Here is a situation that comes up quite a bit in the world of business contracts containing indemnification provisions, and in the insurance industry as well. First, a party (“Party A”) gets sued, or threatened with a suit, and settles the claims against it.  Party A then seeks indemnification from another party (“Party B”) for all, or a portion of, the settlement payment that Party A made.  Party B, in addition to challenging in other ways whether it owes Party A anything at all, believes it is able to show that some portion of the settlement payment relates to issues outside the scope of the indemnification provision, and/or that other parties are the ones truly responsible for some or all of whatever amount of indemnification Party A might be owed. This fairly common situation raises a host of complex issues, requiring analysis of all potentially applicable contracts, the specific claims that were asserted against Party A, the basis for its settlement, and other legal considerations like causation.

In late 2017, the U.S. Court of Appeals for the Eighth Circuit issued an order dealing with indemnification for prior settlements, and it could have a hugely beneficial impact on potential indemnitors, including sellers of mortgage loans as well as insurers. UnitedHealth Group Inc. v. Executive Risk Specialty Insurance Company, 870 F.3d 856 (8th Cir. 2017) (rehearing and rehearing en banc denied) addressed an insured’s burden to allocate between “covered” and “non-covered” claims when seeking reimbursement from its insurer for settlement payments. The Eighth Circuit affirmed the District of Minnesota’s holding that, when an insured seeks indemnification for settlements that encompassed both covered and non-covered claims, the insured must present sufficient evidence to establish with reasonable certainty the value that the settling parties attributed to the covered claims.  Moreover, the insured’s allocation must be predicated on “what the parties knew at the time of settlement.” Id. at 863.  In other words, the insured cannot point to evidence or case law identified or arising after the settlement in order to justify an allocation that deviates from the settling parties’ reasonable valuation of the various claims at the time of settlement.

Limitations on Using Expert Testimony to Establish Allocation:

In UnitedHealth, the Court held that because the underlying lawsuits that precipitated the settlement payments at issue were “complex lawsuits involving different claims and legal theories[,] allocation required either contemporaneous evidence of valuation or expert testimony on relative value to provide a reasonable foundation for a jury’s decision.” Id. at 865.

The Court rejected the expert testimony offered by the plaintiff in support of its attempted allocation because the expert failed to analyze the value of the non-covered claims, and was unqualified to do so.  The Court held that “[w]ithout analyzing the [non-indemnifiable] suit, [the expert] could not provide an expert opinion about its value.  And without knowing the value of the [non-indemnifiable] suit, the expert could not testify as to the relative value of the [indemnifiable] suit compared to the [non-indemnifiable] suit.” Id.  Therefore, under this opinion, when a plaintiff seeks to establish its allocation based on expert testimony alone, that expert must analyze both the covered and non-covered claims, and must have sufficient expertise to guide that analysis.

The Court’s mandate that the allocation be based on information known at the time of settlement constrains the expert analysis and testimony offered in support of a plaintiff’s allocation.  A key take-away from UnitedHealth is that a party cannot later manipulate or “reverse engineer” a valuation of the covered claims in an attempt to maximize its indemnification recovery.  Rather, the required reasonableness inquiry seeks to approximate the value the settling parties actually attributed to the indemnifiable claims, and to limit the plaintiff’s indemnity accordingly.  The option to provide expert testimony therefore should not be construed as a loophole in a plaintiff’s obligation to allocate based on information known at the time of settlement. The expert’s analysis must be limited to that same factual and legal context.

Application of holding to the mortgage industry:

In the past several years, there has been a proliferation of lawsuits filed by private purchasers of mortgage loans and issuers of mortgage-backed securities (RFC/ResCap and Lehman Brothers Holdings, among others) against correspondent lenders that sold them loans. Those lawsuits often seek indemnification for composite settlements (including bankruptcy settlements) that the plaintiffs made with trustees, investors, insurers, or government departments and agencies.  These lawsuits typically claim that the loans sold by the defendants breached various representations and warranties the defendants made, and therefore necessitated some portion of the plaintiff’s settlement payments, for which defendants are alleged to be liable.  However, like the settlement at issue in UnitedHealth, the settlements underlying these mortgage-related lawsuits regularly include non-reimbursable claims and dollar amounts that should not be attributed to defendants: for example, claims related to loans not originated or sold by the defendants, or payments related to common law fraud and securities fraud claims, breach of contract claims, or time-barred claims.

The seller contracts that give rise to defendants’ purported indemnification obligations in these cases almost universally limit defendants’ obligations to damages caused by their material breaches of representations and warranties. Accordingly, just like the insured in UnitedHealth, the plaintiffs in these actions bear the burden of establishing what portions of their settlements (if any) can be attributed to defective loans sold to them by defendants.  And, also like an insured, these plaintiffs cannot retroactively manufacture a settlement allocation between covered and non-covered claims that artificially inflates the defendants’ indemnification liability.  Rather, such Plaintiffs must be limited to the amounts that they and their creditors genuinely attributed to at-issue loans originated by a particular defendant.  Given the massive and complex nature of these settlements, most correspondents’ loans are a miniscule drop in the bucket—a relative handful of loans among dozens or even hundreds of trusts that were involved in the settlement. This calls into substantial question the true value, if any, of the claims against correspondents for the remedy of indemnification.