PENDERGEST-HOLT v. CERTAIN UNDERWRITERS AT LLOYD’S LONDON (S.D. Tex. Jan. 26, 2010)

As is well known, the SEC initiated a civil action against Robert Allen Stanford and a number of directors and officers of Stanford International Bank. The SEC alleged that Stanford orchestrated a multi-billion dollar Ponzi scheme whereby Stanford conspired to deceive investors by selling sham certificates of deposit. Subsequent to the SEC action, a court-appointed receiver seized all assets in the possession of Stanford defendants, including insurance policy proceeds.

Shortly after the commencement of the SEC action, plaintiffs made claims against a directors and officers insurance policy issued by the defendant as well as an associated excess policy for fees and costs incurred in defending against the SEC action. The insurer agreed to provide a defense under a reservation of rights.

Thereafter, James Davis, a Stanford insider, pleaded guilty to three charges and during his allocution, made a variety of statements implicating plaintiffs in a wide range of alleged illegal activity. On November 16, 2009, the insurer issued denial letters to the plaintiffs. While acknowledging payment of defense costs up until August 27, 2009, the insurer retroactively declined to extend coverage for costs and charges incurred in defending the SEC and criminal action after that date. The plaintiffs, in turn, filed the instant action. The plaintiffs then filed a motion seeking an order from the court directing defendant to pay plaintiffs’ defense costs in the underlying criminal action and the SEC action pending adjudication in those cases. Specifically, plaintiffs sought an order from the court requiring the insurer to withdraw its retroactive denial and compelling the insurer to pay all reasonable and necessary defense costs and expenses incurred in the SEC and criminal actions.

The court noted that the plaintiffs in this instance were seeking an injunction prohibiting defendant from retroactively withdrawing coverage under the policy as opposed to a declaration of rights under the policy. In order to obtain such an injunction, it was necessary for the plaintiffs to establish: (1) a substantial likelihood of prevailing on the merits; (2) a substantial threat of irreparable injury if the injunction were not granted; (3) that the threatened injury outweighs any harm that will result to the non-movant; and (4) the injunction with not disserve the public interest.

Initially, the parties conceded that this was not a duty to defend case. In fact, the policy did not require the insurer to defend plaintiffs. Indeed, the policy specifically stated that it shall be the duty of the insureds, not the duty of the insurer, to defend against a claim. However, the policy required the insured to pay costs, charges, and expenses no more than once every sixty days.

In response to the motion, the insurer argued that since this was not a duty to defend case, the eight-corner rule was inapplicable. Under the eight-corner rule, an insurer’s duty to pay defense costs is determined by examining only the policy provisions and the claims in the underlying complaint without regard to the truth or falsity of those allegations. While the district court noted that the Supreme Court of Texas has not specifically ruled upon this exact issue, it still concluded that the Texas court would not create an exception to the eight-corner rule as suggested by the insurer. Consequently, the court applied the eight corners rule and concluded that plaintiffs are likely to succeed on their argument that the insurer was contractually obligated to pay defense costs until a final adjudication in the underlying litigation.

With respect to irreparable harm, the court stated that the plaintiffs would suffer real, immediate, and irreparable harm if injunctive relief was denied, concluding that the potential breach of the contractual duty impedes plaintiffs’ right to secure counsel of their choice and seek a speedy resolution of criminal charges against them. Moreover, the court concluded that the prospect of going unrepresented in the underlying SEC action, and being deprived of counsel of their choosing in the criminal action, undoubtedly outweighs any harm to the insurer. The court noted that the extent of harm to be suffered by the insurer was purely economic and was, in fact, capped at the policy limits.

Finally, the court concluded that the plaintiffs had met their burden of demonstrating that a preliminary injunction would not disserve the public interest. Accordingly, the court entered the injunction prohibiting the insurer from denying coverage for the costs incurred subsequent to August 27, 2009, and the insurer was prohibited from withholding payment of all costs, charges, and expenses already incurred or incurred in the future in the underlying actions.

Impact: The Stanford Ponzi scheme continues to produce litigation and noteworthy decisions concerning coverage under the directors and officers policy. In this case, the policy affirmatively limited the insurance company’s duty to defend. Despite this, the court employed the eight-corner rule to determine whether the insurer was required to reimburse the policyholders for defense costs incurred. This decision is notable because the court used the same duty to defend standard despite the fact the policy’s insuring agreement imposed the duty to defend on the insured rather then the insurer.

For a copy of this decision, click here: http://insurancecoverage.typepad.com/insurance_and_reinsurance/2010/02/cases-for-professional-liability-monthly.html