In This Issue:

• California Appellate Court: All Claims “Arising From” Ponzi Scheme Are Precluded
• Georgia Supreme Court Takes Tough Stance On “Consent To Settle” Clause
• Injured Worker Qualifies As An “Employee,” Triggers Policy Exclusion
• Tenth Circuit Applies Colorado’s Notice-Prejudice Rule Exception For Claims-Made Policies With Date-Certain Requirement

California Appellate Court: All Claims “Arising From” Ponzi Scheme Are Precluded

Why it matters: Concluding that any claims related to a Ponzi scheme—even if they involved different investors, investments, or broker-dealers—all arose from the same scam, a California Court of Appeal determined that a securities firm was not entitled to defense in litigation brought by victims of the scheme. An investor notified Crown Capital Securities of his claim that the company allegedly failed to exercise due diligence in assessing the legitimacy and viability of certain investments that were determined to be a Ponzi scheme. Crown submitted an application for a professional liability policy and disclosed the claim. But a few months later—after the policy had been issued—three other investors launched arbitration proceedings against Crown. The insurer refused to provide a defense, arguing that the subsequent proceedings arose from the same Ponzi scheme. Crown sued the insurer, arguing that the arbitration proceedings involved different investors, investments, and broker-dealers, but the appellate panel affirmed a trial court’s grant of summary judgment for the insurer. The claims all arose out of the same Ponzi scheme, the court said, even though a different Crown investment advisor was involved and different investors were allegedly harmed.

Detailed discussion: Crown Capital Securities received a letter from investor George Bou-Sliman in October 2009. Bou-Sliman included a report from a bankruptcy examiner in the case of DBSI, Inc., an entity that filed for bankruptcy in November 2008. The letter accused Crown of failing to perform the necessary due diligence into the activities of DBSI, which was determined by the examiner to be a Ponzi scheme. Bou-Sliman alleged that Crown investors recommended investment in DBSI properties to his detriment.

The letter and report detailed the activities of DBSI over an eight-year period, when the company made marketing claims that “no investors had ever lost money” while newly raised investor funds were being used to pay off existing investors.

A few months later a Crown employee executed an application for a professional liability policy with Endurance American Specialty Insurance Company for its security broker-dealers and investment advisors. The employee answered “yes” to Question 9 as to whether the company had knowledge of any “claims, suits or proceedings” made against it over the last five years.

However, to Question 10 asking whether Crown was “aware of any fact, circumstance, incident, situation, or accident” that could result in a claim being made against it, the employee answered “no.”

The policy contained an Application Exclusion, which stated: “It is agreed that any claim or lawsuit against the Applicant, or any principal, partner, managing member, director, officer or employee of the Applicant, or any other proposed insured, arising from any fact, circumstance, act, error or omission disclosed or required to be disclosed in response to [the questions], is hereby expressly excluded from coverage under the proposed insurance policy.”

After the application was submitted, three investors initiated arbitrations against Crown Capital by filing claims with the Financial Industry Regulatory Authority (FINRA) based on investments made with DBSI projects on their behalf. Each of the three worked with a different investment advisor and their money was invested in a different project.

Crown reported all three of the claims to Endurance but the insurer refused to defend each one. The policyholder then filed suit against the insurer alleging breach of contract and bad faith based on the denial of coverage. Endurance responded with a motion for summary judgment, arguing that the Application Exclusion precluded coverage.

A trial court agreed and the appellate panel affirmed.

“The Bou-Sliman claim notified Crown Capital of DBSI’s bankruptcy,” the court said. “Like the Bou-Sliman claim, the [three arbitration proceedings] arose out of the DBSI Ponzi scheme—i.e., DBSI used new investor money to pay existing debt and payment obligations—and those claimants alleged that Crown Capital failed to exercise due diligence in assessing the viability of DBSI investments.”

From the Bou-Sliman claim and accompanying report, Crown Capital was aware that DBSI had declared bankruptcy and had allegedly been operating a Ponzi scheme, the panel noted—as well as that its broker-dealers had sold other DBSI investments to their customers that were part of the Ponzi scheme and bankruptcy proceedings.

“Thus, Crown Capital was aware of facts and circumstances that might result in a claim or claims being made against it, which awareness it was required to disclose under Question 10 of the application for the Policy,” the panel wrote. “This requirement existed even though the [arbitration claims] did not involve the same investor or the same investment that was at issue in the Bou-Sliman Claim, and none of the investments at issue in the [arbitration claims] was recommended by the same Crown Capital dealer-broker who recommended the [investment] to Bou-Sliman. The Application Exclusion applied to claims that were the subject of required disclosure under Question 10.”

Crown Capital’s alternative arguments that the Application Exclusion was ambiguous as it applied to the arbitration claims and that the “arising from” language should have been applied narrowly failed to persuade the court. California courts have consistently given a broad interpretation to the terms “arising out of” or “arising from” in insurance policies, the panel wrote.

“The trial court did not interpret the ‘arising from’ language in the Application Exclusion in such a manner that it excluded coverage for the [arbitration claims] merely because they had some relation to DBSI,” the court said.

Instead, “The trial court ruled that Endurance properly denied coverage for the disputed claims under the Application Exclusion because Crown Capital was aware that DBSI had declared bankruptcy and allegedly had been operating a Ponzi scheme; that Bou-Slimon claimed that Crown Capital had failed to exercise due diligence in connection with a DBSI investment; and that its broker-dealers had sold other DBSI investments to their customers. Thus, Crown Capital was aware of the facts and circumstances that might result in a claim or claims being made against it for any investment in a DBSI investment property. Accordingly, we do not believe there was any potential for coverage under the terms of the Policy or doubt as to Endurance’s duty to defend,” the panel concluded.

Even Crown’s contention that the arbitration claims asserted other theories of liability, bringing them within the policy’s reach, did not change the court’s mind, as “all of the causes of action” asserted in the arbitration claims “concerned the purchase of DBSI investments.”

“At the time that Crown Capital applied for the Policy, it was aware of facts and circumstances that might result in a claim being made against Crown Capital—i.e., DBSI’s bankruptcy, the alleged operation of a Ponzi scheme, and the investment by Crown Capital’s customers in DBSI investments,” the court said. “The awareness of those potential claims brought such claims within the Application Exclusion regardless of the theory upon which claims might be based.”

To read the opinion in Crown Capital Securities v. Endurance American Specialty Insurance Co., click here.

Georgia Supreme Court Takes Tough Stance On “Consent To Settle” Clause

Why it matters: The Georgia Supreme Court dealt a blow to a policyholder hit with a securities class action, holding that because the company settled the litigation without the insurer’s consent, the insurer was not obligated to contribute to the settlement fund. After years of litigation, Piedmont Office Realty Trust agreed to settle a securities class action against it. Piedmont—which had already exhausted a $10 million primary policy as well as $4 million of excess coverage—requested consent from the excess carrier to settle the case for the remaining $6 million in coverage. The excess insurer promised to pay only $1 million. Piedmont then settled the case for $4.9 million and sought reimbursement from the excess carrier, who refused. A federal district court dismissed Piedmont’s bad faith failure to settle suit, and the Eleventh Circuit Court of Appeals asked the Georgia Supreme Court for help. Answering the federal appellate panel’s questions, the court found that reimbursement was unavailable because Piedmont ran afoul of the policy’s consent to settle provision, as the policyholder “failed to fulfill the contractually agreed upon condition precedent.” While the decision noted a split among jurisdictions on the issue, policyholders should take note that some courts will strictly enforce a consent to settle clause, with the possible result of losing a settlement contribution from an insurer.

Detailed discussion: Piedmont Office Realty Trust was named as a defendant in a federal securities class action lawsuit seeking damages in excess of $150 million. As the litigation went on, the parties traded motions until the district court granted summary judgment for Piedmont. But the plaintiffs appealed the ruling, and Piedmont agreed to discuss a deal.

At this point Piedmont had already exhausted a $10 million primary policy as well as $4 million of an excess policy issued by XL Specialty Insurance Company. The policyholder requested XL’s consent to settle the suit for the remaining $6 million under the excess policy. The insurer agreed to contribute just $1 million towards the settlement, and nothing more.

Piedmont then settled the dispute for $4.9 million and asked XL to pay up. The insurer refused based on a “consent to settle” clause in the policy, which stated: “No claims expenses shall be incurred or settlements made, contractual obligations assumed or liability admitted with respect to any claim without the insurer’s written consent, that shall not be unreasonably withheld. The insurer shall not be liable for any claims expenses, settlement, assumed obligation or admission to which it has not consented.”

The policy also contained a “no action” clause which prohibited an insured from taking any action against the insurer “unless, as a condition precedent thereto, there shall have been full compliance with all of the terms of this policy, and the amount of the insureds’ obligation to pay shall have been finally determined either by judgment against the insureds after actual trial, or by written agreement of the insureds, the claimant, and the insurer.”

Piedmont filed suit against XL alleging breach of contract and bad faith failure to settle. A federal district court granted the insurer’s motion to dismiss the complaint and Piedmont appealed to the Eleventh Circuit Court of Appeals.

The federal appellate panel sought guidance from the Georgia Supreme Court, certifying three questions: “Under the facts of this case, and in the light of the Final Judgment and Order—in the Underlying Suit—approving of and authorizing and directing the implementation of the terms of the settlement agreement, is Piedmont ‘legally obligated to pay’ the $4.9 million settlement amount, for purposes of qualifying for insurance coverage under the Excess Policy?”

Secondly, the court asked whether “In a case like this one, when an insurance contract contains a ‘consent-to-settle’ clause that provides expressly that the insurer’s consent ‘shall not be unreasonably withheld,’ can a court determine, as a matter of law, that an insured who seeks (but fails) to obtain the insurer’s consent before settling is flatly barred—whether consent was withheld reasonably or not—from bringing suit for breach of contract or for bad-faith failure to settle? Or must the issue of whether the insurer withheld unreasonably its consent be resolved first?”

Finally, the appellate panel wondered whether Piedmont’s complaint was properly dismissed.

The complaint was properly dismissed and Piedmont’s request for coverage was unavailing, the Georgia Supreme Court determined, relying on state precedent (Trinity Outdoor, LLC v. Central Mut. Ins. Co., 285 Ga. 583 (2009)) that refused to permit an insured to sue in the face of a consent to settle clause where it neglected to obtain consent prior to settlement.

“In this case, as in Trinity, the plain language of the insurance policy does not allow the insured to settle a claim without the insurer’s written consent,” the court said. “It also provides that the insurer shall only be liable for a loss which the insured is ‘legally obligated to pay.’ Finally, the policy contains a ‘no action’ clause which stipulates that the insurer may not be sued unless, as a condition precedent, the insured complies with all of the terms of the policy and the amount of the insured’s obligation to pay is determined by a judgment against the insured after a trial or a written agreement between the claimant, the insured, and the insurer. In light of these unambiguous policy provisions, we hold that Piedmont is precluded from pursuing this action against XL because XL did not consent to the settlement and Piedmont failed to fulfill the contractually agreed upon condition precedent.”

Piedmont argued that the policy also expressly provided that XL could not withhold its consent to settle unreasonably, but the court said the provision was essentially superfluous because Georgia law prohibits insurers from unreasonably refusing to settle a covered claim.

Although Piedmont tried to distinguish the prior case law because the policy in that case did not contain a consent to settle provision, the court said the clause was implied based on Georgia law. “And, in spite of this implied provision, we determined that the insured in Trinity could not settle the underlying lawsuit without the insurer’s consent and then sue the insurer for refusing to settle in bad faith,” the court wrote.

The district court’s approval of the settlement in the underlying litigation had no bearing on the coverage question, the court added. The consent to settle clause “precluded Piedmont from entering into a settlement agreement without XL’s prior consent,” the court reiterated. “Piedmont could not settle the underlying lawsuit without XL’s consent—in breach of its insurance contract—and then, after breaching the contract, claim that the district court’s approval of the settlement imposed upon XL a distinct legal obligation to pay the settlement on Piedmont’s behalf.”

Courts are split on the question of whether an insured who settles a lawsuit in violation of a “no action” clause can still bring a bad faith claim against the insurer, the court noted, acknowledging cases from Oregon and Utah where the suits were allowed, but citing a similar conclusion from Florida.

“In sum, absent XL’s consent to the settlement, under the terms of the policy, Piedmont could not sue XL for bad faith refusal to settle the underlying lawsuit in the absence of a judgment against Piedmont after an actual trial,” the court wrote.

To read the opinion in Piedmont Office Realty Trust, Inc. v. XL Specialty Insurance Co., click here.

Injured Worker Qualifies As An “Employee,” Triggers Policy Exclusion

Why it matters: Was a worker assisting with a contracting job an “employee” that fell under a policy exclusion for bodily injury to employees? According to a federal district court judge in Mississippi, the answer was “yes,” leaving the insured without defense coverage in a suit brought by the injured worker. Nallmark Electrical Contractors, a sole proprietorship, performed a contracting job at a dry ice facility, where one of the workers was seriously injured. He sued Nallmark, and the company tendered defense to American Southern Insurance Co. The insurer denied coverage, pointing to an exclusion for bodily injury to “[a]n ‘employee’ of the insured arising out of and in the course of” employment by the insured or performing duties related to the conduct of the insured’s business. In a declaratory action, the court said the company had the right to—and actually did—control the worker’s tasks and the worker performed work that was part of the company’s regular business, bringing him under the exclusion.

Detailed discussion: Donald Nall operated Nallmark Electrical Contractors as a sole proprietorship, using workers as necessary for various jobs. In April 2010, George Randy Williamson assisted Nall in an electrical contracting job at a dry ice facility and suffered significant burns to his face, head, hands, and arms, leaving him in a coma for almost two months.

Williamson filed suit against Nall’s estate (he passed away from unrelated causes) in Mississippi state court. The estate tendered defense of the suit to American Southern Insurance Company pursuant to a commercial general liability policy purchased by Nall for the relevant time period.

The insurer responded with a declaratory judgment action, seeking a declaration that it owed no coverage to Nall or Nallmark based upon the Employer’s Liability Exclusion in the policy. Williamson countered that he was not Nall’s employee when the injury occurred.

But U.S. District Court Judge Daniel P. Jordan III sided with the insurer on the issue of employment status.

Looking first to the policy itself, the court noted that it excluded coverage for “bodily injury” to “[a]n ‘employee’ of the insured arising out of and in the course of: (a) Employment by the insured; or (b) Performing duties related to the conduct of the insured’s business.” The policy provided that an “employee” included a “leased worker” but excluded a “temporary worker,” with no additional definition.

Williamson was not a “leased worker” under the policy because he was not leased by a labor leasing firm, nor was he a “temporary worker” because he was not “furnished” to Nall. Given the limited guidance from the policy on the definition of an “employee,” the parties all looked to Mississippi common law.

Under state law, courts consider a host of factors to determine whether a worker is an employee, including the skill required in the particular occupation and the method of payment, with the primary factor the right to or degree of control exhibited by the employer.

Applying the four principal factors under the control test, Judge Jordan ruled that Williamson acted as Nall’s employee. Although Williamson contended that Nall did not control his work, the court noted that his complaint used the terms “employee” and “employer” and averred that Nall “controlled the means, manner, and details of the work to be performed by [Williamson].”

In addition, the court noted Williamson acted as an assistant to Nall on the day of the accident, lacked expertise in the electrical field with unrelated employment history, and was not bonded or insured to do electrical work. Nall dictated his assignments, telling him where to report and when, as well as what he wanted done.

“These facts show that Nall exercised control over Williamson,” the court said. Even though the worker had “some discretion” about which assignment he wanted to perform when multiple tasks were available to multiple workers, the court said it was insufficient. “This is the decisive factor in the analysis.”

Turning to the second and third factors, the court said Williamson’s hourly rate favored employee status, as did the fact that Nall furnished the most significant equipment for jobs, despite Williamson’s argument that he brought his own “little old tool pouch” along on jobs. Finally, Judge Jordan said Nall had the right to fire Williamson, which also favored employee status.

“In short, nothing about Williamson’s testimony indicates that he was working independently from Nall’s direction, supervision, and control,” the court wrote. “Instead, it supports his admission that he was working as Nall’s assistant.”

Although neither Williamson (who claimed to be an independent contractor) nor Nall (who stated on his application for the policy that he had no employees) labeled Williamson as an employee, the court added that “the labels the parties attached to their relationship ‘are only a part of the inquiry…. The true test incorporates a consideration of all the facts and the economic realities.’ ”

Concluding that Williamson was Nall’s employee, the judge found that the Employer Liability Exclusion was triggered, eliminating coverage.

To read the order in American Southern Insurance Co. v. Williamson, click here.

Tenth Circuit Applies Colorado’s Notice-Prejudice Rule Exception For Claims-Made Policies With Date-Certain Requirement

Why it matters: Applying a ruling from the Colorado Supreme Court on the state’s notice-prejudice rule, the Tenth Circuit Court of Appeals tossed a policyholder’s declaratory injunction suit seeking coverage. Earlier this year the state’s highest court answered a certified question from the federal appellate panel to hold that Colorado’s notice-prejudice rule does not apply to a date-certain notice requirement in a claims-made insurance policy. Dean Craft, the principal shareholder and president of Campbell’s C-Ment Contracting, was sued in July 2010 for alleged misrepresentations he made during a merger. Unaware the company had a directors and officers policy, Craft initially defended himself. When he learned of the policy in 2012, he immediately requested coverage. Carrier Philadelphia Indemnity Insurance Co. balked, arguing that the claims-made policy—which required written notice “as soon as practicable” but “not later than 60 days” after the policy expired—had expired on Nov. 1, 2010. Craft sued, relying on the notice-prejudice rule to contend Philadelphia wasn’t prejudiced and should step up to provide a defense. A federal court in Colorado granted the insurer’s motion to dismiss Craft’s suit, and when Craft appealed, the Tenth Circuit certified the issue to Colorado’s highest court. After the Colorado Supreme Court issued its decision, the Tenth Circuit affirmed dismissal of the suit, concluding that Craft “gave notice of his claim far past the policy’s 60-day date-certain notice requirement.”

Detailed discussion: As the principal shareholder and president of Campbell’s C-Ment Contracting, Inc., Dean Craft was covered by the company’s directors and officers (D&O) insurance policy issued by Philadelphia Indemnity Insurance Company that ran from November 2009 to November 2010. One problem: Craft was unaware of the policy.

When he was sued in July 2010 in Colorado state court for allegedly making misrepresentations as part of a stock purchase and merger option agreement, Craft initially defended himself. He learned of the Philadelphia policy in March 2012 and immediately notified the insurer of the lawsuit against him.

Craft then sued Philadelphia in Colorado state court for breach of contract, breach of good faith and fair dealing, and unreasonable delay and denial of payment of insurance benefits. Philadelphia removed the case to federal court and argued that coverage was not available to Craft because he failed to comply with the notice requirements in the policy.

The claims-made policy stated that insureds were to give notice of a claim “as soon as practicable” and required the insured to give notice of the claim by a date certain “not later than 60 days” after the expiration of the policy. Because Craft didn’t notify Philadelphia until 16 months after the policy expired, he was not entitled to coverage, the insurer argued.

Craft contended that the notice-prejudice rule applied in Colorado, which meant Philadelphia had to demonstrate that it was prejudiced by the delay in notice before dodging its coverage obligation. The federal court disagreed and dismissed the suit, and Craft appealed to the Tenth Circuit Court of Appeals.

The federal appellate panel certified two questions to Colorado’s highest court: whether the notice-prejudice rule applies to claims-made liability policies in general and whether the rule applies to both types of notice requirements in those policies (prompt notice as well as the date certain).

Tweaking the questions to focus solely on the date-certain notice requirement, the Colorado Supreme Court answered that the notice-prejudice rule did not apply. “[E]xcusing noncompliance with such a requirement would alter a fundamental term of the insurance contract and would not serve the public policy interests that originally supported the adoption of the notice-prejudice rule,” the court wrote.

Although the state’s highest court established the notice-prejudice rule in 2005, the policy at issue in that case was an occurrence policy, the court explained, and the “conceptual differences between occurrence and claims-made liability policies lie at the core of this case.” While claims-made policies provide coverage for claims that are made during a policy period regardless of the timing of the events that gave rise to the claim, occurrence policies provide coverage for occurrences that take place within the policy period, regardless of when a claim is made.

“In a claims-made policy, the date-certain notice requirement defines the scope of coverage,” the Colorado Supreme Court wrote. “Thus, to excuse late notice in violation of such a requirement would rewrite a fundamental term of the insurance contract.”

The date-certain notice requirement “defines the temporal boundaries of the policy’s basic coverage terms,” the court explained, and “timely notice of a claim is the event that triggers coverage.” For this reason, “although excusing late notice and applying a prejudice requirement make sense in the context of a prompt notice requirement, extending such concepts to a date-certain notice requirement ‘would defeat the fundamental concept on which coverage is premised.’”

Principles of contract law in the insurance contract supported this conclusion, the court added. Excusing late notice “would prevent parties from defining coverage with certainty, no matter how definitive or express the notice requirement. Such a result would significantly diminish the advantages of claims-made policies for both insurers and insureds: insurers could no longer ‘close the books’ on previous policy periods, and policy premiums presumably would rise to account for the risk that an insured might notify the insurer of a claim after the policy period has expired.”

The Colorado Supreme Court returned the case to the Tenth Circuit, where the federal appellate panel applied the ruling to the facts of the case and affirmed dismissal of Craft’s suit.

“Because Craft’s was a claims-made policy and he gave notice of his claim far past the policy’s sixty-day date-certain notice requirement, the Supreme Court’s ruling requires that we affirm the district court’s dismissal,” the panel wrote.

To read the Colorado Supreme Court’s opinion in Craft v. Philadelphia Indemnity Insurance Co., click here.

To read the Tenth Circuit’s order, click here.