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Posted: December 12, 2018

Coverage Under Excess D&O Policy Barred By Warranty Statement

On December 6, 2018, the Second Circuit issued a decision in Patriarch Partners, LLC v. Axis Ins. Co., Case No. 17-3022, holding that a Warranty Statement executed in connection with the issuance of an Excess D&O policy barred coverage because the insured had knowledge prior to the issuance of the policy of “facts or circumstances that would reasonably be expected to result in a Claim.”

The coverage dispute in this case arose from an SEC investigation of Patriarch Partners, a private equity investment firm.  The investigation began as an “informal inquiry”, but on June 3, 2011, the SEC issued a formal Order of Investigation.  Although the Order of Investigation was not public, Patriarch admitted that its outside counsel “became aware” of the Order on June 13, 2011.  Further, on August 11, 2011, an SEC officer sent an email to Patriarch’s counsel requesting certain information and stating that the SEC “will follow this voluntary request with a subpoena.”

That same month, Patriarch added a third layer of excess coverage to its existing $20 million in D&O coverage.  The new excess insurer, Axis, conditioned issuance of the excess policy on a Warranty Statement signed by Patriarch’s sole director and officer (Lynn Tilton).  The Warranty stated that as of August 12, 2011, “neither the undersigned nor any other director or officer of Patriarch is aware of any facts or circumstances that would reasonably be expected to result in a Claim under the [Axis] policy.”  The Warranty further provided that the policy “does not provide coverage for Claims relating to facts and circumstances that, as of the date of this letter, Patriarch was aware of and would reasonably have expect to result in a Claim covered by” the excess policy.  Under the primary policy — and thus under the Axis policy, which followed the form — a claim was expressly defined to include an “order of investigation” by the SEC.

The SEC subsequently filed an administrative enforcement action against Patriarch.  The cost of defending that proceeding depleted the underlying $20 million in coverage, triggering the Axis policy.  Axis denied coverage, and a coverage action followed.  Axis argued, inter alia, that the Warranty Statement excused coverage.  After extensive discovery, Judge Caproni of the Southern District of New York granted summary judgment to Axis on another ground: that the claim was barred by a “pending or prior claim” exclusion.  (See our prior post about this policy provision here.)

The Second Circuit’s decision on appeal focused on the Warranty Statement.  Patriarch made two principal arguments:  (1) the Warranty only excluded claims relating to facts and circumstances of which Tilton (Patriarch’s sole officer and director) was personally aware; and (2) the Warranty referred only to Claims in excess of $20 million – i.e., those that would trigger liability under the Axis policy.  The Second Circuit rejected these arguments, explaining:

Patriarch’s position that the Warranty applies only to facts or circumstances subjectively known by Tilton is unsupported by the text of the Warranty, which explicitly refers to facts or circumstances that “Patriarch was aware of.” Moreover, under traditional principles of agency an attorney’s knowledge must be imputed to her client.  Thus, at a minimum, we consider that facts and circumstances that were known not only to Tilton, but to Patriarch’s outside counsel and Patriarch’s in-house counsel are facts and circumstances that “Patriarch was aware of” for purposes of analyzing the Warranty.

Patriarch’s position that the Warranty applies only to known facts or circumstances that Patriarch would reasonably have expected to result in a Claim with losses exceeding the $20 million in underlying policies is also not established by the text of the Warranty. The Warranty’s use of the capitalized term “Claim” indicates that it is a defined term and thus means “Claim” as defined in the CNA Policy. The CNA Policy definition of “Claim” is not limited in the manner Patriarch urges. It is true that the Warranty refers both to Claims “under” the Axis Policy—a term best understood to mean “defined by”—and to Claims “covered by” the Axis Policy. Patriarch insists that the Axis Policy “covers” only Claims whose losses exceed $20 million. Reading the Warranty as a whole, however, and taking into consideration its context and purpose, we are not persuaded by Patriarch’s interpretation.  Because the Axis Policy is a “follow-form” policy, the same Claims that are “covered by” the CNA Policy are also “covered by” the Axis Policy and other underlying excess policies. That Axis provides excess insurance does not change or limit the class of Claims that it provides coverage for; it changes only the circumstances under which Axis must pay for losses resulting from such Claims.  The only reasonable interpretation of the Warranty, in our view, is that it excludes claims arising from facts or circumstances of which Patriarch was aware as of August 12 and that Patriarch would reasonably have expected to result in a Claim as defined by the CNA Policy.

(Citations omitted).

Importantly, the facts that triggered the Warranty Statement in Patriarch Partners – the firm’s awareness of an SEC administrative order prior to issuance of the policy – were undisputed.  D&O insurers cannot rely on the government’s allegations against the insured (or other disputed facts) to avoid their coverage obligations (see our previous blog post on this issue here).

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