nystateOne of the standard features of D&O insurance policy is the fraud exclusion, which these days typically provides that the exclusion is triggered only after a “final” judicial determination that the precluded conduct has occurred. But what is it that makes a determination “final”?


On June 23, 2015, in a decision that has a number of important implications, the New York (New York County) Supreme Court, Appellate Division, First Department, applying New York law, held that the imposition of a post-conviction criminal sentencing constitutes a “final judgment” that not only triggered the fraud exclusion in a D&O insurance policy but also required the convicted individual to reimburse the carrier for amounts it had already paid – even though the individual’s appeal of his criminal conviction was pending.


As discussed below, the court’s opinion has some important lessons for D&O insurance practitioners. A copy of the court’s opinion can be found here.



Rodney Watts was the chief investment officer of GDC Acquisitions. In August 2010, he was indicted for conspiracy to commit bank fraud, bank fraud, and making false statements. Watts sought to have GDC’s D&O insurer fund his defense. He obtained a preliminary injunction directing the insurer to pay for his defense in the criminal action. In May 2013, a federal jury found Watts guilty. He was ordered to pay $15.3 million and to serve seven years in prison. Watts filed an appeal of his criminal conviction.


Following Watts’s sentencing, the D&O insurer returned to court in order to be relieved of its obligation to pay for Watts’s continuing defense, “particularly” (as the appellate court put it) “the appeal from his conviction that he was already pursuing.” In seeking this relief, the D&O insurer relied on the policy’s fraud exclusion, which was triggered upon a “final judgment against its insured.”


The trial court agreed with the insurer, vacated the preliminary injunction, and held that the insurer was no longer required to pay Watts’s defense expenses in the criminal action. The trial court directed Watts to reimburse the insurer for the amount it had previously expended on his defense. Watts appealed the trial court’s coverage ruling.


The June 23 Decision

In a terse, three-page per curiam opinion, the New York Supreme Court, Appellate Division, affirmed the trial court, saying that “in the context of a criminal prosecution, it is well settled that the imposition of the sentence constitutes the final judgment against the accused.” Even though the appeal might “at some point” relieve Watts of the judgment, “the finality of it is not changed by the pendency of the appeal.”


The appellate court said that the exclusion’s language is “clear” – that is, “once the final judgment for fraud was entered against Watts, defendants’ obligation to defend him from those claims ceased.” The appellate court also held that the trial court had correctly concluded that Watts was obligated to reimburse the insurer for the amounts it had already expended.



Assume for a moment that Watts has meritorious grounds for appeal and that his conviction will be overturned if he pursues the appeal. Assume also that Watts does not have the financial resources to pursue the appeal on his own, without insurance. If you make these assumptions, then the continuing availability of the insurance funding was all that stood between Watts and prison. The court’s ruling strips Watts of the insurance funding at an absolutely critical moment.


I have not read the parties’ briefs in this case, but I suspect that Watts likely argued something along the lines that the word “final” as used in the exclusion means “there are no further proceedings of any kind.” The appellate court rejected this suggestion, relying instead on the post-sentencing procedural finality of the criminal judgment that triggered Watts’s appeal rights. However, the court’s conclusion leaves a host of important questions unanswered.


Again, assume for the sake of discussion that Watts’s appeal is meritorious and that his conviction will be overturned on appeal. What does the court’s opinion here suggest would happen then? Will coverage be reinstated? Will the insurer then have to pay Watts back the amounts for which he has reimbursed the insurer? Obviously, from a coverage perspective, the fact that there is an appeal pending means there is a contingent question – that is, it is not possible to make a conclusive coverage decision precisely because the criminal proceedings are not “final” until the appeal has been heard and all proceedings are concluded.


From my perspective, where the appellate court went off the tracks in its analysis was when it tried to sort out these coverage issues by referring to case law discussing when a criminal conviction is final for purposes of the defendant’s appeal. That is not the question the court was asked to address. If the court had rather looked to case law addressing questions of an individual’s rights to advancement of defense expenses based on the laws of indemnification – which is much closer to the question the court was in fact asked to address – the court likely would have reached a different conclusion.


By way of illustration, in a July 30, 2008 Delaware Chancery Court opinion (here) then-Vice Chancellor Leo Strine (now the Chief Justice of the Delaware Supreme Court) held that the Sun-Times Media Group had to continue to advance the defense expenses of four former officers, including Lord Conrad Black, even though: 1) the four had been convicted of various criminal offenses; 2) the four had already been sentenced; 3) the convictions had been upheld on appeal; and 4) the company had already advanced $77 million in defense expenses for the four. Vice Chancellor Strine held that under Delaware statutory law and the applicable by-law provisions, requiring advancement until “final disposition,” the obligation to advance expenses continued until the “final, non-appealable conclusion” of the criminal action, which had not yet been reached. (Yes, of course, the Sun-Times Media Group case was decided under Delaware law not New York law, but bear with me, I am making a point.)


The specific wording of the exclusion at issue may explain why the New York appellate court applied the analysis that it did here. These days, the typical D&O insurance policy fraud exclusion will usually refer to a “final adjudication.” However, the fraud exclusion at issue in this policy referred not to a “final adjudication” but to a “final judgment.” I would argue based on the spirit of the principles enunciated in the Sun-Times Media Group case that, when defense cost advancement is at stake, this wording distinction should not make a difference. However, the use in this exclusion of the word “judgment” rather than the word “adjudication” arguably is what led the court to refer to decision in the jurisdiction concerning the finality of criminal judgment, which in turn now means that Watts is left to try to appeal his conviction without the benefit of insurance.


This case is a reminder of the potential importance of the distinction between a “judgment” and an “adjudication.” So practice lesson number one is to make sure that the fraud exclusion refers to a “final adjudication” and not to a “final judgment.”


There is yet another point about the wording of the exclusion at issue that probably needs to be made here as well. There are a number of D&O insurance policies available in the marketplace with fraud exclusions that refer not just to a “final” adjudication but rather refer to a “final, non-appealable” adjudication. I know that in light of cases such as the Sun-Times Media Group, many D&O insurance professionals may have viewed the inclusion of the word “non-appealable” to be redundant and even unnecessary. However, given the appellate court’s holding here, the inclusion of the word “non-appealable” may be indispensable in order to prevent a D&O insurer from leaving its insured in the lurch at an absolutely critical moment.


So there’s practice lesson number two.


As I noted in a recent post, in his May 2015 opinion discussing the advancement rights of former Massey Energy CEO Donald Blankenship, Delaware Chancellor Andre Bouchard began his analysis of Blankenship’s rights by saying that the case involves an “all too common scenario” – that is “the termination of mandatory advancement to a former director and officer when … it is needed the most.” Although Bouchard was referring to corporate advancement obligations and not to advancement obligations under a D&O insurance policy, the sentiments are equally applicable. All too often corporate executives are faced with the loss of their right to have their defense expenses funded precisely at the moment when they need it most.


To be sure, two New York courts have now upheld this insurer’s interpretation of the policy language at issue, so it may be hard as an analytic matter to find fault with the position that the insurer took here. So I will put it this way. I wish that before a D&O insurance carrier takes a position denying coverage under its D&O insurance policy, it would think about how it would look if some day somebody were to write a blog post about the company’s position.


More About the Insurer’s Right of Recoupment: As I have noted in prior posts (most recently here), courts generally recognize the rights of D&O insurers to seek recoupment of amounts they have paid upon a determination of non-coverage under the policy. However, these cases generally turn upon whether or not the policy has language expressly providing the insurer with a right of recoupment. Where the D&O insurance policies are silent on the question of a D&O insurer’s right of recoupment, the extent of the insurer’s right to recoupment is less clear.


In this case, the appellate court simply did not say one way or the other whether the policy at issue here expressly provided the D&O insurer with a recoupment right. Nevertheless, the court seemed clear that because of its determination that coverage for Watts’s defense expenses was precluded by operation of the policy’s fraud exclusion, the carrier had the right to seek recoupment of the amounts it had already paid. What strikes me as odd is the fact that the court concluded that the insurer had the right of recoupment even though, as the court itself expressly acknowledged, Watts’s conviction might possibly be overturned on appeal. As I noted above, the court did not examine what might happen next if Watts were to prevail on appeal.


As I have noted before (here), it is relatively rare for D&O insurers to seek recoupment, primarily because it is relatively rare that there are case determinations that unambiguously establish that the conduct exclusions have been triggered. Another reason it is relatively rare for D&O insurers to seek recoupment is that usually by the time that things have progressed to the point that the insurer can seek recoupment, there often are no longer any assets from which a recoupment might be obtained. Yet another reason why D&O insurers often hesitate to seek recoupment is that it can be a poor public relations move to seek to reclaim amounts that have been paid.


Special thanks to several loyal readers who sent me a copy of the New York appellate court opinion.