In yet another insurance coverage dispute in which a D&O insurer denied coverage for a claim based on the assertion that the claim was interrelated with a prior claim first made before its policy period, District of Massachusetts Judge Rya Zobel has ruled that BioChemics is not entitled to summary judgment on the issue of its D&O insurer’s duty to defend an SEC enforcement action against the company and its CEO. Judge Zobel ruled that the insurer is first entitled to discovery on the issue whether the wrongful acts alleged in the SEC enforcement action are interrelated with wrongful acts underlying SEC subpoenas served prior to the policy period of the insurer’s policy. A copy of Judge Zobel’s August 7, 2013 opinion can be found here.
In May 2011 and September 2011, the SEC served document subpoenas on BioChemics requesting a broad range of documents and indicating that the SEC had issued a formal order authorizing the investigation. At the time the 2011 subpoenas were served, BioChemics had a D&O insurance policy in place with a predecessor insurer. In November 2011, when the predecessor insurer’s policy expired, Biochemics placed its insurance with a different insurer, the one whose policy is at issue in the insurance coverage dispute. The new insurer’s D&O insurance policy had a policy period between November 13, 2011 and November 13, 2012.
In January 2012, during the policy period of the successor D&O insurance policy, the SEC served deposition subpoenas against John Masiz, BioChemics’ CEO, and two other individuals. In March 2012, the SEC served document subpoenas on BioChemics and Masiz. The 2012 subpoenas referenced the same SEC investigation identification number as had the 2011 subpoenas. The March document subpoenas noted that Masiz was not required to produce any documents that had already been produced in response to the 2011 subpoenas.
BioChemics submitted the 2012 subpoenas to its D&O insurer (the one whose policy went into effect in November 2011). The insurer denied coverage for the subpoenas, asserting that the SEC investigation was a single claim that was first made at the time of the first document subpoena in May 2011, before its policy took effect.
In December 2012, the SEC filed an enforcement action alleging that from 2009 to mid-2012 BioChemics and Masiz had engaged in a fraudulent scheme to mislead BioChemics’ investors about the company’s financial condition. BioChemics submitted the SEC enforcement action to its D&O insurer, which took the same position with respect to the enforcement action that it had taken with respect to the 2012 subpoenas, namely that the enforcement action was part of a single claim first made in May 2011.
BioChemics and Masiz filed a lawsuit against the insurer in Massachusetts state court (a copy of the complaint can be found here). The insurer removed the coverage action to Massachusetts federal court. BioChemics and Masiz moved for partial summary judgment, arguing that the available record was sufficient to permit the court to determine that the insurer owed them a duty to defend. In response, the insurer contended that further discovery was required and in particular that it was entitled to discovery of the communications between the plaintiffs and the SEC to determine whether it had any duty to defend.
The D&O insurer’s policy defines “Interrelated Wrongful Acts” to mean “any and all Wrongful Acts that have as a common nexus any fact, circumstance, situation, event, transaction, cause or series of causally or logically connected facts, circumstances, situations, events transactions or causes.”
The August 7 Order
In her August 7 order, Judge Zobel denied the plaintiffs’ motion for summary judgment without prejudice and granted the insurer’s motion for discovery.
The plaintiffs had argued that the D&O insurer’s policy establishes on its face that the insurer owes them a duty to defend them against the 2012 SEC subpoenas and the SEC enforcement action because those were claims were made against them during the D&O insurer’s policy period. The insurer argued that the 2012 subpoenas and the enforcement action are part of a single ongoing claim first made before its policy period began. The insurer sought discovery of materials related to the plaintiffs’ dealings with the SEC to show that the entire investigation arises from a single set of interrelated wrongful acts.
The plaintiffs argued that in determining the insurer’s duty to defend, the insurer cannot rely on extrinsic evidence but instead the insurer’s duty must be decided solely by reference to the underlying complaint and the policy. The insurer argued that the rule against using extrinsic evidence to determine an insurer’s duty to defend applies only where the insurer seeks to challenge the allegations of the third party’s complaint, not where the insurer is challenging an extrinsic fact that will not be litigated in the underlying action. The insurer’s relied on Edwards v. Lexington Ins. Co., a 2007 First Circuit opinion applying Maine law, which said that the rule against extrinsic evidence “cannot be rigidly applied in the context of claims-made policies where the determinative event is the timing of the claim, a fact that likely will be …irrelevant to the merits of the underlying tort suit and therefore absent from the pleadings.”
Judge Zobel said that “though the question is close,” the D&O insurer “has the better of the argument.” She said that
An insurer may not use extrinsic evidence to avoid its duty to defend if the allegations in the complaint are reasonably susceptible to an interpretation that states a claim within the scope of the policy. But an insurer may use extrinsic evidence to deny a duty to defend based on facts irrelevant to the merits of the underlying litigation, such as whether the claim was first made during the policy period, whether the insured party reported the claim to the insurer as required by the policy, or whether the underlying wrongful acts were related to prior wrongful acts. (Citations omitted.)
Judge Zobel held that because the material the D&O insurer sought to discover might affect the outcome of the plaintiffs’ summary judgment motion, the D&O insurer was entitled to the discovery.
She rejected the plaintiffs’ argument that because the SEC enforcement action referenced alleged wrongful acts that allegedly took place after the 2011 subpoenas were served, the enforcement action could not be interrelated to the wrongful acts underlying the earlier subpoenas. She said that the question of whether there is a “common nexus” between the 2011 subpoenas and the SEC enforcement action could only be determined after the parties had completed discovery.
Finally, Judge Zobel determined that under Massachusetts law, the insurer did not have an obligation to defend the plaintiffs pending resolution of the coverage dispute.
I have previously noted that questions of whether or not claims involve interrelated wrongful acts can be particularly troublesome and that the court decisions on the issue are all over the map. As this case illustrates, these questions can be particularly difficult for insured persons, because these vexing issues often arise, as they have here, at the outset of the underlying claim when the insured persons must defend themselves against the underlying allegations. The practical effect of Judge Zobel’s summary judgment denial is that now this company and the company’s CEO must defend themselves out of their own resources, rather than having the insurer fund the defense. In addition, they must now deal with the insurer’s discovery requests while also confronting the SEC’s action against them.
One question I had while first reading this opinion had to do with the predecessor D&O insurer – if, as the subsequent insurer asserted, the claim was first made before its policy period, why wasn’t the predecessor insurer also involved in this dispute (or even defending the SEC proceedings)? A quick reference to the insurance coverage action complaint suggests what might have happened. Though the predecessor insurer is not a party to the coverage dispute, BioChemics’ insurance broker is named as a defendant. The coverage action complaint alleges, among other things, that the broker recommended that BioChemics move its insurance from the predecessor D&O insurer to the successor insurer allegedly without discussing with BioChemics whether there were any circumstances that needed to be reported to the predecessor insurer and without calling attention to the option under the predecessor policy of purchasing extended reporting period coverage. The suggestion is that notice of the 2011 subpoenas was not given to the predecessor insurer during the predecessor insurer’s policy.
Another question I have has to do with the issue of whether or not the 2012 subpoenas and enforcement action involved actual or alleged wrongful acts that are interrelated with the wrongful acts underlying the 2011 subpoenas. The fact is that subpoenas in general typically do not allege wrongful acts or make allegations of any kind. Indeed, some D&O insurers have taken the position that their policies do not provide coverage defense costs associated with responding to subpoenas, because the subpoenas do not allege a wrongful act. There may well be a procedural thread that ties all of these various SEC proceedings together. Just the same, I wonder how it will be determined if there is a “common nexus” of alleged wrongful acts between the earlier subpoenas and the later proceedings and enforcement if the earlier subpoenas in fact allege no wrongful acts.
At least based on Judge Zobel’s opinion, this dispute does not appear to involve some of the issues that often arise when there are coverage questions about SEC subpoenas. At least based on the opinion, it does not appear that there is a dispute whether the subpoenas involve a claim within the meaning of the policy, a dispute that often arises with respect to SEC subpoenas (about which refer here). Also because the initial subpoena was issued and served pursuant to a formal investigative order, the parties’ dispute at least does not also involve the question that often arises about the extent of coverage under a D&O insurance policy for defense costs incurred in connection with an informal SEC investigations (about which refer here).
Though the dispute apparently does not involve these often recurring coverage issues, it still does present a cautionary tale about the need for attentive management of D&O insurance issues. The implication from the insurance coverage complaint is that at the time that BioChemics received the first subpoenas in May and September 2011, it did not provide notice of claim regarding these subpoenas to the insurer whose policy was in force at the time. Had the company done so, or had it done so at any time prior to the expiration of the predecessor insurer’s policy, many of the insurance problems confronting BioChemics as it deals with the SEC enforcement action likely would have been avoided, because the SEC investigative and enforcement proceedings would be being taken care of under the predecessor policy.
The allegations in the coverage complaint against the company’s broker provide another cautionary tale. It isn’t clear that moving coverage at renewal in and of itself created coverage issues, but the company is at least taking the position that the broker failed to provide sufficient counsel when moving coverage, particularly with respect to question of whether or not there were any circumstances that should have been noticed to the predecessor insurer prior to its policy expiration. For anyone involved in advising companies in the insurance placement process, there is a lot to contemplate in the allegations that company has made against the broker.