Source: http://www.joneslemongraham.com/blog/category/directors-and-officers-liability-insurance/
Timestamp: 2019-04-18 15:17:34+00:00

Document:
Are directors entitled to defense expenses when D&O policy is subject to asset freeze and held in receivership?
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.
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 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.
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.
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.
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.
• 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.
Will your claims-made liability insurer pay when policy-period and pre policy-period claims arise out of “interrelated wrongful acts”?
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?
Based on the broad definition of “interrelated wrongful acts” …, as well as the substantially similar factual web surrounding the  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.
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.
When does a prior acts exclusion apply to future wrongful acts?
It’s 2008. The subprime lending crisis begins. You’re an officer of a bank holding company. It’s approaching insolvency. It’s also facing a class-action by its investors. And regulators are investigating its subsidiary bank for “unsafe and unsound practices” in mortgage lending. Another officer transfers $80 million in new capital to the subsidiary to keep it afloat.
There’s a D&O insurance policy which, subject to its terms, covers the holding company and subsidiary, and their directors and officers including you. Unfortunately for you, that D&O insurer wants off the risk and provides a notice of non-renewal.
But your company’s broker finds another D&O insurer offering alternative terms including: (1) for a $350,000 premium, $10 million in limits and a “prior acts” exclusion, applicable to “Loss in connection with a Claim arising out of… any Wrongful Act committed or allegedly committed, in whole or in part, prior to [November 10, 2008],” the policy inception date; (2) for a $650,000 premium, $10 million in limits, but with no prior acts exclusion; and (3) at your company’s request, for a $700,000 premium, $20 million in limits, but also with a prior acts exclusion.
Which option do you want? Easy answer: the one that wasn’t offered—namely, without the prior acts exclusion and with $20 million in limits. Which option does the company pick? $20 million in limits and prior acts exclusion. So how does that choice work out for you?
After the new D&O policy incepts, the subsidiary needs even more money to stay afloat; so in early 2009, you and another officer transfer—in two installments–$46 million of holding-company tax refunds to the subsidiary. Not enough. Regulators shut down the subsidiary bank, and a receiver is appointed. The holding company files for a reorganization under Chapter 11 of the United States Bankruptcy Code. Not good. What happens next?
An administrator is assigned for the holding company’s Chapter 11 bankruptcy plan. He sues you and the two other officers. He alleges you all breached fiduciary duties thereby causing the holding company and subsidiary to fail, and prolonging their existence leading to greater losses. He alleges misconduct by the officer who transferred $80 million to the subsidiary before the new D&O policy’s inception, and seeks to recover $80 million in damages from him. And he alleges that by transferring $46 million in tax-refunds to the subsidiary after the D&O policy’s inception, you and another officer violated the Florida Fraudulent Transfer Act; the transfers allegedly occurred when the holding company was insolvent or it became insolvent as a result of the transfers, and without receiving reasonably equivalent value in exchange.
You notify the D&O insurer. The response: coverage denied; it’s because of the prior acts exclusion—they say. Now what?
You want out. You settle. Under one of the settlement agreements — apparently, an attempt to avoid the prior acts exclusion—you and the other officers resolve the administrator’s claim involving the post-November 10, 2008 tax-refund transfers occurring after the D&O policy’s inception. The post-November 2008 transfer settlement is for $15 million “to be paid [to the administrator] by either” the D&O insurer or you and the other two officers. Under that agreement, you and the other officers also assign all rights under the D&O policy to the administrator, who then sues the D&O insurer. Who wins?
Under Florida law, the phrase “arising out of,” as used in the prior acts exclusion, “is not ambiguous and has a broad meaning, even when used in a policy exclusion; ‘arising out of’ is more than ‘mere coincidence,’ but less ‘proximate cause’, and means ‘originating from,’ ‘having its origin in,’ ‘growing out of,’ ‘flowing from,’ ‘incident to’, or ‘having a connection with.’” The fraudulent transfer act claim, about the 2009 transfer, thus, arose out of pre-November 10, 2008 Wrongful Acts.
According to the Court, it didn’t matter that the administrator — presumably to avoid the prior acts exclusion — chose not to incorporate into the fraudulent transfer count certain prior allegations describing the officers’ pre-November 10, 2008 misconduct.
Comments: The Court suggests that the holding company had its wallet on its mind in choosing the D&O policy with a prior acts exclusion. But, as far as we can tell, that option actually was the most expensive one—presumably because it included double the limits of the other two options. But when a financially troubled company chooses a D&O policy with double limits with a prior acts exclusion with “arising out of” wording, are the double limits really worth foregoing the lower-limit option without a prior acts exclusion? What are you really getting, especially since the lower-limit option without a prior acts exclusion cost $50,000 less? In this case, not much.
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).
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.
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.
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.
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.
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.
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”?
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.
[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).
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!
Here we go again: Are these Claims based upon or do they arise out of Interrelated Wrongful Acts?
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.

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