Portfolio Media. Inc. | 860 Broadway, 6th Floor | New York, NY 10003 | www.law360.com Phone: +1 646 783 7100 | Fax: +1 646 783 7161 | customerservice@law360.com The Continuing Struggle For D&O Coverage Law360, New York (November 29, 2010) -- In the current financial turmoil and turbulence, directors and officers must feel as though they have targets on their backs. Whether as the result of a collapsed Ponzi scheme or of a creative creditors' committee, suits against directors and officers abound. When sued, these individuals frequently turn to their directors and officers liability policies for protection. Unfortunately, insurers, in reply, often turn their backs on their insureds. As a general rule, D&O policies provide much less coverage than policyholders expect. A constant tension exists between the efforts of brokers and consultants to enhance coverage and the insurers' efforts to narrow it. Moreover, the liability of directors and officers is Robert D. Chesler constantly changing. As a result, the D&O insurance world is in a constant state of flux, and insurers are quick to find novel arguments to deny coverage. The cases discussed below demonstrate that policyholders must be vigilant in protecting their insurance rights. Money Laundering Exclusions : Faced with the fallout from the Stanford Ponzi scandal, the U.S. District Court for the Southern District of Texas barred coverage for three directors and officers of the Stanford Financial Group entities (collectively, “the Group”) where they “knew, suspected or reasonably should have known or suspected” that the Group’s (i ) financial records contained fictitious or unsubstantiated information and (ii) reports to the holders and prospective purchasers of certificates of deposit (“CD”) contained misrepresentations and omissions regarding the Group’s financial condition. Pende rgest-Holt v. Certain Underwriters Danielle C. Carmona at Lloyd’s of London, et al., No. 09 -3712, U.S. Dist. LEXIS 108920 (S.D. Tex. Oct. 13, 2010). In Pendergest-Holt, the plaintiffs — the sole owner of the Group and the chief accounting officer and controller of one of the Group’s entities — were accused of participating in a massive Ponzi scheme in which the Group allegedly defrauded CD holders of several billion dollars. Following the commencement of criminal and SEC actions related to the alleged fraud, the plaintiffs sought coverage from their insurers for defense costs under several D&O policies. Importantly, the policies contained exclusions for money laundering. The exclusions barred coverage if the insured engaged in certain acts with respect to “criminal property,” which is a benefit that the insured knew, suspected or reasonably should have known or suspected was obtained from criminal conduct. If money laundering occurred, the policies imposed an obligation on the insurers to pay defense costs “until such time that it is determined that the alleged act or acts did in fa ct occur.” Policyholders should note that that this “in fact” standard is less favorable than a “final adjudication” standard.
Though the insurers initially agreed to pay defense costs, they later denied coverage retroactively back to August 27, 2009 — the date on which the Group’s chief financial officer entered into a plea agreement admitting partic ipation in the scheme and falsification of documents. In denying coverage to the plaintiffs and seeking reimbursement, the insurers relied upon the money laundering exclusion. The plaintiffs sought and obtained a preliminary injunction ordering the insurers to advance defense costs, leading the insurers to appeal. The U.S. Court of Appeals for the Fifth Circuit affirmed the preliminary injunction, but remanded the case to the district court to render an “in fact” determination as to whether money launderin g had occurred. On remand, the district court conducted the “in fact” determination as part of an evidentiary hearing for the injunction. In vacating th e injunction, the district court found that the insurers had proven, by a preponderance of the evidence, that there was a substantial likelihood that the money laundering exclusion applied to the plaintiffs. This case highlights that insurers are constantly adding exclusions to D&O policies. (See discussion, infra, of “bump - up” exclusion.) Despite the use of brokers and consultants, policyholders need to be vigilant in reviewing their insurance policies and, in particular, the endorsements added by the insurer. The Duty to Defend: The U.S. Court of Appeals for the Ninth Circuit held that the former officer of a corporation was entitled to a defense under a D&O policy even though the underlying complaint did not specifically allege that he committed certain acts “in his capacity as” chief executive officer. Goerner v. Axis Reinsurance Co., 2010 U.S. App. LEXI S 21624 (9th Cir. Oct. 20, 2010). In Goerner, the Ninth Circuit recognized that, were it to bar coverage in this instance, the CEO “would not be owed a defense even for actions he was directly ordered by his superiors to undertake if the third-party plaintiff failed to allege in the complaint that those actions were undertaken in his capacity as CEO.” Such an outcome would not only “defeat the purpose of insurance coverage,” but would also be inconsistent with an insured’s reasonable expectation of coverag e. Because the facts contained in the underlying complaint raised the “possibility of coverage,” the Ninth Circuit found that the insurer had a duty to defend the CEO under the policy. As Goerner illustrates, an insurer’s duties do not depend on the label that plaintiffs attach to their claims against the insured; rather, the insurer’s duties depend on how the facts of the underlying case relate to the insurance policy. If a complaint is ambiguous, courts will typically construe such ambiguities in favor of coverage and require the insurer to defend the suit. However, these rules of construction do not prevent insurers from contesting coverage. In Goerner, the district court ruled for the insurer, and the circuit court reversed. Settlement Agreements Relieving Insured of Obligation to Pay Judgment: In U.S. Bank National Association v. Federal Insurance Company, et al., No. 10-CV-0266-W-HFS, 2010 U.S. Dist. LEXIS 105553 (W.D. Mo. Oct. 4, 2010), the U.S. District Court for the Western District of Missouri held that an officer who had settled claims against him for a $56 million judgment suffered no “loss” under a D&O policy where the settlement agreement relieved him of his obligation to pay the judgment. Since such settlements are typical, this case is potentially of great concern. Policyholders can only hope that few courts will follow this reasoning. In U.S. Bank, the trustee of a creditor’s trust sued the former officer of the debtor -corporation in a fiduciary action seeking more than $100 million in damag es. The officer sought and was denied coverage under the debtor’s D&O policies, but eventually settled his claims. As part of the settlement, the officer was promised that, upon assigning his coverage rights to the trustee, “he would not be pursued for payment.” As assignee, the trustee filed suit against the D&O insurers, which, in turn, moved to dismiss the action.
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