californiaMost D&O insurance policies have conduct exclusions precluding coverage for fraudulent, criminal, or willful misconduct. However, mere allegations are insufficient to trigger this exclusion. If allegations alone were enough, then many claims that would otherwise be covered under the policy would be precluded from coverage, because many D&O claims involve allegations of fraudulent, criminal, or willful misconduct. These days, the conduct exclusions in most D&O policies require a judicial determination in order for the exclusion’s preclusive effect to be triggered. Exactly what is constitutes a sufficient judicial determination is a matter of policy wording. A recent California intermediate appellate court considered a policy that required a “final adjudication” in order for the exclusion to be triggered and determined that the exclusion did not apply to preclude coverage while the insured person’s appeal remained pending, despite the insured person’s criminal securities fraud conviction. The opinion provides an interesting insight into operation of the conduct exclusion with wording of a type found these days in many D&O insurance policies.


The California Court of Appeals’ unpublished March 8, 2017 opinion can be found here. A March 13, 2017 summary of the case on the Wiley Rein law firm’s Executive Summary Blog can be found here.



Mitchell Stein acted as an officer of Heart Tronics, a medical device company. (There was an issue in the coverage litigation about whether or not Stein actually was an officer of the company within the meaning of the policy, but for purposes of this post, assume he was an “officer.”) In 2013, a jury found Stein guilty of securities fraud. Stein was sentenced to 17 years in prison. Stein appealed the conviction. In January 2017, the Eleventh Circuit affirmed his conviction but vacated the sentence and remanded the matter for resentencing. On February 7, 2017, Stein moved for an en banc rehearing before the Eleventh Circuit. The motion for rehearing remains pending. (Detailed background regarding Stein’s criminal prosecution can be found here.)


During the relevant time period, the company maintained a program of D&O insurance consisting of a layer of primary insurance and a layer of excess insurance. The primary insurance was exhausted by payment of defense expense.  After his conviction, Stein tendered his criminal appeal to the excess carrier. The excess carrier (hereafter, the insurer) denied coverage on a number of grounds. Stein sued the insurer in California state court, alleging breach of contract, fraud, and breach of the covenant of good faith and fair dealing.


The insurer demurred to Stein’s complaint, arguing, among other things that the defense expenses Stein incurred in his criminal defense and in a related SEC proceeding were not covered under the Policy. The trial court sustained the insurer’s demurrer, holding, among other things that coverage was precluded under the policy’s Willful Misconduct Exclusion because Stein’s criminal conviction was “final under federal law until it is reversed.” The insurer appealed the trial court’s ruling.


The insurer’s policy provided coverage for “loss,” which the policy defined as “any amount,” including defense expenses the insured would be obligated to pay as a result of a Claim. The policy defines the term “Claim” to include any civil or criminal proceeding, and expressly included “an appeal from such proceeding.”


The Willful Misconduct Exclusion, as amended, provided in relevant part that “Except for Defense Expenses, the Insurer shall not pay Loss in connection with any Claim” occasioned by willful misdconduct. The exclusion is triggered “only if there has been … a final adjudication adverse to [the] Insured Person in the underlying action … establishing that the Insured Person” committed the willful misconduct. The policy provides further that “If it is determined that [the exclusion] applies,” the insured would be obligated to repay the insurer any defense expenses paid on his or her behalf.


The March 8 Opinion

In an unpublished March 8, 2017 opinion written by Justice Victoria Gerrard Chaney for a unanimous three-judge panel , the California Court of Appeal , Second District, Division 1, held that the trial court had improperly sustained the insurer’s demurrer, stating that when a policy expressly provides for litigation expenses on appeal, an exclusion precluding coverage only  upon a “final adjudication” of the insured’s culpability applies only after the insured’s direct appeals have been exhausted.  (There are several other holdings in the Court’s decision, but I discuss only the “final adjudication” issue here.)


In rejecting the trial court’s conclusion that under federal law Stein’s criminal conviction was “final … until it is reversed,” the appellate court noted three “fatal flaws” in the insurer’s arguments on appeal as well as in the trial court’s analysis.


First, the appellate court said, “nothing in the policy indicates that the parties intended that the phrase ‘final adjudication’ carry the same meaning in the exclusion as it carries in federal law,” adding that nothing in the policy refers to federal law. The fact that Stein’s conviction was in federal court is “irrelevant to the policy.”


Second, the court said, “a thing that is ‘final until reversed’ is not final,” adding that “an appellate court can render an adjudication as well as a trial court can, with the added benefit [of] greater finality.”


Third, the court said that even if as the insurer argues that the Willful Misconduct Exclusion comes into play when a final adjudication determines culpability, “the point is irrelevant because the exclusion by its terms does not apply to defense expenses.”


The court also rejected the insurers argument that courts have “repeatedly held that all exhaustion of appeals is unnecessary” to satisfy a “final adjudication” requirement in an exclusion. The appellate court said that the two cases the insurer cited for this “repeated” holding had different exclusionary language that provided that a “judgment or other final adjudication” would trigger the exclusion. The courts the insurer cited treated this phrase in the disjunctive, so that a judgment of conviction was sufficient to bar coverage.  The exclusion at issue here is not disjunctive, there is only a single trigger of “final adjudication” – if anything, the court noted, this “implies that a judgment alone would not trigger the exclusion.”


The court concluded that the insurer’s policy “covers an insured’s litigation expenses incurred in directly appealing a conviction” and therefore that the trial court should have overruled the insurer’s demurrer.



At one level, you can certainly understand the insurer trying to avoid having to fund Stein’s appeal. He already has various judgments and fines pending against him; if the insurer has to front Stein’s appeal and Stein loses, the likelihood of the insurer ever successfully exercising its rights of recoupment under the policy seems remote.


There are some very good reasons why D&O insurance policies are so that defense obligations continue following criminal convictions. The most important is that the alternative would be if the insurer could yank the coverage while a case is on appeal, the insured person would lose coverage at the precise moment when he or she needs it most. Imagine for a moment that the appeal is meritorious. Imagine also that without access to the insurance, the insured is unable to pursue the appeal. The result would be that a wrongful conviction would be allowed to stand. Simply put, the availability of insurance through the appeal stage is a fundamental part of providing an insured with a defense. If the insurance does not carry through the appeal stage, the insured person may be deprived a key element of his or her defense.


Another reason that the insurance policies are set up this way is that the insurance is there to provide a contractual way for companies to fulfill their advancement and indemnification obligations to their directors and officers. Because the analytic models on which D&O insurance is based are advancement and  indemnification, the policy should work the way advancement and indemnification do. In general, directors’ and officers’ rights of advancement continue through all appeals.


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  individuals had been convicted of various criminal offenses; 2) the four individuals had already been sentenced; 3) the individuals’ convictions had been upheld on appeal; and 4) the company had already advanced $77 million in defense expenses for the individuals. 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.


As this appellate court found when analyzing the cases on which the insurer sought to rely in trying to argue that courts have “repeatedly held” that final adjudication does not require exhaustion of all appeals, the specific language used in the exclusion makes a significant difference.


To see this point, compare the case under New York law, discussed here, and involving an exclusion that applied to preclude coverage upon “final judgment,” with the discussion of the Dole Foods case under Delaware law, here, in which the court considered a fraud exclusion with “final adjudication” language.


In the New York case, involving the “final judgment” language, the court found that a trial court conviction was sufficient to support the D&O insurer’s effort to recoup its defense costs, even though the individual’s appeal of his criminal conviction was pending.


By contrast, in the Delaware case, the court found that even thought the  trial court had determined that the individual defendants had committed “fraud,” coverage under the policy was not precluded where the fact determination was not part of the subsequent post-settlement final judgment in the case.


As I noted at the time in my discussion of the Delaware case, the “after adjudication” wording at issue there as well as in this case proved to be much more protective of the insured. The exclusion at issue in the Delaware case had an additional feature which would have been even more helpful to the insured here; the policy at issue in the Delaware case required not only  a “final adjudication” but it specified further that in order for the exclusion’s preclusive effect to apply, the adjudication must be “non-appealable.” This inclusion of the word “non-appealable” clearly would have helped Stein in this case.


The upshot from these various cases seems to be that the most protective wording for the conduct exclusion trigger is a requirement of a “final non-appealable adjudication” – with the proviso that the trigger should refer to an “adjudication” rather than to a “judgment.”


There was one feature of the exclusion at issue in this case that was noteworthy and also proved to be helpful to the insured, and that was the fact that the exclusion as amended specified that its preclusive effect did not apply to defense expenses. Obviously, wording of this type is also beneficial to the insured persons and provides yet another way of ensuring that the exclusion’s preclusive effect does not undermine their efforts to defend themselves through appeals.


One Thing that Bothers Me About This Court’s Opinion: While I think the appellate court correctly analyzed the conduct exclusion issues, there is one aspect of the court’s opinion to which I object. That is the fact that the court designated the opinion as “not to be published in the official reports, “ which means that under California Rules of Court Rule 8:1115 the decision “must not be cited or relied on by a court or a party in any other action.”


I have a problem with designating opinions as not for publication, at least where as here it means that the opinion cannot be cited by anyone.


First of all, in this day and age even supposedly unpublished appellate opinions are routinely published and freely available on the Internet. Readers will note that I linked above to the opinion on the Court’ s website. What can it mean to say that this opinion isn’t published if it is freely available to anyone  with Internet access? Of course, I know that it means that the opinion won’t appear in the official case reporter, but the fact is that even if it does not appear in the reporter, the decision is in fact published.


Second of all, I really don’t like what a court seems to be implying when it designates an opinion as unpublished, if the effect is that other parties cannot cite the opinion. It is as if the court is saying, here’s our opinion, but don’t hold us to it.


Third of all, trying to hold back court decisions from future citation is inconsistent with the centuries’ old traditions of our legal system. Our judicial processes as well as parties’ legal expectations are built on the assumption that our law is based upon courts’ prior decisions. To take an extreme example, what is this court going to do if next week it gets another case raising the exact same “after adjudication” issue, is it going to go through the whole rigmarole again and not refer back to this prior decision? Of course not, that wouldn’t make sense and it would be inefficient. The clear sense of referring back to this decision holds not just for future cases before this same court but before other California courts as well.


There is another, more disturbing aspect to courts’ willingness to designate opinions as unpublished. That is that this designation might be interpreted to suggest either that the court did not consider the parties dispute important enough to come up with an opinion it was willing to live with — or that the court really didn’t think it gave the dispute the kind of attention that would be required in order for the court to be prepared to live with the opinion in the future. Either way, the process of designating an opinion as not for publication risks the possibility of undermining the court’s legitimacy because it devalues the whole process.


There is one last thing that bothers me about this, and now I am getting to what really gripes me about courts designating opinions as not for publication, and that is that courts regularly and routinely seem to do it in insurance-related cases.


My deep concern is that this regular designation of insurance-related cases as not for publication could be interpreted to suggest that the courts just don’t think insurance cases are as important other cases.


It is true that at one level a particular dispute between an insurer and a policyholder is just a contractual dispute about money; nevertheless, there are important reasons why even this kind of dispute is worth a court’s full attention (and also of whatever is required to get court opinions to be published) and that is that the court’s decision will help other parties to insurance contracts interpret and apply their own contracts of insurance. Court decisions provide rules of the road for operating insurance policies. They also inform insurers and policyholders about the difference that policy wordings make, so that all parties can take these considerations into account when forming insurance contracts.


All of these good and important considerations are undermined when courts designate their opinions as not for publication,  if that designation means that no one can cite the opinion. Seriously, if no one can cite this appellate opinion, it doesn’t do anybody other than the immediate parties any good, it wastes the potential value of the court’s labor, and it reduces the court’s role to that of a referee at a high school wrestling match – the wrestlers wrangle for a while, then they step to the center, the referee raises one wrestler’s hand, and then it is on to the next match.


All of that said, this would bother me a lot less if things worked as they do in the federal court system, where parties are free to cite unpublished federal appellate court opinions as long as the parties citing the case provide the court and other parties with copies of the unpublished opinion that are not freely available (see Fed. R. App. Proc. 32.1, here). Under this approach, the only consequence of designating a decision as not for publication is that it does not appear in the official case reporters; the decision still has precedential value and still may be cited.


UPDATE: On April 6, 2017, the appellate court modified its opinion among other things to allow for partial publication of its opinion. Refer here for the court’s order.