Facing a Government Investigation: Common Insurance Issues

After learning there is an investigation, a policyholder's first priority is hiring excellent defense counsel. Whether an investigation is commenced by a state government or the federal government, the defense costs associated with the investigation can be very significant. A top priority should also be accessing your insurance coverage. In many cases, insurance policies will cover the defense costs relating to an investigation. The process of getting an insurer to promptly pay the defense costs, however, can be difficult. A policyholder that is mindful of a few issues that commonly arise in seeking coverage for an investigation is in a much better position to obtain prompt payment of defense costs. This article addresses four common obstacles to obtaining prompt payment of defense costs.

Is There a 'Claim'?

One of the threshold issues in assessing whether a government investigation is covered is whether a “claim” has been made. Policy definitions of “claim” vary significantly. Some policies broadly define “claim” to include “a civil, criminal, administrative or regulatory investigation of an Insured Person ' ” AT&T Corp. v. Faraday Capital Ltd., 918 A.2d 1104, 1107 n.7 (Del. 2007). This definition is quite clear and will cover most investigations. Other policies, however, do not include such explicit language. Courts have reached different results on whether an investigation constitutes a “claim” when the language is not explicit, focusing on the precise policy language at issue and the nature of the governmental action. One favorable decision for policyholders is National Stock Exchange v. Federal Ins. Co., No. 06C1603, 2007 WL 1030293 (N.D. Ill. Mar. 30, 2007) (“National Stock Exchange“). In National Stock Exchange, the policy defined “claim” to include “formal investigative order or similar document.” Id. at *3. The court ruled that a SEC “Order Directing Private Investigation and Designating Officers to Take Testimony” was a “claim” covered under the policy. Id. at *5. In doing so, the court rejected the insurer's argument that a claim did not arise until a proceeding was commenced directly against an insured person. Id. See also Polychron v. Crum & Forster Ins. Cos., 916 F.2d 461, 463 (8th Cir. 1990) (legal fees incurred in defending a target of a grand jury investigation were covered defense costs); Richardson Electronics, Ltd. v. Federal Ins. Co., 120 F. Supp. 2d 698, 701 (N.D. Ill. 2000) (Justice Department investigation was a claim).

A related issue is whether a subpoena from a governmental entity for documents or testimony constitutes a “claim.” Some courts held that there is a “claim” when the governmental entity conducting an investigation issues a subpoena for documents or testimony. For example, in Minuteman Int., Inc. v. Great American Ins. Co., No. 03C6067, 2004 WL 603482 (N.D. Ill. Mar. 22, 2004), the policy defined a claim to include “a written demand for monetary or nonmonetary relief.” The court ruled that a SEC subpoena fell within this definition of a claim because the investigation had sought “nonmonetary relief” in the form of documents and testimony. Id. at *7. However, other courts have not allowed coverage for defense costs incurred in responding to a subpoena. In Center for Blood Research, Inc. v. Coregis Ins. Co., 305 F.3d 38, 42 (1st Cir. 2002), the court held that a policyholder's defense costs associated with responding to an investigative subpoena issued by the U.S. Attorney for the District of Massachusetts did not constitute a “claim” under the policy. The subpoena was served on the policyholder merely in its capacity as the custodian of records, and there was no indication that the policyholder was the target of any investigation. Id. at 42-43. Thus, courts have reached different results about whether insurance policies cover the costs of complying with a subpoena issued by a governmental entity.

Give Prompt Notice; Pay Attention to the Wording

When a government investigation is initiated, a policyholder should notify its insurers in a timely manner. In some situations, failure to provide prompt notice could preclude coverage altogether. In fact, in many states, courts will decide a late notice defense under a directors' and officers' policy without regard to whether insurers were prejudiced by the purported late notice.

Notice provisions typically describe how to give notice of a claim and the situations that might give rise to a claim. Policyholders should be careful about how they give notice of a claim. In the event of a government investigation, policyholders may have to decide whether to notify their insurers of a “claim” or “potential claim.” Once a “potential claim” or “claim” is noticed, subsequently issued policies typically will not cover the noticed claim or subsequent claims. Further, the policyholder's characterizations in that letter may influence coverage determination by the insurer. Therefore, a policyholder needs to give prompt notice and to carefully consider the content of the notice letter.

Policy Exclusions Typically Do Not Preclude a Defense

Insurers may also try to invoke certain policy exclusions to avoid paying for the defense costs associated with government investigations. Exclusions in an insurance contract are construed strictly to give the interpretation most beneficial to the insured. See e.g., Altstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376, 400 (D. Del. 2002) (“illegal profit” exclusion should be construed strictly). If an exclusion is ambiguous, it is construed against the insurer.

Given implicit or explicit allegations of wrongdoing that may be part of a government investigation, insurers are most likely to invoke the so called “personal conduct” exclusions. These exclusions relate to illegal profits, fraud, or intentional violations of law. For a number of reasons, these types of exclusions normally should not excuse an insurer from its obligations to either defend or reimburse defense costs while an investigation is ongoing.

As an initial matter, most directors' and officers' insurance policies include provisions that require the insurer to advance defense costs at least until the final disposition of the claim. While a policyholder may have to repay the insurer for defense costs after the final disposition of the claim, at the very least these types of provisions allow a policyholder to have a full defense while the claim is pending. In Sun-Times Media Group, Inc. v. Royal & Sunalliance Ins. Co. of Canada, No. 06C-11-108, 2007 WL 1811265, at *1 (Del. Super. June 20, 2007), the court considered three insurers' claims that personal conduct exclusions relieved them of their obligation to pay defense costs. The court ruled that even if personal conduct exclusions might apply at a later time, “this still does not prevent the advancement of defense costs at the present time because the policy provides that the Insured must pay back money they received but were not entitled to.” Id. at *11-12. In order to excuse its obligation to advance defense costs, the insurers would have to “unequivocally” show that all of the allegations in the complaint fell within the personal conduct exclusions. Id. at *11. Therefore, insurers cannot avoid coverage under the language of most personal conduct exclusions until the final adjudication of the claim. Until that time, the insurer must continue to pay defense costs.

Policyholders should be aware, however, that some courts have taken a broad view of “final adjudication.” In Millennium Partners, L.P. v. Select Ins. Co., No. 601878/2007, 2009 WL 586127, at *1 (N.Y. Sup. Ct. March 9, 2009), a policyholder brought an action against its insurer for failure to reimburse defense costs incurred in connection with an investigation by the New York Attorney General and the SEC. To avoid possible criminal charges, the policyholder entered into settlement agreements with these two entities. Id. at *1. The settlement agreements contained factual findings that, among other things, the policyholder had “devised and carried out a fraudulent scheme,” but also provided that the policyholder was consenting to the settlement “without admitting or denying the findings.” Id. at *2. As part of the settlement, the policyholder was required to pay nearly $150 million in “disgorgement.” After the settlement agreements were signed, the insurer refused to reimburse defense costs because the settlement agreement and the disgorgement amounted to a finding that the policyholder had improperly acquired the money, which was not covered under the policy. Id. at *2. The court agreed with the insurer and denied the policyholder's request for reimbursement of defense costs associated with the investigation. Id. at *3-4.

Finally, many policies contain a severability clause. This type of clause typically prohibits an insurer from imputing to an insured person any statement made or knowledge possessed by another insured person for the purpose of determining whether coverage is available. A severability claim can be very important during a government investigation of a corporation where a large number of employees, officers, and directors, all with varying degrees of knowledge concerning the events that gave rise to the investigation, are involved. In the aftermath of the Tyco financial scandal, former CEO Dennis Kozlowski obtained declaratory relief obligating his insurer to pay his defense costs in several actions (criminal and civil) by arguing, in part, that a severability clause prevented the insurer from imputing to him a guilty plea by another Tyco director. See Federal Ins. Co. v. Kozlowski, 792 N.Y.S.2d 397, 401 (N.Y. App. Div. 2005).

Billing Guidelines

Once the investigation has begun and notice has been given to the insurer, some insurers will agree to defend. However, many insurance companies will attempt to limit their responsibility by unilaterally imposing some sort of restrictions or limitations on the defense costs that they will pay. This is done through the unilateral imposition of billing guidelines or litigation guidelines. The guidelines prohibit billing for certain legal costs, such as the use of online legal research databases, local travel, and interoffice conferencing. Insurers may also refuse to pay billing rates above a set rate, and that rate is usually below the level charged by most defense attorneys. Especially in cases as complex as government investigations, these billing or litigation guidelines can have the practical effect of diminishing the effectiveness of defense counsel and depriving the insured of the defense it is entitled to under the policy.

Policyholders should carefully analyze any billing guidelines the insurer sends and raise any concerns about compliance immediately. Specifically, a policyholder should not agree to guidelines that interfere with a lawyer's professional judgment, such as requiring prior approval before performing legal research or dictating how work is to be allocated among defense team members.

Numerous state bar opinions have stated that billing guidelines are improper. For example, the Supreme Court of Ohio's Board of Commissioners on Grievances and Discipline, in Opinion 2000-3 (June 2000), clearly stated that certain guidelines per se interfere with a lawyer's professional judgment and are therefore unethical for a lawyer to follow. These include guidelines that require prior approval before performing online legal research, dictate how work is to be allocated among defense team members, require approval before conducting discovery, taking depositions, or consulting with expert witnesses, and guidelines that require the insurer's approval before filing motions and pleadings. Op. at 1.

The Rhode Island Supreme Court, in Ethics Advisory Panel Opinion No. 99-18 (October 1999), similarly held that a fact-specific determination was unnecessary with certain billing guidelines. The Panel stated that any guidelines that require the insurer's pre-approval for specified legal services such as conducting research, filing counterclaims and motions, visiting accident sites, and conducting depositions, among other activities, infringe upon the attorney-client relationship by “interfering with the independent professional judgment of defense counsel and ultimately with the quality of legal services provided to the insured.” Op. at 1.

In Nortek, Inc. v. Liberty Mutual Ins. Co., 858 F.Supp. 1231 (D.R.I. 1994), the policyholder argued that the insurer failed to meet its defense obligation by not reimbursing the plaintiff all necessary defense costs. The insurer had accepted its defense obligation subject to billing restrictions:

As set forth in Liberty Mutual's letter of November 14, 1990, the “defense” was made subject to restrictions unilaterally imposed by Liberty Mutual and not found in the Policy. The restrictions included a “cap” of $105 per hour for attorney's fees, $55 per hour for paralegal time, no reimbursement for secretarial overtime, no reimbursement for “meals or over night [sic] trial without pre-approval,” and no reimbursement for any costs, expenses or attorneys' fees that were incurred before October 15, 1990. Id. at 1234, n.3.

The court held that the defendant breached its obligation to defend, in part, by its failure to reimburse the plaintiff policyholder for “all of the reasonable fees and expenses [it] incurred defending itself against all the claims[.]” Id. at 1238-39.

Conclusion

Government investigations can be very expensive. Insurance is an important asset to eliminate or defray the litigation costs. A policyholder faced with a governmental investigation should carefully review the “notice” and “claim” provisions of the relevant insurance policies immediately. State law varies on the many key insurance issues and, therefore, the policyholder should also examine the applicable law to determine how to proceed. In short, while there are usually many things to worry about during a government investigation, whether your insurer will pay for defense costs should not be one of them.

Andrew M. Reidy, a member of this newsletter's Board of Editors, is a partner and Chris Kellett is an associate in the Washington, DC office of Howrey LLP. They represent policyholders in disputes against insurance companies.

After learning there is an investigation, a policyholder's first priority is hiring excellent defense counsel. Whether an investigation is commenced by a state government or the federal government, the defense costs associated with the investigation can be very significant. A top priority should also be accessing your insurance coverage. In many cases, insurance policies will cover the defense costs relating to an investigation. The process of getting an insurer to promptly pay the defense costs, however, can be difficult. A policyholder that is mindful of a few issues that commonly arise in seeking coverage for an investigation is in a much better position to obtain prompt payment of defense costs. This article addresses four common obstacles to obtaining prompt payment of defense costs.

Is There a 'Claim'?

One of the threshold issues in assessing whether a government investigation is covered is whether a “claim” has been made. Policy definitions of “claim” vary significantly. Some policies broadly define “claim” to include “a civil, criminal, administrative or regulatory investigation of an Insured Person ' ” AT&T Corp. v. Faraday Capital Ltd. , 918 A.2d 1104, 1107 n.7 (Del. 2007). This definition is quite clear and will cover most investigations. Other policies, however, do not include such explicit language. Courts have reached different results on whether an investigation constitutes a “claim” when the language is not explicit, focusing on the precise policy language at issue and the nature of the governmental action. One favorable decision for policyholders is National Stock Exchange v. Federal Ins. Co., No. 06C1603, 2007 WL 1030293 (N.D. Ill. Mar. 30, 2007) (“National Stock Exchange“). In National Stock Exchange, the policy defined “claim” to include “formal investigative order or similar document.” Id. at *3. The court ruled that a SEC “Order Directing Private Investigation and Designating Officers to Take Testimony” was a “claim” covered under the policy. Id. at *5. In doing so, the court rejected the insurer's argument that a claim did not arise until a proceeding was commenced directly against an insured person. Id. See also Polychron v. Crum & Forster Ins. Cos. , 916 F.2d 461, 463 (8th Cir. 1990) (legal fees incurred in defending a target of a grand jury investigation were covered defense costs); Richardson Electronics, Ltd. v. Federal Ins. Co. , 120 F. Supp. 2d 698, 701 (N.D. Ill. 2000) (Justice Department investigation was a claim).

A related issue is whether a subpoena from a governmental entity for documents or testimony constitutes a “claim.” Some courts held that there is a “claim” when the governmental entity conducting an investigation issues a subpoena for documents or testimony. For example, in Minuteman Int., Inc. v. Great American Ins. Co., No. 03C6067, 2004 WL 603482 (N.D. Ill. Mar. 22, 2004), the policy defined a claim to include “a written demand for monetary or nonmonetary relief.” The court ruled that a SEC subpoena fell within this definition of a claim because the investigation had sought “nonmonetary relief” in the form of documents and testimony. Id. at *7. However, other courts have not allowed coverage for defense costs incurred in responding to a subpoena. In Center for Blood Research, Inc. v. Coregis Ins. Co. , 305 F.3d 38, 42 (1st Cir. 2002), the court held that a policyholder's defense costs associated with responding to an investigative subpoena issued by the U.S. Attorney for the District of Massachusetts did not constitute a “claim” under the policy. The subpoena was served on the policyholder merely in its capacity as the custodian of records, and there was no indication that the policyholder was the target of any investigation. Id. at 42-43. Thus, courts have reached different results about whether insurance policies cover the costs of complying with a subpoena issued by a governmental entity.

Give Prompt Notice; Pay Attention to the Wording

When a government investigation is initiated, a policyholder should notify its insurers in a timely manner. In some situations, failure to provide prompt notice could preclude coverage altogether. In fact, in many states, courts will decide a late notice defense under a directors' and officers' policy without regard to whether insurers were prejudiced by the purported late notice.

Notice provisions typically describe how to give notice of a claim and the situations that might give rise to a claim. Policyholders should be careful about how they give notice of a claim. In the event of a government investigation, policyholders may have to decide whether to notify their insurers of a “claim” or “potential claim.” Once a “potential claim” or “claim” is noticed, subsequently issued policies typically will not cover the noticed claim or subsequent claims. Further, the policyholder's characterizations in that letter may influence coverage determination by the insurer. Therefore, a policyholder needs to give prompt notice and to carefully consider the content of the notice letter.

Policy Exclusions Typically Do Not Preclude a Defense

Insurers may also try to invoke certain policy exclusions to avoid paying for the defense costs associated with government investigations. Exclusions in an insurance contract are construed strictly to give the interpretation most beneficial to the insured. See e.g. , Altstrin v. St. Paul Mercury Ins. Co. , 179 F. Supp. 2d 376, 400 (D. Del. 2002) (“illegal profit” exclusion should be construed strictly). If an exclusion is ambiguous, it is construed against the insurer.

Given implicit or explicit allegations of wrongdoing that may be part of a government investigation, insurers are most likely to invoke the so called “personal conduct” exclusions. These exclusions relate to illegal profits, fraud, or intentional violations of law. For a number of reasons, these types of exclusions normally should not excuse an insurer from its obligations to either defend or reimburse defense costs while an investigation is ongoing.

As an initial matter, most directors' and officers' insurance policies include provisions that require the insurer to advance defense costs at least until the final disposition of the claim. While a policyholder may have to repay the insurer for defense costs after the final disposition of the claim, at the very least these types of provisions allow a policyholder to have a full defense while the claim is pending. In Sun-Times Media Group, Inc. v. Royal & Sunalliance Ins. Co. of Canada, No. 06C-11-108, 2007 WL 1811265, at *1 (Del. Super. June 20, 2007), the court considered three insurers' claims that personal conduct exclusions relieved them of their obligation to pay defense costs. The court ruled that even if personal conduct exclusions might apply at a later time, “this still does not prevent the advancement of defense costs at the present time because the policy provides that the Insured must pay back money they received but were not entitled to.” Id. at *11-12. In order to excuse its obligation to advance defense costs, the insurers would have to “unequivocally” show that all of the allegations in the complaint fell within the personal conduct exclusions. Id. at *11. Therefore, insurers cannot avoid coverage under the language of most personal conduct exclusions until the final adjudication of the claim. Until that time, the insurer must continue to pay defense costs.

Policyholders should be aware, however, that some courts have taken a broad view of “final adjudication.” In Millennium Partners, L.P. v. Select Ins. Co., No. 601878/2007, 2009 WL 586127, at *1 (N.Y. Sup. Ct. March 9, 2009), a policyholder brought an action against its insurer for failure to reimburse defense costs incurred in connection with an investigation by the New York Attorney General and the SEC. To avoid possible criminal charges, the policyholder entered into settlement agreements with these two entities. Id. at *1. The settlement agreements contained factual findings that, among other things, the policyholder had “devised and carried out a fraudulent scheme,” but also provided that the policyholder was consenting to the settlement “without admitting or denying the findings.” Id. at *2. As part of the settlement, the policyholder was required to pay nearly $150 million in “disgorgement.” After the settlement agreements were signed, the insurer refused to reimburse defense costs because the settlement agreement and the disgorgement amounted to a finding that the policyholder had improperly acquired the money, which was not covered under the policy. Id. at *2. The court agreed with the insurer and denied the policyholder's request for reimbursement of defense costs associated with the investigation. Id. at *3-4.

Finally, many policies contain a severability clause. This type of clause typically prohibits an insurer from imputing to an insured person any statement made or knowledge possessed by another insured person for the purpose of determining whether coverage is available. A severability claim can be very important during a government investigation of a corporation where a large number of employees, officers, and directors, all with varying degrees of knowledge concerning the events that gave rise to the investigation, are involved. In the aftermath of the Tyco financial scandal, former CEO Dennis Kozlowski obtained declaratory relief obligating his insurer to pay his defense costs in several actions (criminal and civil) by arguing, in part, that a severability clause prevented the insurer from imputing to him a guilty plea by another Tyco director. See Federal Ins. Co. v. Kozlowski , 792 N.Y.S.2d 397, 401 (N.Y. App. Div. 2005).

Billing Guidelines

Once the investigation has begun and notice has been given to the insurer, some insurers will agree to defend. However, many insurance companies will attempt to limit their responsibility by unilaterally imposing some sort of restrictions or limitations on the defense costs that they will pay. This is done through the unilateral imposition of billing guidelines or litigation guidelines. The guidelines prohibit billing for certain legal costs, such as the use of online legal research databases, local travel, and interoffice conferencing. Insurers may also refuse to pay billing rates above a set rate, and that rate is usually below the level charged by most defense attorneys. Especially in cases as complex as government investigations, these billing or litigation guidelines can have the practical effect of diminishing the effectiveness of defense counsel and depriving the insured of the defense it is entitled to under the policy.

Policyholders should carefully analyze any billing guidelines the insurer sends and raise any concerns about compliance immediately. Specifically, a policyholder should not agree to guidelines that interfere with a lawyer's professional judgment, such as requiring prior approval before performing legal research or dictating how work is to be allocated among defense team members.

Numerous state bar opinions have stated that billing guidelines are improper. For example, the Supreme Court of Ohio's Board of Commissioners on Grievances and Discipline, in Opinion 2000-3 (June 2000), clearly stated that certain guidelines per se interfere with a lawyer's professional judgment and are therefore unethical for a lawyer to follow. These include guidelines that require prior approval before performing online legal research, dictate how work is to be allocated among defense team members, require approval before conducting discovery, taking depositions, or consulting with expert witnesses, and guidelines that require the insurer's approval before filing motions and pleadings. Op. at 1.

The Rhode Island Supreme Court, in Ethics Advisory Panel Opinion No. 99-18 (October 1999), similarly held that a fact-specific determination was unnecessary with certain billing guidelines. The Panel stated that any guidelines that require the insurer's pre-approval for specified legal services such as conducting research, filing counterclaims and motions, visiting accident sites, and conducting depositions, among other activities, infringe upon the attorney-client relationship by “interfering with the independent professional judgment of defense counsel and ultimately with the quality of legal services provided to the insured.” Op. at 1.

In Nortek, Inc. v. Liberty Mutual Ins. Co. , 858 F.Supp. 1231 (D.R.I. 1994), the policyholder argued that the insurer failed to meet its defense obligation by not reimbursing the plaintiff all necessary defense costs. The insurer had accepted its defense obligation subject to billing restrictions:

As set forth in Liberty Mutual's letter of November 14, 1990, the “defense” was made subject to restrictions unilaterally imposed by Liberty Mutual and not found in the Policy. The restrictions included a “cap” of $105 per hour for attorney's fees, $55 per hour for paralegal time, no reimbursement for secretarial overtime, no reimbursement for “meals or over night [sic] trial without pre-approval,” and no reimbursement for any costs, expenses or attorneys' fees that were incurred before October 15, 1990. Id. at 1234, n.3.

The court held that the defendant breached its obligation to defend, in part, by its failure to reimburse the plaintiff policyholder for “all of the reasonable fees and expenses [it] incurred defending itself against all the claims[.]” Id. at 1238-39.

Conclusion

Government investigations can be very expensive. Insurance is an important asset to eliminate or defray the litigation costs. A policyholder faced with a governmental investigation should carefully review the “notice” and “claim” provisions of the relevant insurance policies immediately. State law varies on the many key insurance issues and, therefore, the policyholder should also examine the applicable law to determine how to proceed. In short, while there are usually many things to worry about during a government investigation, whether your insurer will pay for defense costs should not be one of them.

Andrew M. Reidy, a member of this newsletter's Board of Editors, is a partner and Chris Kellett is an associate in the Washington, DC office of Howrey LLP. They represent policyholders in disputes against insurance companies.