by Christopher Graham and Joseph Kelly

George Herbert Walker Bush. James Baker. John Major. Frank Carlucci. These are a few of the political figures reportedly associated with the global private equity firm known as the Carlyle Group.

Carlyle even has been in the movies. Michael Moore’s Fahrenheit 9/11 claimed that Carlyle was in essence one of the United States’ largest defense contractors, while also having an association with the Bush family and taking investments from Bin Laden family.

Today’s post isn’t movie worthy. But it’s at least blog worthy.

Back in 2006, the Carlyle Group, like other private equity companies, set up a company to invest in residential mortgage-backed securities. It seemed like a good idea at the time, right?

The shares of the company, known as Carlyle Capital Corp., were sold in private placements and then in public offerings and public trading. But, as you know—unless you’ve been living under a rock—the market for those investments collapsed in 2008. Carlyle Capital then bit the dust. And its investors, shareholders, and liquidator sued various “Carlyle” limited liability companies involved with Carlyle Capital, including one working under an investment management contract.

The LLCs naturally had professional liability insurance, including primary coverage and multiple tiers of excess coverage.

The LLCs bargained for a broad definition of Professional Services Claim and Professional Services so they’d have the broadest professional liability insurance coverage.

Professional Services included “the giving of financial, economic or investment advice regarding [a wide-range of] investments . . . ,” “the rendering or failure to render investment management services . . . ,” “the organization or formation of, the purchase or sale or offer or solicitation or for purchase or sale of any interest(s) in, the calling of committed capital to, a Fund or prospective Fund,” and “the providing of advisory, consulting, management, financial or legal advice or other services for, or the rendering of any advice to, or with respect to an Organization or Fund . . . or a Portfolio Entity . . . .”

But Carlyle’s professional liability insurers didn’t want anything to do with Carlyle Capital. Maybe they saw the train wreck coming? Maybe they didn’t? But for whatever reason, Carlyle Capital wasn’t an Insured under the professional liability policy for the Carlyle LLCs. And the LLCs’ policy also provided that “the Insurer shall not be liable to make any payment for Loss in connection with any Professional Services Claim arising from Professional Services provided to the Carlyle Capital Corp.” The exclusion thus incorporated the policy’s broad Professional Services Claim and Professional Services definitions so the Carlyle Capital exclusion was correspondingly broad.

The policy wasn’t a duty-to-defend policy. But Defense Costs were included in the Loss definition. ‘ The Carlyle LLCs demanded that the insurers advance Defense Costs for the suits relating to Carlyle Capital. The insurers said, “No.” So the LLCs sued. The insurers moved to dismiss. Who wins?

“The insurers,” said the court in Carlyle Investment Mgmt. LLC, et al v. ACE American Ins. Co., et al, Case No. 2013 CA 00319 B (D.C. Sup. Ct. May 15, 2014. The insurers had no duty to advance the Carlyle LLCs’ Defense Costs given that the Professional Services exclusion targeted Claims involving Professional Services provided to Carlyle Capital.

As the court stated, the District of Columbia’s “eight corners rule”—requiring comparison of the 4-corners of the underlying complaint to the 4-corners of the insurance contract—controls whether the insurers must advance Defense Costs, just as it controls when the policy includes a duty-to-defend. Applying that rule, the court explained:

Each claim in each complaint arises from the provision of Professional Services to [Carlyle Capital], whether it relates to the alleged false marketing of the shares to private investors . . . , the alleged failure to make required disclosures to purchasers of publicly traded shares . . . , [one LLC’s] alleged mismanagement of [Carlyle Capital] under [a management contract] . . . , the alleged misrepresentation or failure to warn investors and failure to take appropriate actions to maintain adequate liquidity when the market was showing signs of collapse and [Carlyle Capital] was over-leveraged . . . , or the operation of [Carlyle Capital] with divided loyalties by acting as ‘de facto directors’ or ‘shadow directors,’ allegedly for the benefit of other Carlyle interests and to the detriment of [Carlyle Capital] and its outside shareholders . . . .

Further: “To the extent that these claims – or some of them – would be classified as ‘management-liability claims’ in the insurance industry generally or in some other insurance contract, in this contract they are Professional Services Claims arising from Professional Services provided to [Carlyle Capital].”

The LLCs argued that “the Exclusion is narrower than the coverage and was intended to exclude only claims arising from professional services in the nature of those provided by lawyers and accountants (‘E&O’ claims), not ‘management-liability claims,’ such as those alleging acts, errors, or omissions in corporate governance, often referred to as ‘directors and officers claims’ . . . .”

But as the court stated, “Whatever might be true in the insurance industry generally, in this insurance contract, ‘Loss in connection with any Professional Services Claim arising from Professional Services provided to Carlyle Capital Corp.’ was expressly excluded from coverage.”

Several officers and directors of the LLCs also were directors of Carlyle Capital, which reportedly had its own D&O policy. No word on how those D&O carriers fared—but we suspect not well.

Moral of the story: If Carlyle wanted the terms, Professional Services Claims and Professional Services, to have narrower meanings in the exclusions it should have asked for the policies to be written another way or tried other carriers. Some courts have deemed undefined terms to have broader meanings when used in coverage grants and narrower meanings when used in exclusions. But in Carlyle’s policy the terms in the coverage grant and exclusions not only were defined, but defined the same way. A policyholder doesn’t get to pick and choose when contractually defined terms apply to a particular claim—even if the policyholder is part of the Carlyle Group!

Tags: professional liability insurance, errors and omissions insurance, E&O, private equity, advancement, eight corners rule, contractually defined terms, professional services exclusion, District of Columbia, management liability