Insurance Coverage for the Economic Crisis:

Transcription

1 Co-Sponsored by: Insurance Coverage for the Economic Crisis: Hedging Your Financial Losses Steve Gilford, Proskauer Rose LLP Marc Rosenthal, Proskauer Rose LLP Jeff Nielsen, Navigant Consulting, Inc. John Failla, Proskauer Rose LLP

2 Topics & Panelists Litigation from Financial Crisis Insurance Coverage for Key Exposures Notice and Renewal Issues Proactive Approach to Policies Steve Gilford Marc Rosenthal Jeff Nielsen John Failla 1

3 2 Litigation from Financial Crisis

4 3 Litigation from Financial Crisis

5 4 Litigation from Financial Crisis

6 Availability of Coverage Many of the exposures inherent in litigation from financial crisis are covered by insurance Historic coverage may be relevant Claims made (D&O/E&O/EPL) vs. occurrence (CGL) vs. discovery (Fidelity/Crime) Need to review carefully and creatively The factual allegations are more important than the captions on the counts or complaints 5

7 Co-Sponsored by: Category #1: Borrowers Class Actions

8 7 Category #1: Borrowers Class Actions

9 Category #1: Borrowers Class Actions Geneva M. Spicer, et al. v. IndyMac Bank, FSB, et al. U.S. District Court, Central District of California (Case No. CV AHS) Date filed: May 25, 2007 General allegation(s): Alleges IndyMac failed to disclose material information related to option ARMs, concealing that the loan repayment schedule was designed to result in negative amortization Claim(s): TILA, 15 U.S.C.A & 12 C.F.R. 226 California Business & Professions Code California Business & Professions Code Breach of contract Breach of the implied covenant of good faith and fair dealing California Financial Code

10 Category #1: Borrowers Class Actions Time period at issue: June 1, 2003 May 31, 2007 Status: Order granting substitution of FDIC as receiver on August 19, 2008 Stayed until April 13, 2009 Two types of coverage potentially applicable Errors & Omissions ( E&O ) Comprehensive General Liability ( CGL ) 9

11 Category #1: Borrowers Class Actions E&O insurance Covers professional negligence of a lender (bankers, mortgage company or broker) Indemnity for claims made during the policy period against the insured for wrongful act in professional capacity Claims made coverage Wrongful acts broadly defined any act, failure to act, error, omission, breach of contract or duty or libel or slander committed or allegedly committed in the insured s professional capacity Generally will not cover ministerial acts Covers intentional acts, but not intentional harm 10

12 Category #1: Borrowers Class Actions Key E&O exclusions Fraud Typically applies only on final adjudication This policy excludes any Claim alleging the fraud or dishonesty of any Insured, if a final judgment or other final adjudication shall establish, or the Insured shall admit in writing, that such fraud or dishonesty was committed Return of fees This Policy excludes claims for return, withdrawal or reduction of fees Difficult issues about what is return of fees and what is damages 11

13 Category #1: Borrowers Class Actions RESPA cases for failure to properly disclose fees Insurer claimed return of fees not covered Court held return of fees was part of compensatory damage arising from insured s breach of fiduciary duty and therefore covered For vs. arising out of Language in exclusion may determine whether negligence or derivative liability claims are excluded 12

14 Category #1: Borrowers Class Actions CGL Occurrence based so may reach back in time Triggered by time of the act Not date of claim or discovery CGL policies are generally limited to coverage for liability due to bodily injury, property damage, personal injury or advertising injury These cases do not involve bodily injury or property damage 13

15 Category #1: Borrowers Class Actions Advertising injury under CGL policy Must be advertising Some cases require injury to a competitor Most modern forms limit coverage to copyright and trademark infringement or misappropriation of advertising idea Some policies are not so limited and may cover liability for falsehoods in advertising Personal injury Some CGL policies, particularly older ones, include coverage for discrimination as part of personal injury 14

16 Category #1: Borrowers Class Actions For example: Personal Injury means injury covered by an offense of: False arrest, false detention or other false imprisonment Malicious prosecution Wrongful entry, wrongful eviction or other violation of a person s right to private occupancy Electronic, oral or written publication of material that libels or slanders a person or violates a person s right of privacy Discrimination, harassment or segregation based on a person s age, color, national origin, race, religion or sex 15

17 Category #1: Borrowers Class Actions Case law is mixed as to whether such references to discrimination extend beyond discrimination based on race, religion, gender, etc., particularly in employment context Majority of cases are limited Some discriminatory lending practice claims include protective class Some cases find coverage for price discrimination or discrimination in home maintenance under Fair Housing Act Courts find that discrimination merely means differential treatment 16

18 Category #1: Borrowers Class Actions Duty to defend Advantage of CGL policy is that it often includes duty to defend E&O may or may not Duty to defend is normally based on allegations of complaint Claim only needs to be potentially covered If duty to defend, it normally extends to whole case even if some claims are not covered Where there is a duty to defend, issuance of reservation of rights creates conflict between insurer and insured Under the circumstances, in most states, insured can pick counsel and control defense at insurer s expense 17

19 Co-Sponsored by: Category #2: Securities (D&O) Claims

20 19 Category #2: Securities (D&O) Claims

21 Category #2: Securities (D&O) Claims New York State Teachers Retirement System, et al. v. New Century Financial Corporation, et al. U.S. District Court, Central District of California (CV DDP) Date filed: February 8, 2007 General allegation(s): Plaintiffs (purchasers of various New Century securities) allege GAAP violations related to loan loss allowances, repurchase reserves, among others, related to the company s whole loan sales and securitizations. Claim(s): 33 Act 11, Act 10(b) & Rule 10b-5, 20(a) Time period at issue: May 5, 2005 March 13, 2007 Status: Motions to dismiss and strike denied on December 3,

22 Category #2: Securities (D&O) Claims Key sources of insurance coverage: Directors & Officers Liability E&O Investment Advisor Professional Liability Directors & Officers liability insurance Protects directors and officers against claims for loss arising from actual or alleged wrongful acts done in their role as directors or officers Public Company D&O often covers Securities Claims against the Company as well as numerous types of claims against the individuals Private Company D&O often covers a wider variety of claims against both the entity and the individuals Not all policies contain Entity coverage 21

23 Category #2: Securities (D&O) Claims Although most D&O policies contain similar general provisions, their language varies greatly and manuscripting and revisions are both possible and very productive Even what appear to be small and technical language changes often pay enormous dividends in obtaining payment D&O exclusions of concern Fraudulent, dishonest, willfully illegal conduct Often requires final adjudication as discussed above Personal profit to which insured is not entitled Critical language distinction in fact vs. final adjudication Professional services or E&O exclusions For or arising out of predicate is key 22

24 Category #2: Securities (D&O) Claims D&O coverage should address most of the securities lawsuits arising from the financial crisis Stock drop cases Alleged misrepresentations about asset quality, exposure to risk Failed deals, financing issues, alleged broken investment promises or commitments Three important points to consider at the outset Quality and extent of coverage for securities claims Investigation, criminal and regulatory coverage Defense coverage and the duty to defend 23

25 Category #2: Securities (D&O) Claims Quality and extent of coverage for securities claims Two common but alternative formulations in D&O policies Coverage only for claims involving securities issued by the insured company Restrictive coverage fine for stock drop cases or claims involving misrepresentations or omissions involving insured company securities Policies with this formulation will exclude coverage for broader securities claim risks Coverage for claims that involve any violations of securities laws or regulations Broken deal, financing, investment cases covered Example: Apollo Hexion Huntsman Litigation 24

26 Category #2: Securities (D&O) Claims Investigation, criminal and regulatory coverage Common misconception that coverage is limited or unavailable Key is to ensure that coverage applies as early in the investigatory process as possible Significant costs often incurred in early stages Common policy provisions contain important nuances Most restrictive Formal administrative, criminal or regulatory proceeding Formal administrative, regulatory, or criminal investigation Can be triggered by subpoena, formal order of investigation, notice of charges, or Wells notice substantial differences Formal or informal regulatory investigations or inquiries Wells notices 25

27 Category #2: Securities (D&O) Claims Defense coverage and the duty to defend Standard provisions are not optimal for policyholders No duty for insurer to assume defense Sometimes no obligation to advance or reimburse costs as incurred Obligation of D&Os to return advanced defense costs if ultimately determined no coverage exists Unfavorable allocation provisions Positive developments for policyholders Language enhancements provide for contemporaneous advancement or reimbursement Neutral allocation language 26

28 Category #2: Securities (D&O) Claims Advancement or reimbursement decided on same standard as duty to defend Based on allegations of complaint No need to wait until case concluded Claim only needs to be potentially covered If duty to defend, it normally extends to whole case even if some claims are not covered Injunctive relief available to compel insurers to advance 27

29 Category #2: Securities (D&O) Claims New York Insurance Department Office of General Counsel Opinion No (October 16, 2008) Unlawful under New York law for D & O insurers to issue policies that impose the duty to defend on policyholders instead of insurers Unlawful to impose allocation provisions that restrict insurers duty to defend the entire case if an allegation potentially triggers coverage for a portion of the case Applies to sophisticated policyholders Positive implications for policy negotiation and claims handling Caution required to ensure control of the defense 28

30 Category #2: Securities (D&O) Claims Investment management liability coverage Mutual fund complex, private funds, private equity, hedge funds, venture capital Auction rate securities, money funds, investor claims challenging disclosure, risk, investment decisions Broad D&O, E&O coverage Key issues involve program structure (combined or separate funds-only coverage) and limits adequacy 29

31 Co-Sponsored by: Category #3: Contract Claims

32 Category 3: Contract Claims MBIA Insurance Corporation v. Countrywide Home Loans, Inc., et al. Supreme Court of the State of New York (Case No ) Date filed: September 30, 2008 General allegation(s): Countrywide breached certain representations and warranties related to home equity loans sold into securitizations for which MBIA provided credit enhancement. Countrywide subsequently refused to repurchase said loans. 31

33 Category 3: Contract Claims MBIA Insurance Corporation v. Countrywide Home Loans, Inc., et al. Supreme Court of the State of New York (Case No ) (cont d) Claim(s): Fraud Negligent misrepresentation Breach of contract insurance agreement Breach of contract sale and servicing agreement Breach of implied duty of good faith & fair dealing Indemnification Time period at issue: Status: Active 32

34 Category 3: Contract Claims E&O coverage Contractual liability exclusion Exclusion often does not apply if the policyholder would face similar liability in the absence of the contract provision e.g., negligent misrepresentation and contract Duty to defend valuable 33

35 Category 3: Contract Claims Fidelity bond or crime coverage Not limited to embezzlement Often broad coverage extensions in endorsements Endorsements covering losses for mortgage securitization or mortgage pooling and other financial instruments Often covers losses due to forgery or alteration Broader coverage where payor signature obtained through trick, fraud or false pretenses or where mortgage note is for any other reason illegal, invalid, non binding or not enforceable in accordance with its terms. Discovery trigger and strict notice, proof of loss and suit limitation clauses 34

36 Co-Sponsored by: Category #4: Employee Action

37 Category 4: Employee Action Michele Viera, et al. v. Accredited Home Lenders Inc. et al. U.S. District Court, Western District of Texas (Case No. A07CA71988) Date filed: 8/24/2007 General allegation(s): Accredited Home Lenders Inc. failed to give at least 60 days advance notice prior to terminating former employees without cause. Subsequently, said employees failed to receive wages and other employee fringe benefits for a 60-day period following their respective terminations. Claim(s): WARN Act 2101 Time period at issue: August 10-22, 2007 Status: Class certified on April 15,

38 Category 4: Employee Action CGL and D&O policies often exclude employment related claims EPL policies Typically claims made, regardless of when conduct or injury took place Covers discrimination, harassment, wrongful termination, wrongful failure to hire or promote and other wrongs arising from the employment context Generally includes a laundry list of offenses Typically includes duty to defend 37

39 Important EPL exclusions ERISA and benefits claims Claim may include wrongful termination as well as mishandling of ERISA benefits plan ERISA claims would be covered by ERISA fiduciary liability policy Fines, penalties and injunctive relief Intentional acts Category 4: Employee Action Claims of discrimination, sexual harassment and wrongful termination are frequently based on intentional acts General rule is that a liability policy covers unintended results of intentional acts Not really an intentional acts exclusion but, rather, an intentional harm exclusion Intent to harm will not necessarily be inferred in discrimination and harassment type claims 38

40 Co-Sponsored by: Category #5: Bankruptcy Claims

41 Category 5: Bankruptcy Claims Mortgage Lenders Network USA, Inc. v. Merrill Lynch Bank USA et al. U.S. Bankruptcy Court, District of Delaware (Case No PJW) Date filed: March 31, 2007 General allegation(s): Merrill Lynch Bank USA received certain preferential and fraudulent transfers prior to the Chapter 11 bankruptcy of Mortgage Lender Network USA related to mortgage collateral securing certain warehouse lines of credit. 40

42 Category 5: Bankruptcy Claims Mortgage Lenders Network USA, Inc. v. Merrill Lynch Bank USA et al. U.S. Bankruptcy Court, District of Delaware (Case No PJW) Claim(s): Uniform Commercial Code 9-625(b) Uniform Commercial Code 9-608(c) & 11 U.S.C. 542 Avoidance of preferential transfers, 11 U.S.C. 547 & 550 Breach of repurchase agreement Avoidance of fraudulent transfers, 11 U.S.C. 548 & 550 Time period at issue: Chapter 11 filed February 5, 2007 Status: Active 41

43 Category 5: Bankruptcy Claims Claims like preferences and fraudulent conveyances are not usually covered Case law generally holds return of moneys not entitled to are not an insurable loss But misrepresentations may be covered Bankruptcy presents an array of issues, especially for creditors Claim by trustee vs D&Os presents issues of who owns the D&O policy The company or the D&Os If the company owns the policy, it may be property of the estate and the automatic bankruptcy stay may preclude D&O access to policy even though claims against D&O continue Seriously complicates order of payment and ability to obtain advances for defense Absent order of payment provision in the policy, normally has to be resolved by agreement or litigation 42

44 Category 5: Bankruptcy Claims Some of these issues may be avoided by purchase of commercially available clauses Side A only coverage 100% allocation to D&Os where company is co-defendant usually for securities claims Order of payments clause Pay D&Os first Next pay company for indemnity paid to D&Os Last pay claims against company 43

45 Co-Sponsored by: Notice and Renewal Issues

46 Notice and Renewal Issues Prompt notice is key Claims made and occurrence policies require prompt notice of a claim May hinge on knowledge of risk manager or general counsel Failure to give notice may preclude coverage even without prejudice to insurers Whether prejudice required varies by state New York s recently enacted Chapter 388 repeals state s no prejudice rule for personal injury or property damage claims under occurrence-based policies, but generally does not impact on coverages discussed today (possible exception of CGL discrimination claims) Notice of circumstances Most claims made policies permit notice of circumstances to tie circumstances which have not yet resulted in a claim to an expiring policy Some claims made policies require such notice 45

47 Notice and Renewal Issues Exclusions typically preclude coverage for claims or circumstances likely to give rise to a claim known before inception of policy Application typically requires disclosure of claims or circumstances likely to give rise to a claim Many applications require warranties of no such claims or circumstances Unless existing claims are likely to exhaust coverage, important to shake the trees to identify and notice all existing claims and circumstances under an expiring policy by appropriate deadline Establishment of paper trail and procedures helps to defend insurer claims of inadequate disclosure and rescission 46

48 Notice and Renewal Issues Interplay of notice of circumstance and renewal application requirements can raise significant issues Notice of circumstances typically requires full particulars Insurers want particulars so can identify what is noticed Insurers may contend notice of circumstance is insufficient without them Renewal application and required warranty may seek broader disclosure of any event which may lead to a claim 47

49 Notice and Renewal Issues Example Bank issued mortgage backed securities, but not sued or threatened with suit Other banks issuing similar instruments were sued Shareholders and employee benefit plans claiming negligence or failure to disclose Do you disclose? As circumstance? At renewal? Insurers will argue insufficient particulars for notice of circumstance on expiring policy If not disclosed, insurers will argue for rescission based on material omission in application leading to rescission May rescind as to all claims Particularly problematic under UK law where arguably required to disclose all material information to underwriters even if not requested 48

50 Notice and Renewal Issues Important to make notice decision early enough to permit insurer response and renewal If give notice of circumstances, easy to give notice on renewal If notice of circumstances is not required, more pressure on renewal disclosure Case-by-case analysis Standard not same (probable/possible/likely) but need to coordinate with those responsible for securities and Sarbanes Oxley compliance 49

51 Co-Sponsored by: Provisions to Seek on Renewal

52 Provisions to Seek on Renewal Important Provisions to Review and Revise Loss definition Contains buried exclusions Must ensure explicit coverage for Section 11 and 12 claims under 1933 Act to avoid disgorgement, ill-gotten gains, uninsurable as a matter of law restrictions Critical importance because many of latest filings in financial crisis cases are state court Section 11 and 12 cases Conduct exclusions Final adjudication Severability Defense provisions 51

53 Provisions to Seek on Renewal Allocation Application and rescission protection Materiality threshold Severability Limits on application materials Claim cooperation, settlement approval, and hammer provisions Exclusions of significance to particular businesses Professional services Libel and defamation Environmental 52

54 Provisions to Seek on Renewal Excess layer issues Follow form Beware of inconsistent provisions and additional exclusions Representation and warranty letters and application severability REFCO example Exhaustion and attachment traps Avoid excess policies that will not pay unless the underlying insurers actually pay their full policy limits Insolvency of underlying insurer or settlement with primary or lower level excess insurer for less than full limits could cause massive program failure Avoid sharing of limits clauses Insist on language that requires excess policy to attach if underlying insurer OR policyholder pays the underlying limits and which has insolvency protection 53

55 Provisions to Seek on Renewal Protecting against insurer insolvency Often unpredictable and rapid Can use ratings downgrade clauses with pro-rata premium return Better to address through program structure Excess program with more layers and diversity of insurers Language, cost and capacity issues Quota share programs Reinsurance cut-through (captive and industry insurer groups) Flex excess policies upper layer resembles umbrella policy and drops down to cover lower insolvent layer DIC coverage to protect individuals against rescission, insolvency, coverage denial, exclusions 54

56 Co-Sponsored by: Questions & Answers Steve Gilford, Proskauer Rose (312) Marc Rosenthal, Proskauer Rose (312) Jeff Nielsen, Navigant Consulting (202) John Failla, Proskauer Rose (212)