Obtaining insurance coverage for a government investigation is often complicated by the type of investigation and the available coverage.  Most policies that cover aspects of government investigations–directors and officers liability policies or errors and omissions policies–are written on a claims-made form and exclude claims that relate back to prior or pending claims.  Very often the insurance company asks for a signed warranty that the insured and its officers are unaware of any actions that might result in a claim during the policy period.

Recently, the United States Court of Appeals for the Second Circuit issued a Summary Order (non-precedential) addressing an attempt to obtain coverage for a government investigation from a new third layer excess insurer.

In Patriarch Partners, LLC v. Axis Ins. Co., No. 17-3022 (2d Cir. Dec. 6, 2018), an SEC investigation started slowly with an informal inquiry, which required the insured’s outside counsel to become engaged.  Some time later, the matter shifted to an informal investigation, which culminated in a formal order of investigation.  The order mentioned a possible violation of the federal securities laws.  Two employees were subject to interviews and their expenses were indemnified by the policyholder. Formal subpoenas were issued and outside counsel met with the SEC. Outside counsel advised the sole officer of the subpoena and a retention policy reminder was sent out.

While all this was going on, the policyholder’s directors and officers insurance renewed and the policyholder, at the broker’s recommendation, sought an additional $5 million of coverage.  The insurance company gave a quote for this additional coverage, which the policyholder accepted.  The new excess policy was a “following form” policy, following the terms of the primary policy issued by a different insurer.  The primary policy provided coverage for any claim first made against an insured during the policy period and defined claim to include an investigation of an insured for a wrongful act.  Investigation was defined to include a formal regulatory investigation or inquiry, including an SEC order of investigation.

Importantly, before the new excess insurer came on board, it requested that the insured sign a written warranty statement, which the parties negotiated, that stated the insured (including its officers and directors) were unaware of any facts or circumstances that would reasonably be expected to result in a claim under the policy.  The warranty recognized that the policy did not provide coverage for any claim related to facts and circumstances known by the insured as of the date of the warranty.

After the insurance program renewed, the SEC served a subpoena on the policyholder for documents.  A few days later, the insured put its insurers on notice of the subpoena as a new matter.  While it appears that the primary insurer accepted the tender as a claim under its policy, the new excess insurer reserved its rights.  Over three years later, after the cost of defending an administrative enforcement action exhausted the insurance limits below the new insurer, the policyholder asked the new excess insurer to assume the defense.  The insurer refused and the insured sued.

The district court granted summary judgment to the insurer based on the exclusion for pending and prior claims.  On appeal, the Second Circuit went in a different direction.  The court found that the warranty of no known claims precluded coverage.  The court rejected the policyholder’s arguments that the warranty only precluded claims that the sole officer or director actually knew about (she claimed she did not know about the order of investigation) and that it only applied to claims that the insured would have reasonably expect to result in losses exceeding the underlying policy limits.

The court found that outside counsel’s knowledge was imputed to the policyholder, and not just specific knowledge of the sole officer.  The court held that the only reasonable interpretation of the warranty was that it excluded claims arising from facts or circumstances of which the policyholder was aware of as of the date of the warranty and that the policyholder would reasonably have expected to result in a claim as defined by the primary policy.  The court also rejected the policyholder’s request that the court look at extrinsic evidence, concluding that the warranty contained no ambiguity.  Because the warranty excluded the policyholder’s losses arising from its defense of the SEC investigation claim from coverage under the excess policy, the court did not have to reach the argument that the claim was barred by the exclusion as well.