D&O Insurance: Guilty Pleas Trigger Coverage Exclusions, Entitle Insurer to Recoupment

D&O Insurance: Guilty Pleas Trigger Coverage Exclusions, Entitle Insurer to Recoupment

 In a detailed April 23, 2014 opinion (here), Eastern District of Virginia Judge Liam O’Grady, applying Virginia law, held that the guilty pleas of executives of Protection Strategies, Inc. triggered four separate exclusions in the D&O coverage section of PSI’s management liability policy and that the management liability insurer was entitled to recoup the defense fees that it had advanced.


PSI is a global security management and consulting company. On January 30 and 31, 2012, PSI received a subpoena from the NASA Office of Inspector General and a search and seizure warrant issued by the United States District Court for the District of Virginia. The warrant stated that the government was seeking evidence of violation of violations of various false statement and fraud provisions in the U.S. Criminal Code. On February 1, 2012, the NASA OIG executed a search of PSI’s headquarters. In June 2012, PSI received a letter from the U.S. Attorney for the Eastern District of Virginia stating that the U.S. Attorney and the DoJ were investigating PSI’s participation in a Small Business Administration program.

In March 2013, four PSI executives entered into plea agreements in the Eastern District of Virginia. PSI’s former CEO Keith Hedman pleaded guilty to a criminal information charging him with major fraud against the United States and conspiracy to commit bribery. Three additional PSI officials pled guilty to conspiracy to commit fraud and major fraud against the United States. Criminal judgments were subsequently entered against each of the four individuals and the four were sentenced to terms of incarceration.

In his plea agreement, Hedman stipulated that he and others had engaged in a scheme between approximately 2003 through February 2012 to defraud the Small Business Administration and several other U.S. government agencies by creating a sham company under the control of Hedman and PSI and by falsely representing that the sham company was eligible for SBA contracting preferences. Hedman admitted that the sham company received over $31 million in U.S. government contracts as a result of the scheme, with over $5 million of those funds flowing to PSI. Hedman agreed that he was aware of the illegal activities, including the activities of the three others. He also stipulated that his actions were done “willfully, knowingly and not because of accident, mistake or innocent reasons.”

The D&O coverage section of PSI’s private company  management liability insurance policy contained several exclusions, including the following, referred to in the opinion, respectively, as the personal profit, fraud and prior knowledge exclusions:

This policy shall not cover any Loss in connection with any Claim …

(a) arising out of, based upon, or attributable to the gaining of any profit or advantage or improper or illegal remuneration if a final judgment or adjudication establishes that such Insured was not legally entitled to such profit or advantage or that such remuneration was improper or illegal;

(b) arising out of, based upon or attributable to any deliberate fraudulent act or any willful violation f law by an Insured if a final judgment or adjudication establishes that such act or violation occurred;


(d) alleging, arising out of, based on or attributable to any facts or circumstances of which an Insured Person had actual knowledge or information of, as of the Pending or Prior Date set forth in Item 6 of the Declarations as respects this coverage section, and that he or she reasonably believed may give rise to a Claim under this policy.

The policy also states that in determination the applicability of Exclusions (a) and (b), “the knowledge possessed by, or any Wrongful Act committee by, an Insured Person who is a past or current [chief executive officer] …shall be imputed to the Company.

In connection with its purchase of the management liability insurance policy, PSI had provided the carrier with a February 15, 2011 Warranty Letter signed by Hedman which represented that “no person or entity proposed for insurance under the policy referenced above has knowledge of information of any act …which might give rise to a claim(s), suit(s), action(s) under such proposed policy.” The warranty letter further stated that if any such “knowledge or information exists, then … any claim(s), suit(s) or action(s) arising from or related to such knowledge or information is excluded from coverage.”

Section 6 of the Management Liability Insurance Policy’s general terms and conditions states that the Insurer “shall pay defense costs prior to the final disposition of any claim,” but that “in the event and to the extent that the Insureds shall not be entitled to payment of such Loss under the terms and conditions of this policy, such payments by the Insurer shall be repaid to the Insurer by the Insureds.”

In a separate coverage lawsuit, PSI and the insurer cross-moved for summary judgment. The insurer contended that the guilty pleas triggered each of the three exclusions quoted above as well as the exclusion in the warranty letter. The insurer also argued that it was entitled to recoup the amounts that it had advanced for the company’s and the individual defendants’ attorneys’ fees.

The April 23 Opinion

In his April 23, 2014 opinion, Judge O’Grady granted the insurer’s summary judgment motion and denied that of PSI, stating that “the Court finds that the policy’s exclusions apply and are a complete bar to coverage for the investigation of PSI and its Officers. Because the entirety of the defense costs advanced … fall under the exclusions in the policy,” the insurer “is entitled to recoupment.”

First, Judge O’Grady found that both the personal profit and fraud exclusions “unambiguously apply to the Claims in this case.” He went on to say that

Mr. Hedman’s plea agreement clearly establishes that PSI and its executives knowingly, intentionally and improperly gained an advantage and an illegal remuneration of at least $31 million by fraudulently creating Company B and representing that it was eligible for the SBA Section 8(a) program. It also establishes that PSI’s officers …willfully violated the law by committing fraud against the U.S. government. Neither party contests that each plea agreement is a “final judgment or adjudication,” nor is it disputed that under the terms of the policy, Mr. Hedman’s knowledge and wrongful acts are imputed to PSI itself. Because the Claims against PSI and its executives involve precisely the type of loss contemplated by the Profit and Fraud Exclusions, the Court finds that the Claims are not covered by the 2011 Policy.

PSI had tried to argue that the exclusions, even if triggered, only applied to the losses going forward – that is, that the insurer could not recoup any of the amounts it had advanced. However, Judge Grady found that the policy specifically excluded ‘any Loss” in connection with an excluded claim, adding that “while the policy language requires a final judgment or adjudication to trigger the Profit or Fraud exclusions, it nowhere suggests that the timing of the final adjudication affects the insurer’s obligation to pay.”

Judge O’Grady also concluded that the guilty pleas triggered the prior knowledge exclusion, as the pleas showed that each of the four officers had knowledge in February 2011 when the policy incepted of an ongoing scheme to defraud the government. He concluded that the preclusive effect of this exclusion applied even to PSI’s own defense expenses because they were “based upon or attributable to” facts of which an Insured Person had knowledge at the inception of the policy. He emphasized that the exclusion provides that “any Claim” is excluded when it arises from facts of which an Insured Person was aware; the exclusion is not limited to the specific Claim made against that particular Insured Person.

Judge O’Grady also concluded that the exclusion in the warranty letter had been triggered based on Mr. Hedman’s “material misrepresentation” that no person had knowledge of facts that might give rise to a claim.

Finally, Judge O’Grady concluded that “under the clear terms of the insurance policy and under recent Fourth Circuit precedent,” the insurer is entitled to recoupment of al defense costs it advanced to PIS related to this investigation,” adding that “because PSI was not entitled to coverage for any losses arising out of these Claims for the reasons described above, the recoupment provision applies.” (The Fourth Circuit precedent to which Judge O’Grady was referring is the appellate court’s 2013 opinion in the Farkas case, discussed here.)


This case presents the rare instance where a D&O policy’s “after adjudication” provisions appear to have been unambiguously triggered. (Indeed, as Judge O’Grady’s opinion noted, PSI itself did not even attempt to argue that the plea agreements had not triggered the conduct exclusions.) Similarly, because of the express recoupment language in the policy, it was going to be very difficult for PSI to persuade the court that, once the exclusions were triggered, the insurer was not entitled to recoupment.

As I have noted before (here), it is relatively rare for D&O insurers to seek recoupment, primarily because it is relatively rare that there are case determinations that unambiguously establish that the conduct exclusions have been triggered. Another reason it is relatively rare for D&O insurers to seek recoupment is that usually by the time that things have progressed to the point that the insurer can seek recoupment, there often are no longer any assets from which a recoupment might be obtained. Yet another reason why D&O insurers often hesitate to seek recoupment is that it can be a poor public relations move to seek to reclaim amounts that have been paid – however, it could be argued that these constraints may be less compelling where as here the insureds’ senior executives have pled guilty to a massive multiyear effort to defraud the government.

The courts are relatively uniform in affirming the insurer’s right to seek recoupment where express policy language specifies the insurer’s recoupment right. The courts are more divided on the carrier’s right to recoupment where the sole basis on which the carrier asserts its right to do so is its own reservation of the right at the outset of the claim. Some courts have even taken the position that recoupment or reimbursement is prohibited in the absence of an express policy provision in the insurance contract preserving those rights.

 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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