Directors & Officers Coverage for Government Investigations

DIRECTORS & OFFICERS COVERAGE FOR GOVERNMENT INVESTIGATIONS

By David A. Gauntlett

Introduction

Government investigations commenced by a government entity, state or federal such as the Securities Exchange Commission (“SEC”) or Department of Justice (“DOJ”) through service of a subpoena or with a request for production of documents secure data to evaluate whether actionable conduct has arisen that allows a government agency to pursue a claim implicating a policyholder’s “Directors and Officers (“D&O”) policy. Such investigations create significant potential exposure for policyholders in investigation costs. Additionally, in responding to government subpoenas or demands for information, even before the start of an investigation, policyholders often expend significant amounts of time and money securing the information required.

The availability of insurance coverage for investigation defense costs is unclear leading to apparent inconsistent decisions. The policyholder, however, that actually pursues coverage for those claims often succeed. The failure to notify the insurers of the claims will deprive insured of any potential coverage where the investigation proceeds to a “Claim.” At minimum, these interactions should be reported to the present D&O carrier as a potential claim under the policy provisions allowing the report of a “notice of circumstance.”

Government Investigations Fall Within the Definition of a “Claim”

Insurer’s typically argue that government investigation subpoenas and demands do not trigger coverage under the policy’s definition of a “Claim.” Some courts have favored this insurer’s argument.[1] The forums, however, that have awarded policyholder recovery offer pathways for securing policy benefits. For example, in Guaranteed Rate, Inc. v. Ace Am. Ins. Co.,[2] the U.S. Attorney’s Office for the Northern District of New York and the U.S. Department of Justice pursuant to the False Claims Act served subpoenas as part of an investigation to determine whether Guaranteed Rate had violated 31 U.S.C. § 3729. Ace denied coverage for the civil investigation demand. It asserted that it did not qualify as a “Claim” under their policy. The court disagreed and determined that the civil investigation demand fell within the policy’s definition for “a civil, administrative or regulatory investigation against the Insured.”[3] It explained that:

For purposes of determining coverage, there is not distinction between the investigation of, or actually alleging, an unlawful act. The duty to pay defense costs must be “construed broadly, and in favor of coverage whenever factual allegations raise the possibility of liability covered by the policy.[4]

This ruling followed the rationale in MBIA Inc. v. Federal Ins. Co.[5] which held that:

We reject the insurers’ crabbed view of the nature of a subpoena as a “mere discovery device” that is not even “similar” to an investigative order. The New York Case law makes it crystalline that a subpoena is a primary investigative implement in the NYAG’s tool shed. We also reject the insurer’s argument that because the definition does not include a proceeding commenced by service of a subpoena, a subpoena is not included. This reading puts form over substance the fact that the definition does not say “service of a subpoena” is not dispositive.[6]

Prompt Notice is Key to Secure Coverage for Government Investigations

Providing prompt notice is crucial in any insurance coverage dispute as it is the most common bar to a potentially covered claim. It may be the case that where a policyholder is given demand or subpoena for a government investigation, it may not realize that a government investigation could be a covered claim where policyholders fails to notify the insurer fatally losing any chance to secure coverage relief. Thus, it is crucial that at the first indication of a government investigation, a policyholder must consider whether it must provide notice to its insurer to secure any potential coverage benefits.

In some jurisdictions, late notice of a claim bars coverage not only for investigation costs but also defense costs and any subsequent lawsuit or other legal proceedings that may subsequently arise. Even if a subpoena or government investigation is determined to not qualify as a “Claim” under the policy, a policyholder may still benefit from notifying its insurer of any demand issuing a government investigation as reporting a potential claim or “circumstance that may give rise to a claim.”

Coverage for Government Investigations Arising from Fraudulent “Wrongful Acts”

As a matter of public policy, coverage for fraudulent acts, typically associated with government investigations, are considered uninsurable claims in many forums.[7] Those jurisdictions limit coverage contractually where public policy statutes are absent or may not address what rights an insured has to secure investigation costs or defense fees in a formal proceeding. D&O policies typically include a “Profit/Fraud” exclusion that bars coverage for losses “based upon, arising out of or attributed to… any deliberately …fraudulent act.” The Delaware Supreme Court, in RSUI Indem. Co. v. Murdock,[8] held last year that coverage for alleged fraud claims though an adjudication of liability was available. It reasoned that because the plain meaning of the Profit/Fraud exclusion required a “final and nonappealable adjudication” and no adjudication addressed the alleged fraudulent conduct, to read such language to bar coverage for the alleged fraud claims would not be in accord with the Insured’s reasonable expectations. As the court explained:

Insurance contracts should be interpreted as providing broad coverage to align with the insured’s reasonable expectations… [such that it’s] the insurer’s burden to establish that a claim is specifically excluded. Courts will interpret exclusionary clauses with a ‘strict and narrow construction… [and] give effect to such exclusionary language [only] where it is found to be “specific,” “clear,” [and] “plain.”[9]

Following this rationale, absent an adjudication, policyholders can potentially secure coverage for government investigations issued for alleged fraudulent conduct, like that in Guaranteed Rate, under a D&O policy avoiding the Profit/Fraud exclusion.

Similarly, in AR Capital, LLC v. XL Specialty Ins. Co.,[10] a subpoena issued to a corporate officer led the court to hold that an SEC investigation is sufficient to evidence a “Claim,” but the launch of an internal audit was insufficient. A subsequently filed class action case asserted conduct issuing “a federal investigation for violations of the securities laws by misleading investors in the filing of fraudulent financial statements.”[11]

Coverage for Alleged Criminal Acts

Consistent with the logic of Murdock, Dupree v. Scottdale Ins. Co.,[12] ordered payment of defense fees incurred in a criminal proceeding. Following a finding of criminal liability against Duprees, however, the court ordered that ruling vacated and ordered that Scottsdale was no longer obligated to pay defense fees in the criminal proceeding.[13] On appeal, Watts’, the Chief Investment Officer, defense fees were confirmed to no longer be Scottsdale’s obligation because “[i]n the context of a criminal prosecution, it is well settled that the imposition of the sentence constitutes the final judgment against the accused.”[14] But, recoupment was available if the conviction establishes a lack of entitlement to coverage under a “prior acts” exclusion.[15]

Conclusion

Fraud and criminal acts generate significant defense fees even when they are only in the investigation stage. Failure to notify a D&O insurer in such cases can be fatal so too failing to secure a D&O policy is equally problematic.

If you enjoy this content, you can find my full list of blogs here: https://docs.google.com/document/d/1N3YsMmn0Ii1GqHWSBEE1pPzh1jQbU6htkJZ2e55Y2eM/edit?usp=sharing

[1] See, MusclePharm Corporation v. Liberty Ins. Underwriters, Inc. 712, Fed. Appx. 745, 755 (10th Cir. (Colo.) 2017); Employers’ Fire Ins. Co. v. ProMedica Health Systems, Inc., 524 Fed. Appx. 241, 252 (6th Cir. (Ohio) 2013); Oceans Healthcare, L.L.C. v. Illinois Union Ins. Co., 379 F. Supp. 3d 554, 564-565 (E.D. Tex. 2019)

[2] Guaranteed Rate, Inc. v. Ace Am. Ins. Co., C.A. No. N20C-04-268 MMJ CCLD, 2021 Del. Super LEXIS 552 (Del. Super. Ct. – New Castle County Aug. 18, 2021)

[3] Id. at *4

[4] Id. at *5

[5] MBIA Inc. v. Federal Ins. Co., 652 F.3d 152, 159 (2nd Cir. (N.Y.) 2011); see also, Sycamore Partners Mgmt., L.P. v. Endurance Am. Ins. Co., C.A. No. N18C-09-211 AML CCLD, 2021 Del. Super. LEXIS 584, *46-47 (Del. Super. Ct. – New Castle County Sept. 10, 2021); Conduent State Healthcare v. AIG Specialty Ins. Co., C.A. No. N18C-12-074 MMJ [CCLD], 2021 Del. Super LEXIS 493, *10-11 (Del. Super. Ct. – New Castle County Jun. 23, 2021); Minutemen Int’l Inc. v. Great Am. Ins. Co., Case No. 03 C 6067, 2004 U.S. Dist. LEXIS 4660, *18-20 (N.D. Ill. Mar. 18, 2004)

[6] Id. at 160

[7] See, e.g., California Insurance Code 533 (bars indemnification of willful acts defined to include as actions undertaken with an intent to harm.)

[8] RSUI Indem. Co. v. Murdock, 248 A.3d 887 (Del. 2021)

[9] Id. at 906

[10] AR Capital, LLC v. XL Specialty Ins. Co., 2018 Del. Super. LEXIS 1568 (Del. Super. Ct. – New Castle County Dec. 12, 2018)

[11] Id. at *33-35

[12] Dupree v. Scottsdale Ins. Co., 100 A.D.3d 467, 468 (N.Y. App. Div. 1st Dept. 2013)

[13] Dupree v. Scottsdale Ins. Co., 2013 N.Y. Misc. LEXIS 3480, *5 (Aug. 1, 2013)

[14] Dupree v. Scottsdale Ins. Co., 129 A.D. 586, 587 (N.Y. App. Div. 1st Dept. 2015)

[15] XL Specialty Ins. Co. v. Level Global Investors, L.P., 874 F. Supp. 2d 263, 282 (S.D.N.Y. 2012)