Law and Insurance

Stanford Judge Refuses to Stay Discovery of Insurer's Requests for Admissions

Pendergast-Holt v. Certain Underwriters at Lloyd's of London, No. H-09-3712 (S. D. Tex. Aug. 11, 2010) see Order.

This seemingly minor order denying the insureds' motion for a protective order barring certain discovery probably marks the begining of the end for Robert Allen Stanford's (and other directors of the doomed Stanford financial entities) quest for D&O insurance coverage for their criminal defense expenses.  You remember Stanford and his fellow directors, who sued Lloyd's in 2009 to restart the flow of insurance proceeds to fund one of the costliest criminal defense trials of the modern age.  (Lloyd's had initially agreed to fund defense costs but stopped after one of the directors, Leornard Davis, copped a plea and told the bizarre tale of Stanford's ponzi operations.  In Lloyd's judgment, Davis's plea triggered an exclusion in the policy by establishing "in fact" deliberate wrongdoing).  The judge presiding over the criminal trial also ruled in the coverage lawsuit that Lloyd's had to continue funding the criminal defense.  On appeal, the 5th Circuit remanded the case back to the lower court for a new determination by a different judge but ordered Lloyd's to continue paying defense costs until the new judge ruled.  I described the peculiar circumstances of the 5th Circuit ruling here.

The new judge understood her instructions from the 5th Circuit as follows: (1) whether excluded conduct "in fact" occurred was something that Lloyd's could not arbitrarily decide on its own; a court must decide; (2) the court overseeing the criminal trial could not also determine the insurance issues; and (3) Lloyd's must continue to advance defense expenses until the court decides whether, and at what point, excluded conduct was judicially established "in fact" (i.e., when Davis pled out, when Stanford et al. admit to wrongdoing, or some other trigger the court decides).  The new judge noted that as of July 30, 2010, Lloyd's had advanced more than $15 million for defense costs (out of potential total limits of $90 million). 

Which brings us to this discovery order.  Because the coverage action is a civil lawsuit, Lloyd's gets to ask the other side questions in interrogatories and, more important, gets to ask the directors to admit or deny certain things, like all of Davis' admissions in his plea.  Like many criminal defendants, Stanford et al. are, or will be, standing on their 5th amendment right to remain silent rather than self-incriminate, a right they say answering Lloyd's discovery will violate.  Hence the motion for protective order that they not be required to answer the discovery.

The court denied the motion.  Following the lead of the 5th Circuit, the court noted that the insureds bargained for a D&O policy with an "in fact" trigger for the relevant exclusion.  Also available are so-called "actual adjudication" policies, under which the conduct exclusions do not apply until a fact finder establishes the excluded conduct in the trial itself.  Lloyd's, therefore, is entitled to an "in fact" determination of the conduct "in which all admissible evidence is welcome," said the 5th Circuit.  Also, Lloyd's continues to bleed.

[The insureds] will not be permitted to seek through this suit ... continued payment of defense costs under the Policy, while simultaneouly denying [Lloyd's] discovery that [Lloyd's] seeks in an effort to defend themselves against Plaintiffs' claims and thus liability for those costs.

What about the directors' 5th amendment rights?  The judge acknowleged that other courts have on occasion stayed discovery in a civil action rather than force criminal defendants to choose between their right to remain silent and some advantage in a civil suit.  The difference here is that the insureds filed the coverage lawsuit; the insureds were defendants in the other cases.  Also, Lloyd's is under a continuing injuction to fund the criminal defense to the tune of millions of dollars. 

The plaintiff who retreats under the cloak of the Fifth Amendment cannot hope to gain an unequal advantage against the party he has chosen to sue.  To hold otherwise would, in terms of the customary metaphor, enable plaintiff to use his Fifth Amendment shield as a sword.

With this loss, the Stanford defendants must either find a way to respond to Lloyd's discovery requests that does not establish "in fact" the excluded wrongdoing or go down to swift defeat by summary judgment.  Maybe the directors might hope to raise fact questions in their responses that avoid summary judgment and keep the tap flowing until a jury decides the coverage issues.  But even so, the civil trial is likely to occur on an expedited basis before the criminal trial.

David S. White, Thompson & Knight LLP

www.tklaw.com

Second Circuit Finds "Insured-vs-Insured" Exclusion Ambiguous

Macey, et al. v. Carolina Casualty Ins. Co., No. 08-6067 (2d Cir. June 30, 2010), see Decision

This decision from the U.S Court of Appeals for the Second Circuit created an immediate buzz in the Directors-and-Officers insurance world because the court held that the so-called "insured-vs-insured" exclusion was ambiguous, always a terrifying word for insurers.  D&O insurance protects officers and directors against lawsuits alleging a wide assortment of wrongful acts while in office, usually shareholder actions in response to a stock plunge.  Excluded from coverage, however, are claims brought by one D or O against another.  Insurers are not keen to fund inter-corporate squabbles or revenge suits brought by a former director against the scoundrels that threw her out of office.  If courts strike down the insured-vs-insured exclusion as ambiguous, insurers might have to cover a whole lot more lawsuits.

But insurers take heart.  The Macey case probably does not portend the demise of the insured-vs-insured exclusion due to the unsual facts uderlying the decision.  In fact, the court did not actually say that the exclusion was ambiguous.  It remanded the case to the lower court to determine if the plaintiffs in the underlying lawsuit were in fact directors of the insured corporation.  In other words, the court held that the exclusion might or might not apply, depending on whether the insured corporation existed when the plaintiffs were directors.  The facts, you see, are complicated.

An Illinois corporation, call it CRA-Illinois, reorganized in May 2004 and merged with an investment company.  It emerged as a Delaware corporation, CRA-Delaware, later that year with new majority ownership.  The directors of CRA-Illinois became minority shareholders (named "Legacy Shareholders") and also became directors of CRA-Delaware but, according to the Share Purchase Agreement, only for the purpose of signing the paperwork necessary to complete the reorganization.  The Agreement also required that two of the three Legacy Shareholders resign from the board in order to close the merger.  The Agreement named as new directors three other inviduals (Macey et al.), who were later sued by the Legacy Shareholders.

After the merger, the company applied for D&O insurance, making the following representation:

On May 3, 2004, the company had a merger with an investment entity.  A new Chariman and Chief Executive Officer was installed.  The prior ownership remained in a minority capacity but were no longer participants on the Board or officers of the corporation.  On August 2, 2004 a Chief Financial Officer was hired.

The policy that issued incorporated the application as part of the insuring agreement, arguably becoming a stipulation of facts in the policy.  A year later, CRA-Delaware effected yet another merger, which pushed the Legacy Shareholders out completely, whereupon they sued the new directors.  The defendants sought coverage, which the insurer denied based on the insured-vs-insured exclusion.  The coverage action followed.

The lower court agreed with the insurer that the plaintiffs were former directors of CRA-Delaware, however slight their tenure may have been, and applied the exclusion.  On appeal, however, the court said that the lower court had not looked at the record closely enough.  Applying Virginia law to interpret the policy, the Second Circuit noted that an insurance provision is ambiguous if it is reasonably capable of two different intepretations.  The court continued:

The parties' opposing arguments are both reasonable interpretations of when CRA-Delaware came into existence.  On the one hand, [Macey, et al.] argue that CRA-Delaware came into being only at closing when it merged with CRA-Illinois, which occurred at the same time [the Legacy Shareholders] resigned, an interpretation that is captured in the [application].  On the other hand, Carolina argues that CRA-Delaware came into being at some point before the execution of all the documents and issuance of stock, and thus the Legacy Shareholders rightly fall within the "insured vs. insured" exclusionary clause.  Both of these interpretations rely on the language of the Policy and are reasonable in light of the various provisions of the Policy.

The court held that the exclusion appeared to be capable of two reasonable interpretations and remanded the case to the lower court to determine if the Legacy Shareholders should be considered "insureds" under the policy.  So why is this ruling not the death-knell of the insured-vs.-insured exclusion, at least in the Second Circuit, given that most courts will interpret an ambiguous policy in favor of coverage?

The court noted that there are two kinds of ambiguity: (1) when the provision is ambiguous on its face, called patent ambiguity, and (2) when the contract, though clear when written, "because of subsequently discovered or developed facts, may reasonably be interpreted in either of two ways," or latent ambiguity.  Although the court does not explicitly say so, this is probably a case of latent ambiguity, which should not have much persuasive effect on future court decisions.  The facts of this case are not likely to be repeated, particularly a representation in the policy itself that some individuals are not directors.  A finding of patent ambiguity might start the ball rolling in other courts.  Latent ambiguity may be a harder sale for policyholders.

Nonetheless, we may expect directors and officers to use the Macey decision to bolster an argument that the exclusion is ambiguous.  The insured need only persuade a court that it has a reasonable interpretation favoring coverage, and finding reasonable arguments is what lawyers do.

David S. White, Thompson & Knight LLP

www.tklaw.com

Court Holds that D&O Insurer Cannot Unilateraly Decide If Excluded Conduct "In Fact" Occurred

Pendergest-Holt v. Certain Underwriters at Lloyd's of London, No. 10-20069 (5th Cir. March 15, 2010) see Decision

In this case, the Fifth Circuit considers a Director & Officers (D&O) insurer's refusal to pay defense costs to insured criminal defendants because an exclusion bars such payment when "it is determined that [money-laundering] did in fact occur."  The key issue for the reviewing court is who gets to decide when the excluded conduct "in fact" occurred.  Lloyd's argued that it could decide when the exclusion kicked in and why.  The insureds said that only a jury in the underlying criminal case could trigger the exclusion with a guilty verdict.  The court held that both sides were wrong.  A court, not the insurance company, had to determine if the exclusion applied and at what point.  But that determination did not have to await a final verdict of guilt or innocence.  The issue could be decided by a separate court in a coverage lawsuit.  Said the court, "This works a sensible construction of an awkwardly drafted instrument, aided by the equity power of the court to grasp the realities at hand."

This is a significant decision because many D&O policies have some kind of "occurred-in-fact" exclusion. Every D&O policy I have seen contains exclusions for certain kinds of bad conduct.  Most exclude deliberately fraudulent or criminal acts as well as receipt of illicit, undeserved profits.  Because no plaintiffs-lawyer worth her salt would draft a securities complaint that doesn't paint the directors' and officers' conduct in the blackest of terms, the bad-conduct exclusions in D&O policies are almost always potentially in play.  So, if the mere allegation of excluded conduct was enough to trigger the exclusions, directors and officers would never get the benefit of any coverage. 

In order to get companies to buy their D&O insurance, insurers' like Lloyd's, draft the exclusions to permit advancement of defense costs while the lawsuit is pending until the bad conduct is established in some manner, at which point, the spigot is turned off and the bad characters have to fend for themselves.  Often, the policy will even require the insureds to reimbursement the insurer for costs previously advanced.  Roughly speaking, the exclusions have one of two cut-off points: (1) when the bad conduct is established by a "final adjudication" (which the court in this case said always means adjudication in the underlying D&O proceeding - p. 16); or (2) it is determined "in fact" that the conduct occurred.

Here the D&O policy had a number of conduct exclusions, all but the the money-laundering exclusion to be determined after a final adjudication.  Unfortunately for the defendants, the policy described money-laundering very broadly, and just about all of the conduct alleged by the government in this ponzi scheme fall within the definition.  And this exclusion was triggered by an "in fact" determination.  So the court held that the insurer had to advance defense costs until a court decided the cut-off point.  That could already have occurred when one of the defendants copped a plea and pointed a finger at the others.   Or it may be established by other evidence.  Or it might have to await a jury verdict.

Interestingly, the court noted that the lower court judge who decides the issue might find that the exclusion has already been triggered, but an innocent verdict  would effectively reverse that determination.  That possibility is what the court had in mind when it referred to the courts' equity power.

On a final note, the appellate court held that the court hearing the criminal trial should not be the court to determine the coverage issue.  By its holding here, the Fifth Circuit has relegated to a footnote the extraordinary holding by the lower court that Lloyd's payment obligation should be decided under Texas' strict 8-corners rule that an insurer's duty to defend is determined with reference only to the allegations in a lawsuit, not to actual facts established by extrinsic evidence.  I say extraordinary because under this policy, and just about every D&O policy in existence, Lloyd's has no "duty to defend."  Its obligation is to indemnify the insureds for their defense costs, or, at best, to advance costs.  This is not the same as the more robust duty to defend. 

The Fifth Circuit pointed out that if the 8-corners rule applied, then the mere allegation of money-laundering would immediately settle the issue in Lloyd's favor.  The appellate court deftly characterized the 8-corner issue as a "red herring" and remanded the coverage action to some other court that was not burdened with the responsibility of rendering a fair trial in a high profile case. 

D&O Insurer Prevails On Coverage Challenge to Katrina Loss

Carolina Cas. Ins. Co. v. James E. Sowell, et al., No. 3:07-CV-1783-D (N. D. Tex. February 17, 2009)

I have a confession.  I usually write about general liability policy decisions because the coverage issues tend to be simpler and more accessible to risk managers than, say, Directors & Officers (D&O) policy issues, as presented in this case.  In troubled economic time like these, however, insurance covering liability for a company's mistakes and misadventures is perhaps now worth a little more consideration than in fat years.  Besides, the facts are fairly straightforward and the issues instructive to all who purchase D&O insurance.

The insureds are three apparently affiliated entities in the oil and gas supply business in or around New Orleans and their officers and directors, including James Sowell, a principal of one of the entities (James Sowell Co, L.P.) and a  shareholder/director of DGS, L.L.C., another insured entity apparently run principally by Leonard Doussan III, Leonard Doussan, Jr. and others (DGS, L.L.C. was formerly called "Doussan Gas & Supply, L.L.C."). 

OK, I lied.  The facts are as twisted and serpentine as the snake pit in Indiana Jones' first movie.  Also, the scene is New Orleans after Katrina, so nothing about this will be simple.  Let me, therefore, cut to the chase. 

The risk management function for this assortment of corporate bedfellows appeared to reside with DGS.  Katrina severely damaged the companies' facility, leased from a company called Doussan Properties, L.L.C., and DGS had failed to buy enough property insurance to cover the losses.  Lawsuits followed in rapid order.  Let me mention only two.  First, Doussan Properties sued all the insured entities for failing to maintain adequate insurance as the lease required.  Second, James Sowell sued the DGS and the Doussan clan in a shareholder derivative action for a variety of mismanagement sins, including failing to purchase adequate insurance.

Happily, DGS had purchased a D&O policy that seemed to cover a broad array of "wrongful acts" by the companies and management.  A D&O policy is much like a buffalo.  Looked at head-on, it appears massive, but by the time one reaches the tail, it has tapered down to one of the animal kingdom's smallest butts.  The insuring agreement of most D&O polices appears to cover about anything an officer or director might be accused of doing, any mistake, misstatement, misrepresentation, error or omission.  Down and dirty fraud and deliberate or criminal wrong doing is excluded, but otherwise, the insuring agreement appears quite broad.  However,  when the exclusions and limitations and conditions are rolled out, to say nothing of the endorsements that often add more exclusions, limitations, and conditions, the scope of coverage has shrunk. 

The D&O insurer quickly denied the claim for liability coverage for all the actions against all the insureds, corporate and personal, for a number of reasons.  I mention two.  First, the policy contained a "contract" exclusion eliminating any claim:

based upon, arising out of, directly or indirectly resulting from, or in consequence of, or in any way involving any oral or written contract or agreement.

In other words, any time a lawsuit comes within 100 miles of a contractual dispute, the insurer will probably cry, "contract exclusion."  In this case, it's not even close.  The landlord's suit for breach of lease clearly falls within the contract exclusion. 

Second, the policy excludes any claims against any insured "by, on behalf of, or in the right of the Insured Entity, or by any Directors or Officers."  James Sowell was a director as well as a shareholder of DSG.  Therefore, his suit against DSG and other directors clearly fell within the "insured-vs-insured" exclusion, even though the policy carved out (and so covered) shareholder derivative actions.  The carveout applied only if the derivative action was instigated and continued totally independent of, and totally without the active participation of another insured.  Because Sowell was an insured director and instigated and drove the derivative action, the claim was excluded.

These claims were rightly denied.  D&O insurance is crafted to avoid covering internal company squabbles or situations like this, in which one affiliate makes a mistake that costs the enterprise a great deal of money, so the insureds seek to recover the loss by initiating litigation hoping the loss will be covered as an insured liability.  Often, however, exclusions that hit everything "arising out of " this or that are over-inclusive.  Take the litigation mess we are beginning to see from the subprime mortgage fiasco.  Shareholders with arguably legitimate claims for financial institution mismanagement bring derivative or direct actions, pointing perhaps to a misrepresentation in an SEC filing.  Should D&O coverage for that kind of claim be excluded because back down the line the whole thing started with a mortgage contract? 

I doubt D&O insurers would even try to make that case, but the message here for risk managers is to be aware of the unintended reach "arising out of" exclusions can have.

D&O Insurance Rates Expected To Hold Steady Except For Financial Institutions

Because shareholder actions are expected to proliferate against finacial institutions caught in the subprime mortgage debacle, it should come as no surprise that premiums for directors and officers insurance for those institutions are beginning to rise.  So says Kristin Gunderson Hunt in an article in "Business Insurance."  See D&O Rates on the Rise.  In the past month, D&O rates have climbed 5% to 10% for fincancial institutions.  For companies in other industries, rates may have stopped declining as in the past three or four years, but they do not appear to be rising.

 The number of such lawsuits and the nature of the allegations asserted by shareholders and investors remains to be seen.  From what is already known, however, the class-action plaintiffs bar will have much to work with: incredibly lax mortgage underwriting procedures, bogus or baseless valuations of impossibly complex securities, overly rosy projections, tardy disclosures, blind-leading-the-blind investment strategies --- it won't be pretty.  Perhaps we will not see as much dirty fraud as in the Enron case, but early indications portend an industry-wide recklessness not seen since the captain of the Exxon Valdez lumbered through Prince William Sound.

However, reports Ms Hunt, companies not subject to these lawsuits should have little trouble obtaining D&O coverage at no worse than expiring rates.

Unjustified Severance To Departing Officer Is Uninsurable Disgorement, Says Houston Federal Court

National Union Ins. Co. of Pittsburgh v. U.S. Bank and John Stanley, # 4:07-CV-1958 (S. D. Tex., June 11, 2008)

Because Texas courts rarely have the opportunity to interpret directors and officers (D&O) insurance policies, the U.S. Bank decision is worth a look.  This case concerns D&O coverage, or lack of it, when an insured officer of a failing company was forced to disgorge his $2.27 million severance payment in a bankruptcy proceeding (the company was insolvent at the time), even though the severance had been approved by the board of directors.  The defendant officer sought reimbursement from his D&O insurer.  However, the insurer denied coverage arguing that covered "loss" did not include (1) matters uninsurable under the law, or (2) profit or advantage to which the insured was not legally entitled.  Disgorgement, said the insurer, is both uninsurable and an justified profit.

By the way, the distinction between loss or damage on the one hand and disgorgement or restitution on the other is a hotly contested insurance issue across many jurisdictions and many lines of insurance, not just D&O.  If the insured is simply giving back what it had no right to receive in the first place, then insurance shouldn't provide a windfall to the insured.  But it is not always easy to tell the difference between money damages and disgorgement of money.

In this case, U.S. Bank was in trouble long before the current D&O insurer, National Union, came on the scene.  The bank went through bankruptcy in 1999, and was back in business in 2000 under a reorganization plan that put John Stanley in the driver's seat as CEO for at least three years.  The plan provided for a severance payment of varying amounts depending on whether or not termination was for cause.  The bank continued to fare poorly.  In 2002, the board determined to exercise the termination option.  After tough negotiations (in which Stanley threatened to drag the bank through litigation if he did not get favorable severance terms), Stanley agreed to resign, and the board agreed to characterize his resignation as "termination without cause," allowing Stanley to receive up to $3 million severance.  If he reigned, he got no severance.

Back to bankruptcy court.  The bank was insolvent at the time severance payments were made to Stanley, and the liquidating trustee (curtains for U.S. Bank) sought to recover the payment as an avoidable preference and a fraudulent transfer.  In an adversary action, the bankruptcy court found that Stanley was a bank insider during negotiations of his severance, that he in fact resigned, and thus was entitled to no severance.

Stanley sued National Union for indemnity of the disgorged severance arguing that he incurred a covered loss under the D&O policy.  Stanley argued that he had a clear contractual right to the severance.  He was not giving back that to which he had no right.  Wrong, said the court.  The underlying adversary action determined that he had no contractual right because he resigned voluntarily.  The board action characterizing the resignation as termination for cause was done under threat of litigation and thus was a sham transaction. 

Accordingly, said the court, the payment was both an uninsurable disgorgement and a profit or advantage to which Stanley had no legal right.  Summary judgment for National Union granted.  Case dismissed.

In view of the lower court's determination that Stanley had no contractual right to the severance, this is an easy case for the district court.  However, as mentioned above, it is not always so easy to distinguish loss from disgorgement.  In many transactions, after money has changed hands or securities have been bought and sold, what seems to be loss or damage to the allegedly injured plaintiff can also be called unjust enrichment to the defendant.  So, is the plaintiff recovering damages, or is the defendant disgorging ill gotten gain?  Policyholders should be aware that insurers press the later position frequently and vigorously.

Pollution Exclusion in D&O Insurance Policy Should Not Completely Bar Shareholder Securities Claim, Says Canadian Court

Boliden Ltd. vs Liberty Mutual Ins. Co., 85 O.R. (3d) 492 (Ontario Superior Court of Justice, April 1, 2008) see Boliden Decision

Several years ago, a federal appeals court sent shivers through many American boardrooms by ruling that a securities lawsuit, brought derivatively by shareholders over alleged misrepresentations in SEC filings, was not covered due to a pollution exclusion in a Directors & Officers (D&O) insurance policy.  It seems that the alleged misrepresentations concerned management's failure to report certain fines and costs for a subsidiary's mishandling of waste (the company was in the waste-hauling business), and the exclusion applied to any claims "arising out of pollution [including waste])."  See National Union Fire Ins.Co. v. U.S. Liquids, Inc., 88 Fed. Appx. 725 (5th Cir. 2004).

U.S. Liquids never expected its D&O insurer to cover pollution lawsuits or clean up costs, but it was shocked to learn that it had no coverage for shareholder securities actions simply because the remote subject of alleged SEC misstatements related to operations that related to pollutants.  Foul!

In a case of first impression in Canada, the Boliden court reached the opposite conclusion, at least in part.  The facts are substantially similar to those in U.S. Liquids.  A Spanish subsidiary owned a mine which flooded large tracts of land with contaminated tailings after a dam failed.  Boliden's shares plummeted, and shareholders sued the company alleging misrepresentations in a Prospectus issued a year before the disaster in an initial public offering.  The D&O insurer refused to cover the claims relying on the pollution exclusion ("[Insurer] shall not be liable under this policy to make any payment for loss respecting a claim . . . for or in respect of pollution loss.")

Boliden argued that the loss in question was the drop in value of its shares, not the damage to land and rivers in Spain.  Insurer said the loss in value of shares was caused by the discharge of pollutants and so fell within the exclusion.  Liberty also pointed to U.S. Liquids and other American cases.  However, the Canadian court noted that the American cases applied very broad "but for" causation, which Canadian courts do not accept.

Finding little helpful guidance from Canadian cases discussing causal language (such as "arising out of," "attributable to," and resulting from"), the Court made its own analysis and determined that some of the allegations did not sufficiently involve pollution, though some did.  For reasons not fully explained, the court held that allegations regarding construction defects and poor maintenance of the dam were not excluded, but other allegations were excluded.  The policy contained an allocation clause requiring Liberty to pay 80% of the defense costs where claims involved both covered and uncovered claims.  Accordingly, the court required Liberty to cover 80% of the loss.

Although the result is a victory for the policyholder, the holding may offer little useful guidance if the issue arises again in Canadian jurisprudence.  The court's analysis is very fact-specific.  The best advice to policyholders is to get enhancements to the pollution exclusion before experiencing a loss.  Most D&O insurers are willing to carve out from the exclusion shareholder derivative actions or claims against individual insureds.  The D&O market is still soft, and underwriters are generally in an accommodating frame of mind.  The best way to fix questionable policy language is before a claim is asserted.

Federal Courts Reach Opposite Results Over Scope of Insured vs Insured Exclusion in D&O Policies

Home Federal Sav. & Loan Ass'n v. Federal Ins. Co., No. 06-CV-3053 (N.D. Ohio, September 14, 2007); 

 

Westechester Fire Ins. Co. v. Wallerich, No. 07-2145 (D. Minn., September 25, 2007)

 

These two Federal District Courts reached opposite results on whether an "insured vs. insured" (IvI) exclusion in a directors & officers (D&O) liability insurance policy excludes all coverage for the entire lawsuit when only one of several plaintiffs is an insured under the policy.  (As the name implies, the IvI excludes any “Claim” brought or maintained by any insured).  The Minnesota court held that because the policy defined “Claim” as “a civil proceeding . . .,” the exclusion should apply to the entire lawsuit, not just to the insured’s claim.

 

The Ohio court held that the exclusion applied only to the insured plaintiff's claim and allowed coverage for the claims asserted by the other plaintiffs, because the term “Claim” could refer to separate civil proceedings had each plaintiff filed its own lawsuit.  Therefore each plaintiff’s claim is separable.

 

Also, the Ohio court held that “Claim” may be ambiguous because the term is used elsewhere in the policy to refer to the allegations asserted, not the civil proceeding as a whole.  Specifically, the Ohio court looked at the policy’s defense-cost-allocation clause that pre-sets the percentage of total defense costs the insurer will pay when a lawsuit alleges both covered and uncovered “claims.”  Therefore, the insured’s Claim may be separated from the other Claims and excluded without excluding the other Claims.

 

Apparently, neither policyholder argued that the Claims should be separated because the definition of ”Claim” includes more than just “a civil proceeding, . . .”  Most D&O policies include “a written demand for monetary or non-monetary relief” as a “Claim.”  Accordingly, any case that was preceded by several demand letters, as often happens, began with several “Claims.”  Arguably, most courts would be reluctant to accept an interpretation of the term that allowed a different result depending on whether the demand letter or the civil action was used as the operative “Claim,” or whether the plaintiffs wrote separate demand letters. 

 

The Minnesota court may have reached its decision based on the fact that the plaintiffs were husband and wife, and the wife had nothing really to do with the company other than to receive assets in the marital estate.  In other words, the lion’s share of the “Claim” was against the insured husband.  In the Ohio case, by contrast, the insured plaintiff was one of many shareholders suing the company.

Analysts Predict SEC Will Require Corporate Disclosures of Global Warming Risks

In mid September, a number of state pension funds, treasurers, attorneys general, and interested organizations petitioned the US Securities and Exchange Commission (SEC) to issue an interpretive release clarifying that material climate-related information must be included in corporate disclosures under existing law.  See SEC Petition for Interpretive Guidance.  Earlier this month, the Kiplinger Report stated that the SEC would issue such guidelines under pressure from investor groups, who want to know the companies most at risk for future climate-change lawsuits and what they are doing to reduce carbon emissions.  See Kiplinger Report on SEC Disclosures.  Other analysts have echoed that prediction.

Risk from global warming is, of course, a huge potential insurance nightmare (or opportunity), both from a property/casualty standpoint and that of corporate governance.  Insurance companies themselves may be targeted for failing to disclose foreseeable environmental risks.  SEC action could exacerbate the risk potential.  One of the last times the SEC issued a bombshell interpretive-guidance release was after Enron when the agency announced that disclosure of off-balance-sheet transactions had always been material information under existing law (leaving the plaintiff's bar to infer that corporations that had failed to make such disclosures were potentially liable). 

What will happen to companies that did not disclose climate-impact information in their 2007 disclosures but do so in a big way in 2008?  If 2008 witnesses a recession, then unhappy shareholders may put the blame for sliding stock prices on failures to disclose environmental risk factors, whether this is justified or not.  Either way, the increase in securities lawsuits almost certain to follow will test the softening D&O insurance market.  Interesting times lie ahead.

Justices Impose Greater Burden on Investors in Securities Fraud Actions

The United States Supreme Court ruled yesterday that investors suing companies and their directors for securities fraud should not be permitted to proceed with their action unless they can "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," which the law defines as "the intention to deceive, manipulate or defraud" (generally called "scienter," Latin for "knowingly" or degree of intentionality).  In the Private Securities Litigation Reform Act of 1995, Congress required the showing of a "strong inference" of scienter but provided no guidance to the courts as to what that means.

In this action. investors sued Tellabs, Inc. and its CEO for allegedly overstating revenue projections.  The lower court had held that the suit should be allowed to go forward if a "reasonable person" could infer that the person acted with the required intent.  Speaking for the 8-1 majority of the high court, Ruth Bader Ginsburg rejected this standard and held that “The inference of scienter must be more than merely ‘reasonable’ or ‘permissible’ — it must be cogent and compelling, thus strong in light of other explanations.”   The lone dissenter, John Paul Stevens, said that he would require "probable cause," the standard required in a criminal indictment, arguing that Congress would not placed a high burden on a plaintiff in a civil action than is required of the state in a criminal proceeding. 

This decision is seen as a significant victory for public companies.  For a fuller description of the Tellabs decision, see N.Y. Times article.