Due to the complexity both of the D&O insurance policy and of the kinds of claims that can arise, the question of whether and to what extent a particular claim may be covered is often disputed. Sometimes though a particular claim is simply not covered. That was the case in a recent coverage dispute in Montana federal court, where a bank sought insurance coverage for losses it incurred on a customer counterclaim in a debt recovery action the bank had initiated. Magistrate Judge Keith Strong’s September 23, 2013 opinion (here) reads like a catalog of the ways that coverage can be precluded under a D&O insurance policy. As discussed below, within the court’s rulings are some noteworthy determinations that merit further consideration. 



In July 2007, First Interstate Bank loaned money in connection with a condominium project in Ocean Shores, Washington. The president of the borrower, Paul Pariser, provided a personal guaranty on the loan. At the same time, Pariser had a deposit account at the bank which on April 2, 2009 contained at least $2,623,396.40.


In April 2009, the bank decided to exercise certain rights it believed it had under the loan agreement and the guaranty. The bank sued Pariser, declared the loan in default, and also declared itself insecure under the loan. Acting on the declarations, the bank immediately removed $2,623,396.40 from Pariser’s personal account and applied the proceeds to reduce the borrower’s principal and interest. Pariser countersued alleging that the bank had violated the loan documents and seeking to have the funds, restored.


The underlying action resulted in a verdict that the bank has not properly exercised its contract rights and thus was entitled to no recovery. On Pariser’s counterclaim, the jury returned a verdict of $2,623,396.40, which as the court in the subsequent coverage action noted, is “the precise amount the Bank simply took from Mr. Pariser’s personal account.”


Pariser filed his counterclaim against the bank on June 25, 2009. However, the bank did not formally notify its management liability insurer of the lawsuit until October 18, 2010, more than a year after the policy period during which Pariser first made his claim had expired. In the subsequent coverage action, in order to try to show compliance with the policy’s notice requirement, the bank attempted to rely on a June 30, 2009 litigation summary letter from its outside counsel to the bank that the bank had provided to the carrier in the course of the underwriting of the company’s renewal policy. 


Among other things, the June 30 letter contained the following reference to the litigation with Pariser:


This much can be summarized about the affirmative claims for damages asserted by Mr. Pariser and the borrower against the bank in both proceedings: (1) all claims involve a common nucleus of facts – the decision of the bank to deem itself insecure, made demand under Mr. Pariser’s guarantee, and setoff his deposit account in the amount of nearly $2.7 million; (2) the decision of the bank to take such action was carefully considered when made, with the full knowledge of the litigation likely to follow, including the associated liability that could arise; and (3) the actions taken by Mr. Pariser and the borrower have been predictable and entirely consistent with those known (and fully anticipated risks).


After the bank submitted its formal notice of claim, the insurer denied coverage for the claim and filed an action in the District of Montana seeking a judicial declaration that it owed no duty to indemnify the bank for any loss or expense incurred in the bank’s litigation with Pariser. The bank countersued seeking a declaration that the insurer had a duty to indemnify and also seeking contract and tort damages. The parties filed cross motions for summary judgment.


The September 23 Opinion

In his September 23, 2013 opinion, Magistrate Judge Keith Strong granted summary judgment in the insurer’s favor, finding that the insurer had no duty to defend and no duty to indemnify the bank under its policy.


The Magistrate Judge first determined that the insurer was entitled to judgment as a matter of law because, he found, the bank had “failed to meet an express condition precedent to coverage by providing notice of a claim first made as soon as practicable during the policy period or within 60 days after expiration.” He noted that the bank’s formal notice for a claim that was first made in June 2009 was not given until October 2010. He noted that “no reason for the delay appears of record.” At the same time, however, he noted that the June 30, 2009 letter from bank’s outside counsel shows that it would have been “practicable” for the bank to notify the insurer of the claim at that time, which “supports a judgment that the Bank did not give notice as soon as practicable.”


The court also noted that even though the June 30, 2009 letter had been provided to the insurer as part of the bank’s insurance renewal, the letter did not provide notice of claim to the insurer within the policy’s requirements. As the Magistrate Judge noted, the letter “lacks any suggestion even to [the bank’s] management that the Bank could, would, should or even might seek insurance coverage for any aspect of the Pariser litigation.” The letter “did not give [the insurer] notice that the Bank considered the Pariser loss covered by a policy of (the insurer’s] insurance.” The court added the observation “that a commercial bank is involved in a number of litigated matters does not give notice that insurance coverage is claimed under any specific one.”


Though the court’s determination that the bank had not provided timely notice of claim was sufficient to find that coverage was precluded under the policy, the court then went on to consider and reject other grounds on which the bank sought to rely in trying to establish coverage under the policy.


He rejected the bank’s argument that the insurer had breached its duty to defend, noting, among other things, that the policy expressly stated in bold, capitalized text on the policy’s first page that “The Insurer has not duty under this policy to defend any claim.”


Magistrate Judge Strong also rejected the bank’s argument that the $2,623,396.40 the jury awarded Pariser represented covered loss under the policy. In its verdict, “the jury simply made the Bank return what the Bank wrongfully took.” The verdict “was for the return of money wrongfully taken as principal and interest payment and … all the litigation arose from the wrongful taking and application to principal and interest.”


The court went on to conclude that coverage for the claim was also precluded under both the improper profit exclusion and under the contract exclusion. With respect to the improper profit exclusion, the court noted that the June 30, 2009 litigation letter makes it indisputable that “all the litigation centered on the question whether the Bank took money it was not legally entitled to take.” The amount for which the bank seeks coverage is “excluded because it arises from the Bank taking and trying to keep money to which it was not legally entitled. “


The court determined that coverage is also precluded under the policy’s contract exclusion because “the dispute was a contract dispute and one that the Bank deliberately started under the guise of its own contract rights. If there had been no contracts there would have been no dispute.”


The Magistrate Judge also rejected the bank’s argument that the jury verdict of $2,623,396 should be considered a covered loss because the verdict included a jury finding that the bank had breached the implied covenant of good faith and fair dealing. The bank argued that the breach represented a tort loss, rather than a contract loss, and therefore is not excluded from coverage. The Magistrate Judge rejected this argument based on Montana case law holding that the breach of the implied covenant is a contract breach only, not a tort.


In his conclusion, the Magistrate Judge summarized the case this way:


First Interstate Bank deliberately exercised what it believed were its loan and guaranty contract rights to seize money from Mr. Pariser’s account and apply the seized funds to principal and interest on the loan. First Interstate Bank was not entitled to do so. It was held liable to return the money it had taken. First Interstate deliberately started [the litigation] all flowing directly from its decision to take Mr. Pariser’s money. For well over a year all of First Interstate Bank’s actions relevant here were consistent with this court’s interpretation: the Pariser litigation did not trigger coverage under [the insurer’s] liability policies. The first litigation summary letter almost seems a summary of exclusions under the policy. The notice was late but there was no coverage under the policy in any event.



In the end there should be little surprise that a management liability insurance policy does not cover a jury verdict award representing an amount the bank wrongfully took from its customer and was obliged to return. Seriously, was the bank proposing that it should be allowed to keep the wrongfully taken funds and simply pass the bill to the insurer? Though some policyholder side advocates vigorously dispute the principle that a D&O insurance policy provides no coverage for disgorgement amounts or for the return of ill-gotten gains, I suspect that even these advocates would find it hard to argue that this bank could pass off to its insurer the bank’s obligation to restore the funds it had wrongfully taken from its customer.


At the same time, the bank had a serious late notice problem – which its own counsel expressly acknowledged when the bank provided notice to the insurer. According to the Magistrate Judge’s opinion, counsel for the bank reportedly said in the email accompanying the notice that “They won’t be happy with the late notice, but these cases have been very well defended and there has been no prejudice.” Readers of this blog know I am no friend of attempts to preclude coverage based on supposed late notice, but here where a sophisticated party has counsel involved throughout and only belatedly provides notice without any apparent excuse or explanation, the arguments against enforcing the notice requirements are more difficult to sustain. (Moreover, counsel’s e-mail comment about late notice evinces awareness that the prior provision of the litigation letter during the renewal underwriting process did not satisfy the policy’s notice requirements, about which see more below.) 


But if the possibility of coverage here was always going to be remote, the opinion nevertheless incorporates some important determinations that are worth noting.


First, the Magistrate Judge determined that the bank’s provision of the June 30, 2009 letter as part of the renewal underwriting process did not constitute notice. The question whether provision of information about a claim to the underwriting department is sufficient to satisfy a D&O insurance policy’s  claims notice requirements is a recurring issue (as discussed most recently here). In this case, the magistrate judge rejected the argument because there was nothing about the June 30, 2009 letter to suggest that the bank was submitting the referenced litigation as a claim or that it expected coverage under the policy. The magistrate judge did not address the larger issue whether information provided in the underwriting process could ever constitute notice of claim, but he did at least determine that in this case under these circumstances the provision of the litigation letter did not constitute notice under the policy.


The magistrate judge’s rejection of the bank’s argument that the policy provided coverage for the breach of the implied covenant of good faith and fair dealing is also noteworthy. Many corporate and business disputes have a contract at the center. Many D&O insurance policies (particularly those issued to private companies) contain an exclusion precluding coverage for contract disputes. However, in these kinds of corporate and business disputes, the complaint often asserts claims other than those specifically arising out of the contract. Policyholders often argue that these other claims are not precluded by the contract exclusion. These kinds of allegations often include a claim based on an alleged breach of the implied covenant of good faith and fair dealing. Carriers often argue that the alleged breach of the good faith covenant is precluded from coverage under the contract exclusion, while policyholders argue that the alleged breach of the implied covenant sounds in tort and therefore is not excluded.


The Magistrate Judge’s determination that the breach of the implied covenant represented a contract claim and therefore is precluded from coverage under the policy’s contract exclusion is interesting and relevant to this recurring coverage issue – although it should be noted that his determination in that regard expressly relied on Montana law and a recent decision by the Montana Supreme Court. In other contexts, the law applicable in the relevant jurisdiction might lead to a different result


Finally, the Magistrate Judge’s ruling presents the relatively rare occasion where the improper profit exclusion operates to preclude coverage. Although insurers often invoke this exclusion, it is relatively rare that there is an actual determination that the amount for which the insured was seeking indemnity represented a profit or advantage to which the insured was not legally entitled. While this application of this exclusion here is a reflection of the peculiar circumstances of the case, the circumstances do provide an illustration of how the exclusion operates and of the kinds of circumstances to which it would apply.


Special thanks to Mark Johnson of the Gregerson, Rosow, Johnson & Nilan law firm for sending me a copy of the opinion.


More About State and Local Government Securities Litigation Risk: In recent posts, I have noted the increasing involvement of state and local governments as defendants in securities enforcement actions and even in private securities litigation. In a September 27, 2013 Law 360 article entitled “Municipal Underwriters On SEC’s Fraud Radar” (here, subscription required) William E. White and Jeffrey A. Lehtman of the Allen & Overy law firm take a look at what they describe as the “notable uptick in municipal securities actions” by the SEC’s enforcement division against state and municipal government entities, as well as against municipal underwriters.


According to the authors, the SEC has “increasingly dedicated attention and resources to the municipal securities market, and there has been a corresponding uptick in enforcement actions involving municipal securities market participants.” The authors cite five cases the agency has launched since March 2013, including, among others, actions against the state of Illinois; South Miami, Florida; and Harrisburg, Pa.


The authors state that “there is every reason to believe that these cases are not a blip.” In addition to specific features of the Dodd-Frank Act (including the whistleblower provisions), the authors cite the increased public scrutiny that has filed in the wake of a number of high profile municipal bankruptcies. The authors conclude that “the public pressure for regulators to examine municipal finances, including the underwriting of municipal bonds, is greater than ever.”


In other words, though there may as yet still be a low level of awareness of the risk, there may well be further enforcement actions against state and local governments to come.


Court Preliminarily Approves a Mostly Stock Class Settlement: On September 26, 2013, Northern District of California Judge William Alsup preliminarily approved an unusual proposed securities class action settlement. The parties to the Diamond Foods securities class action had proposed to settle the case for a combination of $11 million in cash and the issuance to the class of 4.45 million shares of the company’s common stock.


The cash component of the settlement represented the amount of the company’s remaining D&O insurance. The stock component was worth about $85 million as of the date the plaintiffs moved for approval of the settlement. The parties explained the inclusion of the stock in the settlement as owing to the company’s poor financial condition. As Judge Alsup noted in his order preliminarily approving the settlement, “Given Diamond’s strained financial state and the uncertainty (over) lead plaintiff’s ability to collect on any judgment,” the decision to enter a settlement consisting mostly of stock was justified.


As Alison Frankel notes in a September 27, 2013 post on her On the Case blog (here), Judge Alsup did insist on a number of tweaks to the settlement, but “on the big question of whether it’s OK to compensate allegedly deceived shareholders with more stock in the company that supposedly lied to them, Alsup answered with a reluctant yes.”


My own concern when I first learned of this settlement was that the cash portion of the settlement would all go toward payment of the plaintiffs’ attorneys’ fees, while the class members would get stuck with only stock. However, Frankel notes that class action activist Ted Frank is arguing that the lead counsel fees ought to be paid in the same cash-to-stock ratio as the class’s recovery. As Frankel notes, “Knowing what they know about Diamond’s prospects, lawyers for the class probably aren’t thrilled about that. But considering who the judge is, they probably won’t have much of a choice.”


Can You Detect the Pattern?:



















3. A season after losing 94 games, the Cleveland Indians win 92 games — including their last ten regular season games in a row — to clinch a wild card playoff berth.And the Cleveland Browns win their second game in a row, winning both with their third string quarterback. (Admittedly, this entry is here for the benefit of those few sports fans who may not follow Cleveland sports as closely as the rest of us do.)