In an April 9, 2008 opinion (here) written by Chief Judge Frank Easterbrook, the Seventh Circuit held that there was no coverage under Arthur Anderson’s fiduciary liability policy for the firm’s settlement of a retiree pension benefits dispute.
The dispute arose after the firm’s Enron-related difficulties undercut the firm’s ability to honor retirees’ demands for lump-sum payment of retirement benefits. Litigation ensued. The retirees claimed, among other things, that the firm had breached its duties under ERISA. The firm retained defense counsel and also (through its broker) provided notice of claim to its fiduciary liability insurer. The plaintiffs then voluntarily dismissed the lawsuits and initiated arbitration proceedings instead. (The full details of the underlying retiree dispute and of the communications between the firm’s representatives and the insurer are set out at length in the district court’s summary judgment opinion, here.)
In November 2002, Arthur Anderson “proposed a compromise to all retirees and wrote to its insurers that it needed at least $75 million from them to fund a settlement.” The firm asked its primary fiduciary liability insurer to tender its full $25 million policy limit. The insurer responded that the arbitration claim did not allege negligence or breach of any fiduciary duty, but rather that it was a “pure contract action” for benefits due, for payment of which coverage is precluded under the terms of its policy. (The relevant policy provisions are set out in the district court opinion linked above.)
In January 2003, the firm settled with most of the retirees for $168 million, and it ultimately settled with the rest of the retirees in 2006 for a further $63 million. In February 2003, the fiduciary liability insurer initiated an action for a judicial declaration that it was not required to defend or indemnify Arthur Anderson.
The district court held (here) that the policy does not require the insurer to fund the settlement but that (as later summarized by the Seventh Circuit), the insurer’s “failure to provide a defense coupled with its delay in filing the declaratory judgment action might require it to pay anyway.” Following a jury trial, the district court entered judgment in the insurer’s favor except to hold that the insurer was liability for $5 million toward the arbitration settlement. Both sides appealed.
The Seventh Circuit affirmed the district court except to reverse as to the $5 million payment required toward the settlement. The Seventh Circuit found first that there was no coverage under the fiduciary liability policy for the retirees’ arbitration claim, because it did not allege negligence or breach of a fiduciary duty, but rather was limited exclusively to an alleged breach of contract. The Seventh Circuit also held that the policy’s “benefits due” exclusion also precluded coverage. Judge Easterbrook commented that “the settlement reflects the present value of the pension promise…rather than damages for anyone’s misconduct,” and he noted further that:
No insurer agrees to cover pension benefits; moral hazard would wipe out the market. As soon as it had purchased a policy, the employer would simply abandon its pension plan and shift the burden to the insurer. Knowing of this incentive, the insurer would set as a premium the policy’s highest indemnity, and no “insurance” would remain. Illinois would not read a policy in a way that made it impossible for people to buy the insurance product they want (here, coverage of negligence and disloyalty by pension fiduciaries).
The Seventh Circuit also found that the firm’s failure to obtain the insurer’s prior consent to the settlement provided another preclusion to coverage. Judge Easterbrook noted that “Arthur Anderson didn’t ask for the consent or even the comments of its insurer; it presented the deal to them as a fait accompli. By cutting [the insurer] out of the process, Arthur Anderson gave up any claim of indemnity.”
Having decided that there was no coverage under the policy, the Seventh Circuit then went on to consider whether Illinois principles of “equitable estoppel” nonetheless barred the insurer from asserting its defenses to coverage, as a result of the insurer’s delay in providing a defense and bringing its declaratory judgment action.
The Seventh Circuit first considered the question of what constitutes “delay,” noting that “treating eight months,” the period of the insurer’s putative delay, “as excessive is questionable.” Judge Easterbrook also noted that had the firm complied with the policy’s advance consent to settlement requirement, the insurer could have filed its declaratory judgment before the settlement.
In the end, the Seventh Circuit concluded that the question whether eight months constitutes delay is irrelevant, since at no point did the firm ever ask the insurer “to send a team of lawyers to represent it”; rather, the firm “made it clear that it would control both the defense and the law firm conducting the defense.” By “not tendering its defense," the firm “gave up and basis for demanding immediate action by the insurer.” Judge Easterbrook noted that:
An insured’s need to have legal assistance for its defense from the outset of a suit is the main justification for the rule that Illinois has adopted. When the insured does not want the insurer to supply a defense (lest the insurer also control the defense), it has no complaint if the insurer takes a while to contemplate the question of indemnity. The urgent need is for a defense to the pending suit; liability for indemnity (the coverage question) can safely be decided later.
Finally, Judge Easterbrook concluded that the insurer did not in the end have a duty to defend as the arbitration complaint was “based on contract and nothing but.”
There are several noteworthy things about Judge Easterbrook’s opinion. The first pertains to his commentary that adverse consequences might follow if the insurer were compelled to fund the settlement. It is the very rare court that is willing to consider not only that in some circumstances compelling the insurer to pay might not only undermine the existence of the market for that type of insurance, but could even constitute a “moral hazard.” Judge Easterbrook’s analysis evinces an unusually developed understanding of the insurance mechanism’s fundamental components.
The court’s analysis of the consent to settlement requirement is also noteworthy; indeed, the Seventh Circuit’s discussion of this issue in many ways mirrors the analysis of the recent New York Court of Appeals opinion (discussed here) in which the New York court also enforced the consent to settlement opinion strictly according to its terms. These two holdings underscore not only that the provision means what it says but also that it will be enforced according to its terms. These rulings unmistakably highlight that policyholders who fail to follow the policy’s requirement for advance consent to settlement do so at peril to their insurance coverage.
There is a further important lesson from this case, one that is similar to the lesson of the prior New York case, and that is that nothing good comes from a policyholder’s failure to keep the insurer in the loop. Indeed, if there is one common element in almost every litigated coverage dispute, it is that at some point preceding the litigation, there was some breakdown in communications between the policyholder and the insurer.
There are no guarantees that carriers will respond appropriately even when they are provided with full information. But the single most important way for policyholders to reduce the possibility of a litigated dispute with their insurer is to maintain full and professional communications with their insurer. Indeed, point number on in my list of “Seven Ways Counsel Can Help Clients with D&O Claims” (here) is to “Keep the Carrier Informed.”
Finally, I note that the Seventh Circuit’s discussion of the “benefits due” exclusion is an important accompaniment to my analysis (here) of the insurance implications of the U.S. Supreme Court’s opinion in the LaRue case. As Judge Easterbrook’s opinion makes clear, these policies are not intended to provide a substitute funding mechanism for companies’ benefit obligations to their employees. However, the policies are intended to provide companies with indemnity protection when an insured’s alleged or actual negligence or breach of a fiduciary duty harms a plan participant’s interests. For that reason, it is analytically consistent for insurers to offer, as some now do, an endorsement to their policies to carve out from the benefits due exclusion an agreement to cover a plan participant’s claim of harm to their individual plan investment interests, of the kind recognized in the LaRue decision.
Special thanks to a loyal reader for providing me with a copy of the Seventh Circuit’s opinion.