As part of our beat here at the The D&O Diary, we read a lot of judicial opinions. We are quite accustomed to the fact that the case outcomes can be and often are all over the map. Just the same, every now and then we read a decision that really makes us scratch our heads. That was our reaction when we read Southern District of Mississippi Chief Judge Louis Guirola, Jr.’s October 2, 2015 opinion in the Singing River Health Systems case (here), in which Judge Guirola, applying Mississippi law, held that when a fiduciary liability insurer defends its insured under a reservation of rights, the defense expense payments do not erode the policy’s limits of liability. A number of questions and concerns may fairly be raised about this decision, as discussed below. The Traub Lieberman Insurance Law Blog has an October 5, 2015 post about Judge Guirola’s decision, here.
Singing River Health System was sued in a series of lawsuits alleging it had underfunded its employees’ retirement plan. The organization submitted the lawsuits to its management liability insurer, which had issued a policy to the organization that included several coverage parts. The D&O and EPL insurance coverage parts provided a $5 million limit of liability and the fiduciary liability coverage part had a $1 million limit of liability. The insurer agreed to defend all insureds under the fiduciary liability coverage part, subject to a reservation of rights.
The insurer then filed an action seeking a judicial declaration that the $1 million fiduciary liability coverage part was the operative limit of liability; that the insurer’s payment of defense expenses eroded the limit of liability; and that the insurer may withdraw from the defense upon its payment of the $1 million limit of liability.
Singing River filed a counterclaim against the insurer, alleging a number of causes of action, including breach of contract, breach of fiduciary duty, and bad faith. Singing River then filed a motion for partial summary judgment on the issue of whether the insurer was entitled to deduct the amounts paid for the insureds’ defense expenses from the limit of liability.
The policy’s fiduciary liability coverage part declarations page states that “Unless Optional Separate Defense Costs Coverage is purchased pursuant to Item 2 above, the Limits of Liability will be reduced and may be exhausted by Defense Costs.” Item 2 indicates that the separate defense cost coverage was not purchased. The Declarations page also contains the following notice in all capital letters:
The limit of liability to pay “loss” will be reduced and may be exhausted by “defense costs,” unless otherwise specified herein, and “defense costs” will be applied against the retention. In no event will the company be liable for “defense costs” or other “loss” in excess of the applicable limit(s) of liability.
The policy’s limit of liability clause states that “If the Optional Separate Defense Costs Coverage is not purchased, Defense Costs shall be a part of, and not in addition to the Limits of Liability set forth in Items 3(A) and 3(C) of the Declarations of this coverage section, and the payment by the Company of Defense Costs shall reduce and may exhaust such applicable Limits of Liability.”
The policy defines the term “Loss” to mean “the amount that any Insured becomes legally obligated to pay on account of any covered Fiduciary Claim, including but not limited to damages, judgments, settlement, pre-judgment and post-judgment interest, Defense Costs…”
The policy further provides that “The Company shall have the right and duty to defend any Claim coverage by this coverage section…. The Company’s duty to defend any Claim shall cease upon exhaustion of the applicable Limit of Liability.”
The October 2, 2015 Decision
In his October 2, 2015 decision, Judge Guirola granted Singing River’s motion for partial summary judgment, holding that the insurer is not entitled to subtract the amounts it paid as defense costs from the limits of liability.
In reaching this decision, Judge Guirola relied on the Mississippi Supreme Court’s 1996 opinion in Moeller v. American Guarantee & Liability Insurance Company (here), in which the Supreme Court had said the “When defending under a reservation of rights … a special obligation is placed upon the insurance carrier …. Not only must the insured be given the opportunity to select his own defense counsel to defend the claim, the carrier must also pay the legal fees legally incurred in the defense.”
Singing River had argued in reliance on these statements that because an insurer defending under a reservation of its rights must pay for independent counsel, the insured is under those circumstance not “legally obligated to pay” defense costs.
Judge Guirola agreed, noting that the policy’s definition of the term “loss” includes only defense costs that the insured is legally obligated to pay. While the insurer argued that Singing River’s interpretation of the policy is “strained,” it had not, Judge Guirola said, provided “any authority supporting its argument.” At a minimum, the “language is ambiguous and must be construed in favor of Singing River.” The insurer, Judge Guirola concluded “is not permitted to subtract defense costs paid pursuant to Moeller from the policy limits, because the insureds are not legally obligated to pay those costs.” Under Moeller, Judge Guirola said, the insurer “is the party that is legally obligated to pay the defense costs retained for the insureds’ independent counsel.”
Prior to reaching his decision, Judge Guirola recited the basic principles of insurance contract interpretation under Mississippi law, which reflect standards common in most jurisdictions, including the principles that insurance contracts must be read as a whole, all relevant provisions must be read together, and operative effect must be given to every provision.
However, rather than read all of the provisions together and give effect to every provision in this policy – including the numerous provisions in the policy stating that the insurer’s payment of defense expenses erodes the limit of liability – Judge Guirola instead focused only on one part of the policy, that is, the “legally obligated to pay” phrase in the definition of Loss. Judge Guirola’s restricted focus to this single phrase does overlooks the numerous provisions in the policy that specifically and expressly state that defense expenses erode the limit of liability.
Among other things, Judge Guirola overlooked the fact that the policy was expressly set up so that the insured had the option to purchase defense cost coverage outside the limit of liability. However, the policyholder did not elect this option. The policy expressly states if this optional coverage is not purchased, the payment of defense costs erode the limit of liability. These provisions do not depend on or relate to the policy’s definition of loss, much less to that definition’s use of the phrase “legally obligated to pay.” Judge Guirola simply disregards these and the other policy provisions expressly stating that the insurer’s payment of defense expenses erodes the limit of liability – as a result of which Singing River is afforded a policy coverage it had expressly chosen not to purchase.
Judge Guirola reaches this conclusion in reliance on the Mississippi Supreme Court’s Moeller decision. Given the importance of Moeller to Judge Guirola’s interpretation of the phrase “legally obligated to pay,” you might think that the Supreme Court had been interpreting the same language in a similar fiduciary liability policy. However, while the Moeller court was considering an insurer’s duties when defending under a reservation of rights, the Moeller court was not interpreting the phrase “legally obligated to pay.”
Moeller did emphasize that when an insured is entitled to independent counsel because the insurer is defending under a reservation of rights, the insurer has to pay for the independent counsel. Of course, the insurer also has to pay defense counsel when it has accepted the defense without reservation of rights. Basically, the Supreme Court was saying that the insurer has to pay the defense, even when independent counsel is required because the insured has reserved its rights. There is no analysis or consideration of the implications of the insurer’s duty to pay for the independent counsel within the meaning of policy language relating to “legally obligated to pay,” as those issues were not before the Moeller court.
Nor did the Moeller court say that when an insurer is defending under a reservation of rights that the amounts paid do not erode the limits of liability even where there is repeated express policy language saying that payment of defense fees erodes the limit of liability.
There is a particular irony in Judge Guirola’s reliance on Moeller. In his opinion, he considered various cases the insurer cited for the proposition that the insurer’s payment of defense expenses erodes the limit of liability. After reviewing the cases, Judge Guirola concluded that because the insurers in those cases did not argue that the phrase “legally obligated to pay” limited the “defense costs” that could be used to reduce the policy limits, those court did not address the issue involved in this dispute. Of course, Moeller did not involve that issue either; neither party had argued the effect of the phrase “legally obligated to pay” on the question of policy limit erosion, since Moeller did not involve that issue or even address any issue relevant to policy limit erosion. If the cases that the insurer cited are irrelevant because the parties did not make the argument that the policyholder raised here, well, Moeller is every bit as irrelevant.
There is a lot more that I might say about this decision, but let me suffice it by saying that, notwithstanding this opinion, no policyholder that does not purchase the optional defense outside the limit option should assume that its defense expenses will not erode the limit of liability, regardless of whether or not the insurer is defending under a reservation of rights.
Special thank to Brian Margolies at the Traub Lieberman firm for sending me a copy of this opinion. I should add that the views expressed in this post are exclusively my own.