In This Issue:

• More Important Rulings From J.P. Morgan's New York Coverage Litigation
• Coverage for TCPA Suit Denied; Calls Did Not Arise out of “Rendering of Services”
• Subpoenas Issued by the SEC Constituted a “Claim” Under a Claims-Made Policy Making Insured’s Notice Untimely
• Litigation Insurance: Insurers Must Provide Defense for Unfounded Litigation

More Important Rulings From J.P. Morgan's New York Coverage Litigation

Why it matters
A New York Appellate Court unanimously held that a group of insurers could not invoke a Dishonest Acts Exclusion in a professional liability policy to avoid liability for $200 million that its insured paid regulators for market-timing allegations. Bear Stearns (acquired and now owned by J.P. Morgan) entered into settlements and consent orders with the SEC and the NYSE and turned to its insurers for coverage. The insurers denied coverage on several bases, including the application of a Dishonesty Exclusion, which barred coverage if a “judgment or other final adjudication thereof adverse to such Insured shall establish that such Insured was guilty of any deliberate, dishonest, fraudulent or criminal act or omission.” The court concluded that the insurers could not invoke the exclusion because Bear Stearns’ settlement resulted from negotiations and did not qualify as a “judgment or other final adjudication” of wrongdoing as required by the exclusion. The court further reasoned that the settlement could not be used to establish Bear Stearns’ guilt, when the document expressly provided that Bear Stearns did not admit guilt, and reserved the right to profess its innocence in unrelated proceedings. The court did, however, allow a public policy defense to coverage of losses caused by intentionally harmful conduct, based upon findings in such regulatory documents. This decision, the latest chapter in the coverage dispute surrounding Bear Stearns’ market-timing cases, demonstrates that despite the insured’s inclusion of “non-admission” language, the insurer may still be able to raise a public policy defense, providing an important lesson for policyholders to remain diligent when negotiating any findings with governmental agencies.

Detailed Discussion
In 2003, the SEC and the New York Stock Exchange (NYSE) began to investigate Bear Stearns for allegedly facilitating late trading and deceptive market timing by certain customers in connection with the buying and selling of shares in mutual funds.

After the SEC presented Bear Stearns with the evidence upon which it intended to base its civil enforcement proceedings, the company decided to settle the matter. The parties reached an agreement that was formalized into an “Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order.”

The order stated: “Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission’s jurisdiction over them and the subject matter of these proceedings, which are admitted, [Bear Stearns] consent[s] to the entry of [the SEC Order].”

In addition, the order included 170 factual “findings” setting forth the actions the SEC had alleged against Bear Stearns, ranging from how the company operated its late trading and market-timing scheme in “direct disregard” of demands by mutual funds to the “affirmative steps” it took to help its client “evade the blocks and restrictions imposed by the mutual funds” and the efforts the company took to “ensure that [the clients’] rapid mutual fund trades would not be detected by the mutual funds.”

The SEC ordered Bear Stearns to pay $90 million in civil penalties and disgorge $160 million. The company entered into a similar arrangement with the NYSE. Bear Stearns also faced shareholder class actions that the company settled for $14 million.

Bear Stearns sought coverage for the settlements under its professional liability insurance policies. The insurers denied coverage on several bases, including the application of a Dishonesty Exclusion, which barred coverage if a “judgment or other final adjudication thereof adverse to such Insured shall establish that such Insured was guilty of any deliberate, dishonest, fraudulent or criminal act or omission.” The insurers argued that the administrative order contained a series of detailed “findings” that constitute a final adjudication of the insured’s wrongdoing, which triggers the exclusion.

Bear Stearns filed an action for declaratory relief, and the insurers responded with a motion to dismiss. The issues presented in that motion took the case up to New York’s highest court.

The insurers argued that, by consenting to the entry of the order that detailed “findings” and required Bear Stearns to make compensatory payments and pay penalties, Bear Stearns was adjudicated a wrongdoer. According to the insurers, the inclusion of the “findings” effectively transformed them from mere allegations to proven facts.

The Appellate Court disagreed with the insurers, ruling that the SEC order did not “establish” any wrongdoing by the insured because it expressly provided that the insured is not admitting or denying the “findings” set forth in the order.

The court stated that the insurers virtually ignored the part of the exclusion requiring that any adjudication “establish” that the insured was “guilty of any deliberate, dishonest, fraudulent or criminal act or omission.” A dictionary definition of “establish” is “to put beyond doubt.” In the court’s view, it could hardly be said that the SEC order and the NYSE stipulation put Bear Stearns’ guilt “beyond doubt,” as those very same documents expressly provided that Bear Stearns did not admit guilt and reserved the right to profess its innocence in unrelated proceedings. As such, the court held, the dishonesty exclusion was not triggered.

The insurers also asserted an affirmative defense that public policy prohibits insurance coverage for amounts paid by the insured as a result of intentional harm caused by the insured. The insured argued that the absence of an adjudication of wrongdoing bars the insurers from relying on the SEC order for purposes of their public policy defense. The court disagreed with the insured, holding that the court’s strong interest in enforcing public policy permits the use of the settlement orders to establish a public policy defense against insuring intentional wrongdoing, even though the order did not establish intentional misconduct sufficient to trigger the dishonesty exclusion.

To read the opinion in J.P. Morgan Securities, Inc. v. Vigilant Insurance Company, click here.

Coverage for TCPA Suit Denied; Calls Did Not Arise out of “Rendering of Services”

Why it matters
Courts across the country have struggled with the application of insurance coverage for Telephone Consumer Protection Act (TCPA) related lawsuits against insureds. In a recent decision, an appellate court in Illinois found an insurer had no duty to defend an insurance agent under a professional liability policy against a claim alleging the insured sent unsolicited, automated telephone calls advertising its services to nonclients. The court reasoned that the insurer was not obligated to provide a defense because the calls alleged in the underlying complaint did not arise out of the agent’s “rendering of services for others” as required by the policy. While TCPA violations may sometimes be covered under a professional liability policy, the outcome will depend on the specific facts and policy language at issue.

Detailed Discussion
The underlying lawsuit arose out of a class action filed by Scott Margulis against Bradford & Associates (“Bradford”), an insurance agent, alleging common law and TCPA violations. Plaintiffs, nonclients of Bradford, alleged Bradford transmitted unsolicited, automated telephone calls advertising its services to them.

Bradford tendered the lawsuit to its professional liability insurer, BCS Insurance Company, which denied coverage. Thereafter, Bradford and Margulis entered into a settlement agreement for nearly $5 million, which was to be satisfied only from the proceeds of the insurance policies and claims against Bradford’s insurers.

Following the settlement, Margulis filed a declaratory judgment action against BCS. Margulis and BCS each filed a motion for summary judgment. The circuit court granted BCS’s motion and denied Margulis’s motion. Margulis appealed. On appeal, Margulis argued that since Bradford’s advertising calls sought to induce the recipients to use its specialized services as an insurance agent, the policy afforded coverage.

The Appellate Court determined that the allegations in the underlying class action did not fall within the potential scope of the policy’s coverage, as the allegedly negligent acts, errors or omissions of Bradford – the transmission of automated, unsolicited calls advertising Bradford’s services – did not arise out of the conduct of Bradford’s business “in rendering services for others” as an insurance agent, general agent, or broker. Although the call advertised Bradford’s services to the plaintiff class, Bradford was not rendering services for the call recipients as an agent or broker, as the recipients of the transmission were not Bradford’s clients or customers.

The policy at issue provided: “The Company does hereby agree to pay on behalf of the Insured such loss in excess of the applicable deductible and within the limit specified in the Declarations sustained by the Insured by reason of the liability imposed by law for damages caused by any negligent act, error or omission by the insured arising out of the conduct of the business of the Insured in rendering services for others” as a licensed agent or broker.

Margulis contended that the resulting injuries arose out of Bradford’s business. The Appellate Court was not convinced, finding instead that the alleged negligent conduct, i.e., the transmission of unsolicited phone calls, did not arise out of Bradford’s rendering services for others as an insurance agent. Notably, the Appellate Court found compelling that the recipients of automated telephone calls were not insurance clients of Bradford, and in turn, Bradford could not have been rendering services as a licensed insurance agent, general agent or broker.

“Comparing the class action petition against Bradford and the BCS policy, we do not read the allegations in the petition as falling within the potential scope of the policy’s coverage because the allegedly negligent acts, errors or omissions – the transmission of automated, unsolicited telephone calls advertising Bradford’s services – did not arise out of the conduct of Bradford’s business in rendering services for others as an insurance agent, general agent or broker,” the court reasoned.

To read the opinion in Margulis v. BCS Insurance Co., click here.

Subpoenas Issued by the SEC Constituted a “Claim” Under a Claims-Made Policy Making Insured’s Notice Untimely

Why it matters
In a recent decision, the District Court of Massachusetts affirmed the importance of providing timely notice of all D&O liability claims – including subpoenas. An insured sought coverage from its D&O insurer under a claims-made and reported policy for defense costs it incurred as a result of an SEC enforcement action. The policy defined the term “Claim” broadly to include any “civil, arbitration, administrative or regulatory proceeding against any Insured commenced by . . . the filing of a notice of charge, investigative order, or like document.” Typically, insureds will give notice of any event that could be considered a “claim” in order to maximize defense costs paid by their insurer. As a practical matter, a target begins to incur defense costs when it is served with a subpoena, which further illustrates the need to initiate the process immediately. In this case, however, the insurer sought to establish that the subpoenas served prior to the inception of its D&O policy constituted claims in order to pursue a late notice defense. The court held that the insured had no coverage for the enforcement action because the claim related back to two subpoenas that the SEC served on the insured before the D&O policy incepted. The court reasoned that because the subpoenas indicated on their face that the SEC had commenced a formal investigation against the insured, each subpoena was a “Claim” that should have been reported to the insured’s prior D&O carrier. Siding with the insurer, the court found that because the events were a single claim, which started prior to the date the policy took effect, no duty to defend existed. This is a reminder for insureds to treat any governmental or similar notification as a claim if it reaches the specter of potential liability.

Detailed Discussion
BioChemics, Inc., a specialty pharmaceutical company focused on transdermal drug delivery systems, purchased D&O coverage from Axis Reinsurance Company (“Axis”). The policy incepted in November 2011 and insured covered claims that were made and reported during the policy period.

By a formal order, the SEC commenced an investigation of BioChemics and its officers on May 5, 2011. Throughout the year, the SEC served a series of document subpoenas on the insured pursuant to the investigative order. In December 2012, the agency filed an enforcement action against BioChemics and its officers. All of the documents from the SEC featured the caption “In the Matter of BioChemics, Inc. (B-02641).”

The SEC then served deposition subpoenas on the insureds, using the same caption, in early 2012.

BioChemics notified Axis of the 2012 subpoenas. Axis denied coverage, taking the position that the entire SEC investigation was a single “claim” that was first made in 2011 when the SEC issued its first document subpoena to BioChemics – before the Axis policy took effect.

In considering this issue, the court agreed that the subpoenas and the enforcement action were all part of the same investigation that formally commenced in May 2011. Therefore, the court concluded it was improper to consider the proceedings as separate claims for the purpose of triggering coverage under the Axis policy.

“The policy here defines a ‘Claim’ broadly to include, any ‘civil, arbitration, administrative or regulatory proceeding against any Insured commenced by . . . the filing of a notice of charge, investigative order, or like document,’ ” the court stated.

Central to the court’s analysis was that “[e]ach subpoena was issued under, and referred to, the original Formal Order, and investigated the same officers and company for the same pattern of security violations through public material misstatements.” Thus, the court agreed that there was only a single claim asserted against the policy’s insureds, and that because this claim was first made before the policy came into force, Axis’ denial of coverage was proper.

Because the Formal Order was issued on May 5, 2011, and the Axis policy did not take effect until November 13, 2011, the “investigation and enforcement action, the Claim at issue, was thus ‘first made’ before the policy period and is, therefore, not covered under the policy,” the court ruled, granting the insurer’s motion for summary judgment.

To read the decision in BioChemics, Inc. v. Axis Reinsurance Co., click here.

Litigation Insurance: Insurers Must Provide Defense for Unfounded Litigation

Why it matters
The Illinois Appellate Court recently held that an insurer had a duty to defend its insured against numerous vaguely pleaded toxic tort complaints. The central issue was whether facts extrinsic to the underlying complaint, known to both the insurer and insured – that the insured did not even manufacture the products at issue – can abrogate the duty to defend. The court held that undisputed extrinsic facts not pled in the underlying complaint do not relieve an insurer of its duty to defend unless and until proven in the underlying action. The court reasoned that “from all indications, the insured should not have been named as a defendant in the underlying cases. But it was insured against being wrongly sued. Therefore, the insurers are responsible for defending the insured from the allegations against it, however groundless.”

Detailed Discussion
Illinois Tool Works manufactures and distributes tools, equipment, finishing systems, and consumables. Illinois Tool entered the distribution of welding products through a series of company acquisitions beginning in 1993.

Thousands of toxic tort lawsuits named Illinois Tool as a defendant (among dozens of others), alleging injury as a result of exposure to asbestos, benzene, manganese, and other harmful materials. Illinois Tool was named in different capacities in the lawsuits, ranging from a successor-in-interest to the welding companies it later acquired to individual liability or both.

To defend against the lawsuits, Illinois Tool turned to various insurers that provided coverage between 1971 and 1987, including Travelers Casualty & Surety Company. The insurers refused to defend the lawsuits because the last policy they issued expired in 1987 and Illinois Tool did not enter the welding product market until 1993, and there were no allegations made that the insured caused injuries during the periods covered by their policies.

Dismissing this argument, the court emphasized that the validity of the underlying claims was not an issue. “Our inquiry must focus on whether the facts pled by the underlying plaintiffs, if true, would potentially bring the claims within coverage,” the court explained. “When we analyze the underlying complaints under that standard, it is clear that the insurers have a duty to defend.”

Based on their allegations, the court divided the underlying complaints into four categories: direct liability with exposure dates during a policy period; direct liability with unstated injury or exposure dates; pure successor-in-interest liability claims; and a combination of direct liability and successor-in-interest claims.

In the first category, direct liability with exposure dates during a policy period, “the insurers clearly have a duty to defend . . . even if the allegations are, in fact, groundless,” the court wrote. “The unequivocal claim made in these complaints is that Illinois Tool, itself, made or distributed harmful materials during the policy periods that caused the underlying plaintiffs’ injuries.”

To accept the insurers’ position would equate the duty to defend with the duty to indemnify, the court held. While the court acknowledged that in “the majority of the underlying complaints in this category the plaintiffs use ‘group pleading’ or ‘shotgun pleading’ to implicate Illinois Tool . . . the insurer bears the burden of the underlying plaintiffs’ broad drafting.”

“Irrespective of whether or not Illinois Tool will ultimately be found liable in these underlying cases, the insurers agreed to bear the burden of defending against the putative groundless allegations,” the court stated. “Only with knowledge of an extrinsic fact does it become apparent that, contrary to the express allegations in the underlying complaints, Illinois Tool was not in the business of manufacturing or distributing welding products before 1993.”

Similar reasoning applied to the second category of complaints, direct liability claims with an unstated exposure or injury date. Despite the uncertainty in the time frame, “vague, ambiguous allegations against an insured should be resolved in favor of finding a duty to defend,” the court ruled. “The bare allegations of the underlying complaints leave open the possibility that the plaintiffs’ exposure or injury occurred during the policy periods. Accordingly, the underlying allegations do not foreclose coverage.”

The third category of claims, pure successor-in-interest claims, presented a different situation. In these cases, the underlying plaintiffs pled the insurers out of any duty to defend by making clear that their claims were only directed at predecessor companies or activities beginning in 1993, the court ruled. “Illinois Tool did not bargain for a defense for claims made against it by way of any after-acquired companies or for conduct occurring after 1997,” the court reasoned.

In the final group of complaints, the court addressed combined successor-in-interest and direct liability claims. “[U]nder Illinois law, when an insurer has a duty to defend against one claim in a suit, it has a duty to defend against all claims, even if some of the claims standing alone would be beyond the scope of the policy,” the court held. Because the insurers had a duty to defend for the direct liability claims present in the last group of complaints, they must also provide a defense based on successor liability as well, the court held.

“From all indications, Illinois Tool should not be named as a defendant in the underlying cases,” the court wrote. “But it was insured against being wrongly sued. The insurers here are responsible for defending Illinois Tool from the allegations against it, however groundless.”

To read the opinion in Illinois Tool Works Inc. v. Travelers Casualty and Surety Company, click here.