender for liability purposes. That meant when borrowers sued over improper fees, RFC was on the hook even though it never touched that money.
Two class actions followed, known as the Mitchell and Kessler cases, alleging that originating banks had charged unlawful closing, origination and settlement fees. The lawsuits claimed RFC shared responsibility as the purchaser of those loans.
When RFC filed for Chapter 11 bankruptcy, the eventual reorganization plan included settlements of both class actions. The newly created liquidating trust and class representatives then went after RFC's insurers to cover the settlements and defense costs.
The insurers had issued RFC coverage under a General Motors professional liability policy with Lloyd's of London as the primary carrier and a tower of excess insurers above it, including Continental Casualty, Twin City Fire Insurance Company, Swiss Re International SE, and several others. All the policies contained essentially identical language for purposes of this dispute.
The key provision was a fee exclusion that barred coverage for losses arising from any claim for fees, commissions, costs, expenses or other charges paid or payable by or to the insured. At first glance, that might not seem to apply since RFC never received the contested fees.
But the policies also included a deemer clause buried in the exclusions section. That clause said the term insured in the exclusions included any person or entity for whose conduct an insured is legally responsible in rendering or failing to render professional services.
The district court found that combination knocked out coverage. The deemer clause brought the originating banks within the definition of insured for purposes of applying the fee exclusion. Since the banks collected the fees, and RFC was legally responsible for the banks' conduct under federal mortgage law, the exclusion applied.
The trust and class representatives appealed, arguing that the claims weren't really about fees at all, that RFC wasn't legally responsible for bank conduct, and that the banks weren't rendering professional services as defined in the policy.
The appeals court wasn't buying it. On the fees question, the court noted that closing, origination and settlement charges are fees under any ordinary understanding of the word. The policy didn't define the term, so the court looked to Black's Law Dictionary, which describes a fee as a charge for labor or services.
On legal responsibility, the court found the position contradictory. If RFC wasn't legally responsible for the banks' conduct, it would be hard to see how RFC had coverage in the first place. The whole basis for the underlying liability was a federal statute that makes mortgage purchasers answerable for the conduct of originating lenders.
The professional services argument fared no better. The court read the deemer clause to mean that it applies when the insured is legally responsible for another entity's conduct in the course of the insured's own rendering of professional services. Since RFC was in the business of purchasing and securitizing mortgages, and its derivative liability arose from that business, the requirement was met.
The trust and class representatives made one last try, arguing that the fee exclusion applied only to fees paid to the specific insured seeking coverage, not to other entities swept in by the deemer clause. The court rejected this interpretation as inconsistent with giving the deemer clause any real effect.
The bankruptcy court had initially recommended that RFC's liability and costs were not excluded from coverage. However, the district court withdrew the bankruptcy court reference and awarded summary judgment to the insurers in December 2024, a decision the Second Circuit has now affirmed.
The ruling represents a clean win for the insurer group, which coordinated their defense despite being on different layers of the coverage tower. Four other excess carriers, ACE Bermuda Insurance Ltd., XL Insurance (Bermuda) Ltd., American International Reinsurance Company Ltd., and Chubb Atlantic Indemnity Ltd., had their claims sent to arbitration and weren't part of the court proceedings.
For the professional liability market, the decision underscores the value of deemer clauses in extending exclusions to derivative liability scenarios. The ruling shows that when policy language clearly brings third-party conduct within the scope of exclusions, courts will enforce that intent even when the insured had no direct involvement in the excluded activity.
