Alert July 09, 2013

California Federal Court Dismisses Class Action Challenging Bank’s Force-Placed Insurance

The United States District Court for the Northern District of California partially dismissed a class action alleging violations of the anti-tying provisions of the Bank Holding Company Act and backdating on the part of defendant, a bank, among other claims. Plaintiffs’ claims arose out of defendant’s practice of purchasing flood insurance on real property when plaintiffs failed to do so—commonly known as forced-placed or lender-placed insurance. More specifically, plaintiffs claim that defendant “improperly exploited force-placed insurance to its advantage” by entering into an exclusive purchase agreement with a third-party under which defendant purchased all force-placed insurance from the third-party and in return the third-party paid a kickback to defendant or its affiliate, an insurance company. According to plaintiffs, despite receipt of commissions from the third-party, defendant’s affiliated insurance company “performed no services whatsoever.” Defendant moved to dismiss plaintiffs’ allegations that it violated the anti-tying provisions of the BHC Act and plaintiffs’ backdating theory.

In dismissing plaintiffs’ claims that defendant violated the anti-tying provisions of the BHC Act, the Court agreed with defendant that there can be no tying unless the products are distinct. Defendant argued that there were no distinct products because purchasing insurance on behalf of the borrowers and being an insurance agent for the borrowers is the same thing. The Court agreed noting that there was "no functional distinction between the two putative services" of purchasing insurance and of being the agent for obtaining the insurance. The Court also dismissed plaintiffs’ claims that defendant backdated force-placed insurance. In moving to dismiss this claim, defendant argued that backdating is required by the National Flood Insurance Act and that the mortgages plaintiffs signed gave it the authority to backdate. Finding defendant’s argument that it had reasonable basis for the backdating practice (i.e., defendant had no way of knowing whether a loss occurred during the period of lapsed coverage) "persuasive," the Court rejected plaintiffs’ argument that such a practice violated an implied covenant of good faith and fair dealing. Moreover, while the Court held that the National Flood Insurance Act does not require backdating, it did not bar such practice. Instead, the Court held that the National Flood Insurance Act “appear[ed] to authorize [such] practice.” Because the National Flood Insurance Act did not bar the practice of backdating the flood insurance and because defendant had not acted unreasonably when it backdated the policies, the Court dismissed plaintiffs’ claims. Despite defendant’s victory, force-placed or lender-placed insurance has been a cause for concern among state and federal regulators. The FHFA recently issued a proposal to restrict mortgage sellers and servicers from receiving commissions or other remuneration associated with maintaining force-placed insurance with certain providers (see April 2, 2013 Alert) and both the New York Department of Financial Services and the California Department of Insurance recently entered into settlements with force-placed insurers (see April 2, 2013 Alert and November 13, 2012 Alert, respectively).