Negligent Misrepresentation Claim Not Barred By Exclusion for Dishonest Conduct

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The United States District Court for the Northern District of California, applying California law, has held that a dishonesty exclusion in a D&O policy did not bar coverage for an underlying lawsuit alleging a company president’s negligent misrepresentation in inducing investments. Scottsdale Ins. Co. v. Fineman, 2021 WL 411360 (N.D. Cal. Feb. 5, 2021). The court also held that an unconfirmed arbitration award is not a “final judgment” that can trigger the exclusion.

The president of the insured biotechnology company persuaded several individuals to invest in the company. One of the investors subsequently filed suit against him, alleging negligent misrepresentation and a breach of fiduciary duties in connection with his alleged fraudulent inducement of investments. The suit was submitted to arbitration, where two more investors joined as claimants. The company’s D&O insurer provided the president with a defense under a reservation of rights in both the litigation and arbitration. The arbitrator found that the two newly joined investors prevailed on their causes of action for breach of fiduciary duty and negligent misrepresentation, but not fraud, and awarded damages to them accordingly. The arbitrator did not award any amounts to the investor who filed the suit. After entry of the arbitration award, the parties entered into a settlement agreement. The insurer then filed suit against the president to recover the settlement amount and defense costs, arguing that the policy’s conduct exclusion barred coverage for those amounts.

The court rejected the insurer’s argument. First, the court concluded that there was no final judgment in the underlying action. The policy provided that the insurer shall not be liable for “loss” on account of any claim “involving . . . any dishonest, deliberately fraudulent or criminal act of an Insured,” provided that there is a “final judgment against such Insured as to such conduct.” The court noted that the exclusion explicitly required a “final judgment” and not merely a “final adjudication of disputed facts.” In this case, there was no final judgment because the case settled, and the arbitration award was never confirmed by a court. Second, the court concluded that the arbitrator did not find any “intentional, fraudulent, or criminal conduct” attributable to the president. The court rejected the insurer’s argument that the arbitrator’s finding of misrepresentations by the president constituted a finding of “dishonest” conduct that implicated the exclusion. The president’s “overzealousness about [the company’s] prospects while speaking with [investors],” the court concluded, was based on an honest belief in the company’s potential for growth, though he had no reasonable basis for such belief given his recent consultation with bankruptcy counsel.

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