The number of acts and claims and the selection of the date of loss and policy are at the heart of many disputes between insureds, insurers, and reinsurers, reports Perry Kreidman*.
Employment discrimination and sexual harassment claims are mounting. Market volatility and investor mood shifts have swept aside stock increases. Corporations, directors, officers, lawyers, accountants, agents and brokers, and other professionals are faced with mergers, acquisitions, consolidations, downsizing, and other tumultuous transactions.
With insurers and reinsurers asked to cover the inevitable disputes from these events, recurring questions emerge about the policies that apply, the limits, and the numbers and dates of the claims, acts, or losses. It is safe to say that one wrongful act or claim should trigger one policy, one limit, and one reinsurance contract. However, as in asbestos and pollution cases, it may not be easy to determine how many acts were committed, when, or how many claims are involved.
A typical policy covering directors and officers, professionals, and other insureds covers claims first made during the policy, based on wrongful acts during or before the policy. A single wrongful act is deemed to give rise to a single claim, but related wrongful acts or a series of acts are treated as giving rise to a single claim. Such policies may also exclude claims that are the same as claims made before the policy, or based on the same or related wrongful acts that gave rise to prior claims. As these policies contain limits of liability applicable to the individual or aggregate claims during the policy, the determination of the number and timing of the wrongful acts and claims directly impacts the amount of insurance and reinsurance.
Given the financial consequences of determining the number and dates of wrongful acts and claims, insureds and insurers often litigate the amount of coverage and applicable policy. Cedants and reinsurers face similar disagreements under their reinsurance contracts. The cedant will bill its reinsurers for the loss, while the reinsurers may challenge the cedant's position on the number of acts, claims, or policies.
Recent cases address the issues of single or multiple acts and claims and the date of claim. There is also judicial guidance on the reinsurance implications of a cedant's coverage decision under the follow the fortunes principle. These cases illustrate how such significant coverage questions are handled by the courts.
Directors' and Officers' policies
In Eureka Federal Savings and Loan Association, 873 F.2d 229 (9th Cir. 1989), an aggressive lending strategy was established by a savings and loan institution to reverse chronic losses. The directors and officers were sued for breach of fiduciary duty, mismanagement and waste on losses from over two hundred loans. The bank's D&O policy stated that "claims based on or arising out of the same act, interrelated acts, or one or more series or similar acts, of one or more Directors or Officers shall be considered a single loss." The coverage issue was the number of separate or related claims. The court found numerous claims, stating, "the fact that all loan losses arguably originated from one loan policy does not require finding only one loss." The court reasoned that "there were numerous intervening business decisions that took place after the loan policy was initiated that required the exercise of independent business judgment."
In Okada v. MGIC Indemnity Corp., 823 F.2d 276 (9th Cir. 1987), negligent acts by directors and officers led to the failure of the bank. Their D&O policy stated that "claims based on or arising out of the same act, interrelated acts, or one or more series of similar acts, of one or more of the Directors or Officers, shall be considered a single loss." The insureds asserted that each lawsuit arising out of the bank's failure was a different claim because each asserted different wrongful acts. The insurer argued that because the wrongful acts led to the demise of the bank, those acts were interrelated and gave rise to a single claim. The court agreed with the insureds that there were separate claims:
The underlying lawsuits involved separate alleged acts, each of which was a potential "loss" and could have given rise to a distinct claim. Therefore, even though the acts culminated in one result, First Savings' financial collapse, multiple potentially covered "losses" were involved.
The court further held that "more than one 'loss' can lead to one overall result, First Savings and Loans' failure, but one result does not require finding only one 'loss'."
Federal Savings and Loan Insurance Corporation v. Burdette, 718 F.Supp. 649 (N.D. Tenn. 1989), was a suit by FSLIC as receiver for Knox Federal Savings and Loan Association against American Casualty Company under a D&O policy. The underlying suits accused the directors and officers of lack of supervision of 25 loans, which occurred on different dates, involved different collateral, deficiencies, and borrowers, and arose out of separate negligent acts by the directors and officers. The insurer asserted that the 25 loans gave rise to claim because they arose from a single sequence of events - the directors' and officers' lack of supervision. The court rejected the insurer's approach and held that each loan constituted a separate act:
Numerous independent business decisions were made by individual officers and directors after this alleged scheme began concerning the approval of certain loans or participation, and as was concluded in Eureka, even in the face of a "common plan," a finding of multiple losses is appropriate in such a situation.
Additionally, the court, citing Okada, stated that "one overall result can result from several distinct acts, each of which constitutes a separate loss under the policy."
In National Union Fire Insurance Company of Pittsburgh v. Ambassador Group, 691 F.Supp. 618 (E.D.N.Y. 1988), four suits were brought against the directors and officers of the bankrupt Ambassador Insurance Group for securities violations, mismanagement, misrepresentation, and breach of the duty of loyalty. The underlying dispute involved the amount of a bond to be deposited with the court for an interpleader action. National Union asserted that it had deposited the appropriate $3 million bond, while Ambassador Group argued that the bond should have been $6 million. The D&O policy at issue contained a provision that stated:
If claim is made against directors or officers or notice is given of a threatened claim or an occurrence which might give rise to claim, then any claims subsequently alleging the same act or interrelated acts of which notice was previously given to National Union are a part of the same "loss" and subject to the limit of liability of the policy year applicable to that loss.
In deciding whether the suits were interrelated and constituted a single loss, the court found four separate claims:
Broadly construed, the claims are interrelated to the extent that they all involved allegations of wrongdoing of one sort or another and relate, in some way, to the demise of Ambassador Group and its subsidiaries. However, they are legally distinct claims that allege different wrongs to different people.
Another case ruled that claims against directors and officers were not causally connected under a D&O policy. Stauth v. Federal Insurance Company, (W.D. Okla. 1997). The case during the first D&O policy was brought by a competitor of the insured alleging improper pricing practices. The second case during the subsequent policy was a shareholders' fraud suit alleging that the directors and officers failed to disclose the prior suit. The second insurer unsuccessfully argued that the first and second suits were related and covered only by the first policy. The court disagreed, emphasizing the language of the second policy which allowed separate acts and claims to be treated as a single or related claim if there was a causal connection between them. The court found that the shareholder suit was not causally related to the improper pricing practices suit, because of separate, intervening business decisions and activities by the insureds.
Professional liability policies
Similar issues regarding the number and dates of wrongful acts and claims arise under professional liability policies.
Arizona Property and Casualty Insurance Guaranty Fund v. Helme, 735 P.2d 451 (1987), involved the negligence of two doctors. The family of Linward Worsham brought a malpractice action against the doctors based on the "failure of those treating Worsham to either examine spinal x-rays or react to his worsening condition." The doctors' professional liability insurance policy defined an occurrence as "any incident, act, omission, or series or related incidents, acts or omissions resulting in injury." The court found numerous claims under the policy despite a single injury, the patient's death, reasoning that "the number of causative acts, and not the number of injuries produced, determines the number of occurrences." It stated that "multiple acts causing a single injury will constitute multiple occurrences."
Federal Deposit Insurance Corporation v. Mmahat; Federal Deposit Insurance Corporation v. New England Insurance, 907 F.2d 546 (E.D. La. 1990), involved three acts of malpractice by an attorney in advising about a bank's lending policy. The attorney advised a savings and loan institution that it should never turn a loan down because it was over the limit for one customer. The FDIC thereafter sued the attorney for advising the bank to make loans that violated its limitations, maintaining that his motive was to make money for his firm. Under the professional liability policy, the court held that "a single motive does not make a single act." It reasoned that there were three discrete acts of malpractice and that "those discrete acts of malpractice resulted in discrete losses on seven loans."
In Village of Camp Point v. Continental Casualty Company, 578 N.E.2d 1363 (1991), the Village sued its attorney for losses due to his misrepresentations regarding the Village's ability to pledge revenue sharing and sales tax funds to retire its municipal bonds. The attorney's policy stated that "one or more claims arising out of a single act or omission or a series of related acts or omissions shall be treated as a single claim." The court concluded that the "number of acts producing injury or damage, rather than the number of injuries caused, [is] the key on which the definition of occurrence turns." It held that each time the attorney drafted the documents through which the Village pledged funds, he committed a separate wrongful act. The court concluded that "as a result, there are four separate occurrences resulting in four separate and distinct injuries."
In St. Paul Fire and Marine Insurance Company v. Chong, 787 F.Supp. 183 (D.Kan. 1992), Docking, an attorney, represented three Korean clients against criminal charges, but he lacked experience in felony or jury trials, non-English speaking clients, or immigration law. He also knew that one defendant had made a written statement implicating the others. After his clients were convicted, the court upheld their habeas corpus petitions, finding that they had been denied their constitutional right to counsel. A subsequent legal malpractice action was then filed against Docking. Docking's professional liability policy stated that ([it will] pay for all claims that result from a single wrongful act or a series of wrongful acts. The court concluded that wrongful acts "should be defined solely in terms of causation." Examining the cause of the clients' injuries, the court found multiple, unrelated wrongful acts by the attorney which could not be construed to be a single act or claim. The court stated that "there were multiple discrete omissions and actions on the part of Docking which resulted in discrete losses to each of the three defendants."
Cases finding related acts and claims
In contrast, some courts have found related acts and claims under D&O or professional liability policies.
In Atlanta Permanent Federal Savings & Loan Association v. American Casualty Company, 839 F.2d 212 (4th Cir. 1988), cert. denied, 108 S.Ct. 2824, 100 L.Ed.2d 925 (1988), loan customers in an action against a savings and loan and its directors alleged fraudulent sales tactics on a home improvement program. To calculate the deductible amount under the D&O policy, the court held that there was only one loss and one deductible because the claims arose out of a series of interrelated acts - the planning and carrying out of the home improvement loan program.
Gregory v. Home Insurance Company, 876 F.2d 602 (7th Cir. 1989) involved a lawyers professional liability policy. The underlying action involved the sale of videotapes to investors who signed a promissory note and production service agreement authorizing Producer's Brokerage Company, the client of Gregory, the Home Insurance Company insured, to market the videotape. Gregory, an attorney, drafted the production agreement and a tax and securities law opinion letter about the sale of the videos. The IRS subsequently disagreed with the attorney's tax opinion, disallowed the investors' tax deduction, and imposed penalties. A suit was brought by the buyers of the videotapes alleging multiple acts of malpractice, violation of the securities laws and RICO, and common law fraud. Home's policy stated that "two or more claims arising out of a single act . . . or a series or related acts . . . shall be treated as a single claim." The court found that the acts by Gregory constituted a single claim, reasoning that "the individual buyers' claims all arose from the same conduct of [the attorney]."
In Bay Cities Paving and Grading, Inc. v. Lawyers' Mutual Insurance Company, 5 Cal. 4th 854, 21 Cal. Rptr. 2d 691, 855 P.2d 1263 (1993), an attorney for a contractor owed money by another contractor recorded a mechanic's lien, but failed to serve a stop notice on the construction lender or file a complaint to foreclose the lien. The client sued for malpractice based on the lien, the stop notice, and the foreclosure. The attorney's policy stated that "two or more claims arising out of a single act . . . shall be treated as a single claim." The court found that the suit on those 3 acts constituted a single claim involving one "primary right" by the client against the attorney.
In Zunenshine v. Executive Risk Indemnity, Inc., United States District Court, Southern District, August 17, 1998, the court treated two lawsuits against a company and its directors and officers as the same claim, as both were based upon the same wrongful acts. Therefore, the suit during the second D&O policy fell within exclusions for claims or suits prior to the policy that were known to the insured or reported to its prior insurer and that were based upon the same fact, circumstance, or wrongful act as any prior or pending litigation.
A shareholders' securities fraud suit was brought against the company and its directors and officers in 1994 alleging misrepresentations about the company's financial condition. The second lawsuit was filed in 1996 by institutional investors who purchased unsecured notes from the company in 1994 and alleged that the directors and officers made similar misrepresentations. The D&O insurer during the second suit disclaimed coverage based upon exclusions for suits during the policy that were based upon or arose out of similar facts, circumstances, or wrongful acts alleged in suits prior to the policy. The second carrier alleged the institutional investors' suit arose out of the same facts, circumstances, and wrongful acts as the shareholders' suit. The court agreed and ruled that the second policy excluded the investors' suit. The court noted that the allegations in the second suit were almost identical to the first suit, relating to the company's financial condition in 1993 and 1994, its television advertisements, and a trademark infringement suit. Because of the factual connection between the cases, they were deemed to be the same claim and thus excluded by the second policy.
Reinsurers' liability for a cedant's determination on the number and dates of wrongful acts and claims
Reinsurers are most interested in how cedants determine the number and dates of wrongful acts and claims, as such a decision has a financial effect upon the attachment point of their reinsurance contract, the amount of reinsurance, and the number of policies and reinsurance contracts. The principle that governs those issues is follow the fortunes. A cedant's decision to cover and pay a claim is binding upon its reinsurer if based upon a reasonable and businesslike handling of the case and the loss was reasonably within the coverage of the policy. In contrast, if the cedant acted in bad faith in the defense of the case, or paid a claim that was clearly not covered by the policy, directly within an exclusion, or outside the terms and conditions of the reinsurance contract, the reinsurer should not be liable under the follow the fortunes principle.
In International Surplus Lines Insurance Company v. Underwriters at Lloyd's of London, 868 F.Supp. 917 (S.D. Ohio, 1994), the court held that the reinsured made a reasonable, good faith coverage determination that multiple asbestos losses constituted a single occurrence. The insured, Owens Corning Fiberglass, after receiving 85,000 asbestos claims, asserted that they arose from a single occurrence, its manufacture of products containing asbestos. The cedant agreed and made payments on behalf of its insured on a single occurrence basis, applying a single $1,000,000 per occurrence deductible in each policy. The reinsurers rejected the single occurrence position under the policies and reinsurance contracts, asserting that each asbestos claim was a single occurrence subject to a separate $1,000,000 deductible.
The court in the reinsurance dispute ruled for the cedant under the follow the fortunes principle. The court noted that the cedant had reached a reasonable coverage position on the number of occurrences that was consistent with the majority rule in the United States, in which the number of occurrences is based upon the number of causative acts. Since the claims arose from the insured's manufacture of asbestos products, they could be reasonably handled by the cedant as one occurrence under the follow the fortunes clause.
In Reliance Insurance Company v. General Reinsurance Corporation, 506 F.Supp. 1042 (E.D. Pa. 1980), the court declined to follow the cedant's effort to treat two wrongful acts as one for reinsurance coverage purposes. The cedant had been found liable for bad faith in mishandling an auto accident case due to two acts of wrongdoing, i.e. having the claimant sign a statement while hospitalized and taking a part of the auto when it was in the insured's driveway. The cedant settled the bad faith case for $912,000 and billed its reinsurer. As the reinsurance contract had a $500,000 per occurrence attachment point, the reinsurer asserted that the loss arose out of two occurrences or wrongful acts, neither of which resulted in a loss above $500,000. The court found in favor of the reinsurer and declined to impose liability under the follow the fortunes clause, concluding that the cedant's settlement emanated from separate wrongful acts committed on behalf of the insurer.
In Lexington Insurance Company v. Prudential Reinsurance Company of America, No. 95-483, Mass. Super., (Suffolk Co. 1987), a fraudulent conversion claim against the insured was settled by the insurer and submitted to the reinsurer. The reinsurer denied coverage on the ground that such a claim was not insurable as a matter of public policy, based upon a California statute. The cedant argued that under the follow the fortunes principle, its good faith resolution of a coverage issue bound its reinsurer. The court ruled for the reinsurer, finding the cedant had settled a claim clearly outside the coverage of the policy and the reinsurance contract.
A cedant has leeway in deciding that multiple claims against an insured involving multiple wrongful acts constitute either the same or a related claim or independent claims. The cedant's determination on the number of acts will have a direct affect on the date of the loss and policy period. If the cedant's decision is reasonably based upon the provisions of the policy, the facts of the case, and the case law governing the coverage issues, the cedant's payment should be binding upon the reinsurer. If the reinsurer can establish that the cedant's decision was not in good faith, did not reflect applicable coverage principles, or was outside the reinsurance contract, the cedant's decision should not be binding upon the reinsurer.
The number of acts and claims and the selection of the date of loss and policy are at the heart of many disputes between insureds, insurers, and reinsurers. An awareness of the way courts addressed these issues in the past should have a constructive effect on how cedants and reinsurers handle, and perhaps amicably resolve, these points in the future.
Perry Kreidman is a partner at Wilson, Elser, Moskowitz, Edelman & Dicker LLP, New York City.
(*with assistance from Jessica Thaler, Summer Associate)