By Joseph P. Kelly and Shelly Hall

Scenario: An oil-and-gas company and its directors and officers (D&O’s) are charged by the SEC with securities law violations. The Company has a $1 million private-company D&O policy with entity coverage. Defense expenses are paid to the D&O’s first under a priority of payments provision. The Court froze Company’s assets and placed them in receivership.

While the SEC and Receiver, on one hand, and the D&O’s, on the other, fought about whether the directors and officers could tap into the policy for their defense, insurer paid out nearly the full $1 million limit as some of the directors and officers submitted defense expense bills. Then a different D&O submits two years of unpaid defense expenses, saying that he was not aware of the D&O policy. SEC and Receiver want to halt the distribution of the remaining policy proceeds. D&O’s want the remaining limit paid out to fund their defense.

Who gets the proceeds? If it’s the D&O’s, who gets what?

Answer: The D&Os submitting defense expenses got the proceeds in Securities and Exchange Commission v. Faulkner, Civil Action No. 3:16-cv-1735-D, United States District Court, N.D. Texas, Dallas Division, June 6, 2018.

Why?:

The harm of not receiving the D&O policy funds balanced in favor of D&Os and it was not in the court’s jurisdiction to redistribute those funds after the fact.

• The actual harm to the D&Os by not allowing them to access the limits was greater than the theoretical harm to the SEC.

The Court balanced “the potential harm facing the defendants moving for defense costs with the harm to the receivership estate if such funds are released”, looked to harms that are “clear and immediate rather than hypothetical or speculative”, and “examine[d] the contractual terms of the policy to ensure that the defendant retains contractual rights to the contested proceeds.”

The D&Os argued that the “real harms” they faced—e.g. a costly defense—were greater than the concerns of the SEC and the Receiver. In support, the D&O’s cited their reliance on the existence and payment from the $1M D&O Policy and that fact that they had incurred so much in defense costs. The court sided with the D&O’s noting that that the Receiver’s and SEC’s claims to the proceeds are speculative at this time; that the Receiver cannot negate the insureds’ contractual rights to coverage under the D&O Policy; that the insurance proceeds were not obtained through fraud; and that depriving the insureds of insurance proceeds would have a chilling effect upon the ability of companies to retain officers to serve in their companies.

• Redistribution was not in the court’s jurisdiction

The late-coming D&O also wanted the “court to resolve, not whether, but how D&O policy proceeds should be distributed.” However, the Court found that the allocation of the proceeds was not “sufficiently related to a securities-law violation or other claim” to trigger the court’s powers. The Court noted too that the late coming director failed to cite to any case where a court “reallocated D&O policy proceeds that were otherwise allocated in accordance with that policy’s terms.”

Takeaways:

• Is there policy language that could be drafted to ensure all individual D&Os get policy proceeds in equal share?

The insurer here paid out the bulk of the limits in defense expenses to three D&Os. After the late-coming D&O sought his fees, the Insurer paid out the remaining limits in equal shares. The priority of payments provision in the policy didn’t address whether multiple insureds share equally in the defense. The late coming D&O wanted an equitable reallocation of those amounts paid so that he got an equal share. The Court avoided the issue on jurisdiction grounds and we don’t have enough facts and backstory to say whether the late-coming director’s reallocation argument had merit. Perhaps an amendment to the priority of payments provision would be marketable and allow D&O insurers to distinguish themselves in a commoditized D&O market.

• Will this case be the one that encourages private companies to purchase D&O insurance, or higher limits?

From an underwriting perspective, this case could be cited to as a reason sell a private company on higher limits, even without any change to the priority of payments language. Defense outside limits is something that could have helped the directors and officers in this case, but that would obviously drastically increase the exposure for the insurer and the policy cost to the insured, if offered at all by underwriting. For D&Os, be sure there is a D&O policy in place if you are serving at any company, even if a private company, and, if there is a claim, report it and also report defense costs as they are incurred to avoid being left bare like the late submitting D&O here.

by: Chris Graham and Shelly Hall

Summary: Today’s post focuses on a recent Seventh Circuit decision, BancorpSouth v. Federal Insurance Co., No. 17-1425 (7th Cir. Oct. 12, 2017), affirming dismissal, for failure to state a legally viable claim, of a bank’s complaint against an insurer for alleged breach of a duty to defend and pay for a $24 million settlement of a consumer class action alleging improper overdraft fees, and related “bad faith.” It involved a duty-to-defend policy and a broad “fee” exclusion and, although other policies provide otherwise, this one had no exception for Defense Expenses. At the end of this post, we discuss other cases involving similar issues, but with different policy wording and, in some cases, different results. If you’re a broker or a risk manager, this case and those discussed at the end show why you should insist on a Defense Costs exception to a fee exclusion.

The coverage suit: In BancorpSouth, a bank sued an insurer for breaching a contract by failing to defend a class action and pay for a related $24 million settlement and for bad faith. Citing the policy’s exclusion “for Loss on account of any Claim … arising from … any fees or charges,” the Southern District of Indiana, applying Mississippi law, dismissed the bank’s complaint for failure to state a legally viable claim. Given the allegations in the complaint, the Court concluded that the insurer had no duty to defend. Because the duty to defend is broader than the duty to indemnify, moreover, the insurer had no obligation for the settlement; nor was there bad faith. The Seventh Circuit affirmed.

Policy wording: Subject to the policy’s terms, the insurer agreed to “pay, on behalf of an Insured, Loss on account of any Claim first made against such Insured during the Policy Period…for a Wrongful Act committed by an Insured or any person for whose acts the Insured is legally liable while performing Professional Services, including failure to perform Professional Services.” The duty-to-defend policy included a “fee” exclusion providing that the insurer “shall not be liable for Loss on account of any Claim…based upon, arising from, or in consequence of any fees or charges.” “Loss” included “Defenses Costs” and settlement costs. But the fee exclusion had no Defense Costs exception.

Class Action Complaint: The bank customer’s “opening allegation stated: ‘This is a civil action seeking monetary damages, restitution and declaratory relief from [the bank] arising from its unfair and unconscionable assessment and collection of excessive overdraft fees.’” The complaint alleged that the bank “maximized the amount of overdraft fees it could charge customers through a variety of means, policies, and procedures” including by “reorder[ing] debts from highest to lowest, instead of chronologically,” “fail[ing] to provide accurate balance information, and purposefully delay[ing] posting transactions,” “fail[ing] to notify customers of overdrafts, despite having the capability to ascertain at the point of sale whether there were sufficient funds in a customer’s account,” and “fail[ing] to make their customers aware that they can opt out of [the bank’s] overdraft policy upon request.” The customer asserted counts for breach of contract, unconscionability, conversion, unjust enrichment, and violation of the Arkansas Deceptive Trade Practices Act. He also sought to represent a class of “[a]ll customers in the United States who … incurred an overdraft fee as a result of the bank’s practice of resequencing debit card transactions from highest to lowest.” As relief, the customer, for himself and the class, sought a declaration that the bank’s “overdraft fee policies and practices” were “wrongful, unfair, and unconscionable,” “[r]estitution of overdraft fees,”‘[d]isgorgement of ill-gotten gains,” ‘[a]ctual damages,” ‘[p]unitive and exemplary damages,” “[p]re-judgment interest,” “costs and disbursements,” and “other relief” as “just and proper.”

Duty to defend: As is typical and as was the case under Mississippi law, whether the insurer had a duty to defend “depend[ed] upon the comparison of the language contained in the policy with the allegations contained in the underlying action.” In this instance, it was about “compar[ing] … [the fee exclusion], which excludes from coverage any claim ‘based upon, arising from, or in consequence of any fees or charges,’ with the allegations in the [customer’s] Complaint.” That the complaint included allegations that didn’t mention overdraft fees didn’t matter. “[T]hese individual allegations cannot be read in a vacuum, and instead, must be read in the context of the entire complaint.” “Read in its entirety, the only harm alleged by the [customer’s] complaint is [the bank’s] maximization of excessive overdraft fees on its customers.”

As the Court explained further:

The very first paragraph of the … Complaint specifically states that the crux of the lawsuit centers on [the bank’s] “unfair and unconscionable assessment and collection of excessive overdraft fees.” Moreover, the complaint defines the class of plaintiffs as customers who “incurred an overdraft fee.” Finally, every claim for relief asserted is specifically premised on the imposition of overdraft fees. The bank argued that the insurer had a duty to defend inasmuch as, per the complaint, “policies and procedures caused the customers’ alleged injuries, and [excluded] overdraft fees were one type of damages suffered as a result.”

Rejecting that argument, the Court explained: “To be sure, language focusing on ‘overdraft policies and procedures’ appears in a number of places, but it is always connected with the wrongful collection or imposition of overdraft fees.” The bank also argued that the fee exclusion was ambiguous, inasmuch as it didn’t say whether the “fees” were “payable to or by” the bank. Rejecting that argument, the Court explained that the fee exclusion by its plain wording, broadly applied to a “Claim … arising from … any fees or charges,” whether paid by or to the bank. The Court also rejected the bank’s argument that reading the fee exclusion as including overdraft fees paid by customers to the bank would make the “coverage for ‘Defense Costs,’ defined in the policy to include attorneys’ fees, illusory.” The Court explained that the ‘exclusion has no effect on [the bank’s] recovery of any attorneys’ fees on account of claims that are based on something other than fees or charges, such as a claim based on the quality of services provided by [the bank].” The Court also stressed that an insurer’s “decision” to include a fee exclusion in a professional liability policy “serves a necessary purpose of avoiding ‘moral hazard.’” Without the exclusion, the insured “could freely create other customer fee schemes knowing that they would be readily reimbursed by” its insurer.

Comments: Here’s a summary of other recent cases addressing coverage for overdraft class actions and issues similar to those in BancorpSouth:

• Fidelity Bank v. Chartis Specialty Ins. Co., Civil Action No. 1:12-CV-4259-RWS (N.D. Ga. 2013), applying Georgia law, addressed a “fee-dispute” exclusion, applicable to “Loss in connection with any Claim made against any Insured . . . alleging, arising out of, based upon or attributable to, directly or indirectly, any dispute involving fees, commissions or other charges for any Professional Service rendered or required to be rendered by the Insured, or that portion of any settlement or award representing an amount equal to such fees, commissions or other compensations; provided, however, that this exclusion shall not apply to Defense Costs incurred in connection with a Claim alleging a Wrongful Act.” Given the “fee-dispute” exclusion’s Defense-Costs exception, the insurer funded the bank’s defense of the overdraft class action. But it refused to pay the settlement. The District Court granted the insurer a summary judgment, holding that the settlement was uninsurable because the payments amounted to restitution and in any event fell within the fee-dispute exclusion.

• U.S. Bank National Association v. Indian Harbor Insurance Company, Case No. 12-CV-3175 (PAM/JSM) (D. Minn. Dec. 16, 2014), applying Delaware law, addressed exceptions to primary and excess policies’ “Loss” definitions, for “[m]atters which are uninsurable under the law pursuant to which this Policy is construed” or “principal, interest, or other monies either paid, accrued, or due as the result of any loan, lease or extension of credit by [the bank]”; and an exclusion for “any payment for Loss in connection with any Claim made against [the bank] . . . brought about or contributed in fact by any . . . profit or remuneration gained by [the bank] to which [it] is not legally entitled . . . as determined by a final adjudication in the underlying action.” The bank settled the underlying overdraft class action for $55 million, and sought coverage for $30 million of that amount plus defense expenses, excess of a $25 million deductible. The District Court granted the bank a summary judgment, rejecting the insurers’ argument that the settlement was uninsurable as restitution. Without deciding whether restitution was insurable, the Court—citing the “final adjudication” wording in the policies’ ill-gotten gains exclusion—explained that the “policies unambiguously require that a final adjudication in the underlying action determine that a payment is restitution before the payment is barred from coverage as restitution.” See Kevin LaCroix’s December 22, 2014 D&O Diary blog post for a detailed discussion of this aspect of this somewhat controversial decision. When procuring the policies, US Bank’s broker and risk manager had no need to worry about a Defense Costs exception to a fee exclusion; there was no exclusion.

• First Community Bancshares v. St. Paul Mercury Ins. Co., 593 F. App’x 286, 288 (5th Cir. 2014) involved a fee-dispute exclusion for a claim “based upon, arising out of or attributable to any dispute involving fees or charges,” with no Defense Costs exception, but with duty-to-defend wording. The Fifth Circuit, applying Texas law, affirmed a summary judgment for the bank and against the insurer holding that the insurer had a duty to defend. “Construing the [underlying class action] petitions liberally … at least some of the allegations … are not excluded by the fee-dispute exclusion.” Some of the allegations—“regarding [the bank] providing misleading information on its account practices and customers’ account balances–… do not have a causal connection to a disagreement that necessarily includes fees ….” As the Seventh Circuit in BancorpSouth stated: “Crucial to the … [First Community] holding … was [the Fifth Circuit’s] finding that the primary harm was not the assessment and collection of fees, but rather ‘that “customers could not ascertain their account balances and could not accurately plan spending, withdrawals, and deposits.’” In contrast, the BancorpSouth underlying class-action complaint showed that “excessive overdraft fees were the central and only harm”; so there was no duty to defend or pay the settlement. Although the insurer in First Community was required to defend notwithstanding a fee-dispute exclusion with no Defense-Costs exception, it was only because plaintiff’s complaint fortuitously included some allegations falling outside of that exclusion and the bank benefited from pro-policyholder rules for determining an insurer’s obligations under a duty-to-defend policy. The bank in BancorpSouth had no such luck.

• PNC Financial Services. Group, Inc. v. Houston Casualty Co., 647 F. App’x 112, 120 (3d Cir. 2016) (not precedential) involved policies insuring “Loss,” meaning “Claim Expenses” and “Damages”—defined as “a judgment, award, surcharge, or settlement … and any award of pre- and post- judgment interest, attorneys’ fees and costs,” but with an exception for “fees, commissions or charges for Professional Services paid or payable to an Insured” (the “Professional Services Charge Exception”). “Claim Expenses” (defense costs) for a fee suit, thus, weren’t subject to the Loss definition’s Professional Services Charge Exception or to any fee exclusion; so the insurer here would have been required to pay Claim Expenses exceeding a $25 million self-insured retention. The Third Circuit, applying Pennsylvania law, held that the $102 million paid by the bank to settle the underlying overdraft charge class actions (including $30 million for class counsel fees) fell within the Professional Services Charge Exception; defense expenses presumably fell within the $25 million self-insured retention. As the Seventh Circuit in BancorpSouth explained, the insurer in the PNC case had no duty to indemnify the insured where “the class was defined as those who incurred an overdraft fee” and “settlement payments were based on the number of overdraft fees incurred.” As in BancorpSouth: “The essence of [the bank customer’s] Complaint [in PNC was] clearly [the bank’s] maximization of overdraft fees. Since there’s no other was to construe the … Complaint, [the insurer in PNC] had no duty to defend the overdraft fee claims because they are excluded from coverage.” So too in BancorpSouth.

The plaintiffs’ bar has targeted banks and others with class actions alleging they improperly charged fees to consumers. Many suits involved multiples of millions in alleged harm and resulted in multi-million dollar settlements. Defense costs also ran into multiples of millions. In 2010, new Federal rules provided consumers a chance to avoid overdraft fees on certain debit card transactions and ATM withdrawals. But, as a simple Google search will show, that didn’t end the overdraft fee class actions. Earlier this year the Consumer Protection Financial Bureau adopted a rule barring banks, credit-card companies, and financial service firms from requiring consumers to agree to arbitration clauses and class-action waivers. But the Trump administration just struck that rule. So presumably we’ll see fewer consumer class actions involving improper fee charges.

Bottom line: But if you’re a broker or risk manager, why not make sure the policy you’re buying at least has Defense Costs coverage for these types of cases.

by: Chris Graham and Shelly Hall

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The issue: Today’s post is about a recurring issue for claims-made liability insurers and their policyholders: whether a claim arises out of the same or related “Wrongful Acts” as alleged in an earlier claim. If you’re the underwriter, you won’t want to insure a claim that that arises out of the same or related Wrongful Acts as alleged in an earlier claim; or, if you wrote the risk when the earlier claim was made, you’ll at least want to make sure the earlier and new claims are treated as a single claim so that only one limit of liability applies. If you’re a policyholder, you’ll obviously want as broad of coverage as is available. The “relatedness” issue has been litgated frequently. And the litigation outcome will depend on the contract wording and the facts alleged in the underlying claims. Today’s post is about a recent case involving an “interrelated wrongful acts” definition—including pro-insurer “common nexus” wording—that meant that the policyholder would lose.

A Big Easy shoot-out, a City surveillance system, and alleged bid rigging and kick-backs: New Orleans; 2003. There’s a shoot-out. Surveillance cameras capture it. Police as a result nab the bad guys. Great thing! Let’s do it City-wide, says the Mayor. Let’s invite bids. And then the “fun” begins. There are at least three companies involved; we’ll call them “A,” “B,” and “C.” There also are City employees who, depending on who you believe, allegedly steer the work to A, B, or both in exchange for subcontracts and other “favors.” A thinks B is colluding with City employees to cut it out of the City work. C thinks A and B are doing the same thing to it.

A’s 2007 lawsuit against B: In 2007, A sues B, the City employees, and their companies. A alleges that it collaborated with the City to develop a surveillance system; the City and A signed a contract in July 2004; the City promised to keep A’s “technology” confidential; City employees told A that A needed to hire them as subcontractors, but A refused; the Mayor’s Office of Technology then contracted technology work to B; and then B and City employees stopped authorization of A’s work and failed to order and authorize payment for cameras, shared A’s confidential information, and conspired to manufacture a copy of A’s system, sell it to Monster Company, and illegally sell it throughout the State. A and B eventually settle.

B’s 2009 claims-made policy: Fast-forward to 2009. B purchases a Digital and Technology Professional Liability Policy, effective July 1, 2009 to July 1, 2010. Subject to its terms, the policy covers certain claims made during the policy period. As is typical for claims-made policies, this policy carves-out coverage for claims—associated with the circumstances of past claims, such as A’s 2007 lawsuit against B. Thus, “[a]ll claims arising out of the same wrongful act and all interrelated wrongful acts of the insureds shall be deemed to be one claim, and such claim shall be deemed to be first made on the date the earliest of such claims is first made, regardless of whether such date is before or during the policy period.” “[I]nterrelated wrongful acts” means “all wrongful acts that have as a common nexus any fact, circumstance, situation, event, transaction, cause or series of related facts, circumstances, situations, events, transactions or causes.” So what happens next?

C’s 2009 lawsuit against B: C sues B, A, and City employees and their companies, about the same surveillance system at issue in A’s 2007 suit against B. C alleges that it co-developed the system; City employees steered the City contract to A; A in exchange agreed that City employees would assume C’s role in the project and be involved in system sales outside the City; City employees also steered City technology work to B; B in exchange steered its subcontract work to City-employees; and B and those City employees misappropriated C’s confidential information.

The coverage litigation: B tendered the defense of C’s 2009 lawsuit to its claims-made insurer, which refused to defend. B then sued for a declaration of coverage. So who wins?

The decision: In a decision involving a scenario along the lines described above, a Colorado Federal Judge said that the insurer wins. Ciber, Inc. v. ACE American Insurance Company, Civil Action No. 16-cv-1189-WJM-NYW, Dist. Court, D. Colorado, July 9, 2017. According to the Court:

Based on the broad definition of “interrelated wrongful acts” …, as well as the substantially similar factual web surrounding the [2007] and [2009 lawsuits], the Court is persuaded by ACE’s contention that the two proceedings involve a “single scheme”—namely, [(B’s)] alleged participation in a conspiracy to use city employee-run entities as subcontractors to circumvent the July 2004 Contract and misappropriate the surveillance camera project.

In the Court’s view, the allegations in the [2007] and [2009 lawsuits] both arose out of a “single scheme” directed at the developer of the wireless surveillance system (whether [A] alone or in partnership with [C], involving a single contract (the July 2004 Contract), implicating the same transaction or series of transactions involving the surveillance camera project, and seeking a single outcome (to cut out the originators of that system from current and future business dealings). This “single scheme” provides the Court with a sufficient basis upon which to conclude that the [2007] and [2009 lawsuits] share (or are connected and linked by) a common “series of related facts, circumstances, situations, events, transactions or causes.”

The 2009 lawsuit, thus, would be treated as a single claim with the 2007 lawsuit and deemed made in 2007, before inception of the July 1, 2009-2010 policy period; so there’s no coverage.

B argued that “the dictionary’s primary definition [of nexus] is ‘a causal link’ [and] courts construe this causation requirement to include both but-for cause and proximate cause”; “[s]everal courts have followed [this causation] approach in denying insurance carriers’ attempts to limit coverage under interrelated wrongful act provisions”; and that “[b]ecause there is no causal link between all claims in the [2007 lawsuit] and those in the [2009 lawsuit], there is a possibility of coverage, leaving ACE with a duty to defend.”

But according to the Court: “Looking at the plain language of the term ‘interrelated wrongful acts’ and its definition under the Policy…there is no basis to conclude that this Policy term incorporates a causal relationship or ‘but-for’ test.” The Court, thus, would “only examine the record to determine whether there is a ‘connection’ or ‘link’ between the facts or occurrences underlying the alleged ‘wrongful acts’ present in the [2007 and 2009 lawsuits].”

In reaching its decision, the Court distinguished the policyholder’s “causation” cases as based on different related wrongful cats wording. It also cited ACE Am. Ins. Co. v. Ascend One Corp., 570 F. Supp. 2d 789, 798 (D. Md. 2008), KB Home v. St. Paul Mercury Ins. Co., 621 F. Supp. 2d 1271, 1277 (S.D. Fla. 2008), Nat’l Title Agency, LLC v. United Nat’l Ins. Co., 2016 WL 1092485, at *3 (D. Utah Mar. 21, 2016), and Old Bridge Mun. Utilities Auth. v. Westchester Fire Ins. Co., 2016 WL 4083220, at *4–5 (D.N.J. July 29, 2016), which rejected a “but-for” test for “nearly identical definitions of the term ‘interrelated wrongful acts.’”

Comments: Compared to this ACE policy, there are narrower “interrelated” or “related wrongful acts” definitions in certain claims-made policies including definitions requiring a causal connection, including the policy at issue in one of the cases cited by ACE’s policyholder. One claims-made community association D&O policy provides, for example, that “’Related Wrongful Acts’ shall mean Wrongful Acts which are causally connected by reason of any common fact, circumstance, situation, transaction, casualty, event or decision.” Given the “interrelated wrongful acts” definition in the ACE policy, ACE didn’t have to show a causal connection between facts or occurrences underlying the wrongful acts alleged in the 2009 suit and those alleged in the 2007 suit. Plaintiffs in the 2007 and 2009 suits differed, but both suits alleged the same scheme involving the policyholder’s supposed “kick-backs” to City employees in exchange for allegedly steering it City work. This is the kind of scenario the “interrelated wrongful acts” wording was aimed at

by Christopher Graham and Joseph Kelly

Today’s post is our second about a case in Iowa, Progressive Casualty Ins. Co. v. FDIC, et al, Case No. C 12-4041-MWB (N.D. Iowa Jan. 23 2015). In our first post here, we addressed how the court found that the FDIC’s Claim as receiver fell outside of a D&O policy’s insured-versus-insured exclusion. Today’s post addresses an exception to the D&O policy’s Loss definition, for investment loss—which the court also concluded was inapplicable to the FDIC’s Claim. Hog heaven for the FDIC and bank directors and officers!

Here’s the scenario: Bank fails; FDIC is appointed receiver; it sues directors and officers for negligence and otherwise; they ask D&O insurer to pay for a defense; although the D&O policy has no regulatory exclusion, the insurer denies coverage based on insured-versus-insured exclusion; it also cites an investment loss carve-out in the policy’s Loss definition; it advances defense costs while reserving rights; coverage litigation follows.

What’s different about this failed bank case? (Allegations about investment decisions): Most failed bank cases have been about bad decisions relating to loans, many of which were real estate loans. But in this case, the FDIC’s Claim as the court described it was “based primarily on its allegations that the D&O Defendants caused Vantus Bank to use $65 million—120 percent of its core capital—to purchase fifteen high risk collateralized debt obligations backed by Trust Preferred Securities (CDO-TruPS) without due diligence and in disregard and ignorance of regulatory guidance about the risks of and limits on purchase of securities, resulting in losses of some $58 million.”

What else is different? (An investment loss carve-out): Given the FDIC’s focus on damages resulting from investing in Trust Preferred Securities, a central issue in the coverage litigation between the FDIC and directors and officers, on one hand, and the D&O insurer, on the other, was the effect of a part of the D&O policy’s Loss definition, providing that “Loss shall not include: . . . (6) the depreciation (or failure to appreciate) in value of any investment product, including securities, commodities, currencies, options or futures due to market fluctuation unrelated to any Wrongful Act.”

The D&O insurer’s main argument: The D&O insurer cited the investment loss carve-out as an additional ground—besides the insured-versus-insured exclusion—for why the D&O policy supposedly didn’t cover the FDIC’s Claim. As stated in the court’s decision, the D&O insurer argued “that the investment loss that FDIC-R seeks to recover is precisely the result of depreciation in the value of the securities and that depreciation was undeniably caused by market fluctuation, not by the alleged Wrongful Acts of the D&O Defendants.” Under the D&O insurer’s reading of the investment loss carve-out, “Loss does not include ‘depreciation . . . in value of any investment product,’ where depreciation is ‘due to market fluctuation,’ and that ‘market fluctuation’ is ‘unrelated to any Wrongful Act’”—meaning the Wrongful Act had no “causal effect on the ‘market fluctuation,’” as supposedly was the case in this instance.

The Decision: “As a matter of law, the ‘investment loss carve-out’ does not bar coverage for the D&O Defendants for the FDIC-R’s claims,” said the court. The court rejected the D&O insurer’s argument that the phrase “unrelated to any Wrongful Act” modifies the phrase “market fluctuation” and that “market fluctuation” “unrelated to any Wrongful Act’” means a Wrongful Act having no “causal effect” on the “market fluctuation.”

According to the court, the phrase “unrelated to any Wrongful Act” instead could be read—as FDIC and directors and officers argued—to modify the phrase “depreciation (or failure to appreciate) in value of any investment product”—rather than “market fluctuation”; so “depreciation in value” rather than “market fluctuation” would have to be “unrelated to” a Wrongful Act.

Given that there’s more than one reasonable way to read the investment loss carve-out, there’s an ambiguity and, in those circumstances, the reading favorable to the insureds controls.

As the court also explained:

Yet, even if “unrelated to any Wrongful Act” unambiguously modifies “market fluctuation,” the appropriate construction still requires coverage for the FDIC-R’s claims against the D&O Defendants, in light of the interpretation of “unrelated to” as unambiguously meaning “having no connection to.” The FDIC-R’s allegations, if proved, would establish some “connection” between the Wrongful Acts and the “market fluctuation” in the value of the securities at issue, even if the Wrongful Acts did not directly cause the “market fluctuation”—for example, by artificially manipulating the value of the securities for a time or actually causing the crash in the value of the securities. Again, it is the interrelationship or interplay of the alleged Wrongful Acts and the “market fluctuation” that ultimately caused the damage to the Bank, where the alleged Wrongful Acts were purchasing and holding the securities in question, or too many of those securities, which were subject to such “market fluctuation.”

Comments: If there’s more than one reasonable way to read policy wording, it’s not unusual for the policyholder’s reading to control. The “rule” that ambiguous policy wording gets construed against the insurer is an application of the broader rule applicable to contracts generally that ambiguous wording gets construed against the drafter. If the policy was a negotiated contract, perhaps a manuscript policy, with sophisticated parties on both sides, then the rule that wording gets construed against the insurer may not apply. In some instances, where there’s ambiguity, extrinsic evidence may be considered to attempt to resolve an ambiguity. All of these issues are matters of state law.

As this court pointed out, there was a “dearth” of case law on the investment loss carve-out. We couldn’t find any case about it, other than this one.

What has been more typical in bank D&O policies has been unpaid loan carve outs in loss definitions, which may apply, for example, to “any unrepaid, unrecoverable or outstanding loan, lease or extension of any credit to any Affiliated Person or Borrower.”

And there’s been a bit of litigation about those during the recent wave of failed bank litigation. See, for example, discussion here in Kevin La Croix’s D&O Diary.

Tags: Iowa, directors and officers liability insurance, D&O insurance, insured-versus-insured exclusion, IVI exclusion, derivative suit exception, insured versus insured exclusion, FDIC, FDIC-R, failed bank, directors, officers , investment loss carve out, Loss, community banks, regulatory exclusion, collusion, Company defined, “on behalf of”

by Christopher Graham and Joseph Kelly

Introduction: A date-certain notice requirement refers to the absolute time limit found in claims-made policies for reporting claims—namely as soon as practicable, but in no event more than 30, 60 or 90 days or the like following the policy term. In Craft v. Philadelphia Ins. Co., Case No. 14SA43 (Feb. 17, 2015), a landmark decision that brought in heavy-weight friend-of-the court briefs from insurance trade associations, policyholder groups, and trial lawyers, the Colorado Supreme Court joined a number of other courts in refusing to extend the so-called notice prejudice rule to a date-certain notice requirement in a claims-made policy. Doing so, concluded the court, would change the fundamental nature of claims-made insurance.

Underlying suit: Dean owned a cement contracting business. He was its president. One day he sold 10% of his shares to Suburban, entering into a stock purchase and merger option agreement, warranting and representing that his company had certain water rights. But that allegedly was untrue. About two years after the sale, his company acquired his remaining shares. Dean was out. About a year later, Suburban sued Dean for breaching the purchase agreement, based on alleged misrepresentations about the company’s water rights. Later his company became a plaintiff and a fraud claim was added.

The D&O policy and notice: At the time of the suit, the company had a D&O policy, with a 1-year policy period, effective November 1, 2009-2010. As an express condition precedent to coverage, the policy required an insured to provide written notice to the D&O insurer “as soon as practicable” after becoming aware of a claim, but “not later than 60 days” after the policy period expired, so by December 30, 2010.

The company and Suburban purchased the D&O policy, but Dean didn’t know about it. So he defended himself against the claims by Suburban and the company.

In about March 2012, about 16 months after the D&O policy expired, Dean finally learned about the D&O policy and provided the D&O insurer notice of the suit, but received no response.

The coverage suit: Dean settled the suit by Suburban and the Company and then sued the D&O insurer for coverage. As a defense, the D&O insurer raised Dean’s failure to report the claim by the policy’s December 30, 2010 reporting deadline. Dean argued the D&O insurer couldn’t avoid coverage based on late notice absent proof that it was prejudiced by the delay. The D&O insurer argued that the notice-prejudice rule didn’t apply to a date-certain notice requirement in a claims-made policy.

The Federal District court granted the D&O insurer’s motion to dismiss Dean’s claims. Dean appealed. The Tenth Circuit then certified two questions to the Colorado Supreme Court: (1) whether the notice-prejudice rule applies to claims-made liability policies in general; and (2) if so, whether the rule applies to both types of notice requirements in those policies.

The case generated national interest from policyholders and insurers alike. There were friend-of-the-court briefs by the insurance industry including the American Insurance Association, Complex Insurance Claims Litigation Association, and Property Casualty Insurers Association of America; from trial lawyers, including The Colorado Trial Lawyers Association; and from a policyholder group, United Policyholders.

The Decision: The court reframed the Tenth Circuit’s certified questions, limiting the issue to whether the notice-prejudice rule applies to the date-certain notice requirement in a claims-made policy. It then answered that question as “no.”

Colorado, like many states, required that an insurer issuing an occurrence policy prove prejudice to avoid coverage based on late notice. In refusing to extend the notice-prejudice rule to claims-made policies, the court stressed the fundamental differences between occurrence and claims-made policies:

The conceptual differences between occurrence and claims-made liability policies lie at the core of this case. The Colorado Division of Insurance defines an occurrence policy as “an insurance policy that provides liability coverage only for injury or damage that occurs during the policy term, regardless of when the claim is actually made.” 3 Colo. Code Regs. 702-5:5-1-8 (2014). A claims-made policy, by contrast, is “an insurance policy that provides coverage only if a claim is made during the policy period or any applicable extended reporting period.” Id. Thus, occurrence policies and claims-made policies are almost the mirror image of each other: an occurrence policy provides coverage for events that happen during the policy period, even if the claim is brought many years in the future; a claims-made policy provides potential coverage for claims brought against the insured during the policy period, even if the underlying event giving rise to liability occurred many years in the past. See 1 Steven Plitt, Daniel Maldonado & Joshua D. Rogers, Couch on Insurance § 1:5, at 15-16 (3d ed. 2009 & Supp. 2014). With an occurrence policy, an occurrence entitles the insured to benefits under coverage that already exists, and timely notice is merely a condition of retaining that coverage. 3 Allan D. Windt, Insurance Claims and Disputes § 11:5 (6th ed. 2013). Claims-made policies, on the other hand, provide only potential coverage because timely notice of the claim to the insurer is a prerequisite to coverage under such policies. Id. In other words, coverage is triggered only if the insured provides timely notice of the claim.

This conceptual difference has important practical implications for the risks that insurers undertake and the premiums that insureds pay. Claims-made policies proliferated in the 1970s as a solution to the problems many insurers were facing in writing professional malpractice insurance policies. See Sol Kroll, The Professional Liability Policy “Claims Made”, 13 Forum 842, 849-50 (1978). In setting premiums for occurrence policies, underwriters had difficulty predicting decades into the future considerations such as inflationary trends, jury verdicts that outpaced inflation, and new theories of liability. Id. at 846, 848. Faced with increasing costs of doing business, the typical insurer either had to raise premiums, offer fewer products, or withdraw from the professional liability insurance market altogether. Id. at 847. With claims-made policies, however, the risk to the insurer passes when the policy period expires. Given this limitation, “a more predictable rate structure” could be assembled and justified for such policies, and, thus, rates bore a “more reasonable relationship to the current fiscal situation in a given state.” Id. at 848.

Both occurrence and claims-made policies generally require an insurer to provide some sort of prompt notice of a claim. The critical difference between the policies is the date-certain or absolute reporting deadline in claims-made policies. As the court explained:

Claims-made policies typically contain a second type of notice requirement not found in occurrence policies: the requirement that the insured provide notice of a claim within the policy period or a defined reporting period thereafter. See 13 Lee R. Russ & Thomas F. Segalla, Couch on Insurance § 186:13, at 32 (3d ed. 2005 & Supp. 2014). Such a date-certain notice requirement fulfills a very different function than a prompt notice requirement. Whereas a prompt notice requirement serves to allow the insurer to investigate the claim and negotiate with the third party asserting the claim, the date-certain notice requirement defines the “temporal boundaries of the policy’s basic coverage terms.” Id. In other words, timely notice of a claim is the event that triggers coverage. See 3 Allan D. Windt, Insurance Claims and Disputes § 11:5 (6th ed. 2013). For this reason, although excusing late notice and applying a prejudice requirement make sense in the context of a prompt notice requirement, extending such concepts to a date-certain notice requirement “would defeat the fundamental concept on which coverage is premised.” Id.

Tags: D&O, professional liability, errors and omissions, claims-made, notice, date-certain notice requirement, prejudice, occurrence, absolute reporting deadline, claims made and reported, Colorado

by Christopher Graham and Joseph Kelly

Today’s post is about a federal case in Iowa, Progressive Casualty Ins. Co. v. FDIC, et al, Case No. C 12-4041-MWB (N.D. Iowa Jan. 23 2015), which explains the happy hog pictured above. But you won’t hear any squeals of joy from the insurer about the decision in this case.

Here’s the scenario: D&O policy is issued without a regulatory exclusion; bank fails; FDIC is appointed receiver; it sues directors and officers for negligence and otherwise; they ask D&O insurer to pay for a defense; insurer denies coverage based on an insured-versus-insured exclusion, but advances defense costs while reserving rights; coverage litigation follows.

The decision: This Iowa court held that the insured-versus-insured exclusion did not apply to the FDIC’s Claim. It granted a summary judgment for the FDIC and directors and officers, finding that (1) the exclusion’s “on behalf of . . . the Company” wording is “unambiguous,” (2) the exclusion’s purpose—as shown by the wording—is to except collusive suits from coverage, (3) there was no evidence of collusion, (4) there’s no ambiguity merely because there are conflicting court decisions about what the exclusion means, and (5) with no ambiguity, there’s no need to consider “extrinsic” evidence. Those five points set this case apart from other recent cases addressing the exclusion, including some finding similar wording ambiguous.

The wording: The exclusion provided:

The Insurer shall not be liable to make any payment for Loss in connection with any Claim by, on behalf of, or at the behest of the Company, any affiliate of the Company or any Insured Person in any capacity except where such Claim is brought and maintained:

(1) in the form of a cross-claim or third-party claim for contribution or indemnity which is part of and results directly from a Claim which is not otherwise excluded by the terms of the Policy;

(2) by an Insured Person solely as a customer of the Company; provided such Claim is brought independently of, and totally without the solicitation, assistance, participation, or intervention of any other Insured; or

(3) by a security holder of the Company as a derivative action on behalf of the Company or such affiliate; provided such Claim is brought independently of, and totally without the solicitation, assistance, participation, or intervention of any Insured of any affiliate of the Company. (Emphasis added).

The court’s explanation: The court explained its decision against the insurer as follows:

(1) The FDIC’s Claim was not a Claim “by the Company”. Company as defined in the policy didn’t include a receiver. When the insurer addressed receivers or successors, moreover, it used explicit wording. As the court pointed out, the policy definition of “Financial Impairment” included “appointment of any state or federal official, regulatory agency or court of any receiver . . . .” The policy by express language also extended coverage to “legal representatives or assigns” of Insured Persons. “Thus, when the [bank’s] Policy intended to address coverage issues relating to ‘receivers’ and other successors to the Bank, it expressly identified such successors.”

(2) The FDIC’s Claim also was not by “any affiliate of the Company” and wasn’t by an Insured Person. The FDIC as receiver wasn’t an affiliate. Nor was the Claim by any Insured Person—obviously! The insurer didn’t argue otherwise on either point.

(3) The FDIC’s Claim was not “at the behest of the Company.” That phrase was undefined—so the dictionary definition—a “command, injunction or bidding”—controlled. “The insurer has not asserted as an undisputed fact any involvement of the Bank in commanding or bidding the FDIC-R to bring its claims against the [directors and officers],” said the court. It didn’t even argue the FDIC’s Claim was “at the behest of the Company.”

(4) The Claim was not “on behalf of . . . the Company. Without a policy definition, an Oxford dictionary definition controlled—defining “on behalf of” as, “On the part of [another], in the name of, as the agent or representative of, on account of, for, instead of (With the notion of official agency)” (brackets in original). The FDIC’s Claim, said the court, wasn’t “on behalf of . . . the Company . . . ,” as that phrase is commonly understood based on that standard definition. There also was “no basis to graft onto this interpretation of ‘on behalf of . . . the Company’ an action by a receiver or other successor.’” Indeed, “when the [bank’s] Policy intended to address coverage issues relating to ‘receivers’ and other successors to the Bank, it expressly identified such successors.”

(5) Policy wording demonstrated that “the intent of the ‘insured-versus-insured exclusion’ was to preclude collusive suits by and among the Company and Insured Persons, such as the [directors and officers], to recover for mismanagement.” “This intent is apparent from the interplay between the definition of Claim, inter alia, as a civil lawsuit against an Insured Person or against the Company’ and the ‘insured vs. insured exclusion,’ which bars coverage ‘by, on behalf of, or at the behest of’ the same entities.”

(6) The FDIC’s Claim was not “collusive”. “[I]t was brought . . . well after [the] Bank was closed” and under the FDIC’s “independent statutory authority”; and the insurer “identified no evidence to suggest or show beyond dispute that the [FDIC as receiver’s] lawsuit involved the solicitation, assistance, involvement, or participation of anyone from the Bank in bringing or maintaining the claims.”

(7) O’Melveny & Meyers v. FDIC, 512 U.S. 79 (1994), the insurer’s principal authority, was irrelevant. Like other insurers, this insurer argued that under O’Melveny, the FDIC as receiver “steps into the shoes” of a failed bank and, thus, its Claim is “on behalf of” the Company (the bank) and within the Insured-versus-insured exclusion. But, as the Iowa court explained:

a. O’Melveny didn’t address a D&O policy, let alone an insured-versus-insured exclusion, and wasn’t even an insurance case;

b. Equating “on behalf of” with “stepping into the shoes” as used in O’Melveny was a “hypertechnical,” rather than “reasonable viewpoint” as required under Iowa law; and

c. O’Melveny didn’t equate “steps into the shoes” with “on behalf of”, didn’t address what “on behalf of” means or even the word “behalf”, didn’t hold (as the insurer argued) that “the claims by the FDIC are necessarily claims of or that belonged to a failed bank”, didn’t address federal law providing that the FDIC succeeds not only to the rights of the failed institution, but to those “of any stockholder, member, accountholder, depositor, officer, or director of such institution with respect to the institution and the assets of the institution”, and didn’t consider whether federal law authorized a suit by the FDIC on its own behalf, rather than just by “stepping into the shoes” of a failed bank.

(8) There is no ambiguity merely because there are conflicting court decisions about what the exclusion means and, thus, there is no need to consider extrinsic evidence. This was the opposite of what the Eleventh Circuit concluded in St. Paul Mercury Ins. Co. v. FDIC, et al, Case No. 13-14228 (11th Cir. 2014), decided under Georgia law and involving the scenario of this Iowa case. The Georgia district court in St. Paul Mercury held, moreover, that virtually identical “on behalf of . . . the Company” wording unambiguously excluded coverage for the FDIC’s suit—the opposite of this Iowa federal court’s holding finding coverage; and it refused to consider extrinsic evidence or allow further discovery. The Eleventh Circuit found ambiguity and, therefore, reversed and returned the case to the Georgia district court for consideration of evidence that may resolve it. It also explained that “the most compelling argument” for ambiguity was “that the courts which have addressed similarly worded insured v. insured exclusions have reached different results.”

The Iowa court attributed the Eleventh Circuit’s decision to differences between Iowa and Georgia law about reading insurance policies and explained further: “While I acknowledge that different courts have reached different conclusions on whether or not the ‘insured vs. insured exclusion’ bars coverage for claims by the FDIC, I do not believe that the difference of opinion establishes ambiguity as to the meaning of the exclusion, even if it creates some uncertainty about the construction or legal effect of the exclusion.”

Other IvI arguments: The parties disputed whether the shareholder derivative exception to the IvI exclusion applied; in arguing for the exception, the FDIC stressed that its claims as receiver were at least in part on behalf of shareholders, as provided by statute.

The parties also disputed whether extrinsic evidence showed that the exclusion “was intended to bar claims such as the [FDIC as receiver] has brought against the D&O Defendants and whether extrinsic evidence can be considered at all”; “whether the ‘reasonable expectations’ of the D&O Defendants demonstrate that the ‘insured vs. insured exclusion’ does not apply and whether such ‘reasonable expectations’ are relevant”; and “whether the industry practice demonstrates that ‘regulatory exclusions,’ rather than ‘insured vs. insured exclusions,’ are used when the insurer intends to bar coverage for claims by the [FDIC as receiver] and whether any evidence concerning ‘regulatory exclusions’ is relevant, where [the bank’s] Policy contained no such exclusion.”

But the court didn’t address any of the above arguments as it was unnecessary given its holding.

“Investment loss carve-out”: The Iowa court also addressed an “investment loss carve-out” in the Loss definition, holding as a matter of law against the insurer and for the FDIC and directors and officers that the carve-out didn’t apply. We plan to cover this part of the court’s decision soon in a separate post.

What’s different about this case: The Iowa court’s decision about the exclusion is distinct from other recent cases in that it held the exclusion unambiguously inapplicable to FDIC claims as receiver.

While the Iowa court attributed the Eleventh Circuit’s different result in St. Paul Mercury to “differences” between Iowa and Georgia law for determining the meaning of policy wording, a close reading of the law cited in the opinions suggests those differences really were matters of form rather than substance. At least from the opinions, it doesn’t appear that the FDIC argued that the insured-versus-insured exclusion was unambiguous. Neither the Eleventh Circuit, nor Georgia district court opinions in St. Paul Mercury address the meaning of “on behalf of” in any way similar to the Iowa court. Whether the policy, outside of the exclusion, addressed receivers or successors explicitly like the policy in the Iowa case isn’t stated in the opinions.

In our prior blog post here, about W Holding Company, et al v. AIG Insurance Company – Puerto Rico, Case No. 12-2008 (1st Cir. Mar. 31, 2014), the directors and officers won the initial “IvI” exclusion round as the insurer by preliminary injunction was required to advance their defense fees, albeit without waiving the right to repayment. But the First Circuit didn’t decide whether the exclusion applied to FDIC’s claims, only that there was a “likelihood” of a “remote possibility of coverage”; that’s all that was required in considering a preliminary injunction motion. There apparently was no argument that the IvI exclusions was unambiguous and no need to make the argument.

In our prior blog posts here about Hawker v. Bancinsure, Case No. 1:12-cv-01261 (E.D. Ca. Apr. 7, 2014), and here about Bancinsure v. McCaffree, et al., Case No. 12-2110-KHV (D. Kan. Feb. 27, 2014), the insurer won an initial round that the IvI exclusion applied, but the exclusion explicitly referenced a Claim by a “receiver.” Ironically, that insurer, Bancinsure, now known as Red Rock Insurance Co., later entered into a receivership itself! With the “receiver” included in the IvI exclusion, the FDIC obviously couldn’t make the same kind of argument as in the Iowa case.

In St. Paul Mercury Insurance Co. v. Hahn, Case # SACV 13-0424 AG (RNBx) (October 8, 2014 C.D. Cal.), a California federal court addressed “by or on behalf of” wording in a scenario like the Iowa case and granted a summary judgment for the FDIC that the IvI exclusion was inapplicable. Like the Iowa court, the Hahn court found O’Melveny irrelevant. Unlike the Iowa court, the Hahn court held that the exclusion was ambiguous, rather than unambiguous. But, under California law, ambiguity meant that the policy must be construed against the D&O insurer. So the insurer still lost.

From the opinion in Hahn, it appears that the FDIC didn’t argue that the exclusion was unambiguous. Like the Eleventh Circuit, the Hahn court found the exclusion ambiguous at least in part because there were conflicting decisions about whether it applied to claims by the FDIC and similar receivers. As the Hahn court stated, “the question presented in this case has been litigated numerous times over many years across the country.” And, “There can be little doubt that repeated disputes over the IvI exclusion have placed insurers on notice that it is ambiguous” (Emphasis added).

After highlighting the FDIC’s statutory power as receiver to sue on behalf of a failed bank’s shareholders, the Hahn court also stated that it “was unconvinced that the Shareholder [Derivative] Exception [to the IvI exclusion] does not apply to FDIC-R’s [(as receiver)] claims.” It thus “construe[d] the IvI Exclusion to allow coverage for [those] claims . . . .” The Hahn court stated, “The Shareholder Exception ‘evidences an intent to place on insurer the risk for actions against the D&O’s based upon allegations of mismanagement, waste, fraud, or abuse of a failed institution’” (quoting FDIC v Bancinsure, No. CV 12-09882, 2014 U.S. Dist. LEXIS, at * 26 (C.D. Cal. June 16, 2014)). The Iowa court had no need to address this issue.

The uncertainty of what a D&O policy gives bank directors and officers when a bank fails: Except when there were IvI exclusions explicitly addressing receiver claims, no insurer won outright any of the cases discussed above; but the FDIC and directors and officers won two of them outright on summary judgment. Any D&O insurer relying on an IvI exclusion to exclude FDIC claims as receiver may be in for an unpleasant surprise. But, as these cases show, brokers and bank risk managers, directors, and officers can’t necessarily count on D&O insurers to step up when disaster hits and the FDIC sues—even absent a regulatory exclusion or explicit IvI wording addressing receiver Claims. Isn’t it time for a change to how D&O policies address this issue? We’ll have more on this on a future post.

Tags Iowa, directors and officers liability insurance, D&O insurance, insured-versus-insured exclusion, IVI exclusion, derivative suit exception, insured versus insured exclusion, FDIC, FDIC-R, failed bank, directors, officers , investment loss carve out, Loss, community banks, regulatory exclusion, collusion, Company defined, “on behalf of”

by Christopher Graham and Joseph Kelly

Switching insurers? You’re considering switching the insurer for your company’s D&O, professional liability, or other claims-made insurance policies. Many insurers want the business. But, as is typical, their policies include a version of prior-and-pending-litigation exclusion.

Those exclusions generally apply to any claim based upon, arising out of, attributable to, or involving a suit or other proceeding filed or commenced before a new policy’s inception date. Similar exclusions in current insurers’ policies set the date as either policy inception dates or inception dates of policies those insurers first issued to your company.

But, as far as you know, there’s no pending or prior litigation or, if there is, your company reported it to a current or prior insurer. So you’re not concerned. You switch insurers, lower the premium and, you think, receive very similar or better coverage.

The gap: Unfortunately, neither you, nor your broker focus on a problem: the new prior-and-pending-litigation exclusions will apply if, before policy inception, a suit or other proceeding has been filed or commenced against your company, even if no one within your company knows about it.

As it turns out, moreover, your company has been sued, but hasn’t been served, and no one within your company knows about the suit or even about a potential claim. So no one can report anything to the existing insurers so their policies apply if your company eventually is served with suit papers.

Sure enough, service finally does occur when the new policies are in force and any extended reporting period or other deadline for reporting claims under prior policies has expired. You notify the prior and new insurers promptly.

The prior insurers won’t cover the suit because, under its Claim definition, the filed, but unserved suit isn’t a Claim or, even if it is, your company failed to report the Claim by the prior policies’ reporting deadlines and, thus, can’t meet that condition to coverage.

Although the new policies define Claim in a way that requires service of suit papers or at least policyholder knowledge of a demand, the new insurer won’t cover the suit because its prior-and-pending-litigation exclusion applies when a suit is filed before policy inception, regardless of whether the policyholder knows about it. You now realize that your company has a gap in coverage.

The AmerisourceBergen case: Policyholders, AmerisourceBergen and subsidiaries, International Nephrology Network (“INN”) and ASD Healthcare (“ASD”), found themselves with a gap in just that situation, as explained in AmerisourceBergen Corp., et al v. Ace American Ins Co., Case No. 2545 EDA 2013 (Pa. Super Sept. 15, 2014).

From May 1, 2006-2007, their primary professional liability insurer was Travelers. Their excess insurer was ACE. Effective May 1, 2007, ACE became primary and remained so for three consecutive one-year terms. ACE’s policies defined “claim” as “a civil proceeding against [a policyholder] seeking monetary damages . . . commenced by the service of a complaint or similar pleading” or a “written demand against [a policyholder] for monetary damages.”

ACE’s prior-and-pending-litigation exclusion applied to any “claim”:

alleging, based on, arising out of, or attributable to any prior or pending litigation, claims, demands, arbitration, administrative or regulatory proceeding or investigation filed or commenced on or before the earlier of the effective date of this policy or the effective date of any policy issued by [ACE] of which this policy is a continuous renewal or a replacement, or alleging or derived from the same or substantially the same fact, circumstance or situation underlying or alleged therein.

Unfortunately, when the policyholders switched to ACE as primary insurer, they didn’t know that Kassie Westmoreland had filed a “whistleblower” suit against them and her former employer, drug-giant Amgen, alleging violations of the federal False Claims Act, 31 U.S.C. §§ 3729 – 3733. Her qui tam suit, on behalf of the federal government, was filed in Massachusetts federal court, but under seal as the Act requires.

Whistleblowers—frequently employees of entities doing business directly or indirectly with the government—may sue on the government’s behalf and share in any recovery, but they must file their complaint under seal, without service, and serve the complaint and a “disclosure statement” on Justice Department or, for state false claims act claims, the state Attorney General. That process assures that the government can investigate before suit is disclosed to defendants and the public at large. The government may intervene in the case to pursue or dismiss it, or may allow the whistleblower to continue the case while the government monitors. If the government needs more than 60 days to investigate, it may seek a court extension of the seal period.

An extension is what happened in Ms. Westmoreland’s case—a very long extension. Ms. Westmoreland alleged that Amgen, with INN and ASD, used a kickback scheme to induce medical providers to prescribe Aransep, a drug Amgen manufactured to treat anemia. Amgen, INN, and ASD allegedly caused providers to make false representations material to paying Medicare claims for Aransep and conspired to get Medicare to pay false claims for Aransep. But neither INN, nor ASD, nor any other policyholder knew of the suit or any allegations when they switched primary insurers, effective May 1, 2007.

The Justice Department waited until February 2009, over 2 ½ years after Ms. Westmoreland filed her complaint, to advise the policyholders that it was reviewing Ms. Westmoreland’s allegations. In that same month, the Westmoreland court permitted the government to place a redacted copy of the unserved complaint on the electronic docket.

In September 2009, during ACE’s May 1, 2009-10 policy period, the Justice Department advised the court that it was not intervening in the case at that time. On October 30, 2009, also during that policy period, fifteen states and the District of Columbia filed a multi-state complaint in intervention against the policyholders and Amgen. Then in January 2010, the policyholders finally received service of original process.

The policyholders asked ACE to pay for the defense of the suit under the policy effective May 1, 2009-10. But ACE said the claim fell within the prior-and-pending-litigation exclusion, as based on or attributable to Ms. Westmoreland’s suit filed or commenced in June 2006, before the initial ACE primary policy’s May 1, 2007 inception. ACE also claimed that the policy’s “false, deceptive or unfair business practices” exclusion applied.

The trial court granted ACE a summary judgment based on both exclusions. While the policyholders’ appeal was pending, INN agreed to pay $15 million to resolve civil liability arising from its role in the marketing of Aranesp. Amgen ultimately paid over $700 million.

The appeals court affirmed summary judgment, based on the prior-and-pending-litigation exclusion. The policyholders argued on appeal that the exclusion didn’t apply because (1) although filed in June 2006, suit wasn’t served until during the May 1, 2009-10 policy period and (2) suit was filed after ACE’s one-year excess policy became effective on May 1, 2006. On the latter point, the policyholders stressed wording limiting the exclusion to when a prior or pending suit existed before “the earlier of the effective date of [the May 1, 2009-10] policy or the effective date of any policy issued by [ACE] of which [the May 1, 2009-10] policy is a continuous renewal or a replacement . . . .” According to them, ACE’s primary policy effective May 1, 2009-10 was a “continuous renewal or a replacement” of ACE’s excess policy effective May 1, 2006-07.

The appeals court rejected the policyholders’ arguments. It explained that the exclusion applied if suit was “filed or commenced” before the initial ACE primary policy’s May 1, 2007 inception, regardless of when service occurred.

And it explained that “[t]he 2009-10 primary coverage policy is a ‘continuous renewal’ of the 2007-08 and 2008-09 primary coverage policies.” But because the 2009-10 policy was primary, it wasn’t a “renewal” of ACE’s 2006-07 excess policy. Nor did it replace that excess policy. “The only policy that ‘replaced’ the 2006-07 [ACE excess policy] was the 2007-08 [ACE primary] policy.” Quoting definitions of “replace” and “renew” from Webster’s dictionary, the court explained that it “construe[d] ‘replacement policy’ to mean a ‘policy used instead of another policy’ and ‘continuous renewal policy’ to mean ‘a policy that is used again for consecutive policy periods’”.

The appeals court didn’t address the “false, deceptive or unfair business practices” exclusion.

Solutions for the gap: Perhaps if ACE matched the prior-and-pending date in the Travelers policy it replaced—a date presumably no later than the Travelers’ policy’s May 1, 2006 inception date—the policyholders wouldn’t have had a gap. But that would have been only because of the happenstance that Ms. Westmoreland’s sealed suit was filed in early June 2006. Having the new insurer match the prior insurer’s prior-and-pending date, thus, isn’t an adequate solution for the policyholder.

We suspect most underwriters wouldn’t like that solution either. That would be especially so if there’s a prior suit or other claim that could be followed up with “related” claims. Why would any underwriter want to risk having to pick up later “related” claims?

In commenting on the AmerisourceBergen case in his D&O Diary blog, Kevin LaCroix suggests amending the exclusion so it doesn’t “apply to False Claims Act complaints that were filed but not served prior to the effective date of the policy,” but then noted this would leave policyholders with other gaps because “there may be other types of lawsuits, beyond just False Claims Act claims,” where there’s delay between filing and service of suit. No doubt!

A better solution is limiting the prior-and-pending litigation exclusion to circumstances where the policyholder has knowledge of the pre-policy period suit or proceeding. In a recent post on the Professional Liability Underwriting Society blog, Fred Fisher, an attorney and president of Fisher Consulting Group, suggests an approach generally like this.

Kevin LaCroix also suggests that the “exclusion is meant to address separate litigation, not the lawsuit for which coverage is sought,” and the scenario in AmerisourceBergen “just isn’t the sort of situation to which the prior and pending litigation exclusion was meant to apply.”

In fact, if a claims-made insurer doesn’t want to cover a suit filed before its policy period, it ordinarily wouldn’t need to do so through any exclusion. Claims-made policies condition coverage upon a Claim first made during the policy period or an extended reporting period. When a suit is filed before the policy period, it ordinarily would fall outside of the policy’s insuring agreement and, thus, wouldn’t be covered. Although Ms. Westmoreland’s suit was filed before inception of ACE’s primary policy, it didn’t qualify as a claim made before policy inception because a claim, as defined, required service. So ACE couldn’t argue that her suit was outside coverage as a claim made before policy inception.

The more usual scenario for the prior-and-pending-litigation exclusion is found in HR Acquisition I Corp. v, Twin City Fire Ins. Co., 547 F.3d 1309 (11th Cir. 2008), relied on by the AmerisourceBergen court. In HR Acquisition, the pre-policy period litigation was a complaint under the federal False Claims Act filed under seal and unserved, alleging fraudulent Medicare claims. But the policyholder wasn’t seeking coverage for the False Claims Act suit; it sought coverage for a subsequent, shareholder derivative suit based on the same conduct and filed during the policy period. Any Loss from the derivative suit was excluded under the policy’s prior-and-pending litigation exclusion, as Loss based upon, arising from, or in any way related to a suit or other proceeding against an Insured which was pending or existed prior to the policy inception date, or the same or substantially the same facts, circumstances, or allegation as are the basis for such suit or proceeding.

Based on what’s in the appeals court’s opinion in AmerisourceBergen, it doesn’t appear that the policyholders argued that ACE’s prior-and-pending litigation exclusion was limited to circumstances, as in HR Acquisition, where the suit filed during the policy period was separate from the suit filed before then. That may have been because of the wording of the exclusion or also because, within the ACE policy period, multiple states had filed a consolidated complaint in intervention and even Ms. Westmoreland was on her fourth amended complaint.

Kevin also suggests that “the best way to avoid [the] problem [in AmerisourceBergen] would be to line up the language between the prior and pending litigation exclusion and the definition of claim, so that both require service of process.”

In that regard, the following prior-and-pending-litigation exclusion appears along those lines and also consistent with what Kevin suggests as the exclusion’s purpose—namely, as limited to a policy-period claim that’s related to a different pre-policy period claim:

The Insurer shall not be liable under this Coverage Part to pay any Loss on account of, and shall not be obligated to defend, any Claim made against any Insured: . . . Based upon, arising out of, or in any way involving any Claim against any Insured which was pending on or existed prior to the respective Pending or Prior Date stated in the Coverage Schedule of the Declarations, or the same or substantially the same fact, circumstance or Wrongful Act alleged or underlying such prior Claim . . . . (Emphasis added).

Similar to ACE’s policy in AmerisourceBergen, Claim as defined in the exclusion and elsewhere in the policy included a civil proceeding, but only if suit papers are served. Claim also includes any written demand, criminal proceeding, administrative or regulatory proceeding, certain investigations, and certain ADR proceedings—but only if the Insured is served with or otherwise receives the documents showing the matter was initiated.

By referring to a “Claim”—defined as a suit or the like with process or other notice—based upon, arising out of, or involving a Claim, later referred as a “prior Claim,” the exclusion necessarily contemplates two different Claims—the one for which coverage is suit and the one that triggers the exclusion.

Unlike ACE’s prior-and-pending-litigation exclusion in AmerisourceBergen, moreover, the exclusion quoted above also incorporates the policy’s Claim definition—requiring service or the Insured’s receipt of similar Claim documents—in referring to a Claim pending on or existing prior to “Pending or Prior Date”. So a policy period Claim based on, arising out of, or involving a pre-policy period filed, but unserved complaint, such as Ms. Westmoreland’s False Claims Act complaint, wouldn’t fall within the prior-and-pending-litigation exclusion. Her filed-but-unserved complaint isn’t a “Claim.” With an exclusion written like the one quoted above, the policy period derivative suit in HR Acquisition also wouldn’t have been excluded as a result of a pre-policy period False Claims Act suit that no policyholder knew about. The quoted exclusion, thus, may be the best solution for the gap.

Problems for those subject to false claims act suits: Besides the federal False Claims Act, at least 30 states and the District of Columbia have a version of a false claims act, authorizing claims by or for the government against government fraudsters, though proof of “reckless disregard” will suffice.

Policyholders subject to “whistleblower” suits include those doing business with the federal or any state government, or those doing business with those direct government contractors. Health care providers receiving payments under Medicare, Medicaid, or other government insurance programs have been frequent targets.

So have pharmaceutical companies, such as Amgen in the Westmoreland case, because an Amgen-manufactured drug, Aransep, was purchased under government insurance programs. Policyholder, INN, claimed to be a group purchasing organization for medical practice groups. While ASD, was a wholesale drug distributor.

Others targeted by false claims act suits include contractors and subcontractors for state and federally funded construction projects, educational institutions receiving student loan funds such as the University of Phoenix, financial institutions, and defense contractors. It was rampant fraud by defense contractors supplying military goods to the Union Army during the Civil War that lead Congress in 1863 to enact the federal False Claims Act.

Although the “gap” problem in this post isn’t limited to policyholders subject to “whistleblower” suits, they may be subject to a greater “gap” risk, because of the unique procedural requirements for those suits. In some matters, presumably those that are more complex, such as Westmoreland, the complaint may be sealed and, thus, unknown to the policyholder for a year, two years, or even more.

Moral of the story: whether susceptible to false claims act suits or not, mind the pending-and-prior litigation gap when switching D&O, professional liability, and other claims-made policies.

Tags: claims made, professional liability insurance, E&O, management liability, directors and officers liability insurance, D&O, EPL, fiduciary liability, prior and pending litigation exclusion, definition of claim, coverage gap, Pennsylvania, False Claims Act, qui tam

by Christopher Graham and Joseph Kelly

One day a policyholder affiliate’s CFO signed foreign exchange transaction agreements with several banks. The banks later demanded what was allegedly due under them. The policyholder and insured affiliate demanded that their D&O insurer defend the claims and indemnify them for any payment. They alleged that the CFO committed wrongful acts by entering into the agreements without authority. After the D&O insurer denied coverage, the policyholder and affiliate settled several claims. And then they sued the D&O insurer. Who wins?

In PNY Technologies, Inc. v. Twin City Fire Ins. Co., Case No. 11-4547 (SRC) (D. N.J. July 16, 2014), the Judge said the insurer wins.

Typical of D&O policies, this policy had a version of a contract liability exclusion. This one excluded coverage for any claim:

based upon, arising from, or in any way related to any actual or alleged … liability under any contract or agreement, provided that this exclusion shall not apply to the extent that liability would have been incurred in the absence of such contract or agreement.

In granting the insurer a summary judgment, this Judge concluded that the banks’ claims fell squarely within that exclusion: “the claims arose from liability under the foreign exchange agreements, and there would be no claims or liabilities absent those agreements.”

This Judge also held that the banks’ claims fell outside the policy’s insuring agreement for entity coverage. Under that agreement, subject to the policy’s terms and conditions, this insurer agreed to “pay Loss on behalf of an Insured Entity resulting from an Entity Claim … for a Wrongful Act by an Insured Entity.” “Wrongful Act” meant “an actual or alleged act, error, omission, neglect, breach of duty, misstatement or misleading statement by the Company.”

The policyholder and affiliate argued that the CFO committed a “Wrongful Act” by entering into the exchange agreements with the banks, supposedly without authority. But their problem, according to the Judge, was that Entity Coverage was limited to “Loss . . . resulting from an Entity Claim … for a Wrongful Act by an Insured Entity.” The banks didn’t allege a Wrongful Act by an Insured Entity. The banks weren’t even alleging a Wrongful Act by the CFO; the policyholder and affiliate were alleging those wrongful acts.

But what about their failure to pay the banks under the exchange agreements? Didn’t the banks allege breaches by the policyholder and affiliate? Why wouldn’t those breaches qualify as “Wrongful Acts”?

The opinion doesn’t discuss those points. And, given the contractual liability exclusion, the policyholder and affiliate would have lost the case, even if the banks’ allegations of breach by the entity amounted to an “Entity Claim … for a Wrongful Act by an Insured Entity.”

Although this Judge’s decision was based upon insurance contract wording, he also raised the problem of “moral hazard”. If you can commit bad acts with no consequence then there’s no incentive to be good. If you can promise to pay, but not worry about making the payment yourself, then you have no reason to pay. If you can insure the consequences of breaking a promise, then there’s no incentive to keep your promise.

And he’s not the first judge to raise the issue. In reaching his decision, this Judge quoted none other than Judge Richard Posner, a Federal appeals court judge, economist, and prolific writer about law and economics, who often incorporates economic concepts into his opinions.

Here’s Posner’s “moral hazard” quote, from a case about employment practices liability insurance:

[I]nsurance policies are presumed not to insure against liability for breach of contract. The reason is the severe “moral hazard” problem to which such insurance would often give rise. The term refers to the incentive that insurance can create to commit the act insured against, since the cost is shifted to the insurance company. An example is the incentive to burn down one’s house if the house is insured for more than its value to the owner. Or suppose, having somehow persuaded an insurance company to insure you against liability for breach of contract, you hire a contractor to build an extension on your house and after he has completed his work you refuse to pay him, and, when he sues, you turn the claim over to the insurance company.

Krueger International, Inc. v. Royal Indemnity Co., 481 F.3d 993, 996 (7th Cir. 2007).

So insuring claims for contract breaches is “immoral,” right? That’s not quite what Judge Posner or this Judge said. The EPL policy addressed by Posner covered breach of an oral employment agreement, but losses attributable to breach of a written contract were excluded. Posner explained that “breach of a written contract often will be a deliberate act by the insured, while the breach of a contract created by oral representation of an employee is likely to be, from the insured’s standpoint, an unavoidable accident.” Said Posner in addition, “The difference lies in the nature of the act that precipitates the breach: a deliberate decision by the insured, on the one hand, and the careless or unauthorized act of an employee on the other.”

Despite his concerns about moral hazard, Judge Posner’s decision–finding no coverage–was about policy wording: “As there was neither a breach of an oral employment agreement nor misrepresentation [(also an insured act)], there was no insurable act . . . .”

Numerous decisions allow coverage for breach of contract claims, depending on the policy wording. See, e.g., 1325 North Van Buren, LLC v. T-3 Group, Ltd., 716 N.W.2d 822 (Wis. 2006) (coverage for breach of contract claim for insured who allegedly failed to provide competent professional services).

And despite concerns about “moral hazard”, the Judge in the PNY Technologies case also based his decision on contract wording.

So did “moral hazard” make any difference? Without the right policy wording, the insurer would have lost. The Judge also rejected a policyholder/affiliate argument–based on their so-called “reasonable expectation” of coverage–initially because the “reasonable expectations” rule under New Jersey law didn’t apply where, as in this case, there was no ambiguity in the policy wording.

But with moral hazard in mind, this Judge also didn’t otherwise take the “reasonably expectations” argument seriously. After setting forth the quote from Judge Posner’s opinion noted above, this Judge stated, the policyholder and affiliate “seem to contend that they expected their insurance policy to offer coverage that would give rise to such moral hazards,” but they “have not shown this to be objectively reasonable.” And that certainly was the case!

Tags: D&O, management liability insurance, directors and officers liability insurance, moral hazard, New Jersey, breach of contract, wrongful act, contractual liability exclusion, entity coverage, employment practices liability insurance, EPL, reasonable expectations

by Christopher Graham and Joseph Kelly

Whether multiple Claims are based upon or arise out of the same or related Wrongful Acts is a recurring issue in the D&O and professional liability insurance world. The answer often determines: (1) whether a Claim made after a Policy Period nevertheless will be deemed made during that Policy Period, as is required for coverage under claims-made policies; (2) whether a Claim made during a Policy Period will be deemed made before that Policy Period, so that coverage is inapplicable; and (3) how many retentions and policy limits.

Glasscoff v. One Beacon Midwest Ins. Co., et al., Case No. 1:13-cv-01013-DAB (S.D. N.Y. May 8, 2014)], available on Pacer, is yet another case involving the multiple Claim/related Wrongful Acts issue.

In Glasgow, the FDIC sent a demand letter to a failed bank’s directors, alleging breaches of duties relating to their role in the bank’s failure, including failure to supervise, manage, and conduct the bank’s business and affairs to ensure compliance with the law and regulatory authorities. That demand letter was a Claim made during the Policy Period of the bank’s D&O policy.

After the Policy Period, Investors sued the directors based on control person and indirect liability under Arizona securities laws, for the bank president’s actions in inducing Investors to invest with two bank customers.

The bank directors argued that the Investors’ Claim and FDIC Claim should be treated as a single Claim deemed to have been made during the Policy Period, when the FDIC Claim was first made. But the Court disagreed, granting the D&O insurer’s motion for judgment on the pleadings.

The Investors’ Claim couldn’t be considered a Claim made during the Policy Period, said the Court. According to the Court, the Investors’ and FDIC’s Claims weren’t “based upon” and didn’t “aris[e] out of the same Wrongful Act or Interrelated Wrongful Acts . . .”–which were prerequisites for treating the post-Policy Period Investors’ Claim as a Claim made during the Policy Period. “Interrelated Wrongful Acts” meant “Wrongful Acts which have as a common nexus any fact, circumstance, situation, event, transaction or series of related facts, circumstances, situations, events or transactions.” The connection between the Wrongful Acts alleged in the two Claims was too “tenuous.” The directors didn’t show any specific common fact, event, or circumstance. That the two Claims “ostensibly relate to [the directors’] oversight of [the bank president]” was insufficient.

Tags: D&O, New York, directors and officers liability insurance, related Wrongful Acts, Interrelated Wrongful Acts, professional liability insurance, management liability insurance, Claim

by Christopher Graham and Joseph Kelly

It was a very busy summer and early fall here at Jones Lemon & Graham. So we didn’t have time for our D&O Digest. As we get back into our blogging routine, we’re posting brief descriptions of some recent D&O decisions we missed in the past few months. Our first post is about Protection Strategies, Inc. v. Starr Indemnity & Liability Co., Case No. 1:13-cv-00763 (E.D. Va. Apr. 23, 2014), a case we wrote about in October 2013 here. We explained then how the court held that, given the policy’s Claim definition, a Private Company D&O insurer had a duty to defend insureds served with a search warrant and subpoena. But in a more recent decision available on PACER, the court held that the insurer could get it’s money back! The policy included wording requiring the insureds to repay the insurer if it was determined that they weren’t entitled to payment. The insureds pled guilty to Federal criminal charges of fraud and conspiracy. And those guilty pleas triggered the policy’s “profit,” “fraud,” and “prior knowledge” exclusions and the insureds’ repayment obligations. What we can’t tell from the decision is whether the insurer was able to collect any of the money it was owed. Winning is one thing; collecting is another!

Tags: D&O, Virginia, personal profit exclusion, dishonesty exclusion, fraud, prior knowledge exclusion, private company directors and officers liability insurance policy, management liability insurance policy, guilty plea, insurer’s ability to recoup defense expenses, duty to defend