SEPTEMBER 2005

CPI Overview

Key Issue: Initial Disclosures

Recent Case Developments

CPI Model Act Update

MANAGING RISK in a Collateral Protection Insurance Program

Legal Update

Century City

Houston

London

Los Angeles

New York

Northern Virginia

Orange County

Sacramento

San Diego

San Diego - North County

San Francisco

Silicon Valley

Sydney

Taipei

Tokyo

Washington DC www.pillsburylaw.com

During the 1980s and 1990s, many lenders faced liti-gation arising out of their practices in insuring collater-al where borrowers failed to do so. Lender-purchasedinsurance is referred to as "Collateral ProtectionInsurance," "CPI," or force-placed insurance. A smallgroup of plaintiffs' class action lawyers turned CPI liti-gation into something of a cottage industry. Mostmajor lenders faced CPI litigation, and as a result tookaffirmative steps to minimize the risks of future CPI lit-igation.

The vast majority of CPI lawsuits settled without adetermination on the merits (or lack thereof) of theclaims alleged. In some cases, lenders achieved classaction settlements that provided for the lender's con-tinued use of CPI under specified conditions. In othercases, lenders simply opted to "go bare" and assumeall of the expense and risk of loss associated withuninsured collateral. Between these two scenarios, areview of CPI litigation to date shows that lenders cando many things to minimize risk while minimizing thecosts associated with their borrowers' failure to pro-vide adequate insurance.

The best means of minimizing the risk of CPI litigationexposure is to provide adequate disclosure when theloan is originated with subsequent disclosures asneeded. Even where there has been sufficient disclo-sure, the lender needs to closely scrutinize commis-sions, rebates, and tracking charges.

The following is intended as a preliminary guide tomaintaining a CPI program that is less likely to be thefocus of litigation. This information is not intended aslegal advice, and it is not a substitute for the lenderconsulting with its own attorneys to insure full compli-ance with applicable laws and regulations.

OVERVIEW OOF CCPI IISSUES

Many financial institutions are often forced to defendthemselves in lawsuits stemming from their lawfulbusiness activities. Simply knowing that a lawsuitmight be filed should not, and has not, led lenders toclose their doors for fear of litigation.

However, good business practices demand that thelender make an ongoing effort to minimize the risksassociated with such litigation and try to avoid claimswherever possible.

Lenders are often targets for claims arising from feesand other charges applied where borrowers default ontheir loan obligations, and the use of CPI programsthat did not make adequate disclosures got the mostattention. Insurance companies and agents were alsonamed in a few of these lawsuits, though they wererarely the primary targets. Typically, lenders chose tosettle these cases because of the uncertainties of liti-gation. Some lenders successfully fought many CPIlawsuits, but usually at significant expense.

THE NNATURE OOF CCPI

The typical documents for an automobile loan obligatethe borrower to maintain acceptable insurance on thecollateral securing the loan. Under the agreement,absent proof of acceptable insurance, the lender hasthe right to either repossess the collateral or placeinsurance to protect the collateral. If the lender choos-es to place insurance, the lender typically advancesthe policy premium and adds the cost to the balanceof the borrower's loan.

CPI is generally narrower in scope and more expensivethan the "conventional" insurance that would beobtained by a borrower with a good driving record.Conventional (borrower-purchased) insurance general-ly includes coverage for liability and property damage,as well as other coverages such as uninsured motoristcoverage. The lender-placed policy typically providesonly property insurance for the value of the collateralup to the amount of the loan balance in the event thatthe collateral is damaged or destroyed. Even with nar-rower coverage, the premiums associated with CPI aregenerally higher than for borrower-purchased insur-ance for several reasons. First, the lender-placedinsurer typically insures the collateral for all defaultedloans within a lender's portfolio without any informa-tion on borrowers' driving records. In many cases, thereason a borrower does not have acceptable insur-ance in place is that he or she was cancelled or non-

1

renewed by their prior insurer. As a practical matter,borrowers who default on their loan obligations alsotend to be significantly higher risks than the rest of thepopulation. While the cost of lender-placed insuranceis usually higher than what the borrower could obtainon his or her own, the exceptions are numerous. Manyborrowers with CPI insurance would only be able toobtain minimal liability insurance under "assigned risk"programs, and would not be able to obtain insurancefor physical damage to the automobile except at veryhigh prices. For these reasons, it is sometimes thecase that CPI is actually the cheapest insurance avail-able for some borrowers. Additionally, some CPI pro-grams utilize risk-based rates that are not significantlyhigher than normally underwritten insurance would befor similar type and location of vehicle.

Typically, CPI provides a policy under which both theborrower and the lender have the right to receive insur-ance benefits. (Generally, the lender is entitled to pay-ment first; the payment reduces the loan balance. Insome cases, while the borrower is not listed as aninsured, he or she may have the ability to submit aclaim.) In most cases, the lender is the named insuredon a "master policy." The CPI insurer monitors theexistence of insurance on the lender's entire portfolio.When a borrower fails to provide proof of adequateinsurance on the collateral, the insurer, on behalf of thelender, issues one or more notices to the borrowerreminding the borrower of his or her obligation to pro-vide proof of acceptable insurance. If such proof is nottimely received, the insurer issues a notice to the bor-rower indicating that insurance has been placed on thevehicle. The lender advances the premium for theinsurance, and charges it to the defaulting borrower'saccount. The additional loan balance is either collect-ed as part of a higher monthly payment or via a longerterm. In the event of damage to the vehicle, either thelender or the borrower may make a claim.

In the past, lenders sometimes received rebates orcommissions in connection with the placement of CPI.As explained below, rebates and commissions were aparticular target of plaintiffs' lawyers in CPI litigation.Via CPI, many lenders effectively outsource trackinginsurance on the lender's loan portfolio. The mannerin which this "outsourcing" is billed or not billed hasalso been a subject of CPI litigation.

While most lenders' loan documents provide thelender with the right to purchase insurance at the bor-rower's expense, historically, the disclosures in loandocuments often did not cover all of the lender's con-duct. As is typical with consumer litigation of this type,plaintiffs' most forceful arguments were based on theextent of the disclosure by the lender at the time theloan was made. Lenders faced special difficulty wherethe court perceived that the loan agreement providedthat the lender would act in a certain manner, when infact, the lender acted in a different manner. If thelender clearly and conspicuously discloses the termsthat will apply in the event that the borrower fails tomaintain adequate insurance, the likelihood of litiga-tion or liability should be significantly reduced.

COMMON PPLAINTIFFS' TTHEORIES

Plaintiffs' attacks on CPI programs typically focusedon lender behavior that borrowers characterized asopportunistic. The complaints challenged issues suchas the cost of the CPI policy, administrative or trackingfees charged to the borrower, interest charged on theCPI premium, the scope of the CPI coverage, theamount of the CPI coverage, commissions andrebates received by the lender, backdating and thelender's choice of the insurance agent or provider.

CPI litigation often involved both federal and stateclaims. Under federal law, plaintiffs' primary claim wasthat lenders' practices violated the Truth in LendingAct. In essence, plaintiffs contended that the specificcosts and charges associated with CPI were not dis-closed at the time of the loan application. Plaintiffsalso claimed violations of the Bank Holding CompanyAct, alleging that the lender tied credit to the place-ment of CPI or that lender coverages were tied toprocuring the physical damage part of CPI. In addi-tion, plaintiffs claimed violations of the National BankAct arguing that unauthorized charges were usurious,and RICO, alleging that the lender participated in aracketeering activity, usually mail fraud, through mis-representation. Under state statutes, plaintiffs allegedviolations of state insurance laws, motor vehiclefinancing laws, consumer protection laws, unfair busi-ness practices laws and finance laws. Plaintiffs also

2

frequently alleged common law claims based onbreach of contract, breach of the implied duty of goodfaith and fair dealing, breach of fiduciary duty, andnegligence. The specific practices or lender acts thathave been attacked include the following examples:

1. CCommissions oor rrebates. There was a time whenlenders would routinely seek commissions, rebates, orother cost recoveries relating to CPI placement andloss experience. Typically, the lender would create alicensed insurance agency that would receive a com-mission amounting to a percentage of the total premi-um placed. Standing alone, commissions are unre-markable so long as the recipient is properly licensed.However, plaintiffs' lawyers have successfully arguedthat the lender-controlled insurance agency is reallyjust a device to funnel additional funds to the lender.

In defense of the practice, lenders have argued that acommission is necessary to defray the expense andrisk of CPI. The lender is incurring expenses in admin-istering the program and bears the risk of collectingthe policy premium from the borrower. In addition,lenders have successfully defended these charges bypointing to the fact that the lender's CPI program isapproved by a state insurance department, and thusthe rates have already been approved by the agencywith primary jurisdiction in the area. For example, inBrannon v. Boatmen's National Bank of Oklahoma,976 P.2d 1077 (Okla. App. 1998), the court held thatthe commission a lender received from the purchaseof CPI was properly charged to the borrower as part ofthe cost of insurance. In addition, in Kenty v. BankOne, 92 F.3d 384 (6th Cir. 1996), the Sixth Circuit heldthat the lender was entitled to add the insurance pre-miums to the borrower's loan balance, regardless ofhow much the insurance actually cost the lender. Thecourt held that the borrower was required to pay "pre-miums and finance charges" to the lender if she didnot maintain her own insurance. The agreement's lan-guage was not limited to the amount of money it"cost" the lender to buy the insurance in question.(See below for a detailed summary of Kenty.) Whilethese lenders successfully defended the practice, thefinancial benefit of receiving commissions or rebatesshould be carefully weighed in light of the cost todefend a CPI lawsuit.

2. IInterest ccharges. Loan disclosure documents rou-tinely inform the borrower of the cost of the creditbeing obtained. When CPI is placed, the cost of theinsurance is added to the loan balance, and that newloan balance typically bears interest. If the lenderintends to charge interest on the additional funds, itmust ensure that the disclosures make clear that thecosts of CPI will increase the cost of credit.

3. AAmount oof ccoverage. Some states have laws limit-ing the amount of coverage that can be placed eitherin relation to the replacement cost of the collateral, orthe extent of the loan balance. Whether or not astatute exists in a given state, as a practical matterwhen too much insurance is placed, the premiumcosts increase but the benefits do not. As a matter ofinsurance law, an insurer with $20,000 of insurance ona $10,000 car will pay $10,000 if the car is destroyedeven though the lender or borrower effectively paidpremiums on the higher amount. There is no singlesolution to this issue for every state. At a minimum, theamount of CPI coverage should not exceed the loanbalance. However, there are exceptions to this gener-al rule, and lenders should refer to the laws of the statein which CPI is placed for guidance on this issue.

4. SScope oof ccoverage. Since the typical car loanagreement usually only requires insurance coverageon the collateral for damage or loss, plaintiffs haveargued that lender coverages not separately chargedto the lender and going beyond such damage or losscoverage are unauthorized. The borrower is oftenrequired by law to have liability insurance, which doesnot protect the lender. In contrast, CPI typicallyinsures physical damage only, without providing liabil-ity coverage or other state mandated coverages.Sometimes lenders have obtained, at the borrower'sexpense, insurance for conversion, skip, confiscation,premium deficiency, repossession and mechanic'sliens, which borrowers argue afford them no protec-tion. Plaintiff's argument in this regard was success-ful in Logsdon v. Fifth Third Bank of Toledo, 654N.E.2d 115 (Ohio App. 1994), where the plaintiffalleged that the lender breached the contract by pur-chasing insurance that went beyond collision andcomprehensive coverages. The court looked to thelanguage of the loan agreement and found that the

3

language was ambiguous as to what type of insurancethe lender could purchase. Because ambiguities areconstrued against the drafter of the agreement, thecourt held that the language of the loan agreement lim-ited the lender to obtaining collision and comprehen-sive coverage. The lender should make sure that theinitial loan disclosures exactly match insurance that islater placed by the lender, and that the insurance isdesigned to protect both the lender and the borrowerin the event the vehicle is damaged or stolen. The dis-closure should make clear that CPI does not cover lia-bility. Where these lender coverages are desired, thesafer way to proceed is to have the coverages sepa-rately billed to the lender.

5. CCost oof CCPI. CPI is usually more expensive thanregular borrower-purchased coverage. As explainedabove, there are common sense underwriting factorsdriving CPI pricing. First, a CPI insurer obligates itselfto insure all of the collateral within the lender's entireportfolio without regard to individual bad risks.Second, borrowers who default on their loan obliga-tions (requiring CPI) are typically expensive risks toinsure. For that reason, CPI for a single car is gener-ally more expensive than the insurance that a non-defaulting driver would typically obtain. Plaintiffs'lawyers tended to ignore that many drivers with CPIwere such bad risks that alternative insurance couldactually cost more than CPI. Drivers subject to"assigned risk" liability programs are often otherwiseeffectively uninsurable for property damage. Thelender should make sure that the insurer is using ratesapproved by the applicable regulatory agency - typi-cally the state department of insurance - and makesure it discloses that CPI is more expensive (oftentriple) than what a "good driver" might pay.

6. ""Tracking" ccosts. A substantial service provided bythe CPI insurer is tracking loans to ensure that borrow-ers have proper insurance in place. Plaintiffs havecomplained that lenders breach their contracts whenthey charge for the cost of tracking whether insuranceis maintained. Plaintiffs argued that tracking fees arenot for "insurance" and thus not part of the "cost ofinsurance" that the lender is authorized under the con-tract to charge to the borrower. Some courts haveheld that this is an issue of fact for a jury to decide.

Courts have been divided on the issue of trackingcosts.

In Verity v. Bank One of Arizona, M.C.S.C. CV-1997-013019, the lender did not charge a separate "track-ing" fee beyond the charge for the CPI, and thus thecourt held that the lender did not breach the contract.The court noted that the premiums charged by anyinsurance company necessarily cover the costs ofdoing business. In Porch v. General MotorsAcceptance Corporation, 642 N.W.2d 473 (Minn. App.2002), the court found that the insurance company'stracking premium was not excessive and was author-ized by the contract. Therefore, the cost was properlypassed on to the borrower. On the contrary, in Gibsonv. World Savings & Loan Association, 103 Cal. App.4th 1291 (2002)(a property case, not an auto case), thecourt found that plaintiffs' unfair competition lawaction was not preempted by federal law, where thetracking costs passed onto the borrowers were basedon the costs associated with the lenders entire loanportfolio. The court noted that the tracking costs weremore expensive because they included the costs for ahost of other services which benefited only the lender,a fact which the lender failed to disclose. The courtfound that the state could rightly regulate the contrac-tual terms between the parties, including the trackingcosts, without impinging upon any federally regulatedarea.

CPI rates as approved by various Departments ofInsurance routinely allow tracking as a part of a premi-um. While not a guarantee against a claim beingmade, rate approval is a strong defense for the lender.In addition, a contract which explicitly authorizes andclearly describes such costs would also serve to pro-tect the lender.

7. OOther pplaintiffs' aarguments. Plaintiffs' counsel usu-ally took a "shotgun" approach to CPI litigation, mak-ing many arguments that did not carry the force of theprimary disclosure-related arguments. For example,some plaintiffs have argued that the lenders and CPIinsurers "wrongfully" backdate coverage. CPI insur-ance is often backdated to the expiration of the priorborrower-placed insurance. However, plaintiffs' back-dating argument was rejected in Brannon v.

4

Boatmen's National Bank of Oklahoma, 976 P.2d 1077(Okla. App. 1998), where the court held that the lenderwas entitled to coverage for any loss or damage to thecollateral during any period that the borrower did nothave coverage in effect, including any pre-insuranceperiod. The benefit of receiving coverage for unknownlosses that occur before a lapse in coverage is deter-mined should be weighed against the possibility thatthis practice might form the basis of a CPI claim. If thistype of coverage is desired, an appropriate disclosurewill help minimize the risk of a claim.

Plaintiffs also sometimes claimed that the lenderbreached the loan contract by not allowing the bor-rower to select the agent through whom the lenderpurchased the CPI. Plaintiffs claimed that eventhough they failed to maintain the insurance, the con-tract gave them the right to use an agent of their ownchoosing. In Odom v. Trustmark National Bank, 1995U.S. Dist. LEXIS 22260 (S.D. Miss. 1995), the courtaccepted this argument. The court found thatTrustmark's right to obtain CPI did not necessarilyauthorize Trustmark to obtain insurance from an agentof its choosing. The court found the agreementambiguous and therefore construed it againstTrustmark, finding that the borrower still had the rightto direct Trustmark to an agent of the borrower'schoosing. This argument is difficult, however, becausethe likely result is that the lender will not be able toexercise its right to purchase CPI and will be forced torepossess the automobile. However, the lender canavoid this potential problem by disclosing its right tochoose the agent in the event CPI coverage is neces-sary.

As with many aspects of doing business, there arealways trade-offs. At one extreme, CPI claims couldbe avoided by simply self-insuring. However, whileself-insurance guarantees a costly result at thelender's expense, CPI serves to minimize the lender'slosses in the event of borrower default. A logical mid-dle ground would be to establish and maintain a CPIprogram in a manner that minimizes the risks of CPIlawsuits, and in the event a CPI claim is filed, mini-mizes the risk of exposure.

ADDITIONAL CCASE EEXAMPLES

As indicated above, most CPI lawsuits settled. Somedid proceed through trial and appeal, frequently a sev-eral year process. The following are descriptions ofcases that have been reported.

In Acree v. General Motors Acceptance Corporation,92 Cal. App. 4th 385 (2001) plaintiffs brought a classaction against GMAC for alleged breach of contractand unfair business practices based on GMAC'smethod of calculating refunds on cancelled CPI. A juryfound that GMAC breached the implied covenant ofgood faith and fair dealing by using the acceleratedmethod to compute premium refunds upon CPI can-cellation. The class was awarded damages, attorneys'fees and costs. Under the sales agreement, GMACcould force place insurance if the borrower failed tomaintain automobile insurance. The sales agreementprovided that the borrower would be charged for theinsurance. However, the sales agreement was vagueand left the specific terms of the CPI policy to GMAC'sdiscretion, including the method under which anyrefund would be calculated. Given the silence in theparties' agreement, the court found that a borrowercould have legitimately expected that a pro ratamethod rather than an accelerated refund methodwould have been applied. Considering the evidence inthe case, the appellate court found no error in theunderlying decision.

In General Motors Acceptance Corporation v.Baymon, 732 So. 2d 262 (Miss. 1999), the MississippiSupreme Court found in favor of GMAC on plaintiff'sclaims that GMAC breached a fiduciary duty to its bor-rowers and that GMAC breached the implied covenantof good faith and fair dealing in connection withGMAC's placement of CPI. The court found thatGMAC's power to foreclose on a security interest didnot create a fiduciary relationship between GMAC andthe plaintiff and therefore, there was no breach of fidu-ciary duty. In addition, the court found that thecovenant of good faith and fair dealing does not pre-vent the parties to a contract from protecting them-selves or from asserting their rights. Because GMACtook only those actions authorized by the contract andthe act of placing CPI instead of repossessing the

5

vehicle actually benefited the borrower by allowing herthe continued use of the vehicle, GMAC did not breachthe implied covenant of good faith and fair dealing.

In Kenty v. Bank One, 92 F.3d 384 (6th Cir. 1996),plaintiffs brought a class action against Bank One, withwhich they had financed their car purchases, andTransamerica, the insurance company from whichBank One had purchased CPI, for alleged violations ofRICO, the National Bank Act, and the anti-tying provi-sions of the National Bank Holding Company Act. Thedistrict court granted the defendants' motions forsummary judgment and the plaintiffs appealed. TheSixth Circuit affirmed the decision in favor of thedefendants. Specifically, the court held that (1) theallegations in plaintiffs' complaint did not allege thepredicate act of mail fraud with sufficient particularityto state a civil claim under RICO; (2) Transamerica,which issued the insurance policies at the request ofBank One, was exempt pursuant to the McCarran-Ferguson Act on civil claims asserted by borrowersunder RICO; and, (3) Bank One's requirement that bor-rowers purchase casualty insurance on automobilessecuring car loans, as prerequisite to its grantingloans, did not violate anti-tying provisions of theNational Bank Holding Company Act.

Plaintiffs had alleged that Bank One purchased insur-ance coverage beyond coverage for theft and damagethat would affect the value of the collateral. Plaintiffsargued that this was not disclosed and not authorizedby the contracts. In addition, Bank One receivedrebates from Transamerica and these rebates were notcredited to the borrower. The Court held that the state-ments in the insurance notices were not sufficientlymisleading to form the basis of a fraud claim and thatany commission received by Bank One could properlybe included as part of the premiums and financecharges the plaintiffs were contractually obligated topay. The court specifically held that the borrower wasrequired to pay "premiums and finance charges" to thebank if the borrower did not maintain insurance. Thecourt held that the contract language was not limitedto the amount of money it cost the bank to buy theinsurance in question.

In Bermudez v. First of America Bank Champion, 860F. Supp. 580 (N.D. Ill. 1994), the court denied thedefendant's motion to dismiss a RICO action wherethe plaintiff alleged that the lender engaged in mailfraud by charging the plaintiff for CPI coverage thatwent beyond coverage for damage or loss to the vehi-cle. The court held that the contract authorizing thepurchase of insurance was ambiguous as to whetherthe lender could purchase coverage in excess of dam-age or loss coverage, therefore, the plaintiff sufficient-ly alleged a RICO claim. The opinion was subsequent-ly withdrawn by the court.

A common defense to RICO claims is that the claimsare preempted by application of the McCarran-Ferguson Act. This Act is designed to "assure that theactivities of insurance companies in dealing with theirpolicyholders would remain subject to state regula-tion." The Act further provides that "no Act ofCongress shall be construed to invalidate, impair, orsupersede any law enacted by any State for the pur-pose of regulating the business of insurance . . . unlesssuch Act specifically relates to the business of insur-ance." The United States Supreme Court addressed acircuit split on this issue in Humana, Inc. v. Forsyth,525 U.S. 299 (1999). The Court found that RICO wasnot a law related to the business of insurance. It thenheld that where federal law does not impair the state'sadministrative regime, the McCarran-Ferguson Actdoes not bar the federal cause of action. Specifically,the Court found that the RICO claim advanced thestate's interest in combating insurance fraud, wouldnot impair any law, and therefore, was not precludedby the McCarran-Ferguson Act. This case limits thepreclusion defense to those states whose regimeswould be impaired by allowing a RICO claim, such asstates that do not otherwise provide a private right ofaction for victims of insurance fraud. See e.g., In reManaged Care Litigation, 185 F. Supp. 2d 1310 (D. Fla.2002).

In Wells v. First American Bank West, 598 N.W.2d 834(N.D. 1999), a borrower argued that the lender pur-chased more insurance coverage than it was contrac-tually entitled to purchase. The defendants moved todismiss on the grounds that the statute of limitations

6

had run. The district court granted the motion but, onappeal, the court held that the borrower's claims mustbe analyzed in light of the discovery rule which pro-vides that the statute of limitations does not begin torun until the borrower knew, or should have known,about the additional coverage. The borrower claimedhe did not know about the additional "unauthorized"coverage until he watched a television show warningconsumers that extra insurance is often added wheninsurance is lender placed. The borrower argued thathe was never told of the additional insurance in the let-ters from his lender. Therefore, the appellate courtremanded the case for further proceedings to deter-mine when the borrower knew or should have knownof the extra coverage. The case settled on a nuisancevalue basis.

A LLEGISLATIVE SSOLUTION

In 1996, the National Association of InsuranceCommissioners adopted the Creditor-PlacedInsurance Model Act. Since then, a number of stateshave enacted laws or regulations implementing someor all of the Model Act. The Model Act addresses suchCPI issues as policy term and premiums, prohibitedcoverages, disclosures and notices, and commissions.While a complete summary of the Model Act is beyondthe scope of this article, a few key points merit specialattention. Section 5 of the Model Act provides in partthat the coverage may not exceed the amount of thenet debt. Section 6 prohibits several types of cover-ages, including repossession, skip, and conversion,and deductibles of less than $250. Section 14 con-tains several disclosure and notice requirements.

Many states such as Arkansas, California, Illinois,Michigan, Mississippi, Missouri, Tennessee, Texas,New Jersey, New York, Oregon, Washington and WestVirginia have either adopted the Model Act or enactedsimilar legislation or regulations. Similar legislationhas been introduced in Hawaii and Pennsylvania.Lenders in these states should exercise special care toensure that their CPI programs comply with the rele-vant statutory scheme. While compliance with statu-tory requirements does not prevent litigation in all

cases, evidence of compliance should be a significantbenefit to the lender. Of course, non-compliance rais-es the potential for increased liability. Lenders withCPI programs outside of these states should look tothe Model Act for guidance, as many states haveunfair business practices laws which plaintiffs haverepeatedly invoked for CPI litigation

SOME CCONCLUSIONS: HHOW LLENDERS CCAN HHELPAVOID CCLAIMS

There are several things every lender should do beforeplacing insurance to protect collateral.

DISCLOSURE

The lender should make full, complete, clear and con-spicuous disclosures up-front of at least the following:

(1) the lender's option to purchase CPI in the event theborrower fails to maintain coverage;

(2) the scope of coverage provided by CPI (exactlywho and what CPI protects and who and what it doesnot protect);

(3) the fact that the borrower has the right to choosethe insurer, subject to the lender's approval, but that inthe event CPI is necessary, the borrower will be sub-ject to the lender's choice of insurers, until such timeas the borrower secures acceptable replacement cov-erage;

(4) exactly what conduct by the borrower will result inCPI placement;

(5) the lender's rights under the CPI program;

(6) the lender's intention to charge interest on the costof CPI that is added to the loan balance, and how thatinterest will increase the loan balance;

(7) whether the lender or an affiliate will receive com-mission;

7

(8) all administrative fees that the lender intends tocharge to the borrower for the placement of the insur-ance;

(9) the premium rate the borrower can expect to payfor the coverage; and

(10) that CPI will be placed and charged for effectiveon the date the prior coverage lapses or is deemedunacceptable within the requirements of the loan doc-uments.

While no one can ever guarantee that a lawsuit willnever be filed, full and up-front disclosures will lessenthe likelihood of litigation and narrow the issues anddamages should litigation arise.

APPROVAL BBY AAPPROPRIATE SSTATE AAGENCY;LICENSING

The insurer's entire CPI program (all applicable policyforms, etc.) should be approved as an insurance prod-uct in each state in which it is going to be sold. Theinsurer should be properly licensed, and if commis-sions are going to be paid, the recipient must be prop-erly licensed as an insurance agent.

ARBITRATION CCLAUSES

Arbitration has long been analyzed in the financialinstitution arena and is beyond the scope of this arti-cle. However, lenders should continue to considerincluding arbitration clauses in their loan agreements,requiring borrowers to submit their disputes to bindingarbitration. CPI litigation, especially class actions, canbe very costly and can result in negative publicity. Incontrast, arbitration is usually faster and less expen-sive than litigation, leaving a greater opportunity forpreserving customer relations.

In conclusion, there is no way to guarantee that all liti-gation will be avoided. However, lenders can minimizetheir risks of litigation. By implementing protectivemeasures, a lender can decrease its exposure and thelikelihood that it will be the target of a CPI lawsuit.Installing safeguards now, even if not previously inplace, can help lenders minimize future exposure bydecreasing the potential class size in a class action.

For further information, please contact:

Robert LL. WWallan10250 Constellation Blvd., 21st Floor

Los Angeles, CA 90067-6221(310) 203-1163

robert.wallan@pillsburylaw.com

This publication is issued periodically to keep Pillsbury Winthrop Shaw Pittman LLP clients and otherinterested parties informed of current legal developments that may affect or otherwise be of interestto them. The comments contained herein do not constitute legal opinion and should not be regardedas a substitute for legal advice. © 2005 Pillsbury Winthrop Shaw Pittman LLP. All Rights Reserved.

8