Case Briefs

Insurance Rights Not Transferred to Successor Companies Based on  Anti-Assignment Clauses

On Oct. 15, 2008, the Supreme Court of Indiana issued its decision in Travelers Cas. & Sur. Co., et al. v. United States Filter Corp., et al., No. 49S02-0712-CV-596, 2008 Ind. LEXIS 953 (Ind. Oct. 15, 2008), holding that, under the facts of the case, the insurance rights at issue were not transferred to successor companies on the basis of anti-assignment clauses contained in the insurance policies.

In United States Filter, a number of companies brought an insurance coverage action seeking defense and indemnification for silica-related bodily injury claims. The underlying silica-related claims alleged exposure to silica resulting from the operation of an industrial blast machine.

The insurance coverage at issue involved occurrence-based comprehensive general liability (“CGL”) policies that were issued, not to the companies seeking defense and indemnification, but to those companies' predecessors. The companies seeking defense and indemnification argued that the insurance coverage rights passed to them through the same corporate transactions that brought them the blast machine assets and underlying liabilities.

Discovery in the case revealed that the blast machine corporate assets had a complex ownership history spanning nearly a hundred years. As a result of the long history, there were more than 80 insurance policies potentially implicated by the underlying claims. Of critical importance to the dispute was that each of the policies contained an “anti-assignment” clause which purported to bar assignment of the policy without the consent of the insurer. The clauses contained one of two wordings as follows: (1) “Assignment. Assignment of interest under this policy shall not bind the [insurer] until its consent is endorsed hereon” and 2) “TRANSFER OF YOUR RIGHTS AND DUTIES UNDER THIS POLICY. Your rights and duties under this policy may not: be transferred without our written consent except in the case of death of an individual named insured.” Virtually all CGL policies contain the same or similar anti-assignment clauses.

On cross motions for summary judgment, the trial court granted summary judgment against the insurers, holding, inter alia, that the anti-assignment provisions in the insurance policies did not apply as a matter of law and that the insurance rights and liabilities associated with the blast machine had been transferred.

The insurers petitioned for an interlocutory appeal, which the Court of Appeals allowed. The Court of Appeals then affirmed the trial court's decision on the basis that the original insureds' rights to the coverage were transferable to the corporate successors seeking defense and indemnification. In support of its decision, the Court of Appeals reasoned that a chose in action arose under the insurance policies at the moment of each loss, which the court took to mean each claimant's initial exposure to silica. As freely transferable assets, the court reasoned, the choses in action carrying coverage rights then passed to the successor companies via the corporate transactions. Travelers Cas. & Sur. Co. v. U.S. Filter Corp., 870 N.E.2d 529, 541 (Ind. Ct. App. 2007), vacated. In support of its decision, the Court of Appeals distinguished transfer of the rights under the insurance policies from the transfer of the policies themselves, only the latter implicating the consent-to-assignment provisions.

The Supreme Court of Indiana granted review and reversed the lower courts on the principal basis that consent to insurance assignment had not been obtained from the insurers as required by the anti-assignment provisions contained in the insurance policies at issue. The court reasoned and held as follows: “Because the policies require insurer consent before a valid assignment can be made, and that consent was not given ' the several insurance policies at issue here were not transferred in any of the corporate transactions ' ” Following the decision in Henkel Corp. v. Hartford Acc. and Indem., 62 P.3d 69 (Cal. 2003), the court further rejected the argument that “occurred but not yet reported losses can form the basis of choses in action ' ” In regard to this issue, the court held that “ at a minimum the losses must have been reported to give rise to a chose in action.” Accordingly, the Supreme Court of Indiana reversed the lower courts and directed entry of judgment in favor of the insurers.

Note: Acquisitions of businesses or product lines are often accomplished through asset purchase and sale agreements. In some instances, internal restructurings are accomplished through asset transfers. Important questions may exist in this context concerning the extent to which an insurer is obligated to protect a corporate successor. Companies confronting long-tail asbestos, environmental, silica, chemical exposure, and other long-tail liabilities arising out of past assets, as well as buyers and sellers of corporate assets, seek clarity and predictability on the allocation of both pre-acquisition liabilities and pre-acquisition insurance coverage. The cases, however, illustrate the sharp divisions that exist in the case law on the treatment of historical insurance coverage in asset transactions. It is noteworthy that other cases have reached differing conclusions concerning the sorts of claims at issue in United States Filter. Compare The Glidden Co. v. Lumbermens Mutual Cas. Co., No. 81782, 2004 WL 2931019, at *9-*10 (Ohio Ct. App. 8 Dist., Dec. 17, 2004 (holding that a corporate asset purchaser has rights to liability insurance coverage that originally was issued to the predecessor corporation), rejecting Henkel Corp. v. Hartford Acc. and Indem., 62 P.3d 69 (Cal. 2003). Given the number of mergers, acquisitions, and consolidations that take place, this issue is likely to remain an important topic concerning CGL coverage.

Eighth Circuit Applies the Plain Meaning of the Securities Exclusion

Most, if not all, private company directors and officers' liability policies contain a securities exclusion barring coverage for claims alleging violations of certain securities laws, including the Securities Act of 1933, Securities Exchange Act of 1934, and state Blue Sky or securities law. The likelihood that securities-related claims will be asserted against a private company is nominal and, as a result, there have only been a handful of cases interpreting the breadth and scope of the Securities Exclusion. Recently, in Leonard v. Executive Risk Indemnity Inc. (In re SRC Holding Corp.), 545 F.3d 661 (8th Cir. 2008), the Eighth Circuit Court of Appeals held that the Securities Exclusion barred coverage for claims arising out of the insured's ' a private company ' underwriting and sale of bonds.

In Leonard, the insured, Miller & Schroeder, Inc. (“M&S”), was a securities underwriter and broker. Between 1996 and 1999, M&S underwrote $1.4 million worth of bonds, which it sold in 12 municipal offerings. All of the bonds defaulted. As a result, purchasers of the bonds filed lawsuits and arbitration proceedings against M&S, its brokers, and its directors and officers. The plaintiffs alleged violations of federal and state securities laws, the common law, and the rules and regulations of the National Association of Securities Dealers (“NASD”). M&S and its directors and officers sought coverage under their directors and officers' liability insurance policy (“D&O Policy”) for the various lawsuits and proceedings. Relying on the Securities Exclusion, Executive Risk Indemnity Inc. (“ERII”) denied coverage.

M&S defended against the litigation, incurring $750,000 in legal fees. M&S was also assessed millions of dollars in damages. As a result, M&S filed for bankruptcy protection. The trustee of the bankruptcy estate initiated an adversary proceeding against ERII alleging breach of contract and seeking a declaration that the D&O Policy afforded coverage for the defense expenses and resulting judgments. Former M&S directors and officers intervened seeking the same relief.

At issue was the D&O Policy's Securities Exclusion, which barred coverage for, among other things, any claim arising out of: a) “the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, any other federal law, rule or regulation with respect to the regulation of securities, any rules or regulations of the United States Securities Exchange Commission, or any amendment of such laws, rules or regulations”; and b) “any provision in the common law imposing liability in connection with the offer, sale or purchase of securities.” Id. at 667. The dispute centered on whether the exclusion applied to alleged securities violations that involved securities other than those of M&S.

Limiting the applicability of the Securities Exclusion, the bankruptcy court and the district court held that the exclusion only barred coverage for claims arising from the sale of M&S' own stock. Both courts' holdings were based, in part, on the deposition testimony of M&S' insurance broker, who testified that the Securities Exclusion, a standard exclusion in private company directors and officers' liability policies, is intended to bar coverage for liability arising from the insured's sale of its own stock. “Because the typical effect of [the Securities Exclusion] is to preclude coverage resulting from the insured's sale of its own securities ' so the courts' reasoning goes ' the meaning of [the Securities Exclusion] in this policy must accord with that typical effect.” Id. at 667-68. As the lawsuit did not arise from M&S' sale of its own stock, the lower courts found that the exclusion was inapplicable to bar coverage for the lawsuit. The Eight Circuit reversed.

The Eighth Circuit found that the exclusion, as written, was unambiguous. The effect of the Securities Exclusion “as it may be generally applied in practice is not the legal authority that governs our coverage inquiry here; it is the mutually agreed upon policy's plain language that binds M&S and ERII in the first instance.” Id. at 668. As such, the Eighth Circuit held that the lower courts' reliance upon extrinsic evidence to evaluate the purpose or intent of the exclusion was erroneous.

In an effort to create an ambiguity, the insureds argued that other policy provisions created an irreconcilable conflict with the plain meaning of the Securities Exclusion. Specifically, the insureds asserted that, because the policy contained an endorsement excepting the applicability of the Securities Exclusion in the context of a certain transaction, the exclusion was ambiguous. The Eighth Circuit disagreed, finding that the endorsement merely provided an exception to the broader exclusion.

The insureds also argued that ERII's interpretation of the D&O Policy's Securities Exclusion rendered the errors and omissions exclusion (“E&O Exclusion”) superfluous creating an ambiguity. The E&O Exclusion barred coverage for certain professional services of the insureds, including investment banking, services security broker/dealer services, and securities underwriting. As is standard, the exclusion contained a carve-out for claims based on a director or officers' failure to manage or supervise any company's division or group offering such services. Acknowledging that this exclusion poses a more difficult question, the Eighth Circuit found that the E&O Exclusion bars coverage for claims that would not be excluded under the securities endorsement and, therefore, the exclusion is not superfluous. The Eighth Circuit also noted that, “any overlapping in the coverage excluded,” by itself, is “not sufficient to disregard the broad and unqualified language” of the exclusion. Id.

The Eighth Circuit also rejected the insureds' arguments that applying the plain meaning of the Securities Exclusion not only renders the policy's coverage illusory but also is contrary to the insured's reasonable expectations. Given that the D&O Policy affords coverage for claims other than securities-related claims and given that the insureds did not assert that a certain portion of the premium was allocated for such coverage, the Eighth Circuit found that the illusory-coverage doctrine did not apply. As for the insured's reasonable expectations, the Eighth Circuit explained that, because the Securities Exclusion is unambiguous, the doctrine was simply inapplicable.

The Leonard decision is an important reminder for insureds and insurers alike that, while course-of-dealing, individual understandings, and historical practices may be relevant, it is the policy language that most often controls. As the Eighth Circuit explained, “the language [the parties] have mutually negotiated and agreed to is the best of evidence of what those parties intended.” Id. at 668 (emphasis added). While some courts will undoubtedly examine the historical application and purported intent of the policy provision at issue, see, e.g., Alfin Inc. v. Pacific Ins. Co., 735 F.Supp. 115 (S.D.N.Y. 1990), Leonard underscores the importance for insureds and insurers to examine and modify (when and where necessary) the policy's language during the negotiation of the policy, as opposed to after a claim has been made.

Roberta Anderson, of K&L Gates LLP and a member of this newsletter's Board of Editors, and Nancy D. Adams, CPCU, of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo P.C., contributed this month's case briefs.

Insurance Rights Not Transferred to Successor Companies Based on  Anti-Assignment Clauses

On Oct. 15, 2008, the Supreme Court of Indiana issued its decision in Travelers Cas. & Sur. Co., et al. v. United States Filter Corp., et al., No. 49S02-0712-CV-596, 2008 Ind. LEXIS 953 (Ind. Oct. 15, 2008), holding that, under the facts of the case, the insurance rights at issue were not transferred to successor companies on the basis of anti-assignment clauses contained in the insurance policies.

In United States Filter, a number of companies brought an insurance coverage action seeking defense and indemnification for silica-related bodily injury claims. The underlying silica-related claims alleged exposure to silica resulting from the operation of an industrial blast machine.

The insurance coverage at issue involved occurrence-based comprehensive general liability (“CGL”) policies that were issued, not to the companies seeking defense and indemnification, but to those companies' predecessors. The companies seeking defense and indemnification argued that the insurance coverage rights passed to them through the same corporate transactions that brought them the blast machine assets and underlying liabilities.

Discovery in the case revealed that the blast machine corporate assets had a complex ownership history spanning nearly a hundred years. As a result of the long history, there were more than 80 insurance policies potentially implicated by the underlying claims. Of critical importance to the dispute was that each of the policies contained an “anti-assignment” clause which purported to bar assignment of the policy without the consent of the insurer. The clauses contained one of two wordings as follows: (1) “Assignment. Assignment of interest under this policy shall not bind the [insurer] until its consent is endorsed hereon” and 2) “TRANSFER OF YOUR RIGHTS AND DUTIES UNDER THIS POLICY. Your rights and duties under this policy may not: be transferred without our written consent except in the case of death of an individual named insured.” Virtually all CGL policies contain the same or similar anti-assignment clauses.

On cross motions for summary judgment, the trial court granted summary judgment against the insurers, holding, inter alia, that the anti-assignment provisions in the insurance policies did not apply as a matter of law and that the insurance rights and liabilities associated with the blast machine had been transferred.

The insurers petitioned for an interlocutory appeal, which the Court of Appeals allowed. The Court of Appeals then affirmed the trial court's decision on the basis that the original insureds' rights to the coverage were transferable to the corporate successors seeking defense and indemnification. In support of its decision, the Court of Appeals reasoned that a chose in action arose under the insurance policies at the moment of each loss, which the court took to mean each claimant's initial exposure to silica. As freely transferable assets, the court reasoned, the choses in action carrying coverage rights then passed to the successor companies via the corporate transactions. Travelers Cas. & Sur. Co. v. U.S. Filter Corp. , 870 N.E.2d 529, 541 (Ind. Ct. App. 2007), vacated . In support of its decision, the Court of Appeals distinguished transfer of the rights under the insurance policies from the transfer of the policies themselves, only the latter implicating the consent-to-assignment provisions.

The Supreme Court of Indiana granted review and reversed the lower courts on the principal basis that consent to insurance assignment had not been obtained from the insurers as required by the anti-assignment provisions contained in the insurance policies at issue. The court reasoned and held as follows: “Because the policies require insurer consent before a valid assignment can be made, and that consent was not given ' the several insurance policies at issue here were not transferred in any of the corporate transactions ' ” Following the decision in Henkel Corp. v. Hartford Acc. and Indem. , 62 P.3d 69 (Cal. 2003), the court further rejected the argument that “occurred but not yet reported losses can form the basis of choses in action ' ” In regard to this issue, the court held that “ at a minimum the losses must have been reported to give rise to a chose in action.” Accordingly, the Supreme Court of Indiana reversed the lower courts and directed entry of judgment in favor of the insurers.

Note: Acquisitions of businesses or product lines are often accomplished through asset purchase and sale agreements. In some instances, internal restructurings are accomplished through asset transfers. Important questions may exist in this context concerning the extent to which an insurer is obligated to protect a corporate successor. Companies confronting long-tail asbestos, environmental, silica, chemical exposure, and other long-tail liabilities arising out of past assets, as well as buyers and sellers of corporate assets, seek clarity and predictability on the allocation of both pre-acquisition liabilities and pre-acquisition insurance coverage. The cases, however, illustrate the sharp divisions that exist in the case law on the treatment of historical insurance coverage in asset transactions. It is noteworthy that other cases have reached differing conclusions concerning the sorts of claims at issue in United States Filter. Compare The Glidden Co. v. Lumbermens Mutual Cas. Co., No. 81782, 2004 WL 2931019, at *9-*10 (Ohio Ct. App. 8 Dist., Dec. 17, 2004 (holding that a corporate asset purchaser has rights to liability insurance coverage that originally was issued to the predecessor corporation), rejecting Henkel Corp. v. Hartford Acc. and Indem. , 62 P.3d 69 (Cal. 2003). Given the number of mergers, acquisitions, and consolidations that take place, this issue is likely to remain an important topic concerning CGL coverage.

Eighth Circuit Applies the Plain Meaning of the Securities Exclusion

Most, if not all, private company directors and officers' liability policies contain a securities exclusion barring coverage for claims alleging violations of certain securities laws, including the Securities Act of 1933, Securities Exchange Act of 1934, and state Blue Sky or securities law. The likelihood that securities-related claims will be asserted against a private company is nominal and, as a result, there have only been a handful of cases interpreting the breadth and scope of the Securities Exclusion. Recently, in Leonard v. Executive Risk Indemnity Inc. (In re SRC Holding Corp.), 545 F.3d 661 (8th Cir. 2008), the Eighth Circuit Court of Appeals held that the Securities Exclusion barred coverage for claims arising out of the insured's ' a private company ' underwriting and sale of bonds.

In Leonard, the insured, Miller & Schroeder, Inc. (“M&S”), was a securities underwriter and broker. Between 1996 and 1999, M&S underwrote $1.4 million worth of bonds, which it sold in 12 municipal offerings. All of the bonds defaulted. As a result, purchasers of the bonds filed lawsuits and arbitration proceedings against M&S, its brokers, and its directors and officers. The plaintiffs alleged violations of federal and state securities laws, the common law, and the rules and regulations of the National Association of Securities Dealers (“NASD”). M&S and its directors and officers sought coverage under their directors and officers' liability insurance policy (“D&O Policy”) for the various lawsuits and proceedings. Relying on the Securities Exclusion, Executive Risk Indemnity Inc. (“ERII”) denied coverage.

M&S defended against the litigation, incurring $750,000 in legal fees. M&S was also assessed millions of dollars in damages. As a result, M&S filed for bankruptcy protection. The trustee of the bankruptcy estate initiated an adversary proceeding against ERII alleging breach of contract and seeking a declaration that the D&O Policy afforded coverage for the defense expenses and resulting judgments. Former M&S directors and officers intervened seeking the same relief.

At issue was the D&O Policy's Securities Exclusion, which barred coverage for, among other things, any claim arising out of: a) “the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, any other federal law, rule or regulation with respect to the regulation of securities, any rules or regulations of the United States Securities Exchange Commission, or any amendment of such laws, rules or regulations”; and b) “any provision in the common law imposing liability in connection with the offer, sale or purchase of securities.” Id. at 667. The dispute centered on whether the exclusion applied to alleged securities violations that involved securities other than those of M&S.

Limiting the applicability of the Securities Exclusion, the bankruptcy court and the district court held that the exclusion only barred coverage for claims arising from the sale of M&S' own stock. Both courts' holdings were based, in part, on the deposition testimony of M&S' insurance broker, who testified that the Securities Exclusion, a standard exclusion in private company directors and officers' liability policies, is intended to bar coverage for liability arising from the insured's sale of its own stock. “Because the typical effect of [the Securities Exclusion] is to preclude coverage resulting from the insured's sale of its own securities ' so the courts' reasoning goes ' the meaning of [the Securities Exclusion] in this policy must accord with that typical effect.” Id. at 667-68. As the lawsuit did not arise from M&S' sale of its own stock, the lower courts found that the exclusion was inapplicable to bar coverage for the lawsuit. The Eight Circuit reversed.

The Eighth Circuit found that the exclusion, as written, was unambiguous. The effect of the Securities Exclusion “as it may be generally applied in practice is not the legal authority that governs our coverage inquiry here; it is the mutually agreed upon policy's plain language that binds M&S and ERII in the first instance.” Id. at 668. As such, the Eighth Circuit held that the lower courts' reliance upon extrinsic evidence to evaluate the purpose or intent of the exclusion was erroneous.

In an effort to create an ambiguity, the insureds argued that other policy provisions created an irreconcilable conflict with the plain meaning of the Securities Exclusion. Specifically, the insureds asserted that, because the policy contained an endorsement excepting the applicability of the Securities Exclusion in the context of a certain transaction, the exclusion was ambiguous. The Eighth Circuit disagreed, finding that the endorsement merely provided an exception to the broader exclusion.

The insureds also argued that ERII's interpretation of the D&O Policy's Securities Exclusion rendered the errors and omissions exclusion (“E&O Exclusion”) superfluous creating an ambiguity. The E&O Exclusion barred coverage for certain professional services of the insureds, including investment banking, services security broker/dealer services, and securities underwriting. As is standard, the exclusion contained a carve-out for claims based on a director or officers' failure to manage or supervise any company's division or group offering such services. Acknowledging that this exclusion poses a more difficult question, the Eighth Circuit found that the E&O Exclusion bars coverage for claims that would not be excluded under the securities endorsement and, therefore, the exclusion is not superfluous. The Eighth Circuit also noted that, “any overlapping in the coverage excluded,” by itself, is “not sufficient to disregard the broad and unqualified language” of the exclusion. Id.

The Eighth Circuit also rejected the insureds' arguments that applying the plain meaning of the Securities Exclusion not only renders the policy's coverage illusory but also is contrary to the insured's reasonable expectations. Given that the D&O Policy affords coverage for claims other than securities-related claims and given that the insureds did not assert that a certain portion of the premium was allocated for such coverage, the Eighth Circuit found that the illusory-coverage doctrine did not apply. As for the insured's reasonable expectations, the Eighth Circuit explained that, because the Securities Exclusion is unambiguous, the doctrine was simply inapplicable.

The Leonard decision is an important reminder for insureds and insurers alike that, while course-of-dealing, individual understandings, and historical practices may be relevant, it is the policy language that most often controls. As the Eighth Circuit explained, “the language [the parties] have mutually negotiated and agreed to is the best of evidence of what those parties intended.” Id. at 668 (emphasis added). While some courts will undoubtedly examine the historical application and purported intent of the policy provision at issue, see, e.g., Alfin Inc. v. Pacific Ins. Co. , 735 F.Supp. 115 (S.D.N.Y. 1990), Leonard underscores the importance for insureds and insurers to examine and modify (when and where necessary) the policy's language during the negotiation of the policy, as opposed to after a claim has been made.

Roberta Anderson, of K&L Gates LLP and a member of this newsletter's Board of Editors, and Nancy D. Adams, CPCU, of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo P.C., contributed this month's case briefs.