As Alison Frankel recently reported in her On the Case
blog (here),
the insider trading charges to which former Morgan Stanley hedge fund manager
Joseph "Chip" Skowron pled guilty cost the company a lot of money. And, as
demonstrated in the lawsuit the company recently filed against Skowron, Morgan
Stanley wants its money back - the company wants not only the almost $5 million
of legal fees it paid on Skowron's behalf, but also the more than $32 million
in compensation the company paid Skowron, and even the $32 million the company
paid to resolve the SEC's case against Skowron.
An action of this type is unusual, as Frankel's blog post
well documents. (This particular case is also procedurally unusual and complex,
as Frankel also shows). But Morgan Stanley's efforts to recoup all of its costs
from Skowron triggered a question to me from several readers on a parallel
topic: that is, when can a D&O insurer recoup amounts it has paid out after
an insured has pled guilty or when circumstances otherwise establish that
there is no coverage for amounts the insurer has paid?
The recoupment question most often comes up in the
insurance context with respect to attorneys' fees. D&O insurers generally
take the position that when they pay defense fees under their policy, they are
merely advancing defense fees subject to an ultimate determination on
whether or not the amounts are actually covered under the policy, and that in
the event of a determination of noncoverage they are entitled to be reimbursed
for the amount they had advanced.
The carrier's position in this respect may be
particularly understandable when it is paying defense fees under the policy's
corporate reimbursement coverage (usually referred to as Side B coverage); in
those circumstances, the insurance is providing a funding mechanism for the
insured company's own indemnification obligations. Just as the insured company
would typically have the obligation only to advance defense expenses subject to
a right of recoupment if it is determined that the indemnitee is not entitled
to indemnification, the carrier's payment on the insured company's behalf also
represents advancement subject to recoupment.
But even when the carrier's is paying defense fees under
another insuring agreement (whether it is the individual protection coverage
under Side A or the entity coverage under Side C), the carrier will contend
that at the outset of a claim a definitive coverage determination is not possible
and so the insurer is merely advancing defense costs until it is possible to
make the determination.
Just the same, it is relatively rare for a D&O
insurer to try to recoup defense fees it pays. That is largely because it is
pretty unusual in the context of a D&O claim for there to be final factual
determinations, because most D&O claims settle long before the factual
determinations are made. (Indeed, among the many reasons that securities suit
rarely go to trial is the defendants' concern that an adverse verdict would not
only result in a finding of liability against them, but could also result in
the loss of their insurance coverage.)
There is another practical reason that it is relatively
rare for D&O insurers to attempt to recoup defense fees it has paid; that
is, by the time an individual or company grinds all the way through a serious
D&O claim, the person or company is usually broke. There is not much left
for the insurer to go after. It is the very rare case where it is going to be
enough left for it to be worth the insurer's expense and time to try to recoup
amounts paid out.
There is of course another reason why it is rare for
D&O insurers to seek recoupment; in general, it is not a public relations
move for insurance companies to go around suing the persons they insure.
Nevertheless, over the years there have been a certain
number of cases where the D&O insurer has attempted to recoup defense
expenses. The law in this area is not entirely uniform. In some jurisdictions,
the courts have held that, if at the outset of a claim the carrier has reserved
the right to seek recoupment in the event of a determination of noncoverage,
the carrier has the right to seek to recoup defense costs incurred in
connection with claims that are not covered under the policy. Court that follow
this approach reason that allowing the insurer to recoup the defense costs
where a timely reservation of rights was issued promotes the policy of ensuring
that defenses are afforded even in questionable cases. Other courts following
this line have reasoned that it would be inequitable for the insured to retain
the benefits of the defense without repayment where there was no coverage under
the policy.
On the other hand, other courts have held that the policy
itself must specific address the carrier's right to seek recoupment and that
the mere fact that the carrier has reserved its rights to seek recoupment is
not sufficient to create a right that is not otherwise found the policy.
A more interesting question, and one that comes up even
less frequently than the question of the insurer's right to recoup defense
expenses, is the insurer's right to recoup amounts paid as damages or in
settlements. An insurer has the right of subrogation, that is, the right to
proceed against a third party that caused the loss, to recoup the amount of
that loss. Most D&O policies contain subrogation provisions, but even in
the absence of an explicit subrogation provision, the carriers will contend
that they have rights of equitable subrogation entitling them to go against the
persons that caused the loss.
The subrogation provisions of many D&O policies often
specifically address the question of when the D&O insurer may subrogate
against an insured person under the policy. In most modern D&O insurance
policies, the clause will specify that the insurer can exercise the right of
subrogation against an insured person if the person from whom recovery is
sought has been convicted of a deliberate criminal act or has been determined
by adjudication to have committed a deliberate fraudulent act. However, because
so many D&O claims settle, these preconditions for a subrogated recovery
against an insured person are rarely met.
But the subrogation provisions and rights only address
the conditions on the carrier's right to assert a claim in the right of the
party on whose behalf the carrier paid the claim. The carrier's own right to
recover amounts it paid for which it later appears there is no coverage
arguably is a different question. (It is an interesting thought-problem to
contemplate whether a carrier seeking recoupment of amounts paid pursuant to a
settlement or judgment is proceeding by way of subrogation or in its own right;
in the D&O context it may well depend on the insuring agreement pursuant to
which the payment was made. If the payment was made pursuant to the corporate
reimbursement coverage then the recoupment action would appear to represent
subrogation; if the payment was made pursuant to either the individual
protection or entity liability coverage parts, then it might be argued that the
carrier's recoupment rights are direct, not by way of subrogation.)
Although some D&O policies do contain provisions
specifying that the carrier may seek recoupment of amounts advanced as defense
expenses in the event of a determination of noncoverage, it is relatively
unusual for these provisions to address the carrier's right to recoupment of
amounts other than defense expenses. In the absence of specific contractual
provisions addressing the issue, the carrier would be obliged to rely on
equitable arguments - that is, that it would be inequitable for the carrier to
have to bear costs it was not contractually obligated to undertake and that
rightfully should be borne by the person whose conduct caused the loss.
I know of various instances where carriers have sought to
recoup amounts paid as defense expenses, but I cannot recall an instance where
a carrier sought to recoup amounts it paid by way of judgments or settlements
-- but that isn't to say that it never happens; in fact, I expect that it has
happened, and I would be very interested if readers aware of any occasions
where this has happened could share their recollections with other readers by
using the comment feature on this blog.
I will say that it is interesting how a particular
situation, like Morgan Stanley's new lawsuit against Skowron, can set off a
whole cascade of thoughts and associations. My thanks to the several readers
who contacted me with their thoughts and questions about the Morgan Stanley
lawsuit.
Read
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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