How To Get Out Of A Liability Claim For A Wrongful Act By An Insurance Company

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1 Three Courts Look At Interrelated Wrongful Acts By: Robert S. Fraser and Gavin J. Curley Three cases decided this year in three different jurisdictions focus on the critical coverage determination of whether claims filed during a policy period were excluded from coverage because they were related to claims filed prior to that policy period. Two of the cases found that wrongful acts were interrelated where the issue was whether coverage was provided under a renewal tower or by implication to the prior tower. The third case found there was a fact question as to whether the relationships were sufficiently substantial to determine at the pleading stage that the claims were related. In SP Syntax LLC v. National Union Fire Insurance Company of Pittsburgh, Pa., CV (Ariz. Sup. Ct. Maricopa Cnty June 28, 2012), the question presented was whether a specific event exclusion, contained in the primary and first two excess policies, and/or the standard prior notice exclusion, contained in two excess Side A policies, applied to preclude coverage for cases filed in the policy year because of an earlier securities case reported during the immediately preceding policy year. With respect to the standard prior notice exclusion, the court held that the language raised a question of fact requiring extrinsic evidence and denied the motion of the Side A carriers. However, the Court found that because of its broad interrelated acts language, the specific event exclusion applied to preclude under the policy year and granted the motion of the primary and first two excess carriers. In November, 2007, equity investors in Syntax-Brillian Corporation ( SBC ) filed the Tsirekidze action against SBC and certain of its directors and officers ( D&Os ) alleging the defendants misrepresented SBC s financial condition to induce plaintiffs equity investment in SBC. The D&Os submitted the Tsirekidze action for coverage under the policies in effect at that time. In 2008 during the pendency of the policies, SP Syntax LLC filed a lawsuit against certain D&Os in connection with a credit facility agreement ( CFA ) of SBC for a $150 million term loan and a $100 million revolving loan (the Silver Point Action ). The basis of the Silver Point Action was alleged fraudulent statements in the procurement of the loans, including the financial statements that were the subject of the Tsirekidze action. The carriers denied coverage under the policy year on the basis that the Silver Point Action was related to the Tsirekidze action. Subsequently, the D&Os settled with the plaintiffs on a non-recourse basis and assigned their rights against the carriers to the plaintiffs who brought the lawsuit against the insured. The primary policy issued by National Union Fire Insurance Company of Pittsburgh, Pa., contained a standard prior notice provision which said [t]he Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured alleging, arising out of, based upon or attributable to the facts alleged, or to the same or related Wrongful Acts alleged or contained in any Claim which has been reported, or in any circumstances of which notice has been given, under any policy of which this policy is a renewal or replacement or which it may succeed in time. The primary policy also contained a specific event exclusion that applied to claims alleging, arising out of, based upon, attributable to or in any way related directly or indirectly, in part or in whole to an Interrelated Wrongful Act regardless of whether or not such Claim involved the same or different Insureds, the same or different legal causes of action or the same or different claimants or is brought in the same or different venue or resolved in the same of different forum. The endorsement defined an Interrelated Wrongful Act as any fact, circumstance, act or omission alleged in or any Wrongful Act which is the same as, similar or related to or a repetition of any Wrongful Act alleged in the Tsirekidze action. The endorsement also broadly excluded coverage for loss in connection with restatements or revisions of the insured s to SEC filings.

2 The Court determined that the plaintiff in the Silver Point Action pled these wrongful acts as being part of a wrongful course of conduct. Judge J. Richard Gama continued, [w]rongful acts are the same or at least related if they are tied together by a course of conduct aimed at a single particular goal. Upon finding this connection between the Silver Point Action and the Tsirekidze action, he found that coverage was excluded under the specific event exclusion which was contained only in the National Union primary policy and the first and second excess policies. The Side A/DIC policies did not contain the specific event endorsement found in the primary policy which made reference to the Tsirekidze action, but rather contained only a standard prior notice exclusion. The Court however indicated that the plaintiffs and the Side A/DIC carriers were free to argue the issue of whether these policies should drop down on a motion for summary judgment after discovery. The principal differences in the two exclusions was the reference in the standard exclusion to the facts alleged in the prior claim whereas the specific event exclusion referred to in whole or in part and any fact, circumstance, act or omission or any Wrongful Act. XL Specialty Insurance Co. v. Michael Perry, 11-cv-2078 (C.D. Cal. June 27, 2012) involved an action for a declaratory judgment brought by the carriers against former officers and directors of IndyMac Bank ( IndyMac ), which was in receivership and/or its holding company, IndyMac Bancorp, Inc. ( Bancorp ), which was in bankruptcy. At issue was coverage for ten lawsuits and matters (the Underlying Actions ) under a tower of insurance with eight $10 million layers. The Underlying Actions generally concerned IndyMac s failure to follow underwriting standards in making loans, and one lawsuit contains allegations of breach of corporate fiduciary duties in connection with the downstreaming of funds from Bancorp to IndyMac. The policies at issue contained limitations on interrelated wrongful acts, prior notice exclusions, and exclusions for the acts alleged in the Tripp litigation, which had been noticed to the carriers prior to the policy year. Defendants argued that these provisions were ambiguous and, therefore, should not be the basis for denying coverage. Judge R. Gary Klausner found no ambiguity in the following clauses and granted the insurers motions for summary judgment on the basis that one or more of the following exclusions precluded coverage for each of the Underlying Actions: Interrelated Wrongful Act Limitation wrongful acts which have as a common nexus any fact, circumstance, situation, event, transaction or series of facts, circumstances, situations, events or transactions and any wrongful act based on, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any of the same or related, or series of related, facts, circumstances, situations, transactions, or events. Prior Notice Exclusions any payment in connection with a claim based upon [sic] arising out of, directly or indirectly resulting from or in consequence of, or in any way involving: 1) any wrongful act or any fact, circumstance or situation which was been the subject of any notice given prior to the policy period. and based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any fact, circumstance or situation, transaction event or wrongful act which, before the inception date of this policy was the subject of notice given under any other Directors and Officers insurance... 2

3 Tripp Litigation Exclusion no coverage shall be available under this policy for any claim based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving the following: 1) the [Tripp Litigation]; or 2) any fact, circumstance, situation, event, transaction or series of facts, circumstances, situations, events or transactions underlying or alleged in the Tripp Litigation, regardless of any legal theory upon which such claim is predicated. As in the case of the specific exclusion in SP Syntax, these provisions referred to any wrongful act or any fact, circumstance situation or event. Judge Klausner described the Tripp litigation as a class action securities lawsuit alleging that IndyMac ignored its own underwriting standards when originating loans, issued a substantial number of high risk loans in order to increase IndyMac s loan volume, quickly sold these high risk loans-either outright or through securitization transactions-and falsely portrayed the financial stability and health of IndyMac though SEC filings. The judge then gave the following reasons for excluding the following of the Underlying Actions from coverage - 1. FDIC Demand and FDIC Litigation the FDIC had issued a letter indicating its intent to file a lawsuit against IndyMac s officers and directors for issuing loans that did not meet the company s underwriting standards. The FDIC also sued Michael Perry for negligence in the issuance and securitization of high risk mortgages. Judge Klausner found facts, circumstances, situations, events, or transactions in common with the Tripp litigation, as well as the application of the interrelated wrongful acts limitation. 2. FDIC-HBD Matter this matter focused on the actions of the Home Builders Division of IndyMac, and Judge Klausner found that this Division approved loans in violation of IndyMac s underwriting standards, thereby creating a connection to the Tripp litigation. 3. Trustee Demand and Trustee Litigation the trustee for the directors first sent a demand letter to Michael Perry, then sued him for breach of fiduciary duties in connection with a decision by directors and officers to downstream funds from Bancorp to IndyMac. Judge Klausner continued, these claims directly result from the financial situation facing IndyMac as a result of the wrongful mortgage practices that are at the heart of the Tripp litigation. 4. MBIA Litigation and Assured Guaranty the allegations in this case were that the defendants did not follow underwriting standards and did not disclose that the mortgages that were part of the securitization were high risk. The Court found that these allegations have the same factual basis as those in the Tripp litigation. and 3

4 5. SEC Litigation this was an enforcement action brought against defendants Perry and Keys for allegedly making false representations concerning IndyMac s financial condition in SEC filings. Judge Klausner observed that the wrongs alleged in the SEC Litigation directly resulted from IndyMac s decision to abandon its underwriting practices and guidelines and [t]he risky mortgages put IndyMac in a perilous financial condition. Thereupon he had no trouble connecting the SEC Litigation with the Tripp litigation. In Ciena Capital LLC (f/k/a Business Loan Express LLC) v. XL Specialty Insurance Co. and Indian Harbor Insurance Co., No /2010 (N.Y. Sup. Ct. Mar. 26, 2012), the defendant sister insurance carriers, XL Specialty Insurance Co. and Indian Harbor Insurance Co. (together, XL ) moved to dismiss the action for breach of contract and declaratory relief based on Pending and Prior Proceedings Exclusions in the XL policies with a date of May 31, The policy of XL Specialty Insurance Co. provides, in pertinent part, as follows - The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured Person, or with respect to INSURING AGREEMENT (C), the Company based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any fact, circumstance, situation, transaction, event or Wrongful Act, Company Wrongful Act or Employment Practices Wrongful Act underlying or alleged in any prior and/or pending litigation or administrative or regulatory proceeding or arbitration which was brought prior to the Pending and Prior Litigation Date set forth in ITEM 6 of the Declarations and the policy of Indian Harbor Insurance Co. contained a similar provision which referred to investigations as well as regulatory proceedings. The insured sought coverage for a qui tam action styled United States of America ex rel. Brickman v. Business Loan Express, LLC, et al. (the Brickman Action ), which was filed under seal on December 28, 2004 in the United States District Court for the Northern District of Georgia. 2 The Brickman Action involved the small business lending activities of Ciena s predecessor Business Loan Express ( BLX ), and the allegations related to activities allegedly undertaken while BLX participated as a lender in the Preferred Lender Program ( PLP ), pursuant to which the United States Small Business Administration ( SBA ) guaranteed certain loans issued by BLX against default. The Brickman Action contended that BLX, its owner, Allied Capital, and six BLX employees engaged in fraudulent lending practices in connection with specific loans issued in Georgia, Michigan, New York, and Virginia pursuant to which BLX submitted false claims to the government in violation of the United States False Claims Act. XL contended that the Brickman Action was related to three other matters pending prior to May 31, 2007 (the operative date of XL s Pending and Prior Proceedings Exclusions) involving BLX s alleged fraudulent lending practices in connection with SBA guaranteed loans (the Other Proceedings ). The Other Proceedings included: (i) investigations into BLX s lending practices by the United States Securities and Exchange Commission and the United States Department of Justice; (ii) an indictment of BLX Executive Vice President Patrick Harrington for his alleged involvement in the fraudulent origination of seventy-six SBA-guaranteed loans at a BLX office in Michigan; and (iii) a separate qui tam action which was filed by the same relators in the Brickman Action, which asserted that BLX, through its subsidiary and certain employees, committed loan fraud with respect to loans made to Gulf Coast shrimping business as a part of the SBA s General Purpose Lender Program. XL denied coverage for the Brickman Action on the theory that it arose out of or was based on some of the same facts and 4

5 circumstances or Wrongful Acts in the Other Proceedings and, therefore, should be excluded by the Pending and Prior Proceeding Exclusion. Despite the broad language of the exclusions which referred to any facts, circumstances, transactions or Wrongful Acts, Judge Eileen Bransten denied the motion to dismiss on the basis that there was an issue of fact as to whether the Other Proceedings bore a substantial enough relationship to the Brickman Action, particularly because the specific loans at issue in the Brickman Action were not mentioned in any of the documentary evidence submitted by XL with respect to the Other Proceedings, including to the government investigations. Additionally, although the Harrington indictment pertained to BLX loans issued in Michigan, Judge Bransten found the indictment did not have a substantial relation to the Brickman Action because: (i) Mr. Harrington purportedly claimed that he did not have evidence to implicate BLX or its management when he was provided the opportunity by the government to receive a sizable reduction in his prison sentence; and (ii) Mr. Harrington was not named as a defendant in the Brickman Action. Finally, Judge Bransten found that there was not a sufficient factual nexus between the fraudulent procurement of the loans under the SBA s General Purpose Lender Program and the Brickman Action (which pertained to PLP loans). Although this case involved the broader language in the exclusion, the court was not presented with the issue of allocating the claims among two towers as in the other decisions discussed above. XL is appealing the decision. Mr. Fraser is a partner at D Amato & Lynch, LLP. His practice concentrates principally on employee benefit plan fiduciary liability and professional liability insurance coverage and representation. RSFraser@DAmato-Lynch.com Mr. Curley is a partner at D Amato & Lynch, LLP. His practice focuses on corporate, banking and financial representation, as well as directors and officers, and other professional liability, insurance coverage. GCurley@DAmato-Lynch.com 1 XL also moved to dismiss based on a General E&O Exclusion contained in the Management Liability Policy. This argument was also rejected by the court on the basis that the exclusion was ambiguous because it did not define the term services. 2 A copy of the complaint was not provided to Ciena until September 28, Although the Brickman Action remained under seal at all times relevant to the decision discussed above, it should be noted that Ciena received permission from the United States Attorney s office to disclose the existence of the action to the carriers. Both the providing of the complaint to Ciena by the government and the subsequent disclosure of same to the carriers occurred during the term of the carriers respective claims made and reported policies. FROM THE D AMATO & LYNCH, LLP SUMMER 2012 NEWSLETTER 5