In the least surprising development since Charlie Sheen was fired by CBS, Allen
Stanford's lawyers asked to withdraw and have been relieved as counsel. To catch you up, Allen Stanford is accused of a massive investment fraud. He, along with several other Stanford executives, is facing a multitude of criminal and civil charges, none of which have been adjudicated against them--with the notable exception of the claims of his own insurance company, Lloyd's of London.
In its headlong quest to avoid its coverage obligations, Lloyd's, with the imprimatur of the Fifth Circuit, was able to hold a trial to prove the very charges pending against its insureds in order to avoid its obligations to fund the defense of those executives.
To find a greater perversion of insurance-company coverage obligations would be hard.
To begin with, the Stanford Financial Group (which consisted of some 100 different companies) bought a truly lousy directors' and officers' liability (D&O) insurance policy. The policy did not have basic terms that would commonly be found in any decent D&O policy.
The key deviation was one of the so-called "bad acts" exclusions. These types of exclusions are found in every D&O policy, so how they are phrased is critically important. The Stanford fraud exclusion was pretty standard:
"Resulting from any claim ... brought about or contributed to in fact by ... any dishonest, fraudulent, or criminal act or omission by the directors or officers or the company ... as determined by a final adjudication."
As is typical, it required a "final adjudication" to bar coverage.
The "money laundering" exclusion in Stanford's D&O policy was another story. It barred both coverage resulting from any claim "arising directly or indirectly as a result of or in connection with any act or acts (or alleged act or acts) of money laundering."
"Money laundering" was defined to include pretty much any financial misdeed imaginable. While only one count of the 21 asserted against the Stanford insureds alleged money laundering as defined in criminal statutes, every one of the 21 counts constituted money laundering as defined by the insurance policy.
But the real problem was that Lloyd's could withdraw coverage, including defense coverage, once "it is determined that the alleged act or alleged acts did in fact occur," according to the policy wording.
So Lloyd's made that determination itself, arguing that its decision was supported by the following:
1. The SEC action's preliminary finding of "good cause to believe that (the executives) used improper means to obtain investor funds and assets."
2. A temporary restraining order and preliminary injunction in the SEC action, which froze personal and corporate assets and appointed a receiver.
3. The SEC action's preliminary injunction finding that "Stanford engaged in fraudulent conduct, including misappropriating investor funds."
4. The examination report and testimony of the receiver's accounting expert, Van Tassel, that investment proceeds were used to pay interest on existing investment products, commissions, and bonuses, and to make loans to employees.
5. The statements of an alleged co-conspirator that the executives were behind a "massive Ponzi scheme."
STANFORD'S SIDE DEFEATED
Various Stanford executives insured under the D&O policy took issue with Lloyd's right to make that determination on its own. They sued, arguing that the duty to defend is broader than the duty to indemnify and that Lloyd's could not look outside the complaint and the policy in determining its defense obligation.
The federal court in Houston agreed with the insureds and ordered Lloyd's to continue to pay their defense costs. Lloyd's appealed to the Fifth Circuit Court of Appeals.
While the Fifth Circuit rejected Lloyd's argument that it had the unilateral right to make the "in fact" determination, it would have agreed with Lloyd's had the policy explicitly given that authority to Lloyd's. Note to policyholders: Read your policies!
Nevertheless, the Fifth Circuit decided that Lloyd's could force a public trial against its insureds on the very issues they were facing--before the civil and criminal claims against them were tried.
This, of course, put the insureds in a completely untenable position. They would have to assert their rights against self-incrimination under the Fifth Amendment, forcing them to defend against the Lloyd's action with both hands tied behind their backs.
A four-day trial was held in August 2010. Unsurprisingly, given the extraordinary breadth of the "money laundering" exclusion in the D&O policy and the restrictions that the insureds were operating under, the court found for Lloyd's.
"To the extent necessary, the court would hold that the evidence of record supports a conclusion that the underwriters have shown by a preponderance of the evidence that the money laundering exclusion in fact applies, not merely that there is a substantial likelihood this burden has been met," the trial judge wrote.
To soften the obvious injustice of the procedure inflicted on the Stanford insureds, the trial judge wrote: "The court's ruling here is narrow. The court does not reach the issue of whether the evidence supports a finding that Stanford personally engaged in criminal conduct. The ruling is limited to analysis of conduct found by a preponderance of the evidence on a necessarily restricted record and without reliance on inferences that could be drawn from Stanford's invocation of his Fifth Amendment privilege against self-incrimination. These findings and conclusions are not intended for use in the criminal or SEC actions."
Little consolation. The court had just conducted a trial that determined whether these insureds would be afforded the money to defend themselves in the criminal and civil cases pending against them--a trial which they could not defend.
So they lost the trial and their defense coverage, and then they lost their lawyers because the insurance company was allowed to place its interests above those of its insureds with impunity. It's a complete perversion of the insurance company's duty of good faith and fair dealing that I learned about when I started in this business.
DOUGLAS CAMERON is a partner and practice group leader of the firmwide Insurance Recovery Group at Reed Smith.
May 24, 2011
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