Insurance Coverage Litigation - Some Food for Thought

Posted by Joe Monteleone on January 27, 2012

Insurance coverage disputes in the D&O and E&O arena provide substantial grist for the mill that is this blog. Perusing these decisions on a daily basis has led me to some interesting conclusions and many unanswered questions.

My career in D&O and E&O insurance began in 1985 as an in-house claims lawyer. Since then, the coverage litigation landscape has drastically changed, primarily as follows.

We are now bombarded with new decisions on almost a daily basis from various sources, including blogs such as this one, law firm newsletters, electronic and print litigation reporting services, legal newspapers, the insurance press and sundry other sources.

  • Although many of these decisions are ultimately reported officially, and thus will carry more precedential weight than others, there are a host (if not the majority) of decisions that are picked up only on one of the electronic reporting services such as Westlaw or Lexis or are simply unpublished decisions of various courts picked up by enterprising sorts like myself.
  • Like a black market hidden economy, there are an increasing number of coverage disputes that are resolved without seeing the light of day. In addition to old-fashioned face to face negotiations (which in my opinion is the ideal way to resolve these disputes), many disputes are decided in arbitration – either because the insurance policies contain a mandatory arbitration provision or the parties freely elect to arbitrate. Although arbitration can often be a valuable alternative dispute resolution mechanism, one of the downsides is that the results are typically confidential and, unlike with most court decisions, we do not build up a body of precedent to guide the parties in future disputes. An unfortunate result of this is that parties frequently arbitrate the same issues repeatedly.
  • Who wins most of these disputes? I am unaware of any statistics in this area, but I just examined the current issue of LexisNexis® Mealey’s™ Emerging Insurance Disputes, a respected source and not one that has any apparent bias in reporting decisions favorable to one side over the other. That issue contained reports on 11 decisions, with six in favor of the insurer and five in favor of the insured. This is a bi-weekly publication, so the fact that there were 11 decisions in it only underscores my point above about the frequency of coverage disputes.

What are your thoughts on these issues? Please use the Comment feature to share them with all of our subscribers or, if you prefer, e-mail me at jmonteleone@tresslerllp.com.

D&O - Tale of the Two Dishonesty Exclusions

Posted by Joe Monteleone on September 27, 2011

I often say that the bark of the dishonesty exclusion is far worse than its bite. We do, however, see occasional situations where one or more individual director and officer defendants are convicted or plead guilty. In those situations, the wording of the dishonesty exclusion can make all the difference in the world as to whether and how the exclusion may be applied to the guilty pleader or convicted, other individuals and the corporate defendant.

During this past month, we had two decisions come down in this area with arguably partially conflicting results. See, Federal Ins. Co. v. Safenet, Inc., USDC, S.D. N.Y., Docket No. 09 CV 7863 (September 9, 2011) and The Unencumbered Assets, Trust v. Great American Ins. Co., USDC, S.D. Ohio, Docket No. 04-CV-908 (September 16, 2011). Ironically, the insurer in Safenet, which had seemingly beneficial “imputation” language, fared worse than the Unencumbered Assets insurer, which had no such provision.

In Safenet, the following exclusionary language in a policy incepting in March 2005 was at issue.

The insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured . . . . arising out of, based upon or attributable to the committing of any deliberate criminal or fraudulent act by the Insured if a judgment or final adjudication . . . adverse to the Insureds establishes that such deliberate criminal or fraudulent act was committed.

[For the purpose of determining the applicability of this exclusion,] only facts pertaining to and knowledge possessed by any past, present or future chairman of the board, president, chief executive officer, chief operating officer, chief financial officer, or General Counsel . . . of an Organization shall be imputed to an Organization.

The exclusion in Unencumbered Assets is similar, but without the imputation language set forth above in the second paragraph of the Safenet exclusion, and appears in a policy incepting in March 2002.

The insurer shall not be liable to make any payment for Loss in connection with any Claim against any Insured . . . . brought about or contributed to by any deliberately fraudulent or deliberately dishonest act or omission or any purposeful violation of any statute or regulation by such Insured if a judgment or other final adjudication adverse to such Insured establishes such a deliberately dishonest act, omission or purposeful violation.

The Safenet court applied the exclusion to the company’s CFO in the context of a civil litigation claim after she pleaded guilty in a criminal proceeding and had an adverse judgment entered against her.

The Court then turned to the issue of coverage for Safenet itself. Although Safenet was ultimately held to be not covered for other reasons, that Court held that the imputation language in the exclusion applied only to “facts” and “knowledge” of the CFO, and did not require that an adverse judgment against her be imputed. Thus, the exclusion was not applied to Safenet. Applying the Court’s reasoning, the company could never be subject to the exclusion, unless it was personally the subject of an adverse judgment.

Unencumbered Assets also involved four officers who had criminal convictions in parallel criminal proceedings. Although the bulk of the Court’s Opinion addressed rescission issues, the dishonesty exclusion was also at issue.

Three of the four officers had their convictions affirmed at the level of the Sixth Circuit and could no longer be appealed to the Supreme Court of the United States. The fourth officer, however, at the time of this decision was still within the time to seek review from the Supreme Court. However, as the policy language was silent as to “appealability” and the policy used the terms “judgment” or “final adjudication” disjunctively, the Court held that the exclusion applied to bar coverage for the fourth officer as well.

As in Safenet, the insurer in Unencumbered Assets also sought to impute the dishonesty exclusion to the Trust as successor to the insured entity under the policy. Because the policy here had no imputation clause similar to the policy in Safenet, the Court undertook a pure legal, as opposed to contractual and legal, analysis.

The Trust argued that the individuals’ conduct could not be imputed because their interests were adverse to those of the Trust. The insurer argued that this “adverse interest” rule was inapplicable when a principal is dominated and controlled by an agent to the extent that they become alter egos. The Court agreed with the insurer’s argument of this so-called “sole actor rule” and further held that there could be no “innocent insider exception” because the independent directors were powerless to prevent the fraud upon the company. Thus, the Court applied the dishonesty exclusion to all four insureds who were convicted, as well as to the Trust.

The policy language at issue in these cases dates back to 2005 and earlier. There have been some significant enhancements to these exclusions since then, which arguably would have resulted in a different outcome. Note the following sample language, which is similar to many variants in use today.[1]

The Insurer shall not pay Loss in connection with that portion of any Claim made against an Insured Executive that is. . . . for deliberately fraudulent, or deliberately criminal act or deliberately fraudulent or deliberately criminal omission or any deliberate violation of any statute, rule, or law, . . . . provided that the acts or conduct underlying [this exclusion] . . . are determined by a final adjudication, after exhaustion of all appeals (including petitions for rehearing), in the underlying action establishes that such Insured Executive committed such act, omission or violation. . . . . (emphasis added)

One could argue that by requiring the adjudication to (i) take place in the underlying action, rather than in a parallel criminal proceeding, (ii) by inserting exhaustion of all appeals language, and (iii) eliminating the disjunctive “judgment or final adjudication” that the results in each of these cases may have been different. Language similar to this is in fairly prevalent use today. Perhaps whatever “bite” may have been restored by Safenet and Unencumbered Assets has already been vitiated after all.

 

[1] When looking at these exclusions, it is important not to confine the examination to the specimen forms alone. Many insurers are using specimens many years old, and the policies actually issued are heavily endorsed to bring the exclusions and other provisions up to competitive standard.

Guest Post - An Interesting Mediation Pitfall

Posted by Joe Monteleone on August 18, 2011

Many securities fraud class actions, including the attendant coverage disputes that may arise in those claims, are frequently resolved through a mediation process if the litigation survives successful motion practice by the defendants. These mediations are now commonplace, although the mediators in this sector are few in number and often drawn from the ranks of the retired judiciary.

Our guest post today is from a very able mediator who does not come from such ranks and is not one of the usual mediators working in the securities class action arena. Nonetheless, he frequently mediates complex commercial disputes with an overlay of insurance coverage issues, and his article posted below should be of interest to anyone who practices in this area.

The article was originally published on July 26, 2011, by Portfolio Media on their Law 360 daily updates. It is reprinted below with their and the author’s permission.

Use A Mediator, Get Disbarred

By Jeff Kichaven

Law360, New York (July 26, 2011)

Can your mediator expose you to the risk of professional discipline for ethical misconduct?

Yes.

Can you protect yourself from that risk? 

Yes.

You are at risk because so many mediators are liars. Yes, liars. When you know that a mediator will even lie to your own client to bag a settlement, that lying is imputed to you, and lying to your own client can get you disbarred.

Fortunately, lying to your own client really isn't necessary to get cases settled. Honest mediators get cases settled too, and without exposing you to the risk of professional discipline. It takes only two questions to ferret out the liars and protect yourself from these risks.

Strange though it sounds, lying is a virtue in much of the mediation community. Its chief proponent is the late Judge John Cooley. He wrote an influential article in 2000, "Defining the Ethical Limits of Acceptable Deception in Mediation," http://www.mediate.com/articles/cooley1.cfm. Here's what he said:

"That mediation's purpose is to resolve conflict says nothing of the means that may be used to accomplish resolution. And that brings into focus the second criteria for ethical rule design: The rule should not interfere in any significant way with the means by which the mediator or the mediation advocate can accomplish the purpose of mediation.

"The question that must be addressed here is: May a good end justify any means? May truth be bent, colored, tinted, veneered, or hidden by a mediator or mediation advocate if the result is achieving a satisfactory resolution, or better yet, a win-win solution without harm to any party? In short, is there such a thing as a noble lie?

"Our immediate instincts beckon us to answer 'no'; but the reality is that many of us lied to our children so long about Santa Claus - with no catastrophic results and no tinge of shame - that deep down we know that something like a 'noble lie' exists and it's okay. Thus, whatever truthfulness standard is adopted, it must accommodate, or at least acknowledge, the concept of the 'noble lie.'"

Thus ennobled, mediators believe they have the license to, well, to ... lie to your clients! As early as 2003, Max Factor III Esq. catalogued some of the flat-outs which have become "accepted deception" to many mediators:

"1) Defendant is so angry about your charge of Fraudulent Concealment, which he is prepared to spend on defense costs his entire self-liquidating insurance policy of $250,000, unless you drop the Fraud charge and publicly apologize for attacking his character!" [When - in fact - the defendant carrier has authorized the mediator to settle within policy limits, but implicitly promised the mediator that the insurance carrier uses mediators who can save it money.]

"2) I am authorized by plaintiff to give you my evaluation of the impeachment testimony I heard in a telephone call during the private caucus. I believe that, if true, defendant will not be found credible at trial! [When - in fact - the plaintiff's counsel has advised the mediator that plaintiff had just spoken to her strong impeachment witness, who now was wavering about testifying for fear of losing his job.]

"3) I believe the plaintiff is so emotionally outraged that unless he wins Big, he will carry on a dreadful program of adverse public attacks on your company's business practices! [When - in fact - plaintiff has advised the mediator in private caucus that he carries no grudge and will agree to make a confidentiality agreement in exchange for the defendant making a settlement offer in the dollar range the mediator has indicated privately is a reasonable compromise.]"

(Factor, "Thirty FAQ's for California Mediators on Ethical Minefields Involving Business, Construction, Employment and Real Estate Mediations," http://www.mediate.com/articles/factorM2.cfm)

Many mediators aggressively hold themselves out as providing just this service. A simple Internet search will disclose just how many positively brag about it.

Here's the problem: A lawyer is not allowed to lie to her own client. California Business and Professions Code section 6106 provides: "The commission of any act involving moral turpitude, dishonesty or corruption, whether the act is committed in the course of his relations as an attorney or otherwise, and whether the act is a felony or misdemeanor or not, constitutes a cause for disbarment or suspension." Dishonesty with your own client is a fundamental violation of the duty of loyalty and extreme moral turpitude. No asterisk carves out dishonesty which is "noble."

When you know that a mediator will lie to your client to "close the deal," the mediator's lies become yours, too. The standard tort definition of "intent" includes both "purpose" and "knowing that the consequence is substantially certain to result." When you know that the mediator will lie and you select a mediator for the purpose of having that skill available, guess what happens when that mediator performs as advertised? You have just, through the agency of the mediator, intentionally lied to your own client.

From an ethical perspective, it is no different than hiring an investigator to interview an opposing party who is represented by counsel. You can't contact the opposing party yourself. Rule 2-100, California Rules of Professional Conduct. You can't hire somebody to do it for you, either. Rule 1-120.

This deception strips resulting settlements of their integrity. Settlements are supposed to be based on the parties' honest assessments of the strengths and weaknesses of their claims and defenses; the risks and opportunities of litigation; and their interests, needs and values. You settle only if the available deal is superior to your Best Alternative to Negotiated Agreement (BATNA), as Roger Fisher and William Ury described in their 1981 landmark, "Getting to Yes." This is the benefit that mediation promises.

When a mediator lies in order to make you settle, you lose that benefit. There can be no honest assessment of a BATNA, no legitimate determination of whether an available deal is desirable. The lying mediator is neither facilitative nor evaluative. He is a despot, soviet, deceiving parties into settling on his terms, not yours. According to his view of fairness, not yours. His interests, needs and values. Not yours.

Can this seriously be described as a "win-win solution without harm to any party"? If the mediator was truly peddling incense and peppermints, why would he have to lie to get people to agree? Test this against your common sense: "This deal is so good, so right, so obviously wise, that we have to lie to you in order to get you to see its wisdom."

Clients have a constitutional right to a jury trial. Are we really satisfied with mediation that makes them forfeit that right through deception?

Do we really want mediators to make their own subjective judgments about settlements that are "right," "fair" or "good," and then lie, lie, lie to make those settlements happen? Outcomes will become arbitrary and unpredictable, and there won't be a thing you can do about it. After all, if your advice might stand in the way of closing the deal on the mediator's preferred terms, why shouldn't the mediator lie to you, too?

Fortunately, there is a better way. If a deal really is in a client's best interests, then we ought to be able to persuade the client by telling the truth. This is familiar terrain to litigating lawyers. You don't win a trial by lying to the jury. You win a trial by telling the jury the truth, and telling it in a way that makes sense and feels right to them. It's hard work, but lawyers do it all the time.

So it is with clients in mediation. If a deal really is in their interests, then we ought to be smart and insightful enough to figure out how to make the point honestly. Deceiving your own client is as practically unnecessary as it is ethically wrong.

How can you tell if you are at risk? It takes only two questions. Ask the mediator "Who is your client?" and "Do you use caucus-only mediation?"

"Who is your client?" If a mediator tells you that "his client is the deal," watch out. When the "ends" are an abstract idea such as "the deal," there is no limit on the "means" the mediator can use to achieve those ends. How could a lie, any lie, be taboo, if it helps seal the deal? In this perverse world, lying is not a betrayal, it is actually honorable.

It's far better if the mediator tells you that his clients are the lawyers, individuals, business entities and insurance companies who bring him their conflicts. In this world, it would be a profound betrayal of trust for a mediator to deceive people into making a deal.

"Do you use caucus-only mediation?" In caucus-only mediation, the sides never see each other. The mediator parks you at opposite ends of the hall and shuttles back and forth. When you never get to double-check things with the other side, it is much easier for the mediator to lie. While caucusing is one available and often helpful tool, the "caucus-only" model takes you from caucus to quarantine. That spells trouble.

The better approach is for the mediator to facilitate direct communications whenever possible, either through joint sessions with all hands present, or attorneys-only caucuses where you and opposing counsel can look into the whites of each other's eyes and make your own judgments about who is bluffing, who is telling the truth.

The quest to maintain ethical standards requires constant vigilance. Now is the time for lawyers to take a closer look at mediation, and make sure that what happens there starts to make them proud.

The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media, publisher of Law360. This article is for general information purposes and is not intended to be and should not be taken as legal advice.