No E&O Coverage for Settlement of Illinois State Governmental Investigation

The United States District Court for the Northern District of Illinois, applying Illinois law, has held that an E&O policy does not afford coverage for a settlement with two government agencies, including the payment of fines or penalties, to resolve a dispute regarding the insured’s allegedly fraudulent business practices. Diamond Residential Mortg. Corp. v. Liberty Surplus Ins. Corp., 2024 WL 1254220 (N.D. Ill. Mar. 25, 2024).

The policyholder was a mortgage lender in Illinois. In March 2018, a state government agency began investigating allegedly fraudulent loan origination practices in the lender’s Springfield, Illinois branch. The agency ultimately determined that the branch had fraudulently originated certain loans, and the lender negligently supervised that branch. After the agency suspended the branch’s license, the Illinois Attorney General began investigating the branch. In October 2018, the lender, the agency, and the Attorney General entered into a Consent Order and Assurance of Voluntary Compliance that required the lender to pay $1,275,000 pursuant to the Illinois Residential Mortgage License Act of 1987, which authorizes the imposition of fines for originating fraudulent loans.

The lender had purchased an E&O policy that provided indemnity coverage for “Damages and Claim Expenses resulting from Claims” but not losses that result from disciplinary proceedings. The policy defined “Claim” as “a written demand for monetary relief [or] . . . a civil action, suit or arbitration proceeding commenced by service of a complaint or a similar proceeding.” It defined a “Disciplinary Proceeding” as “any proceeding commenced by a regulatory or disciplinary official, board or agency to investigate charges of professional misconduct in the performance of Professional Services.” The policy also carved out “civil or criminal fines or penalties” from the definition of “Damages” and excluded losses resulting from Claims “brought by or on behalf of any federal, state or local government or agency, or bureau thereof.” The E&O carrier denied coverage, and the lender filed suit.

The court affirmed the carrier’s denial of coverage and dismissed the complaint with prejudice. First, it rejected the lender’s argument that the initial investigation, which the lender conceded constituted a Disciplinary Proceeding, transformed into a Claim when the agency sent a letter demanding payment, concluding that the policy unambiguously distinguished between a Claim and a Disciplinary Proceeding. Because the agency’s investigation clearly fit within the definition of a Disciplinary Proceeding, the loss did not result from a covered Claim. Second, the court agreed with the carrier that the payment constituted a non-covered fine or penalty based on the text of the statute cited in the Consent Order. Finally, even if the loss otherwise constituted covered Damages, the policy would still not afford coverage because the purported Claim was brought against the lender by two state government agencies.

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