ROBERT E. PAYNE, Senior District Judge.
This matter is before the Court, following a bench trial, on SunTrust Mortgage, Inc.'s ("ST") affirmative defense to Count IV of DEFENDANT UNITED GUARANTY RESIDENTIAL INSURANCE COMPANY OF NORTH CAROLINA,
For the reasons set forth below, ST has met its burden on the affirmative defense (alternatively, "first material breach defense"). Judgment therefore will be entered for ST on Count IV of UG's Counterclaim.
Count IV of UG's Counterclaim seeks a "declaratory judgment stating that Sun-Trust is obligated under [the insurance policy] to continue making annual renewal premium payments on all loans in each of the Loan Pools, notwithstanding that the Maximum Cumulative Liability amount has been reached with respect to a particular Loan Pool."
The Court realized its failure to consider ST's first material breach defense in a conference call with the parties on May 3, 2011. To allow ST to be heard on its affirmative defense, the Court vacated the order entering summary judgment for UG on Count IV of the Counterclaim.
Of course, Count IV of UG's Counterclaim is just one part of this litigation, it having developed out of the events which gave rise to ST's breach of contract claim, as presented in Count I of the THIRD AMENDED COMPLAINT (Docket No. 121) ("TAC"). In brief, Count I of the TAC alleges that UG breached the insurance policy when, from the spring of 2007 through 2009, it denied ST's claims on IOF Combo 100 Loans.
The questions that must be answered now are whether the improper collection of premiums alleged in ST's first material breach defense was in fact a breach of the insurance policy, and, if so, whether that breach, and the breach already found by the Court, were material in view of the policy. Some preliminary procedural questions must be answered as well, but the substantive questions are limited to those outlined above.
ST is a corporation based in Virginia. It is a subsidiary of SunTrust Bank.
UG provided ST with mortgage insurance to cover losses on second-lien loans in the event of borrower default. Id. at 258:20-24. A written insurance policy effectuated the coverage. The policy consisted of a "Master Policy" issued circa 1998, as modified by a "SunTrust Mortgage Agreement Closed-End Purchase Money Seconds-Flow Business Risk Sharing Program—June 23, 2004" ("2004 Flow Plan") and a "SunTrust Mortgage Agreement Closed-End Purchase Money Seconds-Flow Business Risk Sharing Experienced Rating Plan—October 17, 2005" ("2005 Flow Plan").
Under the insurance policy, the insured party, ST, underwrote the loans and submitted them for coverage on a monthly basis. The insurer, UG, in turn extended coverage to the loans that ST had submitted by issuing them unique certificate numbers. See ST Ex. 3 §§ 1.2, 3.1(a); Trial Tr. 271:12-13. In addition to evidencing coverage under the policy, the certificate numbers assisted UG in tracking the loans, verifying that premiums had been paid on them, and, among other things, qualifying and processing claims on them. Trial Tr. 271:14-18.
UG did not endeavor to determine whether a submitted loan in fact conformed to the underwriting parameters unless and until ST made a claim on the loan. If, after a claim was made on a loan, UG determined that the loan did not in fact meet the agreed-to parameters, UG rescinded coverage on the loan and returned any premiums that it had collected on the loan.
All the loan products covered under the policy fell under an umbrella of products referred to as "Combo Loans." Id. at 69:21-25, 70:6-10. ST began offering Combo Loans around 2000 and continued to offer them when it filed this action in
ST offered at least eight general types of Combo Loans between 2000 and 2009. Id. at 264:3-13. See generally UG Ex. 48. One such type of Combo Loan permitted borrowers to obtain loans with a maximum loan-to-value ratio of up to 90%; another type permitted borrowers to obtain loans with a maximum loan-to-value ratio of up to 95%; and a third type permitted borrowers to obtain loans with a maximum loan-to-value ratio of up to 100%. All of the loan products were further characterized by customizing features that the borrowers selected—for instance, first- and/or second-lien loans that required interest-only payments for a specified period of time, first- and/or second-lien loans that required principal and interest payments for a specified period of time, or some combination thereof. See, e.g., ST Ex. 34 at 24-99. The loans at issue here are second-lien loans made behind an interest-only first-lien loans with a combined loan-to-value ratio of up to 100%. See n. 7, supra.
The second-lien loans were the riskier of the two loans on a real estate parcel. This fact was not lost on ST. It understood that, in the event of foreclosure, the amount owed on the second-lien loans would be satisfied only after the amount owed on the first-liens had been satisfied. Trial Tr. 55:5-11, 56:23-58:24. It also understood that the risk associated with the second-lien loans would increase in a declining residential real estate market. See id. at 57:16-58:24. ST understood, too, that the residential real estate market historically was prone to fluctuation. See id. at 60:15-61:17. Being aware of such risks, particularized and systemic, ST paid UG for mortgage insurance on the second-lien loans in its portfolio. Id. at 55:4-11, 60:11-13. ST "borrow[ed] on [its] earnings in the good times[ ] to protect [itself] in the bad times." Id. at 61:9-17.
From the insurance policy's inception, all the insured loans were grouped into loan pools. Each loan pool corresponded to a "Policy Year," which Section 1.33 of the Master Policy defined as the "annual period from the Effective Date of this Policy until 12:01 a.m. (Eastern Time) of the same day of the following year and each subsequent time period similarly calculated." ST Ex. 3 § 1.33. The effect of Section 1.33 was that all loans issued in a twelve-month interval, the beginning of which was marked by the "effective date of [the] Policy," were placed in the same pool. Trial Tr. 70:17-21; see also ST Ex. 71 ¶ 11. The individual characteristics of the loans therefore had no bearing on their placement in the pools; the singular determinant was their date of origination. This method of placing the loans in pools resulted in the pools each containing different types and quantities of Combo Loans. Trial Tr. 71:16-20.
In the policy's nomenclature, the "maximum cumulative liability" referred to UG's coverage obligation under the policy. Pursuant to Section 1.26 of the Master Policy, the maximum cumulative liability was based on a percentage of the aggregate total of the loan amounts insured in each pool. Specifically, the maximum cumulative liability was "an amount to be determined for each Policy Year" that was equal to ten percent of the aggregate total of the insured loan amount in a pool,
Two realities followed from the maximum cumulative liability being so determined. First, each pool imposed its own coverage obligation on UG. This meant that UG's coverage obligation for a particular loan extended only so far as its coverage obligation for the pool containing the loan. Second, each pool imposed a coverage obligation on UG that, in being dependent on the total amount insured in the pool (which, of course, changed as new loans were insured, loan amounts were paid down, and coverage of existing loans was cancelled), was variable in nature.
Although a pool corresponded to a "Policy Year," the amount in the most current pool (i.e., the one to which newly originated loans were added) was updated on a monthly basis. At the end of each month, ST bundled the Combo Loans that it had issued during the month and submitted the loans for coverage. Trial Tr. 73:14-21, 74:5-11. When the twelve-month period allotted for a loan pool expired, the loan pool was closed, meaning that no other Combo Loans would be added to it, and another loan pool was commenced. Loans were then added to the newly created pool on a recurring monthly basis for the next twelve months. The insurance policy called for this process to be repeated ad infinitum. See ST Ex. 3 § 1.33.
The Master Policy established the basic framework for the payment of premiums. Section 3.3 of the Master Policy provided for the payment of an "Initial Premium" for each newly insured loan under the policy. Id. § 3.3. Section 3.4 of the Master Policy provided for the payment of "Renewal Premiums" on the loans for which an initial premium already has been paid: "[t]he insured's obligation for the payment of [renewal] premium due . . . shall continue for each Loan insured [under the policy]. . . notwithstanding the payment by [UG] of Losses . . . during a Policy Year in an amount equal to the Maximum Cumulative Liability for such Policy Year. . . ." Id. § 3.4. Although Sections 3.3 and 3.4 stated that an initial premium and renewal premium, respectively, were to be paid for each loan insured under the policy, they did not specify how those premiums were to be calculated.
Before the 2005 Flow Plan, UG calculated the premiums without reference to language in the insurance policy. UG's actuaries analyzed data of every loan with all lenders, not just ST, that UG had insured dating back twenty years. Then, based on the analysis of that data, the actuaries established rate factors for each general category of ST loan that was insured under the policy, with each rate factor corresponding to the predicted risk of the loan category to which it was to be applied. The premium for each loan was calculated by applying the rate factor matching that
The 2005 Flow Plan changed the method of calculating the premiums and, for the first time, linked the calculation of the premium to language in the insurance policy. In the mid-2000s, in response to ST's requests for lower premiums, UG offered ST the opportunity to have the performance of its entire loan portfolio "earn" lower premiums. Id. at 275:3-10. UG did this because it valued ST's business and because ST's portfolio had outperformed the majority of its other lenders' portfolios. See id. at 274:20-275:15. The 2005 Flow Plan accordingly established an "Experience Rating Plan": "a special lender pay program that features potential changes in the rate for new and existing business based on the cumulative loss ratio of the insured business." ST Ex. 5. Notwithstanding that the Combo Loans insured under the policy had different risk characteristics (as evidenced by the fact that they had been assigned different rate factors before the 2005 Flow Plan according to the general loan category), the 2005 Flow Plan called for the "cumulative loss ratio" to be calculated by taking the cumulative losses paid out by UG on all the loans insured under the policy and dividing that figure by the cumulative premiums collected by UG on all the loans insured under the policy. Id.; Trial Tr. 276:19-277:14. Also according to the 2005 Flow Plan, the cumulative loss ratio was to be calculated each calendar year (after the 2005 Flow Plan went into effect) using the loss and premium data for the most recent seven-year experience of all the loans insured under the policy.
UG was to apply a rate factor to the outstanding balances of all the loans insured under the policy according to a table in the 2005 Flow Plan listing eleven different rate factors for eleven different cumulative loss ratio ranges. The rate factors increased as the values in the cumulative loss ratio ranges increased as set forth below:
Paid Loss Ratio Annual Rate
0-15 0.35%
15-25 0.40%
25-35 0.50%
35-45 0.60%
45-55 0.70%
55-65 0.80%
65-75 0.95%
75-85 1.00%
85-90 1.05%
90-100 1.15%
100+ 1.35%
Id.
The premiums for the first two years under the 2005 Flow Plan, however, did not make use of the cumulative loss ratio. Pursuant to the 2005 Plow Plan, UG set the "initial rate . . . based on the most recent experience
Use of the cumulative loss ratio (as set forth in the preceding table) to calculate premiums began in the third year of the
UG issued a bill to ST each month stating a gross premium for all the loans insured under the policy. Attached to the monthly bills was a detailed statement stating the portion of the gross amount applicable to each loan. Id. at 181:3-19.
The initial dispute in this action arose in the spring of 2007 when UG began denying claims on IOF Combo 100 Loans that had not been underwritten using Fannie Mae's automated underwriting system, "Desktop Underwriting" ("DU"). This dispute is the subject of Count I of the TAC. UG took the position that IOF Combo 100 Loans that had not been underwritten using DU were excluded from coverage under the terms of the insurance policy. ST disagreed.
The IOF Combo 100 Loans that are at issue in Count I of the TAC are housed in six loan pools. ST Ex. 71 ¶ 151; see also id. at Ex. C (listing the loan pools). ST began originating loans of this kind in late 2004 after the execution of the 2004 Flow Plan, see id. at Ex. C; see also Trial Tr. 190:23-25, but ST originated the majority of the loans between 2005 and 2007 after the execution of the 2005 Flow Plan, see ST Ex. 71 at Ex. C. ST originated and submitted IOF Combo 100 Loans for coverage under the policy for more than three years before the coverage dispute in Count I of the TAC arose. By January 2008, UG was categorically denying claims on IOF Combo 100 Loans that had not been underwritten using DU.
In early 2008, word that UG had begun systematically to deny claims of loans for non-use of the DU method reached Robert Partlow, a Senior Vice President of ST. Trial Tr. 86:21:24. Mr. Partlow initiated communications with UG in an effort to resolve the dispute. During these communications, Mr. Partlow corresponded with John Gaines, a Senior Vice President of UG. Id. at 87:11-14. In June 2008, Mr. Partlow received a letter from Mr. Gaines indicating that UG had denied claims on IOF Combo 100 Loans that had not been underwritten using DU. ST Ex. 10. The letter also indicated that "[t]here are undoubtedly a large percentage of loans remaining in force that will similarly be denied should they default," and that "without [ST's] help, [UG is] unable to identify those loans with interest only first mortgages that are lacking the required DU approval." The letter from Gaines also stated: "[i]t is not appropriate for us [UG] to continue to accept premium on loans that are not eligible for claim payment." Id.
In the months after receiving the letter, Mr. Partlow engaged in additional discussions with Mr. Gaines to resolve the dispute. Trial Tr. 88:7-11. But, the dispute persisted. Accordingly, on October 28, 2008, the parties entered into an agreement (the "Tolling Agreement") recognizing "the intent of the Parties to preserve the status quo as of September 30, 2008 with respect to claims or potential claims between the Parties in connection with [UG's denial of claims on IOF Combo 100 Loans that had not been underwritten using DU]." ST Ex. 56. The Tolling Agreement was to remain in force until November 17, 2008. Id. It was extended not less than seven times while the parties continued
In response to the statement in the Gaines letter that "without [ST's] help, [UG is] unable to identify those loans with interest only first mortgages that are lacking the required DU approval," ST sent UG a list of all IOF Combo 100 Loans insured under the policy that, it believed, had not been underwritten using DU.
Of the 11,981 loans on the list, 1,069 (approximately 9%) had in fact been denied coverage before ST sent UG the list on February 6, 2009. ST Ex. 70 ¶¶ 6, 8. Therefore, not all the loans on the list were performing loans—i.e., loans that had not defaulted and on which ST had not submitted claims. Of course, the vast majority of the loans on the list were performing loans. For those loans, UG submitted
In early July 2009, the parties had reached what appeared to be a final resolution of the dispute and had prepared a settlement agreement. However, UG abruptly and without explanation refused to execute the agreement and declined to further discuss settlement. Trial Tr. 92:24-93:4. By that time, the negotiations had been ongoing for months. As of June 30, 2009, UG had denied not less than $63,894,849 in claims on IOF Combo 100 Loans, ST Ex. 71 ¶ 18, Ex. E; see also Trial Tr. 196:19-25, which, at that time, equated to more than 25% of the total coverage liability of UG for the six loan pools at issue in Count I of the TAC, ST Ex. 71 at Ex. E; Trial Tr. 197:1-5.
Within two weeks of the unexpected end of settlement talks to UG, ST filed the present action.
After receiving the list of loans from Mr. Partlow in February 2009, and even after UG broke off settlement discussions in July 2009, UG has not exercised its contractual right to audit the loans on the list. Id. at 252:22-23. ST Ex. 3 § 7.6; see also Trial Tr. 252:18-21. Thus, UG has not ever determined whether those loans are in fact eligible for coverage under its interpretation of the insurance policy—an interpretation on which it has denied tens of millions of dollars in claims made by ST on IOF Combo 100 Loans that have defaulted. And, at no time between receiving the list of loans from Mr. Partlow in February 2009 and responding to ST's first material breach defense in May 2011, did UG dispute the accuracy of the loan list. Trial Tr. 94:25-95:19. It was only during the course of this litigation, and quite far into the process, that UG raised the specter of the list being unreliable.
The foregoing findings of fact provide a basic factual context for discussion of the procedural and substantive legal issues relevant to ST's first material breach defense. Further findings of fact are made as appropriate in the ensuing legal discussion and conclusions.
Each of the procedural and substantive legal issues relevant to ST's first material breach defense are decided in turn below.
UG argues that the doctrine of waiver prevents ST from asserting its first material
ST counters that it did not waive its right to rely upon UG's denial of claims on the loans as a predicate for its first material breach defense, because, "by its words and deeds, [it] consistently and repeatedly asserted its position that United Guaranty's refusal to pay claims [on the loans] was contrary to United Guaranty's obligations under the insurance policy."
In Virginia, "[a] party claiming waiver has the burden of showing two essential elements of waiver, namely `knowledge of the facts basic to the exercise of the right [waived] and the intent to relinquish that right.' These elements must be shown by `clear, precise and unequivocal evidence.'" Stuarts Draft Shopping Ctr. v. S-D Assocs., 251 Va. 483, 468 S.E.2d 885, 889-90 (1996) (quoting Stanley's Cafeteria v. Abramson, 226 Va. 68, 306 S.E.2d 870, 873 (1983)) (emphasis and brackets in original). The requisite elements of waiver do not conflict with the general principle articulated in 13 Williston on Contracts § 39:31 (4th ed.), and they control its application under Virginia law.
The record shows that UG has failed to carry its burden on its waiver argument. Contrary to evidencing an intent to relinquish its rights, ST's actions in the wake of its receipt of the June 2008 letter from UG demonstrate that it intended to preserve those rights.
When ST received the Gaines letter, it did not accept the position announced by UG that IOF Combo 100 Loans that had not been underwritten using DU were not eligible for coverage under the policy. Rather, ST immediately stated its disagreement and then set out to resolve the dispute through negotiations with UG. When negotiations had not resolved the dispute by October 2008, ST and UG entered into the Tolling Agreement, which, as a result of multiple extensions executed
And, not more than two weeks after UG informed ST in July 2009 that it was no longer amenable to resolving the dispute through negotiations, ST sued UG, alleging, among other things, a breach of the insurance policy on account of UG's denials of claims on IOF Combo 100 Loans that had not been underwritten using DU. Then, when UG filed its Counterclaim, Count IV of which sought a declaratory judgment to enforce provisions of the insurance policy providing for continued payment of renewal premiums after the exhaustion of UG's coverage obligation, ST timely pled its first material breach defense as an affirmative defense to the relief sought by UG.
ST continued to pay the premiums because UG led ST to believe that the dispute could be settled, and ST did not want UG to cancel the coverage for non-payment of premiums under Section 3.6 of the Master Policy while the parties were working to compromise the dispute. Nothing in the record demonstrates that ST continued to pay premiums on the loans because it agreed with UG's stated position in the Gaines letter, or because it had excused UG's denial of claims on the loans. Accordingly, UG has failed to show by clear, precise, and unequivocal evidence that ST intended to relinquish its right to raise ST's denial of claims on IOF Combo 100 Loans as a basis for its first material breach defense.
UG's reliance on American Chlorophyll, Inc. v. Schertz, 176 Va. 362, 11 S.E.2d 625 (1940), and federal cases citing to it, for its waiver argument is without merit.
Second, even if American Chlorophyll were factually applicable (and it is not), this district recently held that American Chlorophyll is no longer good law for the waiver principle for which UG cites it. See Tandberg, Inc. v. Advanced Media Design, Inc., No.1:09cv863, at 9-11 (E.D.Va. Dec. 11, 2009) (Order) (finding "plainly meritless" the proposition that "American Chlorophyll and its progeny remain good law in Virginia" based on the "weight of authority supporting application of Countryside and Horton" and at least twenty other decisions in Virginia state and federal courts permitting operation of the first material breach doctrine to prevent enforcement of a contract by the breaching party even when both parties continued to perform the contract). The decision in Tandberg is well-documented, and independent assessment of the underlying authorities counsels that it is correct. Hence, the Court adopts Tandberg here.
UG argues that, "awarding expectation damages and excusing [ST's] own obligations are overlapping and duplicative remedies that would result in a double recovery and an unjustified windfall."
ST meets that argument by pointing out that it is not seeking a double recovery. "The only remedy sought by SunTrust in this case," argues ST, "is damages for UG's breach."
UG's election of remedies argument must be rejected. It conflates two distinct concepts in the civil litigation process: a remedy sought under a cause of action and an affirmative defense raised as a bar to a
It appears that Virginia courts have never squarely addressed, in the election of remedies context, the ability of a party to seek damages for breach of contract and absolution from further performance under the same contract as a result of the other party's material breach. However, they have, commensurate with the inherent distinction between remedies and affirmative defenses, permitted the award of contract damages in conjunction with the operation of the first material breach doctrine.
The decision in Shen Valley Masonry, Inc. v. S.P. Cahill and Associates, No. 00-75, 2001 WL 34038625 (Va.Cir.Ct. Dec. 11, 2001), is illustrative. There, the court both awarded a plaintiff subcontractor $332,033 in "completed but unpaid labor" and $4,585 in "clean up and equipment removal costs" stemming from a defendant general contractor's breach of a subcontract and denied the defendant general contractor's prayer for liquidated damages based on the latter's "initial material breach" of the subcontract. Shen Valley Masonry, 2001 WL 34038625, at *8-9. The court articulated the first material breach doctrine as follows: "[t]he party who commits the first breach of a contract is not entitled to enforce the contract." Id. at *6 (citing, among other cases, Countryside Orthopaedics v. Peyton, 261 Va. 142, 541 S.E.2d 279 (2001); Horton v. Horton, 254 Va. 111, 487 S.E.2d 200 (1997)). Significantly, the court said nothing about the first material breach doctrine's precluding a plaintiff (even one who benefits from the doctrine's operation) from suing for damages on the contract. The court's silence in this regard is not surprising, because, as explained above, the first material breach doctrine operates not as a remedy requested by a party in its capacity as a plaintiff, but as an affirmative defense pled by a party in its capacity as a defendant.
The Supreme Court of Virginia's decision in ADC Fairways Corp. v. Johnmark Construction, Inc., 231 Va. 312, 343 S.E.2d 90 (1986), further undermines UG's assertion that contract damages and the first material breach doctrine are mutually exclusive "remedies." In ADC Fairways, the court permitted a plaintiff contractor
In sum, the distinct nature of a remedy and an affirmative defense and the distinct functions they serve in the litigation process, as confirmed by Virginia decisions, counsel that a litigant may seek the remedy of damages under a cause of action for breach of contract and, in response to his adversary's countervailing breach of contract claim, may also invoke the first material breach doctrine, all without running afoul of the election of remedies doctrine.
ST argues that UG breached the insurance policy in two ways. First, it argues that UG breached the insurance policy "by failing to pay SunTrust's claims on the loans at issue in Count I of the Third Amended Complaint."
UG concedes, as it must, based on the Court's earlier entry of summary judgment for ST on Count I of the TAC, that, for purposes of applying the first material breach doctrine, it must be considered to have breached the insurance policy when it denied claims on IOF Combo 100 Loans that had not been underwritten using DU.
ST rests its breach argument respecting UG's continued collection of premiums principally on Section 3.6 of the Master
Section 3.6 of the Master Policy, the provision on which ST relies, does not forbid the conduct in which UG engaged respecting the performing loans on the list. The most that can be said about that provision is that it provided UG with a "right," exercisable at "its option," to cancel coverage on a loan for certain prescribed reasons. See ST. Ex. 3 § 3.6. It does not follow that UG was precluded by that provision from continuing to collect premiums on IOF Combo 100 Loans—or any loans, for that matter—that it had decided were not eligible for coverage. That is because Section 3.6 simply does not speak to UG's ability under the policy to collect, or to continue to collect, premiums.
However, UG's conduct in billing for and collecting premiums knowing that it would not pay claims was a breach of the insurance policy because it was a breach of the duty of good faith and fair dealing owed to ST. Although it appears that the Supreme Court of Virginia has never expressly adopted Section 205 of the Restatement (Second) of Contracts ("Restatement"), which states that "[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement," the Court holds that it would do so here.
The task of a district court exercising diversity jurisdiction over an action the substance of which concerns state law is to interpret and apply the relevant state law to the controversy at issue. Where the highest court of a state has yet to address a legal issue that must be decided during the course of the federal litigation, the task of a district court sitting in diversity is to predict, as best as possible, how the state's highest court would decide the issue. See Nature Conservancy v. Machipongo Club, Inc., 579 F.2d 873, 874-75 (4th Cir.1978). In carrying out this task, the Court should consider all of the authority on the undecided issue—of course, giving the most weight to applicable decisions of the state's highest court.
Two courts have found that an implied duty of good faith and fair dealing obtains in first-party insurance relationships in Virginia, and that a breach of the duty gives rise to a contract claim. It seems that only one Virginia court has had occasion to decide whether Virginia law imposes an implied duty of good faith and fair dealing in first-party insurance relationships; and that court found that it did. See Harris v. USAA Cas. Ins. Co., 37 Va. Cir. 553, 568 (1994) (stating "this case . . . involves the application of Virginia law in a first-party insurance context. It is the opinion of this court, after careful consideration of what authority exists in Virginia and nationwide, that the Virginia Supreme Court would imply a duty of good faith in a first-party insurance context [and] would find the breach of same to give rise to a claim for breach of contract. . . .").
Outside the context of insurance, numerous Virginia state and federal courts in Virginia have acknowledged that an implied duty of good faith and fair dealing obtains in contractual relationships under Virginia law. Many of those courts have done so in cases involving contracts governed by the Uniform Commercial Code, which, pursuant to Va.Code § 8.1A-304, there is no question "impose[] an obligation of good faith in [their] performance and enforcement." See, e.g., Charles E. Brauer Co., Inc. v. NationsBank of Virginia, 251 Va. 28, 466 S.E.2d 382, 385 (1996) (stating "[t]he breach of an implied duty under the U.C.C. gives rise . . . to a cause of action for breach of contract"). Many of those decisions, however, have acknowledged an implied duty of good faith and fair dealing in cases involving contracts not governed by the Uniform Commercial Code, and therefore outside Va.Code § 8.1A-304's ambit.
The decisions that have recognized an implied duty of good faith and fair dealing in non-Uniform Commercial Code contracts have done so in line with the position adopted by the majority of jurisdictions: that a duty of good faith and fair dealing governs all contracts at common law. See generally Steven J. Burton, Breach of Contract and the Common Law Duty To Perform In Good Faith, 94 Harv. L.Rev. 369, 369 (1980) (explaining "[a] majority of American jurisdictions . . . recognize the duty to perform a contract in good faith as a general principle of contract law"); id. at 404 (appendix) (providing an extensive list of state and federal cases "explicitly recogniz[ing] a general obligation of good faith performance in every contract at common law"). Of course, this is the position taken by Section 205 of the Restatement, the origins of which, notably, trace to the Uniform Commercial Code provision that served as a genesis for Va. Code § 8.1A-304.
Some who have argued against finding an implied duty of good faith and fair dealing under Virginia law have relied on Ward's Equipment, Inc. v. New Holland North America, 254 Va. 379, 493 S.E.2d 516 (1997). There, the Supreme Court of Virginia wrote: "in Virginia, when parties to a contract create valid and binding rights, an implied covenant of good faith and fair dealing is inapplicable to those rights. This is so under either the common law or the Uniform Commercial Code. . . ." Ward's Equipment, 493 S.E.2d at 520.
Taken in isolation, it has been maintained that the statement in Ward's Equipment counsels against finding an implied duty of good faith and fair dealing under Virginia law. But, the statement was not made in isolation, and therefore it should not be so construed. In the sentence directly following the passage quoted above, the Supreme Court of Virginia wrote: "[g]enerally such a covenant cannot be the vehicle for rewriting an unambiguous contract in order to create duties that do not otherwise exist." Id. (citations omitted). From this latter statement it is clear that the Court was not saying in Ward's Equipment that an implied duty of good faith and fair dealing did not exist at all under Virginia law. Rather, the Court was saying that an implied duty of good faith and fair dealing must yield to the express terms of the contract when the
In summary, the weight of state and federal authority, inside and outside the insurance context, counsels that, commensurate with Section 205 of the Restatement, an implied duty of good faith and fair dealing obtained in the insurance policy executed between ST and UG. Analytically, there is no reason to differentiate between contracts falling under the Uniform Commercial Code and contracts that do not insofar as an implied duty of good faith and fair dealing is concerned. A legal regime that recognized the duty in contracts for the sale of goods but did not recognize the duty in contracts for the sale of land, or, as is relevant here, the provisioning of insurance, would be arbitrary in the extreme. This Court therefore joins the numerous courts that have concluded that Virginia law recognizes no such distinction.
Having found that an implied duty of good faith and fair dealing governed the insurance policy, it must be determined whether UG breached the duty. As the state and federal caselaw instructs, if UG breached the duty, it breached the policy under Virginia law.
The duty of "good faith" defies a fast and true definition. But, at minimum, it includes "faithfulness to an agreed common purpose and consistency with the justified expectations of the other party [to a contract]." Restatement (Second) of Contracts § 205 cmt. a (1981); see also RW Power Partners, L.P. v. Virginia Elec. & Power Co., 899 F.Supp. 1490, 1498 (E.D.Va.1995) (citing, among other authorities, the commentary of Section 205 of the Restatement for a definition of "good faith").
It is beyond dispute that a "justified expectation" of the party who contracts for insurance with an insurance company is that the payment of premiums to the company secures from the company a promise to provide insurance. More specifically, the payment of premiums by the insured, and acceptance thereof by the insurer, secures a promise from the insurer to pay claims on the property for which the premium has been paid.
The record clearly shows that the common purpose that underlay the ST/UG insurance contract was to provide ST a measure of relief from the default of somewhat risky loans. Indeed, ST obtained insurance from UG on second-lien mortgage loans in part because the loans were riskier than their first-lien counterparts and because ST appreciated the historical volatility of the national real estate market. ST's justified expectation was that, if it paid premiums, it would have the coverage for which it paid those premiums. According to ST's records, UG insured about 26,000 second-lien loans affiliated with the IOF Combo 100 Loan product. Not later than June 2008, as evidenced by the Gaines letter, UG decided that it would not pay claims on IOF Combo 100 Loans that had not been underwritten using DU. In Gaines' letter, UG requested ST's assistance in identifying IOF Combo 100 Loans that, according to UG's interpretation of the policy, would not be eligible for claim payments because they had not been underwritten using DU. ST expressed disagreement with UG's interpretation of the policy, but, nonetheless, in February 2009, ST provided UG with a list of some 12,000 IOF Combo Loans that it believed were not subject to coverage under UG's interpretation of the policy. UG confirmed that the loans on the list comported with its records. In the months after receiving the list of loans (March 1, 2009, through March 31, 2011), UG demanded and collected not less than $12,027,250 in premiums from ST for the loans on the list.
UG argues that the "Settlement, Stay, and Tolling Agreement" ("Settlement Agreement") executed between the parties bars ST from advancing the argument, in support of its first material breach defense, that UG breached its duty of good faith and fair dealing in continuing to collect premiums on performing IOF Combo 100 Loans. That position is not well-taken because the limited scope of the Settlement Agreement is evidenced by its clear terms: "Subject to the terms below, UG stipulates to a monetary amount for the fees and costs associated with ST's claim, and ST agrees to accept that monetary amount in lieu of pursuing its fees and costs under Virginia Code § 38.2-209 with respect to Count I" (emphasis added).
UG offered three reasons at trial to justify its continued demand for, and collection of, premiums after its decision in June 2008 to deny claims on IOF Combo 100 Loans that had not been underwritten using DU and after its receipt in February 2009 of the list of IOF Combo 100 Loans that, according to ST, had not been underwritten using DU. First, UG recites (and accurately so) that the policy is silent as to UG's ability to continue to demand and collect premiums. Second, UG says that the list of loans furnished by ST was inaccurate. Third, UG explains that it did not want to impede the settlement negotiations or breach the Tolling Agreement.
UG's first justification is unavailing for the reason explained above that, under Virginia law, UG had a duty to perform the contract in good faith, even if the contract was silent as to that duty. UG's second justification is likewise unpersuasive. The record shows that UG never raised the inaccuracy of the list of loans as a reason why it could continue to demand and collect premiums on the loans. The first time that notion appeared was in response to ST's first material breach defense and even then it appeared late in the litigation.
UG's third justification for its continued demand and collection of premiums is equally unconvincing. The Tolling Agreement entered into in October 2008, and its subsequent extensions, simply preserved the rights of the parties "with respect to claims or potential claims between the parties" (emphasis added). In essence, it foreclosed any waiver of a claim or defense and tolled statutes of limitations. It did not by its terms prohibit either ST or UG from changing its position vis-a-vis the coverage dispute or its course of conduct therein. Thus, a decision by UG to stop billing ST or to stop accepting premium payments would not have breached the Tolling Agreement.
It likely is true, however, that a decision to stop accepting premiums would have disrupted, perhaps even ended, the settlement discussions. But, even if UG was animated by such a motive to avoid that result, it certainly did not have that reason after it refused to execute the settlement agreement and declined thereafter even to discuss settlement further.
The bottom line is that, from March 2009 through March 2011, UG continued to bill for, and collect, premiums on IOF Combo 100 Loans that, by February 2009, at the latest, ST had clearly identified as not being eligible for coverage under UG's expressed interpretation of the insurance policy. Because UG persisted in subscribing to that interpretation of the policy in March 2009, and at all times thereafter, it had an obligation to stop demanding and
Moreover, the record clearly shows that UG wanted to continue to collect premiums on the performing IOF Combo 100 Loans because it understood that the maximum cumulative liability for the pools would likely be reached in any event, and thus it was to UG's benefit to continue collecting renewal premiums on these loans in the future since, whether they did or did not default, UG would still be paying out the same amount in insurance claims to ST (capped at the combined maximum cumulative liability of the applicable pools).
The foregoing are the three arguments UG offered at trial in defense of its continued collection of premiums on performing IOF Combo 100 Loans. In DEFENDANT UNITED GUARANTY'S REPLY REGARDING GOOD FAITH AND FAIR DEALING (Docket No. 543) at 1-3, UG recently posited three additional reasons why, in its view, it cannot be held to be in breach of the duty of good faith and fair dealing. Specifically, UG argues: first, ST has failed to prove by the requisite clear and convincing evidence standard that UG acted in bad faith; second, UG's continued collection of premiums "[did] not prevent ST from enjoying the benefit of the insurance contract," and thus, under Florists' Mutual, 802 F.Supp. at 1436 (stating "for there to be a bad faith claim, there must be some bad faith that in some way impaired the ability of the insured to receive the benefits of the insurance contract causing the plaintiff damages"), cannot act as the basis for a finding of bad faith; and, third, "given ST's position (accepted by this Court) that IOF Combo 100 loans were covered under the insurance contract and eligible for claim payments, UG presumably would have breached the express terms of the contract had it done exactly what ST now urges: return premiums and rescind coverage on the entire body of disputed loans." None of these new rationales for avoiding a finding that UG breached its duty of good faith and fair dealing are persuasive.
First, even if, as UG argues, State Farm Mutual Automobile Insurance Co. v. Floyd, 235 Va. 136, 366 S.E.2d 93 (1988), controls on the issue of the evidentiary burden, thus imposing a clear and convincing evidentiary standard here (and the decision arguably does not control, since it involved allegations, unlike those here, that the insurer acted in bad faith in failing to settle a claim within the policy limits and said: "we hold that bad faith must be proved by clear and convincing evidence in cases of this kind," 366 S.E.2d at 98 (emphasis added)), the records shows, clearly and convincingly, that UG's continued collection of premiums on loans the claims for which it knew it would deny was a breach of its duty to perform the insurance policy in good faith.
Second, Florists' Mutual, 802 F.Supp. 1426, does not bar a finding that UG breached the duty of good faith and fair dealing here because the record clearly establishes that UG's continued collection of premiums impaired the ability of ST to receive the benefits of the insurance contract.
Third, a finding that UG breached its duty of good faith and fair dealing in continuing to collect premiums on performing IOF Combo 100 Loans is separate and distinct from the Court's earlier finding that UG breached the insurance policy by denying claims on IOF Combo 100 Loans based on such loans' not having been DU-underwritten. Relevant to the former is what UG knew at the time it decided to bill for and collect premiums on the performing IOF Combo 100 Loans, not what UG knows now—only after being told by the Court—that its denial of claims on the Count I loans was a breach of the policy. The record clearly shows that, when UG received the Partlow loan list, it believed IOF Combo 100 Loans that had not been underwritten using DU were not covered by the policy and that, despite being of this conviction, UG continued to bill for and collect premiums on loans that ST represented as being IOF Combo 100 Loans that had not been underwritten using DU. This is the temporal context in which the propriety of UG's conduct must be assessed; and it shows UG's conduct to have been improper.
ST argues, and the Court has found, that UG breached the insurance policy, first, in denying claims on IOF Combo 100 Loans that are the subject of Count I of the TAC and, second, in continuing to demand and collect premiums on performing IOF Combo 100 Loans on the Partlow list the claims for which it had decided it would deny. ST further argues that, under Virginia law, both breaches were material in view of the insurance policy. In support of its argument that UG's denial of claims was material, ST notes that, pursuant to Section 6.3 of the Master Policy, UG had an obligation to pay claims within sixty days. According to ST, the fact that the policy imposed a specific timeframe for the payment of claims made the timely payment of claims critical under the policy. Also relevant for ST is that, as of June 30, 2009, around when ST filed suit, UG had denied claims in an amount totaling approximately $63 million. The magnitude of this amount, argues ST, was significant to the point of being material.
UG offers one argument in response to the alleged materiality of both breaches. According to UG, its denial of claims on the IOF Combo 100 Loans at issue in Count I of the TAG will only result in losses to ST of approximately 2% to 3% of the "total consideration" that "ST could have expected under the contract [of] approximately $287 million [in insurance coverage]."
Virginia law defines a "material breach" as "a failure to do something that is so fundamental to the contract that the failure to perform that obligation defeats an essential purpose of the contract." Horton, 487 S.E.2d at 204. It includes a "failure of consideration of such a degree that the remaining consideration may be deemed to be no substantial consideration." Neely v. White, 177 Va. 358, 14 S.E.2d 337, 341 (1941). "Proof of a specific amount of monetary damages is not required when the evidence establishes that the breach was so central to the parties' agreement that it defeated an essential purpose of the contract." Horton, 487 S.E.2d at 204 (citations omitted).
In assessing the materiality of a breach, this district has considered the permissive factors set forth in Section 241 of the Restatement. See, e.g., RW Power, 899 F.Supp. at 1496-97 (quoting and applying the Restatement factors).
Assessment of these factors and the Virginia caselaw on materiality demonstrates that UG's breaches, considered in combination,
The record clearly shows that UG's breaches substantially denied ST the benefit it reasonably expected under the insurance policy. UG's argument, reduced to its core, is that, in the end, ST will get nearly all of what it bargained for in insurance coverage as a consequence of the interaction between the capped nature of UG's coverage obligation and the number and amount of claims that ST has made, and likely will make, for its other loans insured under the policy. What UG's argument ignores is that ST did not pay premiums on the IOF Combo 100 Loans on which UG denied claims to get insurance coverage on other loans for which it was already paying premiums.
And, even if UG had eventually paid the claims on these loans (which it has not), what UG's argument further ignores is that ST did not pay premiums on the IOF Combo Loans in return for a promise by UG to insure those loans at a time when UG saw fit to do so. Pursuant to Section 6.3 of the Master Policy, ST paid premiums in exchange for UG's promise to pay claims within sixty days of their being made. ST Ex. 3 § 6.3; see also Trial Tr. 410:1-16, 421:12-22. The timeliness of UG's payment of claims was critical not just because the policy indicated it was, but also because ST had purchased insurance from UG to protect itself in precisely the type of situation in which it found itself in and around 2007, 2008, and 2009, when its claims were being denied. During those years, ST, like most banks, was under severe stress from the national collapse of the stock and residential real estate markets. Trial Tr. 95:24-96:23. It is hollow for UG to claim that substantially delayed receipt of the insurance coverage is tantamount to receiving the insurance proceeds within the time specified by the policy and that ST needed, and had contemplated needing, in those years. Cf. Tandberg, Inc. v. Advanced Media Design, Inc., No. 1:09cv863, 2009 WL 4067717, at *4 (E.D.Va. Nov. 23, 2009) (stating "under Virginia law, it is well-settled that failure to make timely payment constitutes a material breach" (citing, among other cases, Horton, 487 S.E.2d at 204)).
It must be said, too, that the magnitude of UG's denial of claims forced substantial hardship on ST. In June 2009, shortly before ST filed suit, the claims outstanding for IOF Combo 100 loans was approximately $63 million. ST Ex. 74; Trial Tr. 410:1-16. This outstanding balance equated to more than 25% of UG's total coverage obligation at that time for the six pools
Timely payment of its claims was an integral feature of both the policy and ST's decision to purchase insurance from UG. Moreover, UG's continued demand and collection of premiums on performing IOF Combo 100 Loans for which it knew claims would be denied resulted in ST paying millions of dollars in premiums during a two-year period in which ST was under significant economic pressure.
Where, as here, ST has incurred substantial harm as a result of UG's breaches, it cannot be said that relieving ST of its obligation to pay further premiums on all the loans insured under the policy will result in a forfeiture to UG. UG argues that, "in the two years since SunTrust filed suit on Count I, it has collected over $130 million in additional claims payments and now has less than $6 million in claims payments remaining [as a function of the maximum cumulative liability of the pools] despite owing United Guaranty over $90 million in continued premiums."
Although UG's argument has some superficial appeal, upon closer examination, it is must be rejected. First, UG's argument wholly neglects the fact that UG's obligations under the terms of the insurance policy extended not only to paying ST's claims, but also to paying ST's claims in a timely manner (i.e., sixty days). Thus, while UG may have paid "$130 million in additional claims" since this action has
The remaining two factors of Section 241 of the Restatement augur that UG's breaches were material. There is nothing in the record suggesting that UG has attempted to cure its breaches.
On this record, ST has carried its burden to prove that UG's failures to perform its obligations, respecting both the payment of claims and the collection of premiums, defeated an essential purpose of the contract of insurance.
Having determined that UG breached the insurance policy in two distinct ways, and having now further determined that those breaches were material under Virginia law in view of the language and purpose of the insurance policy, it follows that UG may not sue for further performance on the contract under the first material breach doctrine. See 4A M.J. Contracts § 77 ("The party who commits the first material breach of a contract is not entitled to enforce it or to maintain an action thereon against the other party for his or her subsequent failure to perform."). This is so unless the policy is severable. See 2 Couch on Ins. § 23:1 ("Whether a contract of insurance is considered entire or whether its parts are severable is of great importance in determining the effect of a breach of part of the contract. If the contract is entire, all of the [party's] protection will be lost upon a breach as to any part of the risk, but if the contract is severable, only the part of the policy directly affected by or connected with the breach will be avoided."); see also 15 Williston on Contracts § 45:17 (4th ed.) ("[A] recovery may be had for part performance of a divisible contract, and is not barred by a subsequent breach by the party seeking recovery. By contrast, in an indivisible contract, the entire fulfillment of the promise by either party, in the absence of any agreement to the contrary or waiver, is a condition precedent to the fulfillment of any part of the promise by the other party.").
UG argues that the insurance policy is severable on a "loan-by-loan basis." The corollary of this, contends UG, is that, because UG's breach only related to the IOF Combo 100 Loans that were denied coverage and the performing IOF Combo 100 Loans on the Partlow list, ST's first material breach defense does not bar a judgment, as it seeks in Count IV of the Counterclaim, obligating ST to pay future premiums on the other loans insured under the policy, notwithstanding the maximum cumulative liability having been reached for the pools in which those loans are housed.
UG further argues that the operation of the maximum cumulative liability evidences the severable nature of the policy. UG spotlights that the cancellation or denial of coverage as to one loan in a pool did not set at naught the contractual relationship between the parties; rather, as UG indicates, it merely resulted in the maximum cumulative liability for a pool being adjusted downward to reflect the loss of the removed loan's value.
Additionally, UG maintains that the sheer scope of the policy augurs for severability. UG notes that the policy insures "over a hundred thousand loans presenting different types of risks," and that, "in this context, it cannot reasonably be inferred that the parties intended to let a single, isolated breach (or even the breach of several loans with the same characteristic) unravel the entire contract."
UG acknowledges that a single rate factor was applied to each loan insured under the policy in calculating premiums, but it argues that the significant feature of the premiums' calculations, insofar as the issue of severability is concerned, is that "the rate factor was applied to individual loans and a separate premium was apportioned to each loan."
Among the provisions significant for UG are: first, Section 3.1 of the Master Policy, providing that "if a loan meets the Reporting Program Guidelines, the insured may submit that loan with a New Loan Summary Form"; second, Section 1.2 of the Master Policy, defining "Certificate" as "the document extending the indicated coverage option to a specified Loan under this Policy"; and, third, Section 3.6 of the Master Policy, authorizing UG to
The repeated references to individual loans insured under the policy, according to UG, evidences the parties' intent to enter into an insurance contract making "each loan. . . severable from the others."
ST argues that the insurance policy is not severable based on "the express language of the . . . insurance contract, the manner in which [the] contract was implemented, and the testimony of United Guaranty's own witnesses."
Second, ST argues that UG did not perform a "loan-by-loan risk assessment" in deciding whether to accept loans for coverage under the policy. On this point, ST notes that UG's former president, Alan Atkins, testified that UG formulated and approved "broad guidelines," "parameters," and "criteria" for the types of loan products that it would insure under the policy, and that, rather than assessing the particular risk for each loan as it was submitted for coverage, UG insured each loan so long as it comported with the broad criteria approved by UG in advance of the loan's submission.
Third, ST argues that the method of calculating premiums under both the 2004 Flow Plan and the 2005 Flow Plan establishes the non-severable nature of the policy. Respecting the calculation of premiums under the 2004 Flow Plan, ST takes the view that the initial premiums were based on the twenty-year performance of all the loans UG had insured with all of its lenders, and that UG's actuarial department calculated a rate factor for each loan
Here, ST notes that the initial rate under the 2005 Flow Plan, which governed for the first two years, was based on the most recent seven or eight-year experience of ST's loan portfolio and the quality of the business UG expected in the future. Then, in the third and subsequent years under the 2005 Flow Plan, notes ST, the premium rate was based on the paid loss ratio, which was the ratio of the cumulative losses divided by the cumulative premiums paid by ST for all the loans insured under the policy over the most recent seven years.
Fourth, ST argues that the maximum cumulative liability reveals the indivisible nature of the policy, since, by way of its operation, "United Guaranty's risk regarding any particular loan depends on the status of the entire loan pool."
Eschner v. Eschner, 146 Va. 417, 131 S.E. 800 (1926), states the test for severability in Virginia:
131 S.E. at 802 (internal quotation marks omitted). Furthermore, "[t]he divisibility of the subject matter of the contract will not determine the entire or severable character of the contract, although it may often assist in determining the intention of the parties." Id. (internal quotation marks omitted). In assessing the intention of the parties, "regard is to be had to the situation of the parties, the subject matter of the agreement, the object which the parties had in view at the time and intended to accomplish." Id. (internal quotation marks omitted). "If the intent is expressed in writing, it of course controls; if not, it is to be discovered with the aids referred to in the Eschner case as well as by the practical consideration given the contract by the parties themselves."
The record clearly demonstrates that the insurance policy is not severable on a loan-by-loan basis.
But, when one considers these features of the policy in relation to the broader context of how the policy came to be and how the parties operated under it, it must be concluded that ST and UG intended to implement an indivisible contract of insurance by way of the Master Plan and, later, the 2004 Flow Plan and 2005 Flow Plan. To the extent that the policy called for coverage to be extended and terminated on a loan-by-loan basis, it did so out of convenience and necessity rather than a desire on the part of the parties to create thousands of individual contracts of insurance for each loan insured under the policy.
The record relating to the execution of the Master Policy substantiates this. ST and UG executed the Master Policy to insure second-lien mortgage loans originated as part of ST's Combo Loan program. Under the Master Policy, each month, ST submitted the loans that it had originated for coverage. UG, in turn, issued each loan a unique certificate number, which confirmed coverage pursuant to the terms of the Master Policy and performed the necessary functions of allowing UG to track the loans, verify that premiums had been paid on them, and, qualify and process claims on them. The parties chose this method of doing business, and wrote it into the Master Policy, to provide a means by which UG could insure in bulk ST's Combo Loan products—which were diverse and oftentimes changing—without UG having to pre-approve each loan, which, of course, would have delayed the lending process. If the Master Policy can be said to have done one thing, it was to implement a streamlined method of insuring large quantities of loans with wide-ranging and variable characteristics under one contract of insurance.
The 2005 Flow Plan further reinforces the Master Policy, and hence the policy as a whole, as a document intended to insure ST's loans efficiently on a global scale. It developed in response to ST's increasing requests for UG to insure additional types of Combo Loans and to offer ST sweeping discounts on its premiums. And, further illustrative of its purpose, it resulted in UG's instituting an "Experience Rating Plan," under which the rate factor applied to all the loans insured under the policy would be "based on the cumulative loss ratio of the insured business," with the cumulative loss ratio being the quotient of the aggregate losses over the most recent seven years for all the loans insured under the policy and the aggregate realized premiums for the most recent seven years of all the loans insured under the policy, all without regard to particular loans or loan types. ST Ex. 5. This aggregate method of calculating premiums, which took into account the performance of ST's entire loan portfolio with UG, followed another method of calculating premiums that had been used under the 2004 Flow Plan, which likewise did not rely on any loan-specific rate factor. Under this earlier method of calculating premiums, UG's actuaries calculated a rate factor for each type of Combo Loan product based on the twenty-year performance of all the loans UG had insured with all of its lenders. UG then applied the rate factors derived to the Combo Loan products to which the calculated risk corresponded.
Under both the 2005 Flow Plan and the 2004 Flow Plan, UG calculated the premiums for each loan using each loan's outstanding balance as the base against which the rate factor was applied to determine the premium owed. But, neither the fact that the premium was calculated as to each loan nor the fact that the outstanding balance of each loan factored into the premium counsels for severing the policy on a loan-by-loan basis. East Augusta instructs that the "nature and entirety of the risk" must be considered in assessing the divisibility of a "contract of insurance for a gross premium on several items of property separately valued." 250 S.E.2d at 352. "[W]here the property is so situated that the risk of one item affects the risk on the other, the contract is entire and not divisible." Id. Here, the 2005 Flow Plan, in basing the rate factor for each loan on the aggregate cumulative performance of all the loans insured under the policy, effectively made the risk of insuring any one loan under the policy necessarily bound up with, and thus inseparable from, the risk of insuring all of the other loans under the policy. Under such circumstances, East Augusta teaches that the policy should be regarded as entire and indivisible.
UG's coverage obligation under the policy further reveals the non-severable nature of the contract. With UG's maximum cumulative liability being capped for each pool based on a percentage of the total amount of loans insured in a pool, UG's
In arguing for severability, UG contends that not finding the contract severable would result in the Court having to find "unreasonably" that the "parties intended to let a single, isolated breach (or even the breach of several loans with the same characteristic) unravel the entire contract." This is hyperbole. The only manner relevant to the Court's purposes here in which the contractual relationship of the parties would, to borrow UG's words, "unravel" by function of the law is if one party materially breached the policy; and, as the Court's analysis on the issue of materiality evinces, "material" breaches of contracts are not usually found on an "isolated breach." UG materially breached the insurance policy by denying coverage on more than thirteen hundred IOF Combo 100 Loans and continuing to demand and collect premiums on many thousands more which it knew it would not insure. That conduct—which hardly can be said to be an "isolated breach"—is the reason why ST will not be obligated to perform further under the policy.
The prevailing purpose of the insurance policy, the policy's implementation of premium rates and liabilities, and the parties' conduct under and pursuant to the policy demonstrate that the parties intended to create one contract of insurance to insure second-lien loans en masse. The policy therefore must be held entire and indivisible. The effect of the Court's holding is that UG's ST's first material breach defense not only bars UG from a judgment obligating ST to continue to pay renewal premiums on performing IOF Combo 100 Loans on the Partlow list, but also bars UG from a judgment obligating ST to continue to pay renewal premiums on all other performing loans insured under the policy because the policy is not severable from the former category of loans.
For the reasons stated above, ST has met its burden on its first material breach defense, and judgment will be entered for ST on Count IV of UG's Counterclaim.
It is so ORDERED.
Because Mr. Green used a proxy method, he did not review the individual loan files of the IOF Combo 100 Loans included on the list, which were in ST's, not UG's, possession. Given the information available on ST's electronic records system, review of the loan files would have been the only way to determine— with absolute certainty—whether a loan had been underwritten using DU.
Mr. Green subsequently verified the list of 11,981 loans with an alternate method. Instead of isolating the IOF Combo Loans that had been traditionally underwritten, as he had previously done, he isolated the IOF Combo Loans that ST's records indicated as having been processed through the DU software. Mr. Green learned that IOF Combo 100 Loans that had been so processed would have a first-lien loan with a "DU decision" (also referred to throughout the record as a "DU finding") designation. A "DU decision" refers to a report generated by the DU software after loan data had been put into, and processed by, the software. Id. at 212:16-20. Mr. Green understood that, just because ST's records indicated a "DU decision" for a loan, it did not follow that the loan had actually been underwritten using DU. Id. at 213:12-214:4, 215:23-216:7. The presence of a "DU decision" notation merely meant that the loan had been run through the DU software. Mr. Green found that about 14,000 loans had a "DU decision."
Mr. Green had cause to believe that his initial proxy method was accurate based on the 14,000 figure. DeeDee Hadalski, a ST employee to whom Mr. Green often turned when he needed large data pools pertaining to ST's loans, id. at 206:5-11, had given him a spreadsheet indicating that a total of 26,172 IOF Combo 100 Loans were insured under the policy, UG Ex. 68. With the earlier proxy method indicating that about 12,000 IOF Combo 100 Loans had been underwritten traditionally, Mr. Green would have expected to find that about 14,000 IOF Combo 100 Loans had a "DU decision" designation when that field was acting as a proxy for loans that had been underwritten using DU, since the sum of 12,000 traditionally underwritten loans and 14,000 DU-underwritten loans equaled 26,000 loans, thus accounting for substantially all of the IOF Combo 100 Loans that Ms. Hadalski's spreadsheet showed to be insured under the policy.
In DEFENDANT UNITED GUARANTY'S REPLY REGARDING GOOD FAITH AND FAIR DEALING (Docket No. 543) at 14, UG argues that ST has waived its right to argue that "UG breached the implied covenant of good faith and fair dealing . . . [g]iven [ST's] consistent position throughout this litigation from its early pleadings that UG breached the express terms of the parties' contract, and ST's failure to even mention the possibility that UG breached an implied covenant of good faith and fair dealing" (internal quotation marks omitted and brackets in original). UG is not correct in its conclusion.
First, as ST's statements quoted in note 45, supra, evince, UG had notice that ST's position was that UG's continued collection of premiums on performing IOF Combo 100 Loans was improper. Although ST did not employ the precise phrase "breach of an implied covenant of good faith and fair dealing," it was clear from ST's statements in its briefs before and after trial, as well as its questioning of witnesses and presentation of evidence during trial, that it was alleging that UG's continued collection of premiums was a reason (among others) to hold that UG had materially breached the insurance policy.
Second, the evidence adduced at trial, irrespective of the clarity of ST's position on UG's collection of premiums, clearly supports a finding that UG breached an implied covenant of good faith and fair dealing by continuing to collect premiums on performing IOF Combo 100 Loans. That will be addressed later in the main text of the opinion. Suffice it to say here that it would contravene the Court's role as the finder of fact (the trial on ST's first material breach doctrine being one without a jury) not to make a finding that the evidence clearly supports.
Third, and flowing from the first two points, UG has not shown that it was prejudiced by ST's arguing after trial, for the first time explicitly, that UG breached an implied covenant of good faith and fair dealing in continuing to collect premiums on performing IOF Combo 100 Loans. Because ST made clear its position before, during, and after trial that UG's continued collection of premiums was an affront to basic notions of fair business practices, much of the oral and documentary evidence offered at trial (by both UG and ST, the latter of which UG had fair opportunity to rebut) addressed the issue of why UG continued (and has continued) to collect premiums on the loans in question. Indeed, UG even offered evidence at trial on why ST wanted to continue to pay premiums on the loans. Given the parties', and thus the record's, attention at trial to the fact of UG's continued collection of premiums (not to mention the multiple rounds of briefing, as ordered by the Court, on the discrete issue of the duty of good faith as its pertains to UG's continued collection of premiums), it cannot be said that UG has been denied an opportunity to respond to ST's claim (or, for that matter, the Court's understanding of it) that UG breached an implied covenant of good faith and fair dealing in continuing to collect premiums on the performing IOF Combo 100 Loans.
The Court's own review of Virginia caselaw confirms the continued vitality of Price. See Erie Ins. Group v. Hughes, 240 Va. 165, 393 S.E.2d 210 (1990) (citing Price for the proposition that an insurer has a "duty to exercise good faith in dealing with the offer of compromise" made by a third-party tort claimant that is within the insurance policy's coverage limits); Reisen v. Aetna Life & Cas. Co., 225 Va. 327, 302 S.E.2d 529 (1983) (same); see also Levine v. Selective Ins. Co. of America, 250 Va. 282, 462 S.E.2d 81 (1995). Although the Supreme Court of Virginia's recognition of an implied duty of good faith and fair dealing in third-party insurance relationships is by no means dispositive in the direction of finding an identical duty in first-party insurance relationships, it is reasonable to conclude that such recognition makes it at least more likely that the Supreme Court of Virginia would recognize an implied duty in a first-party relationships too.
Not surprisingly, the axiom also finds support in insurance treatises. See, e.g., 5 Couch on Ins. § 79:6 ("As a general rule, an insurer is entitled only to such premium as the risk carried reasonably warrants. It follows that where . . . a premium has been paid for which there has been no corresponding risk, the unearned premium should be returned to the insured.").
Finally, UG itself acknowledged the inherent impropriety in collecting premiums on property—in this case, loans—that were not eligible for coverage. For example, the Gaines letter stated that "[i]t is not appropriate for [UG] to continue to accept premium on loans that are not eligible for claim payment." ST Ex. 10; see also Trial Tr. 125:18-23. And, Mr. Gaines acknowledged the same at trial: "[UG's] not going to keep somebody's premium if the loan did not qualify [for coverage]. That would not be right." Trial Tr. 302:16-17.
UG places much emphasis on Neely v. White, 177 Va. 358, 14 S.E.2d 337 (1941). There, the Supreme Court of Virginia held that a defendant could not use a non-party corporation's breach of a contract, ninety-three percent of which, the Court noted, had been performed, as a basis for barring the plaintiff from suing the defendant for damages on a separate contract, the obligations of which the defendant had assumed from the nonparty corporation in another transaction. Neely, 14 S.E.2d at 340. Citing Neely, UG argues that, because it allegedly has provided (in the months after June 2009) or will provide in the future ninety-seven to ninety-eight percent of the insurance coverage ST expected to obtain under the policy, it has not materially breached the policy.
UG's reliance on Neely is misplaced. First, Neely is a novel case factually, where the defendant was citing the breach of a non-party as a basis for preempting the contract claim by the plaintiff. The interest of the Neely court in allowing the plaintiff's claim to proceed, despite the non-performance of the non-party corporation, was thus far different from any corresponding interest here. Second, and even assuming, for argument's sake, that Neely's applicability was not limited by its peculiar facts, Neely does not stand for the proposition that a court must look beyond the moment in time in which the breach occurred—in this instance, to a point months, and, indeed, years, after the obligation was due—to afford the breaching party an opportunity to "cure" its prior breach. In contrast to the ninety-three percent performance referenced in Neely, which had taken place by the time of the alleged breach, the ninety-seven to ninety-eight percent performance on which UG hopes to rely can only be said to have taken place (if it took place or will take place at all) at a time significantly after (as judged by Section 6.3 of the Master Policy) the breach found by the Court. Simply put, it is a misapprehension of Neely to argue, as UG does, that the decision requires the Court to ignore the policy's sixty-day limit for the payment of claims and ST's reasons for procuring insurance from UG on the loans at issue in assessing the materiality of UG's breach.
The outcome in Countrywide should not control here for several reasons. First, Countrywide's severability analysis, and ultimately its holding, relied on California's test for severability of insurance contacts articulated in Coca Cola Bottling Co. of San Diego v. Columbia Casualty Ins. Co., 11 Cal.App.4th 1176, 14 Cal.Rptr.2d 643 (1992), which calls for consideration of "special factors" that the Supreme Court of Virginia has not recognized as having such status. Second, even assuming that the "special factors" articulated in Coca Cola Bottling are applicable here, those factors do not show the policy to be severable. The first two Coca Cola Bottling factors inquire whether the policy called for separate and distinct liability limits for each loan and whether the policy called for separately rated premiums for each loan. In contrast to Countrywide, both questions must be answered in the negative here. The Master Policy capped UG's coverage obligation at a percentage of the total loan amounts insured in a loan pool (meaning, therefore, that the policy did not call for separate and distinct liability limits for each loan), and, under the 2004 Flow Plan and 2005 Flow Plan, UG applied different rate factors to different categories of loan products (based on UG's actuaries' assessment of the risk associated with the loan categories) and a single rate factor to all the loans insured under the policy (based on the performance of all the loans as informed by cumulative loss ratio), respectively (meaning, therefore, that the policy did not call for separately rated premiums for each loan). It should be noted, too, that the Countrywide court seemed to misapply the second Coca Cola Bottling factor in finding that application of "a single multiplier based on the . . . overall loan profile" to all loans insured under the policy resulted in premiums being separately rated as to each loan. Id. at 1192, 14 Cal.Rptr.2d 643. Universal application of a single rate factor to all loans insured under a policy—especially when the rate factor is predicated on the performance of the entire loan portfolio—does not result in the policy's loans having separately rated premiums. In order to have separately rated premiums for each loan, separate rates (not separate premiums) must be applied to the loans. The Countrywide court failed to appreciate this subtlety. Third, and finally, as the third Coca Cola Bottling factor (inquiring whether "global rescission would work the absurdity of inviting litigation on irrelevant statements") suggests, the context in which the Countrywide court assessed severability is materially different from the one here. In Countrywide, the insurance company was seeking global rescission of all of the loans insured under the policy based on alleged misrepresentations of the insured that, by concession of the insurance company, did not relate to all the loans insured under the policy. Id. at 1190. The effect of the court not finding the policy severable, therefore, would have been that the insurance company would have been able to execute a global rescission of the policy based on misrepresentations of the insured that, it was uncontested, were of isolated import. ST's first material breach defense not involving an insurer's attempt to rescind coverage on loans, and certainly not involving an insurer's attempt to rescind coverage on all loans insured under a policy based on select misrepresentations of the insured, the Court's interests here respecting severability are materially different than the court's interests in Countrywide. This is all to say that Countrywide does not counsel for the result that UG claims it does.
