The D & O Diary
D&O Insurance: Actions Not Undertaken in an "Insured Capacity" Not Covered
Many organizations purchase management liability insurance to provide liability and defense cost protection for their directors and officers. But the management liability insurance protects the individuals only for their actions undertaken in an “insured capacity.” The policies are not intended to not protect them for actions they undertake in a capacity other than as a director or officer of the organization. These issues proved to be determinative in the action to decide whether or not D&O insurance issued to Jerry Sandusky’s organization, The Second Mile, covered the legal fees Sandusky incurred defending criminal and civil allegations involving misconduct with children.
In a March 1, 2013 Memorandum Opinion, Middle District of Pennsylvania Chief Judge Yvette Kane held that because the alleged misconduct did not arise in Sandusky’s capacity as an employee or executive of The Second Mile, the organization’s management liability insurer had no obligation to provide him defense cost coverage. A copy of Judge Kane’s opinion can be found here. As I note below, I have some concerns about this ruling.
Background
Sandusky founded The Second Mile in 1977. From 1977 until Sandusky was criminally indicted for offenses against children. Sandusky served at times as a volunteer and at times as an executive-level employee of the organization. In November 2011, a grand jury returned a report charging Sandusky with multiple crimes involving children. Following a trial, Sandusky was convicted of a total of 45 charges involving offenses against children. Sandusky has appealed his criminal conviction. Sandusky has also been named as a defendant in a separate civil proceeding brought by one of his alleged victims.
Sandusky sought coverage for the attorneys’ fees incurred in both the criminal and civil matters from The Second Mile’s management liability insurer. Sandusky sought coverage under both the D&O and EPL portions of the policy. The insurer advanced Sandusky’s defense expenses subject to a reservation of its rights under the policy and initiated an action seeking a judicial declaration that it had no obligation to fund Sandusky’s defense expenses. The insurer filed a motion for judgment on the pleadings, arguing that it would be against Pennsylvania public policy to indemnify Sandusky for the child molestation charges against him. As discussed here, in a June 2012 order, Judge Kane agreed that it would be against Pennsylvania public policy for the insurer to indemnify Sandusky, she reserved the question of whether it would be against public policy for the insurer to provide Sandusky with a defense.
After Sandusky’s criminal conviction, the insurer moved for summary judgment, arguing that the acts alleged against Sandusky were not undertaken in an insured capacity. The policy defined the term “Insured Capacity” to mean “the position or capacity of an Insured Person that causes him to meet the definition of Insured Person.” Sandusky argued that the meaning of this provision is ambiguous and the further discovery was required to determine the extent of the coverage provided under the policy.
The March 1 Opinion
In her March 1, 2013 memorandum opinion, Judge Kane granted the carrier’s motion for summary judgment. She found the policy language regarding “Insured Capacity” to be “unambiguous.” She said that in order to determine “whether the actions that form the basis of the claims against Defendant were performed in his capacity or role as an executive or employee of The Second Mile,” she must review the allegations against him. She then reviewed the various abuse allegations that had been alleged against Sandusky. Among other things, she noted that the alleged abuse was alleged to have taken place in a variety of locations, all away from The Second Mile’s facilities.
Based on this review, she concluded that “it is clear that Defendant Sandusky was not acting in his capacity as an employee or executive of The Second Mile in sexually abusing and molesting the victims named in the criminal and civil cases brought against him, and the Court so finds.” She added that Sandusky was not alleged to have engaged in the alleged misconduct “in furtherance of his duties for The Second Mile.” She noted that the fact that Sandusky met his victims through The Second Mile or even that he sexually abused victims “during the course of activities at” The Second Mile “does not change the fact that his sexual abuse of children was personal in nature and performed in his individual capacity.” Because Sandusky’s alleged conduct “was clearly personal in nature and not in furtherance of his duties for The Second Mile, he is owed no criminal defense under the Policy.”
Discussion
The nature of these allegations is so repugnant and the fact that Sandusky has been convicted criminally makes it hard to spend any time thinking about the issues here. I certainly have no interest in defending Sandusky or trying to prove that he has not been dealt with fairly here.
Nevertheless I do have concerns about this ruling. It is easier to see my concerns if we forget about Sandusky and imagine instead that a volunteer or employee of a nonprofit organization has been unfairly targeted by abuse allegations, perhaps as a particularly vindictive part of a smear campaign. Let us say for purposes of this hypothetical that the allegations, though false, are otherwise as heinous as those against Sandusky.
My concern is that under Judge Kane’s ruling, even this falsely accused individual could not look to his origination’s management liability insurer for a defense. Her ruling does not depend on Sandusky’s conviction. She expressly says that “Sandusky’s offenses against children –whether proven or alleged – were not conduct in his capacity as an employee or executive of the Second Mile.” The allegations alone are enough to determine coverage, because “sexual abuse of children” is “personal in nature” and is “performed in individual capacity.” She even said that this conclusion would apply “even if he sexually abused victims “’during the course of activities of Second Mile.’”
If the mere fact that allegations of sexual abuse are personal and individual is enough to preclude coverage for Sandusky, then are mere allegations sufficient to preclude coverage even for a nonprofit official who is falsely accused as part of a smear campaign? Keep in mind, Kane is not interpreting a clause of a policy in which the insurer says “we won’t insure even allegations of sexual molestation.” She was interpreting a clause that talks about the capacity in which a person was sued and for which he or she got sued. In our smear campaign hypothetical, the only reason my hypothetical smear campaign individual was targeted was because they were an official of the nonprofit. Are we prepared to say that this falsely accused individual is under no circumstances entitled to a defense, simply because of the nature of the allegations?
I would be much more comfortable all the way around with this decision if it were based on the fact that Sandusky was actually convicted. Of course, given that his criminal case is still on appeal the judgment in the criminal case is not final, and so the insurer might not be able to preclude coverage on the basis of the criminal conviction for some time yet.
When Judge Kane says that her conclusion that Sandusky was not acting in an insured capacity applies even though he allegedly abused victims “during the course of activities of Second Mile,” that’s when I get uncomfortable with this result. It would be very easy to shrug this result off because of the terrible things for which Sandusky was convicted. But because Judge Kane’s conclusion does not depend on the conviction, this same result could apply to any nonprofit official, even one who is falsely accused and would otherwise be forced to defend him or herself against outrageous allegations without insurance and at their own expense. I am very uncomfortable with this whole subject matter, but I am also not entirely comfortable with this decision.
I invite readers to weigh in on this topic, particularly those who take a different point of view on this decision than I do. (I know I am setting myself up for a raft of messages about the need for separate sexual molestation coverage or the possible problems with the bodily injury exclusion in the typical D&O insurance policy, and perhaps other similar arguments as well. Please bear in mind that my concerns here are focused exclusively on Judge Kane’s reasoning in denying coverage, not on whether there may be other questions that might affect coverage or whether there are alternative insurance arrangements that might better address the sexual molestation exposure.)
Whistleblower Watch: In my annual year-end round up of D&O insurance and liability issues, I more or less said that I thought 2013 would be the year of the whistleblower, or at least the year in which the whistleblower bounty provisions of the Dodd Frank Act kick into high gear. Well, here we are into the third month of 2013, and there still haven’t been any more whistleblower bounty awards. So was I wrong? Maybe I was, but before you decide, you need to take a look at the list that Mary Jane Wilmoth has been compiling over at the Whistleblower Protection Blog.
As Wilmoth reports, the SEC posts Notices of Covered Action when a final judgment order, by itself or with prior orders and judgments in the same action, results in monetary sanctions over $1 million. Individuals who voluntarily provided the SEC original information that led to successful enforcement in the actions identified in the Notices are eligible to apply for whistleblower awards. Once the Notices are posted, individuals have 90 days to apply for an award. The blog post lists 22 actions in which Notices have been posted. The list is complete through February 8, 2013. From looking at the dates on which the Notices have been posted, the SEC is putting up Notices regularly. The pretty clear inference is that this list is going to get a lot longer very rapidly.
Obviously not all of the Notices will lead to whistleblower bounty awards. Indeed, many will not, as there may not be a qualifying individual. But it seems highly probable that there will be some awards, perhaps many. In other words, it still seems possible that 2013 will be the year in which whistleblower bounty provisions kick into high gear. Stay tuned.
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What if we change the facts to criminal allegations of insider trading -- a crime that is arguably "personal in nature" and where the corporation is actually deemed the victim? (I am aware of the caselaw regarding corporate advancement and insurance in that context, but this ruling potentially begs that question, doesn't it?)
I agree with the court's finding that the "capacity" requirement in the policy is unambiguous. Beyond that point, however, it seems that the conviction has weighed on the result here, despite the court's saying the offenses "whether proven or merely alleged" were not in his capacity as employee or executive of The Second Mile. Typically "capacity" questions in the D&O insurance context involve determining which of two corporate entities the insured acted for. The court's holding the acts were committed in Sandusky's 'individual' capacity would create an extremely difficult test to apply. If an executive converts a corporate opportunity to his own use, is that not in his 'individual' capacity? (disregarding the "personal profit or advantage" exclusion, as we assume it's only an alleged theft.) Or plain old sexual harassment on the job -- again it's solely for 'individual' gratification; in both cases the workplace provides the opportunity.
The court asserts it is using strictly a "four corners" comparison of the allegations to the policy (as if this were a duty to defend case), but proceeds to essentially disregard the allegation that some of the abuses occurred "during the course of activities of The Second Mile." Perhaps Sandusky's counsel should have argued it can be inferred from the allegations that Sandusky founded The Second Mile nonprofit in part to facilitate his access to victims. This sad episode illustrates the saying that bad facts can make bad law.
Wow, very much surprised by the Sandusky ruling. While I agree with Judge Kane in that this guy deserves no support, her ruling that his actions were of a personal matter and are not related to his
role in the Charity seem unsupported:
1.) He founded this charity
2.) He met all these boys at Second Mile events
3.) Their main program was for Early Intervention of at risk youth, i.e. children that need extra attention and support. Which is seemingly the guise under which Sandusky gained access to these boys and was able to be around them 24/7 without raising suspicion.
The only way I could possibly see around this is if his only role ever in the organization was as fundraising coordinator or something in which he was to have no interaction with the children. In that
sense his actions were of a personal matter since he was acting outside of his capacity as an insured individual. But again, given his prominent role in the organization that seems far reaching and inaccurate.
To paraphrase my fried Arthur, hard facts do indeed sometimes make for bad law. But, I say that not necessarily sure that the court decided this one wrongly.
Nonetheless, Nate presents an apt analogy in the realm of public company D&O. I believe an even closer analogy would be the case of egregious sexual harassment of a subordinate employee and coverage under an employment practices liability policy. Those policies also aften have insured capacity provisions, but I believe it would be a lot closer call to say that acts of harassment, even if they occurred away from the workplace, would fall outside the scope of coverage.
Interestingly, the court did not have to address the issues of the potential collateral estoppel effect of the criminal conviction or the public policy arguments against insurability. Although the conviction is on appeal, that decision will turn on issues of law and not the facts found by the jury. More troubling, however, is Kevin's well=placed concern about the possible lack of insurance protection for a truly innocent victim of baseless charges. While that certainly is not the case here given the conviction, the court's reasoning might well visit that same result upon such a hapless victim.
What if the defendant was accused of embezzling money, which lead to the insured organization failing to provide promiseed services? That would sound like a personal action that wasn't sanctioned by the insured organization. But, as mere allegations, the insured organization itself would be obligated (in most states) to defend and indemnify the employee. And what if the allegations were that the "embezzlement" was approval of excessive seminar expenses at executive retreats (where the individual was one of the attendees)? Would that really be so far outside the course and scope of duties for the organization as to deprive the individual of coverage?
I work for a non-profit youth sports league, and because of my day job I buy the insurance for it.
There is no ambiguity to me that our D&O policy does NOT cover abuse/molestations defense/liabilities. It covers allegations that we failed to follow bylaws, applied them incorrectly, unfairly discriminated someone by exlcuding them from something, etc.
Our Abuse/Molestation coverage has always been included (or as a rider) on the GL policy we have. I doubt that coverage would step in now that there was a conviction.
I agree with Tim. The D&O is simply the wrong policy to look for coverage under. I am going to guess they did not buy the GL rider and thus looked for coverage anywhere they thought they could find coverage.
The D&O should be preserved for the board for the various allegations against the board in their capacity as directors of Second Mile.
In Kevin's smear campaign example it would seem the Personal and Advertising Injury coverage under a GL policy would apply.
Finally, the first question should be whether the Second Mile would be obligated under their charter and by-laws to provide indemnification to Sandusky. I think the finding would be the same - no.