Recent D&O Insurance

Cases of Note

Published by
The Lowenstein Sandler
Insurance Group

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 Recent D&O Insurance
Cases of Note

Published by
The Lowenstein Sandler
Insurance Group

© 2010 Lowenstein Sandler PC. In California, Lowenstein Sandler LLP. All Rights Reserved.
 Table of Contents
Introduction 4

What Is A Claim?/Notice 5
Always Give Notice
Is it a Claim?

Insured's Duty to Cooperate 7

Recission 8
Platte River v. Baptist Health
J.P. Morgan v. Twin City

Excess D&O Insurance 11

Construing Exclusions: In Fact, Arising Out Of 12

Interrelated Acts Exclusion 13

Bankruptcy/Insured V. Insured Exclusion 14

Biltmore v. Twin City
Westchester

Inadequate Consideration Exclusion 16

Bump Up Exclusion 16

Intentional Conduct Exclusion 18

Bad Faith 19

Litigation Guidelines 20

Whose Money Is It Anyway? 21

 Introduction
Directors and Officers insurance is constantly in a state of flux. Policies issued by different
insurers are not identical, and seemingly minor differences in wording can have an enormous
impact on coverage. Usually without notifying the insured, insurers add endorsements to
policies that can eliminate or modify coverage. Each case law victory by policyholders leads to
revisions to the D&O policy by insurers who attempt to reverse the favorable holding by the
court.

This case law review captures current D&O insurance coverage case law in 2010. It illuminates
gaps and traps in coverage and advises on mechanisms to avoid these pitfalls.

D&O insurance is supposed to provide directors and officers with an umbrella against liability.
However, that umbrella is full of holes. This review helps companies identify and patch those
holes.
 RECENT D&O INSURANCE CASES OF NOTE

I WHAT IS A CLAIM?/NOTICE

A. Always Give Notice

Admiral Insurance Co. v SONICblue Inc., 2009 WL 1308905 (N.D.Cal. May 11, 2009) primarily
addresses the complex and, for the insured, potentially fatal issue of notice in the context of
claims-made policies.

In the context of general liability claims, most jurisdictions will only deny coverage because of
late notice if the insurer can show it was prejudiced by the late notice. However, under claims-
made policies such as D&O and EPLI policies, almost all jurisdictions deny coverage for late
notice without any need for a showing of prejudice by the insurer. This creates a particular
problem for policyholders because the insured must report "claims," and the policies offer broad,
expansive definitions of claim, such as "written notice of a demand for monetary or non-
monetary relief."

In Admiral, the court first held that two letters to the insured in 2002 from one group of
noteholders were not claims. These letters "express[ed] concerns about the company's financial
state and future prospects," but did not "even allude to the possibility of damages or
nonmonetary relief." The court next held that two letters dated December 12, 2003 from the
same noteholders were claims because they contained "specific demands for monetary relief."
The insured did not give notice of the 2002 letters but did give notice of the
December 12, 2003 letters.

A second group of noteholders sent a letter to the insured on November 14, 2002 in which they
expressly "reserve[d] all their claims and rights with respect to the careless and inappropriate
sales of [certain] shares that have already occurred." The insured did not give notice of this letter.
The court did not find that this letter was a "claim," but did find that the insured should have
reasonably expected that the matters discussed in the letter could give rise to a claim, and
therefore required notice.

Finally, the court addressed a letter from the State of Wisconsin Investment Board, which
demanded access to certain information from the insured so that the State could "investigate
possible waste, mismanagement, or breaches of fiduciary duties in connection with the recent
offering…" The court found that the insured should have given notice of this letter because it
described a breach of fiduciary duty and demanded that the directors and officers "take action to
cure the breach."

Policyholders often are unaware that informal notices, such as letters, might constitute "claims"
that they need to notice to their insurer. This case does not provide a convenient bright line test
for policyholders but the lesson to be learned is that even informal notices can be claims that the
company must report. Practically, the only way for a policyholder fully to protect itself is to
provide notice as broadly as possible.
B. Is it a Claim

Definitions of 'Claim' differ markedly among insurance policies, and a broker must use his or her
best efforts to confirm that its client has the most favorable definition. One major battleground is
whether different types of government subpoenas constitute a 'claim.'

In Jemmco Partners v. Executive Risk Indemnity, Inc., Docket No. L-486-07 (N.J Superior Ct.,
filed March 22, 2007), Jemmco, a hedge fund, received subpoenas seeking documents from the
SEC, the Commodities Futures Trading Commission (CFTC), and a grand jury. The subpoenas
involved market timing and late trading.

Jemmco was insured under a D&O policy which provided coverage against ‘claims.’ ‘Claims’
was defined in pertinent part as: (a) “any civil proceeding in a court of law or equity including
any mediation or alternative dispute resolution ordered or sponsored by such court”; (b) “any
criminal proceeding in a court of law”; and (d) “any administrative or regulatory proceeding
commenced by the filing of a notice of charges, formal investigative order, or similar document.”

Jemmco provided notice of the subpoenas to its insurer and the insurer denied coverage, arguing
that the subpoenas related to other parties and mutual funds, and not Jemmco, and therefore were
not "claims" as defined in the policy. Jemmco sued for coverage, taking the position that the
grand jury proceedings were criminal proceedings in a court of law, falling within subsection (b)
of the definition of a claim.

The court found that the grand jury proceeding was a criminal proceeding, and that the SEC and
CFTC matters were administrative or regulatory proceedings. Next, the court addressed the
subsection (d)’s requirement that regulatory proceedings be commenced by ‘the filing of a notice
of charges, formal investigative order or similar document.’ The court found sufficient an
affidavit from Jemmco’s attorney stating that he had seen the formal investigative orders, which
were not public, when he met with lawyers for the SEC and CTFC.

The court then noted that the policy’s definition of ‘claim’ required that the claim be against an
insured ‘for a wrongful act,’ and found that there were disputed issues of fact as to whether the
subpoenas asserted such ‘wrongful acts’ by the insured. The court noted that a subpoena, unlike
a complaint or an indictment, does not ‘allege particular conduct or make accusations.’ Jemmco
Transcript at 37. The court stated that it was unwilling to find that a document such as a
complaint or indictment was necessary for a subpoena to be a claim. It said that a subpoena with
a target letter would be sufficient, and that other circumstances or notices may also qualify.

See also Diamond Glass Companies v. Twin City Fire Insurance Company, No. 06-CV-13105
(S.D.N.Y. Aug. 18, 2008) (grand jury subpoena seeking documents and testimony not a claim);
Ace American Insurance Company v. v. Ascend One Corporation, No. 1:06-cv-03371-CCB (D.
Md. Aug. 7, 2008) (finding that subpoena and investigative demands were claims).
II INSURED'S DUTY TO COOPERATE

In Vigilant Insur. Co., et al. v. The Bear Stearns Companies, Inc., 2008 WL 65620 (N.Y. Mar.
13, 2008), the New York Court of Appeals ruled that Bear Stearns Companies, Inc., was not
entitled to insurance for its $80 million settlement with the Securities and Exchange
Commission, the National Association of Securities Dealers, and the New York Stock Exchange,
because it failed to obtain its insurers’ consent to the settlement.

In early 2002, the SEC, NASD and NYSE, along with state attorneys general, initiated a joint
investigation into the practices of research analysts at various financial services firms, focusing
on the potential conflicts of interest arising from the relationship between the analysts‘ research
functions and investment banking objectives. Bear Stearns, a financial services firm, was among
the companies investigated.

On December 20, 2002, Bear Stearns signed a settlement-in-principle with the SEC, NASD and
NYSE to settle the claims. On April 21, 2003, Bear Stearns consented to be permanently
enjoined from violating a number of NASD and NYSE rules and agreed to pay a total of $80
million to fully resolve the pending regulatory claims. The settlement was allocated $25 million
as a penalty, $25 million in disgorgement, $25 million for independent research and $5 million
for investor education. Three days after executing the settlement agreement, Bear Stearns sent
letters to its insurers requesting their consent to the settlement.

Bear Stearns‘ primary professional liability insurance policy, issued by Vigilant Insurance
Company (the “Policy”), provided $10 million in coverage for losses resulting from claims
against the insured for its ”wrongful acts.“ The Policy attached in excess of a $10 million self-
insured retention. In addition, Bear Stearns had another $40 million in follow form excess
coverage. The Policy required Bear Stearns to obtain the consent of its insurers prior to agreeing
to settle any claim in excess of $5 million.

The insurers denied coverage for the settlement on a number of grounds and brought a
declaratory judgment action in the state supreme court. First, they argued that the insured had
breached the policy provision obligating it to obtain the insurers’ consent before entering into the
settlement. They also denied on the basis of the investment banking exclusion in the policy and
argued that certain portions of the settlement did not constitute covered “losses.”

The insurers moved for summary judgment. The state supreme court found an issue of fact as to
when the settlement became final and, therefore, whether Bear Stearns breached the provision
obligating it to obtain the consent of the insurers prior to settlement. The Appellate Division
agreed that an issue of fact existed as to whether Bear Stearns had breached the policy obligation
to obtain consent to settlement. The insurers appealed, raising a number of objections to the
Appellate Division order. In particular, the insurers argued that Bear Stearns resolved and
finalized the settlement of the case when it executed the settlement-in-principle in December
2002, or, at the latest, when it signed the consent agreement in April 2003, without advising the
insurers.
The Court of Appeals noted that in the April 2003 settlement agreement, Bear Stearns agreed to
pay $80 million and to be permanently enjoined from violating certain NASD and NYSE rules in
order to resolve all the pending regulatory claims against it. The court also noted that in that
agreement, Bear Stearns acknowledged that the SEC could present a final judgment to the
federal court for signature and entry without further notice to the company, evidencing Bear
Stearns‘ intention to settle the matter fully at that time. Moreover, Bear Stearns did not provide
that the settlement was subject to its insurers' approval. Thus, even though the federal court did
not approve the settlement until October 2003, the court determined that the parties had
fully resolved the claim in April 2003. Since Bear Stearns had failed to obtain insurer approval
of the settlement prior to that date, as required by the terms of the Policy, the court held that Bear
Stearns was barred from recovering the settlement proceeds from the insurers.

Unfortunately, in the exigency of litigation, insurance can become an afterthought. Lapses most
frequently occur in the notice process, and late notice of a claim often forecloses coverage.
However, all insurance policies require the cooperation of the insured, and many policies require
the insurers’ consent to settlement, or even to litigation decisions. The adversarial posture that
often exists between companies and their insurers can also cause a company to avoid keeping its
insurer informed or not seek its approval. Insurance management is an essential component of
any litigation strategy.

III RESCISSION

A. Platte River v. Baptist Health

In Platte River Ins. Co. v. Baptist Health, 2009 WL 2015102 (E.D. Ark. Apr. 17, 2009), the
insured Baptist Health (“BH”), a non-profit organization operating hospitals in Arkansas, sought
coverage for claims brought against it after its adoption of an Economic Conflict of Interest
Policy (“ECOI Policy”).

The insurer, Platte River Insurance Company (“Platte River”), disclaimed coverage on the
grounds of BH’s alleged prior knowledge of circumstances that could give rise to a claim. The
ECOI Policy provided that no physician who directly or indirectly acquires or holds an
ownership or investment interest in a competing hospital shall be eligible to apply for initial or
renewed appointment or clinical privileges in the professional staff of any Baptist Health
hospital. This practice is also known as economic credentialing.

Prior to the adoption of the ECOI Policy, BH’s CEO commissioned a project to research ECOI
policies. The research was in response to a request by the Office of the Inspector General of
Health and Human Services for comments regarding the legality of economic credentialing. The
research discovered that several hospitals had been defendants in cases challenging their ECOI
policies. BH retained outside counsel to draft its own ECOI policy in order to avoid violation of
anti-kickback or anti-trust laws. A month before formally adopting the ECOI policy, BH’s CEO
testified at a Federal Trade Commission hearing concerning economic credentialing. At the
hearing, a doctor for a competing institution voiced his concerns about the potential risk to BH
by adopting an ECOI policy. At about the same time, a member of the board of trustees sent a
letter to BH’s CEO expressing his concerns regarding the legality of adopting an ECOI policy.
He believed that the ECOI policy would trigger a suit against BH. BH formally adopted its
ECOI policy in May 2003.

Upon the expiration of its policy with Executive Risk Indemnity Insurance (“ERII”) in October
2003, BH’s broker submitted a renewal application with another insurer. The application stated:
No Entity nor any individual proposed for coverage is aware of any fact, circumstance, situation,
transaction, event, act, error or omission which they knew or should reasonable have known may
result in a claim that may fall within the scope of the proposed insurance, except as follows. If
answer is “None,” so state: BH replied “None.” BH also included a copy of the ECOI policy in
its submission to the underwriter.

The underwriter reviewed the application but would later testify that she did not recall evaluating
any of the risks associated with the ECOI policy. After providing a quote to BH, the underwriter
provided an additional application which asked:
Does anyone for whom insurance is intended have any knowledge or information of any act,
error, omission, fact or circumstance which may give rise to a Claim which may fall within the
scope of the proposed insurance?

BH responded “No.”

Further, both applications contained prior knowledge exclusions. The latter provided that the
statements in the application were material to the acceptance of risk and were relied upon by the
underwriter. Coverage was ultimately bound in December 2003.

BH was first sued because of its adoption of the ECOI Policy in February 2004. Two years later,
the insurer notified BH that it had become aware of issues regarding prior knowledge.
Subsequently, the insurer denied coverage for any suit relating to the ECOI policies and filed an
action seeking declaratory judgment. The insurer moved for summary judgment seeking
rescission on the basis of the alleged misrepresentations in the applications. The insurer also
argued that the prior knowledge exclusions in the applications were incorporated into the policy
and barred coverage.

The court granted the insurer’s motion for summary judgment. First, the court found that the
applications were incorporated into the policy. The opinion found that BH understood that its
statements in the applications were material to the acceptance of the risk. The court rejected
BH’s arguments that the questions on the applications were ambiguous, particularly where both:
(1) requested any facts or circumstances which “may result in a claim.” and (2) were followed by
clear language providing that any claim resulting from knowledge of such facts and
circumstances would be excluded from coverage.

Additionally, the court rejected BH’s argument that the question one of the applications was
subject to a subjective interpretation. Although the question did not explicitly contain any
“reasonable person” language, the question did not call for an answer based upon personal belief
or interpretation. It called for disclosure of “any” knowledge of information, which the court
found triggered an objective standard of foreseeability. The court found that BH was aware of
such facts and circumstances particularly where it knew other hospitals had been sued and where
it already identified physicians that would be affected by its adoption of the ECOI Policy.
Moreover, even if there were no misrepresentations, the court found that the prior knowledge
exclusions included in the applications would have barred coverage because BH had knowledge
of facts which a reasonable person would have foreseen would give rise to a claim.

B. J.P. Morgan v. Twin City

In JP Morgan Chase & Co. v. Twin City Fire Ins. Co., Index No. 601904/06, (N.Y. Sup. Ct.
N.Y. Cty. Mar. 3, 2009), JP Morgan Chase (“JPMC”) sought coverage for losses related to
services it provided to Enron. JPMC held excess insurance policies with Twin City for the
periods 1997-2001 and 2001-2002. In the fall of 2001, JPMC issued a press release detailing
losses associated to its exposure to Enron. On the day before the 1997-2001 policy was to
expire, JPMC placed Twin City on notice of “circumstances that might give rise to a claim” but
asserted that it had “no actual knowledge” of any “Wrongful Acts” as defined in the policy.
The next day, Twin City issued a binder for $10 million in coverage for 2001-02. Subsequently,
JPMC was named as a defendant in several actions by Enron. Twin City refused coverage for
Enron related losses under the 1997-2001 policy. JPMC brought suit against Twin City and
Twin City counterclaimed. In the counterclaim, Twin City sought rescission of the 2001-2002
policy because JPMC alleged concealment of information regarding the full extent of its
exposure to Enron, which it claimed tainted its decision to renew coverage. The insurer also
asserted various other claims, including, inter alia, common law fraud and breach of contract.
The court found that Twin City did not meet its burden on summary judgment as to rescission.
Twin City did not present any evidence that its underwriters had actually relied upon statements
in the Notice or Press Release. The court further noted that these items were not made part of the
renewal packet that was submitted to the insurer in lieu of a more formal application. Despite
the insurer’s assertions that its underwriters were concerned about the Enron situation in
November 2001, the underwriters could not recall even reading the notice prior to issuing the
binder for 01-02.

Moreover, the court did not find any evidence that JPMC deliberately misled the insurers. The
insurer’s only evidence of concealment was a statement by the insured’s broker that the insured’s
relationship with Enron would not have a “material impact.” The insurer pointed to testimony
from its underwriters that it had conversations with the JPMC’s broker regarding the
underwriter’s concerns about exposure to Enron-related losses. The court rejected this evidence
and held that “Twin City must provide more than simply its own suspicions that JPMC intended
to mislead Twin City, and that Twin City’s underwriters actually relied upon the statements
contained therein.”

Further, the court held that Twin City had waived its right to assert rescission. JPMC had fully
disclosed in a press release the extent of its exposure to Enron. Thus, Twin City was aware of
the potential misrepresentation between December 2001 and fall of 2002. Yet, Twin City did not
assert its right to rescind the policy until JPMC filed suit in 2006. Additionally, Twin City
retained JPMC’s premiums during the entire period. The court reasoned that where the insurer
had accepted and retained the premiums with knowledge of the alleged misrepresentations,
rescission would be unreasonable as a matter of law.
The client must rely on its broker to obtain the broadest possible protection against rescission
when drafting an insurance policy. Many D&O policies are now non-rescindable, and directors
can purchase special 'Side A' coverage that is non-rescindable.

IV. EXCESS D&O INSURANCE

Many corporations, even the smallest concerns, are aware of the need for substantial directors
and officers' liability insurance to protect their officers and directors from the risk of liability
while managing the affairs of the company. However, even when the company buys excess
insurance on top of the primary policy to ensure adequate limits to cover both defense expenses
and settlements/judgments, an issue may arise as to whether the excess insurer's obligations are
triggered if the primary insurer pays less than its full limits in a settlement where the company
steps in to pay the gap left by the primary insurer's refusal to cover certain of the claims.

Where a company steps in to fill the "gap" left by the primary insurer, the excess carrier may
assert that its limits are not triggered, thereby blocking a potential settlement of a large claim by
making the excess limits unavailable to the company. Two recent cases demonstrate that this is a
very real risk for policyholders since courts are willing to take the excess insurer's side on this
issue.

In Comerica Inc. v. Zurich Am. Ins. Co., 498 F. Supp. 2d 1019 (E.D. Mich. July 27, 2007),
Comerica entered into a settlement of several securities class action lawsuits for a total amount
of $21 million. Comerica's primary carrier disputed coverage on some of the claims and
ultimately agreed to pay $14 million of its $20 million limit towards the settlement. Comerica
sought coverage from its excess insurer for the $1 million excess of the "gap" it would fill in the
settlement amount with its own money, as well as in excess of $2 million in additional legal fees.
The excess insurer refused to pay, arguing that the underlying policy hadn't been exhausted,
relying upon language in its policy that coverage was not triggered until "after all such
'Underlying Insurance' has been reduced or exhausted by payments for losses." The court came
out in favor of the excess insurer, holding that the language in the excess policy was
unambiguous and coverage was only triggered by the full payment of limits by the underlying
insurance, and that the insured stepping in to fill that gap was not what the excess carrier
contracted for.

Similarly, in Qualcomm, Inc. v. Certain Underwriters at Lloyd's London, 73 Cal. Rptr. 3d 770
(Cal. App. Mar. 25, 2008), the California Court of Appeal affirmed the dismissal of a complaint
by Qualcomm against its excess D&O insurer because the primary insurer did not pay the full
limits of its policy. In that case, Qualcomm gave the primary insurer a full policy release in
exchange for payment by the primary carrier of $16 million of its $20 million limits in resolving
a class action lawsuit and various individual lawsuits by employees and former employees
related to their asserted right to unvested company stock options. Qualcomm then sued its
excess D&O insurer for its unreimbursed defense expenses for the class action and employee
lawsuits totaling over $12 million.

Qualcomm's excess policy stated that the excess insurer "shall be liable only after the insurers
under each of the Underlying Policies have paid… the full amount of the Underlying Limit of
Liability." The court again held that the relevant policy clause unambiguous, stating that there
could be no other reasonable interpretation of that language, other than that the primary carrier
would have to make a full payment of its entire limit before coverage was triggered.

Excess insurers may use the holdings in Qualcomm and Comerica to argue that they are entitled
to the benefit of the language they bargained for regarding exhaustion of underlying limits, and
that the language is intended to prevent settlement between an insured and underlying insurer,
thereby shifting risk to excess insurers that attach at higher levels at a lower premium. The
potential risk of forfeiture of excess coverage is real after Comerica and Qualcomm and
policyholders would be well-served to negotiate specific language insuring that their excess
policies drop down in instances when the insured is called upon to fill the gap in settlement.

V. CONSTRUING EXCLUSIONS: IN FACT, ARISING OUT OF

Exclusions come in a variety of sizes, from extremely broad to very narrow. An exclusion may
apply to

'Any claim based upon, arising out of, attributable to, or directly or indirectly resulting from'
intellectual property

'Any claim arising out' of intellectual property

'Any claim for' intellectual property infringement

Any claim for intellectual property infringement 'in fact'

Any claim resulting in a finding of intellectual property infringement 'by final adjudication.'

Obviously for the policyholder, negotiating the policy to obtain the narrowest exclusionary
language is critical. Except for the 'final adjudication' language, the other formulations leave the
client exposed.

"Arising out of..."

In Sealed Air Corporation v. Royal Indemnity Co., 196 N.J.Super. 601 (App.Div. 2008), a class
action asserted that Sealed air, in connection with a complex financial transaction, had
misrepresented its potential exposure to asbestos claims, resulting in an inflated price for its
stock. The company's D&O policy provided coverage for securities actions. However, the
policy excluded any claim based on, arising out of, or in any way involving' the release of
pollutants, an exclusion invoked by Royal to deny coverage.

The court found that 'the securities holders' complaint has its roots in securities fraud and
misrepresentation, not pollution.' In examining the exclusionary language, the court found that
'based on' and 'arising out of' required a substantial nexus. The court noted that '"in any way
involving" is facially extremely inclusive.' However, the court read that phrase in conjunction
with 'based upon' and 'arising out of' to require a 'more direct causal relationship between the
pollution and the harm.'

The court relied heavily on the basic rules of insurance policy construction to support its
position. Readers should note that other courts have construed similar language more broadly to
deny coverage.

"In fact"

In Westport Insurance Corp. v. Hanft & Knight, P.C., 523 F.Supp. 444 (M.D.Pa. 2007), the
complaint alleged that the lawyer had personally profited by obtaining loans through false
representations. The exclusion at issue excluded "any claim based upon, arising out of,
attributable to, or directly or indirectly resulting from any Insured having gained in fact any
personal profit or advantage to which he or she was not legally entitled." The insured asserted
that this exclusion did not apply because the factfinder in the underlying action had made no
factual finding of wrongful personal profit, and cited several cases to this effect. The court,
however, held that "the allegations and evidence presented by the underlying complaint make
clear that the [insured] procured the loan based on 'fraudulent representations'…"Thus, the court
could itself find, based upon the available evidence, that the insured had 'in fact' personally
profited."

Virginia Mason Medical Center v. Executive Risk Indemnity Co., WL 3473683 (W.D.Wash.
2007) discussed a similar exclusion and reached a similar conclusion. Here too, the insurer
argued that the allegations set forth in the underlying complaint established that the insured had
gained remuneration to which it was not legally entitled. The court disagreed, applied a standard
requiring an objective basis before coverage was foreclosed, and explained that this objective
basis could be a factual finding in either the underlying case or the coverage case, or an
admission by the insured. However, the court then proceeded to hold that the underlying
complaint could provide an objective basis, but the allegations in the underlying complaint in the
case before it were not sufficient in and of themselves to demonstrate an illegal profit, and that
the insurer had not presented any further evidence to support its claim.

Thus, the 'in fact' language in an exclusion provides the insured with little comfort.

VI. INTERRELATED ACTS EXCLUSION

First Trenton Indemnity Co. v. River Imaging, P.A. (N.J. App. Div. August 11, 2009) involved a
series of lawsuits filed against a medical diagnostic company and its officers and directors ("the
Insureds"). The first lawsuit was a breach of contract action in which one of the 27 allegations in
the lawsuit alleged billing by the Insureds for services that were either not performed or
improperly billed.

Later, three insurance companies sued the Insureds for recovery of personal injury protection
benefits that they had paid, alleging that the Insureds had fraudulently obtained payment of the
benefits as a result of several statutory violations and by fraudulently overbilling.
The insured had a D&O policy which contained a standard "interrelated acts" exclusion stating
that if the claim made by the Insured "relates back" to an earlier claim, coverage only exists
under the policy in effect at the time of the earlier claim, and not under the current policy.

The Insureds placed their D&O insurer, Zurich American Insurance Company, on notice of the
insurance company lawsuits and Zurich denied coverage, claiming that these subsequent lawsuits
related back to the breach of contract case.

The trial court denied Zurich's motion for summary judgment on this issue. On appeal, the court
held that even though the interrelated acts provision was not listed as an exclusion, it served that
function. As a result, Zurich had the burden of proof as to its applicability.

The court noted that while there was an allegation of fraudulent billing in the breach of contract
action, this single allegation was "a peripheral component" of the complaint. The court adopted a
"substantial overlap" test. Pursuant to that test, the court found that the breach of contract case
and the subsequent insurance company lawsuits were "distinguishable on the basis of (1) the
parties involved, (2) the factual allegations, and (3) the claims advanced."

Insurance companies often try to apply the inter-related acts provision, even when the
relationship back is extremely attenuated. This decision establishes a favorable standard for
insureds on an issue for which little guidance existed previously.

VII. BANKRUPTCY/INSURED V. INSURED EXCLUSION

A. Biltmore v. Twin City

Biltmore Associates v. Twin City Fire Insurance Company, N. CV-05- 04220-FJM (9th Cir. July
10, 2009) concerns the crucial issue of application of the "insured v. insured" exclusion in the
bankruptcy setting.

The debtor in possession asserted that its directors and officers had looted the company. As part
of the reorganization, the debtor in possession assigned its claims against its directors and
officers to the Creditors Trust, whose trustee then sued the company's directors and officers.

The court denied coverage on the basis of the "insured v. insured" exclusion, finding that "a post
bankruptcy debtor in possession acts in the same capacity as the pre-bankruptcy debtor for the
purposes of directors and officers liability insurance." The court held that since the debtor and its
directors and officers were all insureds under the D&O policy, the "insured v. insured" exclusion
barred coverage. The court found that the assignment of the claim by the debtor in possession to
the creditors committee did not change this result, since the creditors committee was still
pursuing the claim of the debtor.

Courts in many states have addressed the application of the "insured v. insured" exclusion to
claims by debtors in possession, creditor's committees, and trustees. The resulting case law is
wildly inconsistent. Companies should try to endorse their D&O policies to explicitly exempt
such claims from the operation of the insured v insured exclusion.
B. Westchester

In Westchester Fire Ins. Co. v. Wallerich, 563 F.3d 707 (8th Cir. 2009), the Eighth Circuit
considered the proper application of an “insured v. insured" in the bankruptcy context.

The D&O policy issued by Westchester covered the directors and officers of an LLC created to
develop properties for commercial and residential use. One of the officer/directors, Mark
Fayette, and his wife, Shayna Fayette (an investor in, but not employed by, the LLC), filed a
lawsuit alleging breach of various fiduciary duties in connection with management and auction
of properties held by the LLC. The insureds, who held various director and officer positions
within the LLC, timely notified the insurer of the suit and sought coverage for their defense. The
insurer initially refused a defense, but upon reconsideration, agreed to defend subject to a
reservation of rights, including “the right to seek reimbursement of defense expenses in the event
that a court found that Westchester had no duty to defend the insureds.”

The insurer filed a declaratory judgment seeking a determination of whether the D&O policy
obligated it to provide coverage. The insurer also argued that it was entitled to reimbursement of
fees and costs incurred in defending the Fayette suit. The insured ultimately moved for summary
judgment on the grounds that the “insured v. insured” exclusion precluded coverage.

The district court granted in part the insurer’s motion for summary judgment, finding that the
“insured v. insured” exclusion applied because Mark Fayette was a party in the underlying
lawsuit against the other insureds. However, the district court found that Shayna Fayette was not
an insured within the meaning of the policy. The policy’s General Terms and Conditions
provided that:

The . . . spouses . . . of natural persons who are Insureds shall be considered Insureds under this
Policy; provided, however, coverage is afforded to such . . . spouses . . . only for a Claim arising
solely out of their status as such and, in the case of a spouse . . . where the Claim seeks damages
from marital community property, jointly held property or property transferred from the natural
person who is an Insured to the spouse . . . .
(emphasis in original). Further, the “insured v. insured” exclusion provided that:
Insurer shall not be liable for Loss under this Coverage Section on account of any Claim . . .
brought or maintained by, on behalf of, in the right of, or at the direction of any Insured in any
capacity . . . .
(emphasis in original).

The insurer appealed the district court’s ruling that Shayna Fayette was not an insured. The
insurer was particularly concerned that the Fayette’s could merely dismiss their complaint and
re-file in Shayna Fayette’s name alone. The Eight Circuit found that the policy language was not
ambiguous and that Shayna Fayette was an insured under the policy. Because Shayna Fayette
was the spouse of Mark Fayette, himself a director and officer who met the definition of
“Insured,” the court found that she was also an “Insured”. Accordingly, the court held that the
Insurer had no duty to defend because of the “insured v. insured” exclusion.
However, in a dissenting opinion, one judge argued that Shayna Fayette was not an insured
because the language in the clause limited the instances where a spouse can be an insured to
instances where a claim is brought against a spouse in that capacity and where the claim seeks
damages from marital community property. Because the Fayette’s suit did not fall under this
definition, Judge Bye reasoned that the exclusion did not apply. Judge Bye opined, “[i]t is
incongruous to construe the phrase ‘[t]he . . . spouses . . . of natural persons who are Insureds
shall be considered Insureds under this Policy’ independent of the limited grant of coverage
which immediately follows it.” (emphasis in original).

While insurance companies have narrowed somewhat the scope of this exclusion, it still is a
frequent coverage obstacle. Moreover, courts in different states construe this exclusion
differently. Once again, the broker needs to obtain the narrowest possible language here,
including an endorsement that the exclusion does not apply to bankruptcy trustees or creditor
committees.

VIII. INADEQUATE CONSIDERATION EXCLUSION

In Delta Financial Corp. v. Westchester Surplus Lines, 398 B.R. 382 (Bankr. D. Del. 2008), the
insured company engaged in a transaction with its noteholders in which the noteholders were to
receive cash flow certificates with a value of $153,000,000. However, the certificates turned out
to have a value of only about $43,000,000, resulting in litigation. When the company turned to
its Director’s and Officer’s Liability policy, the insurer denied coverage on the basis of an
‘inadequate consideration’ exclusion which stated, in pertinent part, that there was no coverage
for claims ‘based on . . . actual or proposed payment of the Company of allegedly inadequate or
excessive consideration in connection with the purchase of securities issued by any company.’
The court upheld the insurer’s disclaimer.

The ‘inadequate consideration exclusion’ is one of numerous new exclusions that the insurance
industry is adding that sharply reduce coverage, and which often pass unnoticed by insurance
brokers and consultants. The policyholder does have two remedies for new exclusions. In most
states, the insurer on a renewal must advise the policyholder of any reductions in coverage. The
broker has a similar duty to advise its client of any changes to the policy. Both insurers and
brokers often fail in these duties.

IX. BUMP UP EXCLUSION

Directors and officers insurance policies are full of holes and do not provide coverage for many
basic corporate exposures. Genzyme Corp. v. Federal Ins. Co., 2009 WL 3101025, civ. Action
no. 08cv10988-NG (D. Mass. Sept. 28, 2009) demonstrates the prevalence of the insurers'
defense that many settlement payments do not constitute "loss" under the D&O policy but rather
are restitutionary payments that are not covered.

On September 28, 2009, the United States District Court for the District of Massachusetts
dismissed a lawsuit filed by Genzyme Corporation ("Genzyme") seeking insurance coverage
from Federal Insurance Company (the "Insurer") under its D&O insurance policy (the "Policy")
for a settlement of a shareholder class action. In determining that there was no insurance
coverage for the settlement, the Court relied primarily upon the definition of "Loss" in the Policy
and a "Bump-Up exclusion" in the Policy, which relieved the insurer of liability for any
"inadequate or excessive consideration in connection with [the] purchase of securities."

Genzyme is a biotechnology company. It had sold a series of "tracking stock" designed to track
the performance of certain business divisions of the company. From December 2000 through
June 2003, three series of Genzyme tracking stock were outstanding; specifically, the
Biosurgery, Molecular Oncology and General Divisions. On May 8, 2003, Genzyme announced
that it was going to exercise the optional exchange provisions in its Articles of Organization,
which would effectively eliminate the corporation's tracking stocks by exchanging all
outstanding Biosurgery Division and Molecular Oncology Division shares for common stock in
the General Division. Shareholders holding stock in the Biosurgery and Molecular Oncology
Divisions were compensated as part of this share exchange based upon the current market value
of their stock as compared to the value of the common stock of the company.

A number of shareholder lawsuits were filed against Genzyme and its officers and directors as a
result of this share exchange, and these shareholders were certified as a class on August 6, 2007.
While the complaint contained seven counts, it primarily alleged that Genzyme and its officers
and directors conspired to depress the market value of outstanding Biosurgery Division stock in
order to exchange it for common stock at a rate that would result in a profit for the General
Division shareholders - including Genzyme's top officers and directors - at the expense of
Biosurgery Division shareholders. Genzyme agreed to settle the class claims by making a one-
time payment of $64 million.

Genzyme sued the Insurer for coverage under its D&O Policy. The Court determined that
Genzyme did not have coverage for the settlement payment as a result of two key terms in the
Policy - an exclusion from the definition of a covered "Loss" for "matters uninsurable under the
law" and a "Bump-Up" exclusion1 which provided, in pertinent part, that:

[The Insurer] shall not be liable … for that part of Loss … which is
based upon, arising from, or in consequence of the actual or
proposed payment by any Insured Organization of allegedly
inadequate or excessive consideration in connection with its
purchase of securities issued by any Insured Organization.

As an initial matter, the Court determined that the settlement payment was uninsurable under
Massachussets law for reasons of public policy. The Insurer cited abundant case law supporting
the notion that an insured does not incur an insurable "loss" when he is merely forced to disgorge
money or other property to which he is not entitled (i.e., an "ill-gotten gain"). See, e.g., Level 3
Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001). Genzyme argued that
the settlement payment was not restitutionary in nature since the company did not receive any
benefit from the share exchange.

1
According to the Insurer, this exclusion is apparently referred to in the insurance industry as a "bump-up"
exclusion because it is used to describe litigation seeking to increase or "bump-up" the consideration paid for
security.
The Court sided with the Insurer, stating that while the company itself did not profit from the
transaction, it did effectively benefit one class of shareholders at the expense of another class of
shareholders, and the settlement was designed to redress this imbalance. The Court was
concerned that requiring coverage under these circumstances would transform insurance policies
into "profit centers" for companies, stating "[e]veryone would win, except for the insurance
company forced to bear the loss of paying off the disgruntled shareholders." See decision at *8.

The Court then turned to the Bump-Up exclusion in the Policy. Genzyme argued that the share
exchange did not involve an actual "purchase" of securities since it was a share exchange and
therefore the exclusion was inapplicable. The Court relied upon the dictionary definition of
"purchase" which includes an exchange for something of equivalent value, and found that the
share exchange was in fact a "purchase" as that term was used in the Policy. Accordingly, the
Court held that the exclusion was an absolute bar to coverage under Insuring Clause 3 - coverage
for securities claims brought against the entity.

Genzyme further argued that even if it was barred from recovering for securities claims brought
against it as a result of the Bump-Up exclusion, it was still entitled to reimbursement for the
money it paid to indemnify its directors and officers, since the settlement was a global resolution
of the claims in the underlying lawsuit. The Court disagreed, stating that no court has "split the
baby" in this manner where coverage for claims against the entity were barred, since companies
can only act through their directors and officers. Moreover, the Court was concerned that
permitting this type of distinction with regard to a global settlement would permit companies to
structure settlements in a manner to maximize coverage under the indemnification provisions of
a D&O policy where the payment was in fact restitutionary in nature.

This decision to deny coverage for settlement payments made to shareholders was largely driven
by public policy concerns. The Court was very keenly attuned to the risk that providing
coverage for these types of shareholder settlements would encourage fraud and chicanery by
insured corporations. The decision also has far-reaching impact beyond D&O policies
containing a bump-up exclusion since the Court relied upon the disgorgement/restitution
exclusion as an independent basis for barring coverage. In doing that, the Court expanded that
exclusion to include a stock redistribution or recalibration. This was a novel analysis of an
exclusion found in nearly every D&O policy and may give insurers ammunition to go farther
afield in their denials of coverage on the basis of this exclusion, in situations where, as in
Genzyme, the company itself did not profit from the underlying transaction. Accordingly,
insureds may need to argue that the judge's creative recalibration analysis is restricted to the
specific and unusual circumstances of the Genzyme case and should not be broadly applied.

X. INTENTIONAL CONDUCT EXCLUSION

In Greenwich Ins. Co. v. Media Breakwaway, LLC et al., 2009 U.S. Dist. LEXIS 63454 (C.D.
Cal. July 22, 2009) Greenwich filed a declaratory judgment action regarding its duty to defend
and indemnify its insureds, an online marketing company and its CEO and president, for a
lawsuit filed by MySpace claiming multiple violations of state and federal law for "phishing" -
sending unlawful, unsolicited commercial advertisements through MySpace user accounts.
MySpace was awarded over $6 million in damages as a result of arbitration of the underlying
case. The arbitrator found for MySpace on the ground that Media Breakaway "condoned,
encouraged, knew about and benefitted from the unlawful spam attacks on MySpace…"

Accordingly, the insurer argued that the damages were barred by the following exclusions in the
policy for any claim made against an Insured "brought about or contributed to in fact by any: (1)
intentionally dishonest, fraudulent or criminal act or omission or any willful violation of any
statute, rule or law; or (2) profit or remuneration gained by any Insured to which such Insured is
not legally entitled."

The Court agreed with the insurer, concluding that the exclusion for intentional conduct clearly
applied to the arbitrator's findings and therefore, the claim was not covered under the policy.
The Court therefore held that the insurer had no duty to defend or indemnify the insured for the
action and ordered that the insured repay the defense expenses received.

XI. BAD FAITH

Acacia Research Corp. v. National Union Fire Ins. Co. of Pittsburgh, PA, Case No. CV 05-501
PSG (C.D.Ca. 2008) highlights the type of facts and circumstances that a court may find
constitute bad faith on the part of an insurance carrier in denying an insured’s claim as well as
the damages that could result therefrom.

In Acacia, the plaintiffs were insured under a Directors, Officers and Corporate Liability
Insurance Policy (“D&O”) issued by National Union Fire Insurance Company, which provided
coverage to the corporate entities as well as their respective directors and officers. Prior to the
inception of this policy, the insured hired a new Vice President of Research and Development
and Chief Technology Officer. He agreed that all of his inventions while in the insured’s employ
would be assigned to the insured. These inventions subsequently resulted in two patents, both of
which were issued during the D&O policy period. Thereafter, a suit was commenced against the
insured by Nanogen, Inc. (“Nanogen”), claiming that the disputed technology was wrongfully
assigned.

Following the commencement of that action, the insured notified its D&O carrier of the claim.
Approximately two weeks later, on or about December 15, 2000, the insurer transmitted a
written acknowledgment of receipt of the claim and a representation that its preliminary
coverage evaluation would be forwarded “in the near future.” However, two days prior to the
drafting of that correspondence, the claims handler for the insurer opined in an internal e-mail
that the claim “does not appear to be covered.” By March 2001, the claims handler had not taken
any action other than to acknowledge receipt of the claim and request a copy of the policy. The
claim was then reassigned, and thereafter the insurer requested additional information from its
insured. The insured promptly responded to that request and reiterated its willingness to fully
cooperate with the investigation. The insured subsequently transmitted correspondence to its
insurer in April and May 2001 requesting a status of the claim but received no response.

The insurer subsequently removed that claims handler from the claims department in May 2001.
However, the insurer did not reassign the claim until August 2002, by which time the insured had
settled the matter directly with Nanogen. In January 2003, the new adjuster verbally represented
that the settlement was not a covered loss since the policy did not cover patent or breach of
contract claims. However, that adjuster subsequently acknowledged at a deposition that there
was no breach of contract exclusion contained within the policy and that he reached his opinion
without sufficient information about the insured‘s coverage.

The insurer again reassigned the claim in May 2003. On November 3, 2003, the insurer sent its
first and final coverage letter to the insured denying coverage based upon, inter alia, the
insured's alleged failure to cooperate. On these facts, the court concluded that the insurer
improperly and unreasonably withheld in bad faith benefits otherwise due to the insured under
the policy. As such, the insured was entitled to all damages proximately caused by that conduct,
regardless of whether they could have been anticipated. The court ordered the insurer to
reimburse the insured for the amount of the settlement, defense costs and interest.

See also Abercrombie & Fitch v. Federal Insurance Co., 2008 U.S. Dist. LEXIS 18597 (S. D.
Ohio 2008)(court refuses to dismiss bad faith count).

XII. LITIGATION GUIDELINES

In Abercrombie & Fitch v. Federal Insurance Co, Docket No. SOM L-1571-07 N.J. Law Div
Nov. 13, 2009), the insurer agreed to defend the insured, but insisted on compliance with its
Litigation Management Guidelines ("LMG"). At the end of the day, the insurer had failed to pay
a substantial portion of the policyholder's attorneys' fees, alleging failure to comply with the
LMG. The insurer asserted that the block billing by the policyholder's attorneys did not provide
enough specificity to allow it to evaluate the claim. The insurer also asserted individual billing
issues, such as having too many lawyers at a deposition.

The policyholder sued for bad faith. The insurer brought a motion to dismiss the bad faith count,
and the insured cross-moved for a declaration that the LMG were unenforceable.

The insured asserted that the LMG were not part of the insurance policy. The court noted that
while it was true that the LMG were not part of the policy, the policy stated that all payments
needed the insurer's consent, which would not be unreasonably withheld. As a result, the insurer
had some control over the attorneys' fees. Moreover, in its reservation of rights letter, the insurer
had conditioned its agreement to defend on compliance with the LMG, and the insured did not
object.

Ultimately, the court denied both motions because of fact issues. The court found that it needed
to examine the impact and reasonableness of the LMG, whether they had been applied
reasonably, whether the insurer should be allowed to rely on them, and the degree to which the
policyholder had complied with them. The court held that:

"Whether the LMG is enforceable, and if so, to what extent, will depend on the reasonableness of
defendant conditioning its consent on application of the LMG as well as on the reasonableness of
the LMG's provisions and defendant's application of the guidelines. A subsidiary issue is
whether the LMG or its application offend public policy."
Policyholders often struggle with the LMG, and often end up having to discount their bills. The
insurers essentially want the attorney to re-write all of its bills in an effort to comply, a task that,
even if possible, would be prohibitively expensive.

The Abercrombie & Fitch decision is an important weapon for policyholders to insist that the
insurer apply the LMG reasonably. This is an issue best raised at the outset of the proceeding.
Frequently, the insurer will object each month to items on the attorneys' bills as inconsistent with
the LMG, and the policyholder will let the objections pile up. At the end of the underlying
litigation, the policyholder is left with a significant amount of unpaid bills, little desire to
institute a coverage action over them, and with little other recourse.

These cases demonstrate an increasing willingness by courts to hold insurers to their contractual
promises, and to punish them for egregious violations of their fiduciary duty. Importantly, they
stand for the proposition that following the submission of a claim, an insurer is obligated to
timely and diligently investigate, evaluate and adjust claims in good faith. Insureds and their
counsel must be cognizant of the applicable “prompt-pay” and other statutory guidelines
regarding claims processing and not accept unreasonable delays or unjustifiable coverage
positions by the insurer.

XIII. WHOSE MONEY IS IT ANYWAY?

Several executives of Stanford International Bank and related entities are accused of being at the
center of an $8 billion Ponzi scheme and now find themselves as defendants in a securities fraud
case brought by the Securities Exchange Commission pending in the United States District Court
for the Northern District of Texas entitled SEC v. Stanford Int'l Bank, Civ. Action No.: 3.09-CV-
298-N. In that action, the SEC requested that the Court appoint a receiver to protect the assets
obtained in connection with the Ponzi scheme and the Court complied with this request, freezing
the defendants' assets and putting them into receivership.

One of the defendants moved the Court for an order clarifying that the $50 million in D&O
insurance policy limits obtained by the companies were outside of the receivership estate and
could be used for payment of defense costs on behalf of the directors and officers. On October 9,
2009, the Court responded to the defendant's motion, noting that this was an issue of first
impression for the Court.

The Court first noted that the receiver had not yet tendered any claim against the Stanford
entities that might deplete the policy limits, and Lloyds of London - the D&O insurer - was
adamant that any such future claim would be barred by various policy exclusions. Lloyds further
maintained that the receiver would be estopped from arguing that the exclusions do not apply
since he had repeatedly accused the Stanford entities of fraud. The Court noted that while it
wasn't passing judgment on the availability of coverage for such claims, it did highlight to the
Court that the receivership's claim to insurance proceeds was largely hypothetical.

The Court went on to state that permitting the directors and officers to access insurance proceeds
was in the general interest of fairness since many of the defendants denied knowledge of the
fraudulent activities and therefore should be entitled to receive the coverage that they relied upon
in the course of their employment. Thus, the Court reasoned that while the potential harm to the
receivership was purely speculative, individual defendants may be unable to defend themselves
in this matter if they can not access policy proceeds. Moreover, the Court noted that these assets
were different from the other assets being preserved by the receiver in that there was no
allegation that the insurance proceeds were potentially tainted by fraud and the Court had no
duty to preserve them as such.

Thus, the Court ultimately decided that it had discretion to permit disbursement of the D&O
insurance proceeds for defense costs. The Court clarified that its Order was not a coverage
determination as to the right of any individual defendant to defense costs from the policy, and
that Lloyds retained the ability to deny coverage under any applicable policy exclusions.
About the Lowenstein Sandler Insurance Group:

There are few generalities in insurance coverage. Each policy comes with its own set
of rules and insurance law changes from state to state. The attorneys in Lowenstein
Sandler's Insurance Group know the ins and outs of insurance, state-by-state and
policy-by-policy. From traditional D&O, environmental and mass tort insurance
coverage to cyber-insurance coverage for intangible exposures such as lost or
damaged data and intellectual property infringement, we work with our clients to
develop insurance programs that address these and other issues, and to resolve claims
against recalcitrant insurers. Our attorneys know when and how to exert litigation
pressure to reach settlement and attain the maximum coverage, and when necessary,
how to litigate coverage through trial.

For more information on Lowenstein Sandler's Insurance Group, please contact:

Robert D. Chesler
Member of the Firm, Chair of the Insurance Group
(973) 597 2328
[email protected]

Michael David Lichtenstein

Member of the Firm, Co-Chair of the Insurance Group
(973) 597 2408
[email protected]

Cindy Tsvi Sonenblick

Counsel to the firm's Insurance Group
(973) 597 6374
[email protected]

or visit www.lowenstein.com

Lowenstein Sandler makes no representation or warranty, express or implied, as to the completeness or accuracy of this
publication and assumes no responsibility to update the publication based upon events subsequent to the date of its publication,
such as new legislation, regulations and judicial decisions. Readers should consult legal counsel of their own choosing to discuss
how these matters may relate to their individual circumstances.

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