Alternative Mortgage Lenders: Managing Mismanagement Claims
December 11, 2023
The real estate market continues to be unpredictable; risk is ever-present. The record pace of interest rate increases, elevated inflation, and a potential recession creates uncertainty for housing prices across most of the country. And it’s not just borrowers who are feeling the stress. Mortgage lenders all over the market have had to adapt to a heightened risk of loss all-around.
Unfortunately, more financial losses mean more lawsuits—and more liability claims. In the lending industry, you know better than anyone: when people’s finances are tied up, tensions can run high. Despite your best intentions, your advice or actions might be misinterpreted and your organization could face allegations of mismanagement, improper disclosure, or predatory lending practices.
We all know how aggressively plaintiff lawyers can pursue damages for their clients. Even if you’re not directly responsible, a disgruntled third-party won’t just name your firm if they’re looking to recoup a loss—they could also name you personally as a Director or Officer.
How do you respond? Keep reading to learn more about some of the top management exposures for Alternative Mortgage Lenders and how you can protect your organization.
What are the risks?
1. Operational Risks
There are countless management risks all business leaders run into within the regular course of operations—and in the Financial Services sector, you’re particularly prone to corporate litigation.
After all, the mortgage origination process is long, complex, and often contentious. Whether you’re dealing with a borrower, investor, regulator, competitor, mortgage broker, or another stakeholder, complaints could arise at any point during the negotiations. Examples of mismanagement claims against Alternative Mortgage Lenders include:
- Breach of fiduciary duty;
- Failure to follow corporate by-laws;
- Improper disclosure;
- Conflict of interest;
- Suspension of redemptions;
- Failure to pay statutory liabilities, such as taxes or wages;
- And more.
But that’s not all. You could also face allegations of discrimination, wrongful termination, defamation, and more from employees and subcontracted agents. And unfortunately, your Errors & Omissions (E&O) Insurance and Commercial General Liability (CGL) Insurance won’t respond if you’re sued; these policies are designed to protect your business from mistakes or omissions that occur throughout the delivery of professional services, not poor oversight or managerial decisions.
With rising calls for corporate accountability, business leaders in alternative mortgage lending institutions should take steps to protect their balance sheets and boost their organizational resilience by investing in the appropriate Directors & Officers (D&O) Liability Insurance. D&O Insurance will safeguard all past, present, and future Directors, Officers, board members, trustees, committee members, senior managers and executives, and other business leaders if they’re held personally liable for any actual or alleged wrongful acts in managing a corporation.
In the event of a claim, D&O Insurance will protect your personal and corporate assets by covering the cost of legal defence fees, witness and court costs, and any settlements on behalf of a business leader. A standard D&O policy includes:
- Coverage for claims of poor governance, failure to act, management errors, financial losses, misallocation of funds, operational failures, statutory liabilities, regulatory non-compliance, and more;
- Personal Asset Protection to reimburse individual Directors and Officers for losses the organization is not legally or financially able to cover;
- Balance Sheet Protection to reimburse organizations for expenses incurred when defending Directors and Officers;
- Entity Protection to protect your firm for any claims related to traded securities;
- Outside Directorship Liability to cover employees of the insured entity who are appointed to boards of unrelated corporations;
- Employment Practices Liability (EPL) Insurance for claims brought against you by staff, such as discrimination, harassment, wrongful termination, failure to hire, and more (learn more);
To learn more, watch our video: D&O Insurance: Sail Through Troubled Waters With Confidence.
2. Mortgage Fund Management
While D&O Insurance is a critical coverage for all lending institutions, not all policies are created equal. A standard policy won’t protect your firm from the specific risks of managing a Mortgage Fund, such as a mortgage investment corporation (MIC), mortgage trust, publicly traded Fund, LP, syndicated Mortgage, or any other type of mortgage investment vehicle.
In particular, most standard D&O Insurance policies exclude claims related to:
- Breach of contract (i.e., an offering memorandum, subscription agreement, management agreement, or mortgage agreement);
- Changing the disbursement of dividends (i.e., if you were to suspend or reduce dividends due to the financial position of the Mortgage Fund);
- Professional Services (i.e., EMD services, mortgage servicing and administration);
- Suspension and/or restriction of share redemptions; and
- Issuing a security (shares or units in a Mortgage Fund are deemed as securities).
Unfortunately, these types of claims are among the most common risks for Alternative Mortgage Lenders. Why? As a lender, you’re the one making representations to investors, who trust that you’ll allocate their funds according to the terms of their mortgage agreement. But if the returns don’t materialize, they might be motivated to seek damages against you as the Fund Manager, whether you’re at fault or not.
Here’s an example: a significant real estate market correction causes real estate values to decline to the point where the equity in the property does not fully secure your mortgage. As a result, your borrower defaults on their loan. The default and subsequent loss of capital by your investors leads your investors to seek damages from you and your organization. Now, you could face potential lawsuits from those investors who believe that you misrepresented the risk to them, failed to disclose the true value of the assets securing the mortgage portfolio, and/or mismanaged their mortgage portfolio. Similarly, a borrower could simply sue for damages after alleging that you misled them or took advantage of them when making the loan. Whatever the case, if you don’t have the right insurance coverage in place, your firm will be forced to allocate funds to defend itself and to pay damages to those investors.
When you’re looking for insurance, it’s important to work with an insurance broker that understands the unique threats faced by your profession. That way, you can be certain you have the most complete coverage possible for your needs.
As a licensed broker with nearly 20 years of experience in serving Mortgage Brokers, Lenders, and Administrators, PROLINK has access to a comprehensive Directors & Officers Insurance policy, tailor-made for Alternative Mortgage Lenders. In addition to the standard D&O Insurance coverages, PROLINK’s D&O Insurance program will cover your Mortgage Fund, as well as your exposure as a Mortgage Fund Manager (and related services as an Exempt Market Dealer, if applicable), including:
- Breach of duty as a Director or Officer related to the issuance or purchase of securities (i.e. units of the Mortgage Fund);
- Allegations of misleading statements or misrepresentations related to the issuance of dividends;
- Allegations of misrepresentation in the offering memorandum or participation agreements;
- Failure to disclose material facts that could lead to the financial impairment of the Mortgage Fund or Fund Manager; and
- Misrepresentation of warranties provided to purchasers during the acquisition of a covered entity.
3. Professional Services & Investment Fund Management
As a Mortgage Fund Manager, you’re already at a heightened risk of claims from borrowers and investors. But depending on the professional services you provide, you could face additional exposure. And in the event of a claim, you’ll have a tough time finding a D&O Insurance policy to cover your losses. Here’s why:
a) Exempt Market Dealer Services
In addition to mortgage fund management, you might be registered as an exempt market dealer (EMD) under your provincial securities commission. And as an EMD, it’s your job to Know Your Client and Know Your Product. To consider your client’s financial profile, investment goals, and overall suitability before making any recommendations. If your investors lose money or don’t earn as much as they were expecting, they could sue you for professional negligence, alleging that they weren’t properly advised about the risks involved.
b) Lending and Loan Services
Mortgage Fund Managers also face a high risk of borrower claims related to:
- Lending Services, such as refusing to grant a loan or extension of credit.
- Loan Services, such as poor management and administration of loans, extensions of credit or non-performing loans (i.e., loans in default), administrative services, billing and disbursements of principal or interest, credit reporting, and more.
- Non-Performing Loan Services, such as enforcing or disposing of a loan in default and related assets (i.e. restructuring, modification, termination, transfer, repossession, foreclosure, receivership, and more).
c) Coverage Gaps
In general, any mistakes you make throughout the course of your professional activities as a licensed mortgage brokerage and/or administrator are covered by your firm’s E&O Insurance. However, E&O Insurance is intended for company-wide protection; it won’t extend to any claims aimed at individual outside Directors.
Unfortunately, your D&O Insurance won’t respond either; most policies only cover managerial and decision-making responsibilities and explicitly exclude claims relating to professional services or negligence. This unintended coverage gap between your E&O and D&O Insurance policies could leave you and your organization liable for a significant sum. Even worse? If your company is unable or unwilling to cover your losses, you could be personally responsible for paying legal fees and damages.
PROLINK can help you access a custom Mortgage Fund Management D&O policy that’s designed to address your specific business operations, professional services, and the services that stakeholders believe you provide. Our policy is fully integrated with no coverage gaps and includes Errors & Omissions protection for:
- Exempt market dealer (EMD) services;
- Mortgage underwriting services;
- Mortgage lending services; and
- Mortgage servicing and administration.
The main reason why we seek to combine cover for D&O and E&O under the same policy is because the professional service is being rendered at the time the financial product (the security) is being offered.
To cover all of the potential risks associated with Alternative Mortgage Lenders, the Mortgage Fund Management D&O policy is more expensive than a standard D&O policy. However, it’s still a cost-effective way for you to meet regulatory requirements for lender registration by getting two coverages for the price of one. In fact, it’s now mandatory for all Mortgage Lenders in Nova Scotia to carry Errors & Omissions Insurance, which can currently only be obtained through PROLINK’s combined Mortgage Fund Management D&O policy.
Which policy is right for me?
Ultimately, that depends on your organization and the specific services you offer. If you don’t provide EMD services, we’ll remove this coverage and reduce the cost of your policy.
If you do operate as an EMD, Investment Fund Manager, or Restricted Portfolio Manager, we strongly urge you to consider the Mortgage Fund Management D&O Insurance policy for maximum protection; even if you don’t have EMD exposure, there are still cases where you might need the Mortgage Fund D&O Insurance Policy to obtain lender E&O Insurance.
Is D&O Insurance worth it?
It’s critical for Alternative Mortgage Lenders to be fully protected in our current marketplace. Since pandemic-era highs, Canada’s real estate market has been cooling off and the mortgage lending community is facing a lot of uncertainty, with investors, borrowers and regulators.
According to the CMHC, while home prices have been dropping overall and may continue to decrease until next year, there’s little chance of returning to pre-pandemic levels in the short-term. If they fall by more than 15%-20%, lenders could be facing significant losses. However, prices are still elevated in some markets, particularly in Calgary and pockets of Toronto and Vancouver, where property values have steadily increased after dropping due to interest hikes in 2022.
Additionally, rising household debt, inflation, and interest rates will have major implications for affordability. Despite gaining a larger market share, Alternative Mortgage Lenders are encountering a growing number of borrowers opting to renew high-interest mortgages, raising concerns about affordability for individuals in increasingly precarious financial situations. The CMHC predicts that the Bank of Canada will gradually decrease interest rates starting in 2024, offering some relief, but we’ve still been seeing early warning signs of financial strain.
We know: buying insurance is always a hefty cost to bear. But it’s better to plan ahead and pay now, than risk a loss and pay more later. Even if you haven’t had a claim before, you can’t predict when your borrowers or investors could go against you. Without proper protection, you’ll have to pay the damages out-of-pocket. Having a standalone policy that’s carefully crafted for your needs will help you avoid financial strain and ensure that mismanagement claims don’t jeopardize your business, your brand, or your assets.
And keep in mind: even if the allegations are frivolous, you’ll still have to spend thousands in legal fees to defend. With the average financial services D&O claim at $600,000, is that a cost your business—or your personal assets—could comfortably afford without insurance?
How can we help you?
In an industry when things can change seemingly overnight, you’ll need a broker who can keep up with the pace. With over 40 years of experience, PROLINK understands the intricacies of your lending institution like no one else. We can share what steps others in your industry are taking and help you chart the road to organizational resilience. Our dedicated team of risk advisors will help you:
- Navigate industry trends and identify exposures based on your needs and business operations;
- Provide benchmarking data for the insurance protection purchased by Alternative Mortgage Lenders in Canada;
- Adopt a proactive approach to risk management to control your costs long-term;
- Conduct a full analysis of your existing insurance policies to detect any coverage gaps; and
- Secure a specialized solution that aligns with your strategic objectives.
To learn more about your exposures—and how you can protect yourself—connect with PROLINK today!
PROLINK’s blog posts are general in nature. They do not take into account your personal objectives or financial situation and are not a substitute for professional advice. The specific terms of your policy will always apply. We bear no responsibility for the accuracy, legality, or timeliness of any external content.