The Fifth Circuit Court of Appeals recently reversed a ruling that a directors and officers liability policy provided no coverage for an insured financial services firm that fell for a scam involving a fraudulent direction to wire $1 million from one of its customer’s accounts.
After the customer threatened to file a negligence suit against the financial services firm, the firm submitted a claim for coverage under its D&O policy. The insurer declined to defend the firm, citing two exclusions to the policy, causing the firm to sue the insurer for breach of contract. While the insurance litigation was ongoing, the financial services firm and the customer settled. However, that settlement occurred more than two years after the customer’s cause of action against the firm accrued and the limitations period had already run.
The insurer moved for summary judgment in the insurance suit, theorizing that the policy did not provide coverage for settlements made after the limitations period for the underlying cause of action had run. The district court agreed and granted summary judgment.
On appeal, the Fifth Circuit noted that the district court’s ruling was apparently based on two erroneous decisions: (1) treating the policy term “claim” as synonymous with the claimant’s underlying “cause of action”; and (2) treating the phrase “legally liable to pay” as requiring a judgment, not recognizing that under Texas law a contractual obligation can also result in an insured being “legally liable to pay.” With regard to the first point, the Fifth Circuit pointed out that the policy’s definition of a “claim” included a “written demand for monetary damages or other civil non-monetary relief,” including a demand letter. While a claimant’s underlying cause of action can be barred by a statute of limitations, a demand letter cannot.
After clarifying these two misconceptions, the Fifth Circuit found the financial services firm’s claim to be within the policy’s coverage. The policy provided coverage for a loss resulting from a claim. The firm’s customer’s demand letter (i.e., a “written demand for monetary damages or other civil non-monetary relief”) constituted such a “claim.” And the firm’s resultant settlement with the customer constituted a “loss,” as the firm was legally obligated to pay the customer through contract (i.e., the settlement). The fact that the customer’s cause of action may have been barred by the statute of limitations was of no moment under the policy’s language.
The insurer raised two additional grounds upon which it argued the summary judgment should be affirmed: that the settlement between the financial services firm and its customer was not the result of an adversarial process and that the policy’s professional services exclusion applied.
The Fifth Circuit disagreed. It noted that a finding that a settlement arose from a process that was not “fully adversarial” does not necessarily release an insurer from its duty to indemnify the settlement but rather only releases an insurer that breached its duty to defend from being fully bound by the settlement. “In other words, showing the settlement did not result from a fully adversarial process gives insurers the opportunity to contest the amount and validity of the settlement, but it does not give them a get-out-of-coverage free card.”
In addition, the court found the settlement process was fully adversarial. In determining whether a proceeding is adversarial, “the controlling factor is whether, at the time of the underlying trial or settlement, the insured bore an actual risk of liability for the damages awarded or agreed upon, or had some other meaningful incentive to ensure that the judgment or settlement accurately reflects the plaintiff’s damages and thus the defendant-insured’s covered liability loss.” The possibility of being liable for damages or the settlement if the insurer does not provide coverage is an adequate incentive to make such a settlement adversarial. Here, the financial services firm settled knowing that, if it lost its suit against its insurer, it would be liable for the settlement; therefore, the process was sufficiently adversarial.
The insurer also argued that the policy’s professional services exclusion applied. The clause applied to a “Loss … arising from, or in any way related to any actual or alleged … rendering of, or failure to render, any services for or on behalf of others for a fee.” The insurer argued that the financial services firm regularly performed wire services, such as the one the firm was tricked into performing and that led to the parties’ dispute, for a fee. The financial services firm admitted that it provided such services but denied that it did so “for a fee.” Rather, the firm stated it provided such services for free, and therefore the exclusion did not apply. The Fifth Circuit found the firm had produced sufficient evidence to preclude summary judgment on this point and remanded for further proceedings.
