More than two years after the spectacular collapse of the giant Falls Church-based real estate empire known as EPIC, the answer may finally be at hand to a pivotal question: Which victim will eat millions of dollars of losses?

Will it be the savings and loan associations that bought EPIC's securities in the expectation of receiving monthly interest payments -- only to have EPIC default on the payments?

Or will it be the insurance companies that promised to cover a big chunk of the losses in the event of a default, but who are now seeking to revoke this coverage on the grounds that they were defrauded by EPIC?

The S&Ls and insurance companies are pitted against each other in a bitter lawsuit that is scheduled to come to trial tomorrow in federal court in Alexandria after months of procedural maneuvering and information gathering.

Several area savings institutions that invested in EPIC securities or mortgages are involved in the litigation, including Dominion Federal Savings and Loan Association, Continental Federal Savings Bank and Virginia First Savings & Loan.

The trial has drawn interest in the mortgage finance industry because of the new details it could reveal about the inner workings of Equity Programs Investment Corp., or EPIC, the once-flourishing firm that arranged the purchase of more than 20,000 houses around the country before defaulting on $1.4 billion worth of mortgages and filing for bankruptcy.

Several former EPIC insiders -- who, as previously reported, are under investigation by a federal grand jury for their role in the collapse of EPIC and a related company, Community Savings and Loan Association of Bethesda -- are expected to decline to answer questions, citing Fifth Amendment guarantees against self-incrimination.

Perhaps most significantly, the trial also is raising broader questions about the protection that private mortgage insurance offers to investors in the huge global market for mortgages that has emerged over the past two decades.

Investors in billions of dollars of mortgage-backed securities have come to rely on mortgage insurance as a guarantee against losses if borrowers default on the underlying loans. That guarantee now is being called into question by the insurers' effort to cancel their EPIC coverage, according to some S&L officials.

"You have to question quite deeply: If they reneged once on an agreement, would they do it again?" asked one industry official who is not involved with the lawsuit but is familiar with it.

Some observers say that the very principles that hold together the vast secondary market of mortgages and mortgage-backed securities are at stake.

"Independent third-party investors evaluate risk on the basis that insurance contracts are enforceable no matter what" -- even fraud, said a top executive at one of the country's largest S&Ls. "If they couldn't presume that, they wouldn't participate in the market."

The four insurance companies say that's not the issue at all. As they see it, the main principle at stake is the fundamental insurance credo that you don't pay claims on policies that were fraudulently obtained.

EPIC officials, the insurers say in their lawsuits, misrepresented the true risk involved with insuring their mortgages.

"Most insurance companies are in the business to pay claims for default," said Richard Pace, president of Foremost Guaranty Corp. of Madison, Wis. "But if the information you were given was incorrect, then we don't feel an obligation {to pay} at that point."

EPIC was in the mass tax-shelter promotion business, setting up investment partnerships to purchase thousands of rental houses around the country.

An EPIC subsidiary made mortgage loans to finance these purchases, packaged the loans into securities for sale to S&Ls and various institutional investors, and passed on monthly mortgage payments to these investors.

EPIC also purchased private mortgage insurance to cover the top 25 percent of the loans in the event of default -- providing a measure of confidence to the investors.

The trouble was that the rents on the houses generally were inadequate to cover the interest payments, so EPIC made up the difference with cash infusions from its parent, Community.

When Community got into trouble during the Maryland S&L crisis of 1985, those infusions stopped; the EPIC partnership subsequently defaulted on its loans in one of the biggest real estate failures ever.

The trial starting this week actually involves only some of the players in the EPIC debacle. The three insurers that covered the vast majority of EPIC loans already have agreed to pay off their EPIC claims and are participating in a rehabilitation plan for the company's properties.

However, four other companies -- Foremost, Commonwealth Mortgage Assurance Co., United Guaranty Residential Insurance Co., and U.S. Mortgage Insurance Co. -- filed suit soon after EPIC missed payments on its mortgages, seeking to rescind their coverage and not pay EPIC claims.

Collectively, these companies insured about $200 million of the EPIC loans, according to court papers. If they lose the case, they could be liable for as much as 25 percent of the value of those loans -- or roughly $50 million.

The insurers are expected to argue that EPIC officials fraudulently induced them to insure the EPIC mortgages by providing inaccurate and misleading information about the risk involved.

In pretrial pleadings, the companies contended that EPIC Mortgage Co. provided faulty appraisals of the EPIC properties, substantially overstating their worth; submitted misleading financial statements about the health of the EPIC operation; and generally misrepresented the safety of the whole enterprise.

"We underwrite loans based on the papers presented to us. We have little choice but to trust the person who presented those papers," said James Miller, president of Commonwealth. "We brought suit because we believed that the {EPIC} insurance was obtained by misrepresentation."

Lawyers for 34 institutional investors that bought EPIC mortgages and mortgage-backed securities are expected to counter the insurers by arguing that the insurance companies can scarcely charge fraud because they didn't conduct a diligent investigation of EPIC before deciding to insure -- even to the point of not reading EPIC's own disclosure statements.

In pretrial depositions, for instance, Commonwealth's president, Miller, said that before insuring the EPIC mortgages, Commonwealth took no steps to verify or follow up on verbal representations made by EPIC representatives, according to court papers.

The insurance companies "did not appeciate or understand the risks ... only because their underwriters failed to read disclosure documents in their possession that described the very risks they now claim they were deceived about," the lawyers for the investors said.