Professional liability insurance policyholders often breathe a sigh of relief when their insurer begins funding the costs of defending against a civil claim or government investigation. That is one of the reasons they bought the insurance in the first place! However, as one policyholder recently learned, just because the insurer advances defense costs doesn’t mean that the policyholder can forever close its books on those costs. In Protection Strategies, Inc. v. Starr Indemnity & Liability Co., after several former executives of the insured pled guilty to criminal charges – triggering various exclusions in the policy – the Fourth Circuit allowed the insurer to recover all of the defense costs it had advanced to its insured.

In 2012, Protection Strategies, Incorporated (“PSI”) and its officers became the subject of criminal and civil investigations related to the Small Business Administration’s Section 8(a) program, which helps certain small businesses compete in the marketplace. PSI’s D&O insurer, Starr Indemnity & Liability Company (“Starr”), advanced defense costs to PSI subject to a reservation of rights. In total, Star advanced roughly $850,000 to PSI.

Ultimately, four of PSI’s former executives pled guilty to criminal charges, including fraud and conspiracy to commit fraud. After these guilty pleas, Starr sought to recoup the defense costs that it previously had advanced to PSI. Starr argued that the guilty pleas triggered multiple exclusions in the policy – including the fraud and improper profits exclusions – and that this allowed Starr to recoup defense costs pursuant to a recoupment provision in the policy.

Both the District Court, and later the Fourth Circuit, agreed with Starr. Putting it bluntly, the Fourth Circuit held that “Starr was entitled to the remedy of recoupment” and that PSI’s arguments to the contrary were “unsupported by the record and otherwise without merit.”

The Fourth Circuit’s decision serves as a reminder of the importance of closely reviewing and negotiating policy language so as to minimize the risk of the insurer recouping defense costs.

First, it is important to review carefully any provisions addressing recoupment rights by the insurer before purchasing coverage. Some insurer’s form policies not only permit recoupment, but require the insureds to provide written assurances or other guarantees of repayment before the insurer will advance defense costs. Policyholders should be mindful of such provisions and be especially aware of recoupment rights with respect to Side A coverage (non-indemnifiable loss), as returning defense costs can pose an extraordinary burden to individual directors or officers.

Second, the Fourth Circuit’s decision also emphasizes the need for negotiating narrow conduct exclusions that are triggered only by final adjudications of very specific misconduct. If a claim does not trigger an exclusion, then the insurer may not be able to use the exclusion as a basis for seeking recoupment of defense costs.

Policyholders that are not attentive to these issues might find that the D&O insurance they purchased primarily to protect against the costs of defending civil claims and government investigations does not fully serve that purpose.