It sometimes comes as a surprise to some policyholders that D&O carriers contend that they have the right to try to recover amounts they have paid as defense expenses if it turns out that coverage for a claim is precluded by a policy exclusion. However, an insurer’s right of defense expense recoupment is by now fairly well-established, at least under certain circumstances and at least where the policy expressly provides the carrier with the right to seek recoupment. As discussed further below, it is still relatively rare for a carrier to seek to recoup amounts it has paid out.
The right of a carrier to seek recoupment was reaffirmed by a recent appellate court ruling. In a May 27, 2015 opinion (here), the Fourth Circuit affirmed the ruling of district court that the guilty pleas of four employees of Protection Strategies, Inc. (PSI) triggered several policy exclusions and gave the company’s insurer the right to seek recoupment of the defense expenses the carrier had previously paid. A June 4, 2015 post about the Fourth Circuit’s opinion on the Wiley Rein law firm’s Executive Summary blog can be found here.
Background
As discussed in greater detail here, in early 2012, PSI was served with several subpoenas and search warrants. In June 2012, PSI received a letter from the U.S. Attorney for the Eastern District of Virginia stating that the U.S. Attorney and the DoJ were investigating PSI’s participation in a Small Business Administration loan program.
In March 2013, four PSI executives entered into plea agreements in the Eastern District of Virginia. PSI’s former CEO Keith Hedman pleaded guilty to a criminal information charging him with major fraud against the United States and conspiracy to commit bribery. Among other things, in his plea agreement Hedman stipulated that his actions were done “willfully, knowingly and not because of accident, mistake or innocent reasons.” Three additional PSI officials pled guilty to conspiracy to commit fraud and major fraud against the United States. Criminal judgments were subsequently entered against each of the four individuals and the four were sentenced to terms of incarceration.
The D&O coverage section of PSI’s private company management liability insurance policy contained several exclusions, including the following:
This policy shall not cover any Loss in connection with any Claim …
(a) arising out of, based upon, or attributable to the gaining of any profit or advantage or improper or illegal remuneration if a final judgment or adjudication establishes that such Insured was not legally entitled to such profit or advantage or that such remuneration was improper or illegal;
(b) arising out of, based upon or attributable to any deliberate fraudulent act or any willful violation f law by an Insured if a final judgment or adjudication establishes that such act or violation occurred;
….
(d) alleging, arising out of, based on or attributable to any facts or circumstances of which an Insured Person had actual knowledge or information of, as of the Pending or Prior Date set forth in Item 6 of the Declarations as respects this coverage section, and that he or she reasonably believed may give rise to a Claim under this policy.
The policy also states that in determination the applicability of Exclusions (a) and (b), “the knowledge possessed by, or any Wrongful Act committee by, an Insured Person who is a past or current [chief executive officer] …shall be imputed to the Company.”
In connection with its purchase of the management liability insurance policy, PSI had provided the carrier with a February 15, 2011 Warranty Letter signed by Hedman which represented that “no person or entity proposed for insurance under the policy referenced above has knowledge of information of any act …which might give rise to a claim(s), suit(s), action(s) under such proposed policy.” The warranty letter further stated that if any such “knowledge or information exists, then … any claim(s), suit(s) or action(s) arising from or related to such knowledge or information is excluded from coverage.”
Section 6 of the Management Liability Insurance Policy’s general terms and conditions states that the Insurer “shall pay defense costs prior to the final disposition of any claim,” but that “in the event and to the extent that the Insureds shall not be entitled to payment of such Loss under the terms and conditions of this policy, such payments by the Insurer shall be repaid to the Insurer by the Insureds.”
PSI’s D&O insurer contended that the guilty pleas triggered each of the three exclusions quoted above as well as the exclusion in the warranty letter. The insurer also argued that it was entitled to recoup the amounts that it had advanced for the company’s and the individual defendants’ attorneys’ fees. In the separate coverage lawsuit that followed, PSI and the D&O insurer filed cross-motions for summary judgment.
As discussed here, on April 23, 2014, Judge Liam O’Grady granted the insurer’s summary judgment motion and denied that of PSI, holding that the executives’ guilty pleas triggered each of the four separate exclusions on which the insurer relied, and that the insurer was entitled to recoup the defense fees that it had advanced. PSI filed an appeal.
The Fourth Circuit’s Opinion
In a short May 27, 2015 unpublished per curiam opinion, a three-judge panel of the Fourth Circuit affirmed the district court’s ruling, holding that PSI had failed “to establish reversible error in the district court’s judgment.”
The appellate court rejected PSI’s contention that the insurer had waived its right to rely on the policy exclusions; rejected the argument that the district court had impermissibly resolved issues of fact in concluding that the warranty letter exclusion applied; rejected PSI’s argument that the improper profit and fraud exclusions did not preclude coverage for the general counsel and two PSI employees, and holding that the guilty pleas of the company’s CEO and CFO triggered several exclusions in the applicable policy.
Finally, the appellate court rejected PSI’s challenge to the district court’s ruling that the insurer was entitled under the policy to right of recoupment “as unsupported by the record and otherwise without merit.”
Discussion
As I have noted before (here), while carriers often assert their right to seek recoupment, it is relatively rare for D&O insurers to actually seek recoupment. That is largely because it is unusual in the context of a D&O claim for there to be final factual determinations, as most D&O claims settle long before the factual determinations are made. (Indeed, among the many reasons that securities suit rarely go to trial is the defendants’ concern that an adverse verdict would not only result in a finding of liability against them, but could also result in the loss of their insurance coverage.)
There is another practical reason that it is relatively rare for D&O insurers to attempt to recoup defense fees they have paid; that is, by the time an individual or company grinds all the way through a serious D&O claim, the person or company is usually broke. There is not much left for the insurer to go after. It is the very rare case where it is going to be enough left for it to be worth the insurer’s expense and time to try to recoup amounts paid out.
There is of course another reason why it is rare for D&O insurers to seek recoupment; in general, it is a poor public relations move for insurance companies to go around suing the persons they insure and seeking to recover amounts they have already paid. However, these constraints may be less compelling where as here the insureds’ senior executives have pled guilty to a massive multiyear effort to defraud the government.
Once the Court here concluded that the exclusions were triggered, it was always going to be difficult for PSI to persuade the court that the insurer was not entitled to recoupment. The courts are relatively uniform in affirming an insurer’s right to seek recoupment where express policy language provides for the insurer’s recoupment right. Indeed, as discussed here, in an April 2013 opinion, the Fourth Circuit affirmed a district court ruling that the guilty conviction of former Taylor Bean executive Lee Farkas triggered the D&O insurance policy’s conduct exclusions which in turn triggered the insurer’s policy right to recoup the defense fees it had previously paid.
The courts are more divided on the carrier’s right to recoupment where the sole basis on which the carrier asserts its right to do so is its own reservation of the right at the outset of the claim. Some courts have even taken the position that recoupment or reimbursement is prohibited in the absence of an express policy provision in the insurance contract preserving those rights.
These kinds of questions usually come up in the context of an insurer’s attempt to recoup amounts it has paid out as defense expenses. The questions are even more complicated when an insurer seeks to recover amounts it has paid out as indemnity – say, for example, where it has funded a settlement. Often the policy provisions providing an insurer with the right to seek recoupment –like the policy provision on which the insurer here relied — refer only to defense expenses.
For a discussion of a recent case where a federal district court (coincidentally, the Eastern District of Virginia, which is the same court as was involved in the PSI case) rejected a D&O insurers attempt to recoup amounts it had paid out in funding a prior settlement, refer here. Among other things, in rejecting the insurer’s right to recoupment of amounts paid in settlement, the district court judge noted that the policy’s recoupment provision referred solely to the insurer’s right to seek recoupment of defense expenses.
2015 ACI D&O Conference in New York: On September 17 and 18, 2015, the American Conference Institute will be holding is 19th Forum on D&O Liability in New York. This annual event features an all-star line-up of speakers and will be co-chaired by my friends, Diane Parker of AWAC and Doug Greene of the Lane Powell law firm. Readers of the D&O Diary are entitled to a $100 discount off registration if they mention discount code DOD100. Information about the event including registration instructions can be found here. The event brochure can be found here.