American Southwest Mortgage Corp. v. Continental Casualty Co.

Nos. 22-6071 & 22-6075. 10/16/2023. W.D.Okla. Judge Eid. Mortgage Loans—Negligent Audit Reports—Insurance Fraud—Interrelated Audit Reports—Interrelated Claims.

October 16, 2023

American Southwest Mortgage Corporation and American Southwest Mortgage Funding Corporation (collectively, lenders) loaned money to First Mortgage Company, LLC (First Mortgage). Robinson Gary Johnson & Associates, PLLC (auditor) audited First Mortgage’s finances for 2014, 2015, and 2016, preparing a single annual report each year. All reports briefly discussed each lender’s loans to First Mortgage and wrongly stated that all borrowings were collateralized by mortgage loans, and auditor’s annual reports failed to note that First Mortgage was committing fraud. Lenders relied on these reports in extending loans to First Mortgage and consequently lost millions of dollars. Lenders sued auditor, and auditor’s insurer, Continental Casualty, Inc. (Continental), defended the suit. The Continental policy (the policy) would pay up to $1 million per individual claim and up to $3 million in the aggregate. Pursuant to a settlement agreement, in exchange for release of auditor, Continental agreed to pay each Lender $500,000. The parties then filed motions to answer: (1) whether the claims stemming from all three negligent audit reports were “interrelated” such that the lower liability limit applied regardless of how many negligent audit reports there were; and (2) whether lenders’ claims arising from a single audit report were “interrelated,” such that the lower liability limit applied regardless of how many claimants existed. The district court held that each negligently conducted audit report was not “interrelated” to each other, while also holding that the lenders’ claims on each audit in the same year were “interrelated.” In addition, because lenders’ motion for summary judgment mentioned only the 2014 and 2016 audits, the court held that lenders could not claim damages on their 2015 audit. Consequently, Continental owed each of the lenders an additional $500,000, for a total of $2 million.

Both sides appealed. They agreed that Oklahoma law applies in this diversity-jurisdiction case because Oklahoma is the forum state. Under Oklahoma law, an insurance policy is a contract and is thus governed by the rules of construction and analysis applicable to contracts. Lenders argued that the audits were discrete efforts and that auditor’s omissions in each audit were not connected in an inevitable and predictable way. The policy’s language related to “interrelated claims” and “interrelated acts or omissions” is unambiguous and provides that all claims arising out of the same act—i.e., each audit—are interrelated regardless of the quantity or type of claimants. The policy further provides that the different audits are “interrelated” if they are either “logically” connected or “causally” connected. Here, the “relevant act or omission” is the failure to identify the absence of security interests in each audit report. One auditor performed the same service for the same clients three times, and each time that auditor made the same error and perpetuated the same fraud scheme. The common facts and circumstances made additional negligently conducted audits predictable, and therefore, logically connected. Further, the cases that lenders cited in support of their position are distinguishable. Therefore, the district court erred by not finding that each audit was interrelated, and the audits should be considered one “claim” under the policy.

Lenders further argued that the district court erred when it concluded that both lenders’ claims are interrelated to the same year’s negligent audit. Lenders asserted that each of their claims pertaining to an audit are not “interrelated” because auditor owed them each a separate duty of care. The policy, however, makes no exception for special professional duties. Here, the policy clarifies that lenders’ claims arising from a single audit report are interrelated, irrespective of the number or type of claimants. In addition, auditor’s conduct relates to the same audit, auditor owed lenders the same duty, and lenders had the same rights and suffered the same injury. Accordingly, lenders’ claims arose out of a “single act or omission” and each negligent audit is interrelated. Therefore, the district court properly determined that lenders’ claims pertaining to each individual audit are interrelated.

The order was reversed in part and affirmed in part.