2010 Developments In D&O Law

Sunday, April 3, 2011 - 01:00

The current financial crisis has yielded an ever-increasing number of claims against directors and officers and the companies for which they work. But when these individuals and companies turn to their D&O policies for protection, all too often their insurers run for cover and away from coverage. Consequently, D&O policyholders frequently find themselves questioning the protection afforded by their substantial premium dollars.

As with most insurance, a constant tension exists between D&O policyholders' efforts to enhance and maintain minimal levels of coverage and insurers' efforts to narrow coverage. And because the liability of directors and officers is constantly changing and insurers are quick to deny coverage based upon novel arguments, the "D&O insurance world" is constantly evolving. As a result, policyholders and their brokers and consultants must be vigilant in protecting their rights. The following decisions from 2010 demonstrate the critical importance of diligence in understanding, procuring and pursuing D&O coverage.

Regulatory Investigations

In Office Depot, Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pa., et al., No. 09-80554-CIV-MARRA, 2010 WL 4065416 (S.D. Fla. Oct. 15, 2010), the U.S. District Court for the Southern District of Florida denied Office Depot's bid to recover under its D&O policy for fees incurred in responding to an SEC investigation and in conducting an internal investigation and audit. Office Depot filed a notice of appeal, saying it would ask the Eleventh Circuit to overturn the district court's opinion.

Cross-appeals are currently pending before the Second Circuit in MBIA, Inc. v. Federal Insurance Company, et al., 2009 U.S. Dist. LEXIS 124335 (S.D.N.Y. Dec. 30, 2009). MBIA involved whether a subpoena constituted a "claim." The insurer argued that subpoenas issued by the New York attorney general ("NYAG") didn't trigger coverage under the Securities Claim definition in its insurance policy. The SDNY disagreed, noting that even if the subpoena wasn't an "order," the policy's definition of a Securities Claim - which included "a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document" - was broad enough to encompass the NYAG subpoena. The insurer similarly argued that the costs incurred in responding to additional oral requests for documents without the NYAG's issuing a formal subpoena weren't covered as the insured wasn't responding to a "claim" pursuant to the policy language. But the SDNY sided with the insured, finding that the insured was responding to discovery requests in the context of the NYAG's investigation and was therefore responding to a regulatory demand which constituted a Securities Claim.

Bankruptcy

In Groshong v. Sapp (In re MILA, Inc.) 423 B.R. 537 (B.A.P. 9th Cir. 2010), the U.S. Bankruptcy Appellate Panel affirmed the bankruptcy court's order granting relief from the automatic stay to allow the debtor corporation's D&O insurer to pay defense costs the debtor's principal incurred in an adversary proceeding by the trustee. Balancing the harm to the debtor if the stay was lifted and the harm to the principal if it was not, the Appellate Panel lifted the stay, finding that: (1) the debtor wasn't a named insured under the policy and its right to recover was only derivative; (2) the principal's defense costs likely wouldn't exceed the policy limits; (3) there were no other potential indemnification claims against the debtor; and (4) allowing the payments likely wouldn't result in the debtor having to pay indemnity costs. The Appellate Panel rejected the debtor's claims of potential harm as speculative, while finding that the harm to the principal was certain, immediate and continuous.

Brook v. The Education Partnership, Inc., PB 08-4185, 2010 R.I. Super. Lexis 63 (R.I. Apr. 8, 2010), involved an insolvent nonprofit corporation that was placed into receivership and claims by the courtappointed receiver against its former officers alleging, inter alia, breach of fiduciary duty. The receiver submitted a claim under the nonprofit's D&O policy, which was settled for $525,000. The receiver sought to use some of the insurance proceeds to settle a claim brought by one of the nonprofit's secured creditors. The court approved the settlement because the policy covered the nonprofit directly. The policy proceeds therefore belonged to the receivership estate, allowing the receiver to divide the proceeds among the estate's creditors. In re Downey Financial Corp., 2010 Bankr. LEXIS 1347 (Bankr. Del. May 7, 2010), required the court to address the competing rights of individual insureds versus those of the insured company to coverage under a D&O policy. Based on the facts of the case, the court found that the individuals had the right to coverage that was superior to the right of the insured company because the company didn't have viable claims against the policy. Downey and cases like it often turn on the particular facts of the case and underscore the need for "Side A" coverage - coverage that is only available to the individuals and not to the entity.

Bump-Up And Insolvency Exclusions

In In re Delta Financial Corp, 604 F.3d 408 (3d Cir. 2010) (Delaware Law), the insured sought coverage for claims from noteholders arising out of its bankruptcy restructuring. The noteholders asserted that they received inadequate compensation, and the policyholders submitted a claim to their insurer. But because the policy excluded coverage for "allegedly inadequate . . . consideration in connection with the company's purchase of securities issued by any company . . . ," the court foreclosed coverage. Similarly, in Associated Community Bancorp, Inc. v. The Travelers Companies, Inc., 2010 WL 1416842 (D. Conn. Apr. 8, 2010), the court held that an "insolvency exclusion" barred coverage for a policyholder's loss in the Madoff Ponzi scheme.

Duty To Defend

In Goerner v. Axis Reinsurance Co., 2010 U.S. App. LEXIS 21624 (9th Cir. Oct. 20, 2010), the Ninth Circuit required a D&O insurer to defend the former officer of a corporation even though the underlying complaint didn't specifically allege that the former officer committed acts "in his capacity as" CEO.

Finding "In Fact"

"Conduct" exclusions in D&O policies often obligate insurers to pay for the insured's defense until there is a finding "in fact" of wrongdoing. In Pendergest-Holt, et al. v. Certain Underwriters at Lloyd's of London and Arch Specialty Insurance Co., 600 F.3d 562 (5th Cir. 2010), the insurer argued that an insured's guilty plea and implication of other defendants were sufficient to establish wrongdoing "in fact." The court disagreed, finding that "in fact" required a finding by a court of actual wrongdoing by the insured before an insurer could stop paying defense costs. The court rejected the argument that an insurer can decide on its own when it acquired sufficient facts to establish wrongdoing "in fact."

Insured v. Insured Exclusion

In Macey v. Carolina Casualty Insurance Co., No. 08-6067-cv (2d Cir. June 30, 2010), the Second Circuit reversed a district court's grant of summary judgment to the insurer, finding the D&O policy ambiguous with regard to whether the directors of a predecessor entity were insureds for purposes of the "insured v. insured" exclusion.

But in Strategic Capital Bancorp Inc. v. St. Paul Mercury Insurance Co., No. 2:10-cv-2062 (C.D. Ill. July 1, 2010), the district court denied the insured's motion for a preliminary injunction to compel the D&O insurer to provide a defense in a lawsuit brought by five plaintiffs, three of whom were former directors of the insured's subsidiaries, based on an "insured versus insured" exclusion and rejected the insured's attempt to rely upon the Seventh Circuit's decision in Level 3 Communications, Inc. v. Federal Insurance Co., 168 F.3d 956 (7th Cir. 1999) because unlike in Strategic Capital Bancorp, the majority of the plaintiffs in Level 3 weren't "insureds."

"Arising Out Of"

Somerset Medical Center v. Executive Risk Indemnity, Inc., A-6214-08T2, 2010 N.J. Super. Unpub. LEXIS 605 (App. Div. Mar. 22, 2010), involved Somerset's and its directors' and officers' efforts to secure patients. A complaint against Somerset and its directors alleged negligent hiring, negligent supervision and entrustment, negligent reporting, and negligent continuation of employment. The insurer denied coverage because its D&O policy excluded claims "based on, arising out of, directly or indirectly resulting from, in consequence of or in any way involving" bodily injury. The Appellate Division held that there was coverage because the complaint "arose out of" the hospital's "professional negligence," not the bodily injury.

Notice

JPMorgan Chase & Co. v. The Travelers Indemnity Co., 73 A.D. 3d 9 (N.Y. App. Div. 2010), involved claims-made bankers liability insurance and JPMorgan Chase's claims involving settlement of Enron-related lawsuits. The day before its policy expired, Chase informed the insurer that it "anticipated that we may be named in litigation expected to arise out of the financial difficulties of Enron. . . . While [Chase] would vigorously contest the validity of such claims, and has no actual knowledge of such acts, we believe that all of the foregoing constitute Wrongful Acts. . . ." The insurer denied coverage, stating that Chase failed to provide timely notice because Chase "had no awareness of any wrongful acts," and the notice "did not identify any specific wrongful act." The court rejected the insurer's argument finding that the notice was sufficient because "the entire purpose of the notice" was to put the insurer "on notice of the Enron circumstance."

Professional Services Exclusion

The court, in Great American Insurance Co. v. Geostar Corp., 2010 WL 845953 (E.D. Mich. Mar. 5, 2010), declined to grant summary judgment to the insurers, based on an exclusion barring coverage for claims based on the rendering of professional services by the insured. The court found that although the exclusion might bar claims that the insured negligently provided tax advice, it didn't preclude coverage for any claim arising from the insured's conduct of its varied business activities.

Restitution

In re TransTexas Gas Corp., 597 F.3d 298 (5th Cir. 2010) involved a claim arising from a fraudulent transfer bankruptcy judgment against a former corporate executive of a debtor corporation. The insurer denied coverage arguing that, under Texas law, restitution payments aren't insurable. The court agreed, holding that the judgment wasn't a covered "Loss," because "the return of funds due to fraudulent transfers is in the nature of restitution."

Conclusion

Case law develops rapidly and can vary by jurisdiction, and insurance companies modify their policies in response to these developments. D&O policyholders and insurance professionals must therefore be vigilant because developments and seemingly minor word changes can significantly impact coverage. Every line of the D&O policy must be parsed to ensure it includes the best possible provisions. And because insurance companies frequently deny coverage, policyholders must properly position themselves to respond appropriately.

Robert D. Chesler, Member of the Firm and Chair of the Insurance Coverage group at Lowenstein Sandler, represents policyholders in a broad variety of coverage claims against their insurers. He also advises companies with respect to their insurance programs. Joseph D. Jean, Member of the Firm, practices in Lowenstein Sandler's Insurance Coverage group. Based in the Firm's New York office, he represents policyholders in litigations and alternative dispute resolutions involving insurance coverage and complex commercial matters.

Please email the authors at rchesler@lowenstein.com and jjean@lowenstein.com with questions about this article.