Alstrin v. St. Paul Mercury Insurance
2002 U.S. Dist. LEXIS 719, 2002 WL 59067, 179 F. Supp. 2d 376 (2002)
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Rule of Law:
When an insurance policy unambiguously creates two distinct lines of coverage, one 'going-forward' and one 'run-off,' with separate endorsements and premiums, the endorsements specific to the run-off coverage control, precluding the application of general policy endorsements. Furthermore, broad policy exclusions for 'deliberate fraud,' 'illegal profit or advantage,' and 'prior notice' are generally inapplicable to D&O claims for securities fraud or breach of fiduciary duty if they would effectively nullify the explicit coverage granted, and an 'insured v. insured' exclusion does not bar claims by a bankruptcy estate representative who acts as a genuinely adverse party to the former directors and officers.
Facts:
- In 1981, Irwin Cole and Sidney Taylor formed Cole Taylor Financial Group, Inc. (CTFG) as a holding company for commercial banking institutions.
- By the mid-1990s, the Taylor family members (Jeffrey, Bruce, and Sidney Taylor) held top leadership roles at CTFG.
- CTFG operated as a holding company for three subsidiaries, including Reliance Acceptance Corporation (RAC), which rapidly grew its subprime auto loan business from 1993 to 1996.
- From 1995 to 1996, CTFG's board allegedly received reports from the Federal Reserve Bank and internal audits indicating significant problems with RAC's loan portfolio, including high staff turnover and improper credit checks, leading to rising loan losses.
- CTFG was accused of issuing false and misleading financial statements during this period that inflated RAC's assets and earnings by understating loan loss reserves.
- On February 12, 1997, CTFG executed a "split-off transaction," spinning off Cole Taylor Bank and CT Mortgage Company and retaining control of RAC.
- After the split-off, CTFG changed its name to Reliance Acceptance Group, Inc. (RAG).
- On February 9, 1998, less than a year after the split-off, RAG filed for Chapter 11 bankruptcy due to escalating financial losses.
- National Union Fire Insurance Company issued a D&O policy to RAG, effective February 12, 1997, which included both "going forward coverage" for RAG and "Run-Off Coverage" (in Endorsement 17) for CTFG's former officers and directors for acts committed on or before February 12, 1997. This Run-Off Coverage was intended to be excess over an existing D&O program led by St. Paul.
- J. Christopher Alstrin, Melvin Pearl, Jeffrey Taylor, Bruce Taylor, and Sidney Taylor (D&O plaintiffs), as former officers and directors of CTFG/RAG, became defendants in securities class actions and related bankruptcy adversary proceedings and sought coverage from National Union for their legal liabilities.
Procedural Posture:
- Shareholders of RAG initiated class action lawsuits in federal courts in Texas and Illinois, suing officers, directors, and other entities involved in CTFG/RAG, alleging violations of securities laws and other state laws (early 1998).
- The Estate Representative of RAG's Chapter 11 bankruptcy filed two adversary proceedings in the U.S. Bankruptcy Court for the District of Delaware against many of the same defendants, alleging fraudulent transfer and breach of fiduciary duty (September 4, 1998).
- The U.S. District Court for the District of Delaware ordered the consolidation of these adversary proceedings and withdrew the reference from the bankruptcy court (July 15, 1999).
- The Judicial Panel on Multidistrict Litigation transferred the Texas and Illinois class actions to the U.S. District Court for the District of Delaware for consolidated pre-trial proceedings with the adversary proceedings (December 9, 1999).
- J. Christopher Alstrin and other former officers/directors of RAG (D&O plaintiffs) filed a complaint in the U.S. Bankruptcy Court for the District of Delaware, seeking a declaration of their rights under various D&O insurance policies (May 29, 1998).
- The U.S. District Court for the District of Delaware withdrew the reference of this insurance coverage case from the bankruptcy court (July 27, 1999).
- The D&O plaintiffs amended their complaint, adding National Union Fire Insurance Company as a defendant and expanding their claims (April 14, 2000).
- National Union filed a motion to dismiss or stay the action and compel arbitration, but later withdrew the motion (June 16, 2000).
- The D&O plaintiffs filed a second amended complaint, which included more detailed allegations against National Union (May 16, 2001).
- National Union filed its answer to the second amended complaint, asserting numerous affirmative defenses based on policy exclusions and counterclaims (May 25, 2001).
- The D&O plaintiffs moved for partial summary judgment on National Union's defenses relying on nine policy exclusions (July 11, 2001).
- The U.S. District Court for the District of Delaware held oral argument on the D&O plaintiffs' motion for partial summary judgment (November 14, 2001).
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Issue:
Does a D&O insurance policy's 'Run-Off Coverage' endorsement, which contains its own set of specific endorsements and operates distinctly from the policy's general 'going-forward coverage,' preclude the application of the general policy's earlier endorsements and certain policy-form exclusions (e.g., for deliberate fraud, illegal profit, prior notice, and insured v. insured) to claims asserted against former directors and officers?
Opinions:
Majority - McKelvie, District Judge
Yes, the internal endorsements within the "Run-Off Coverage" endorsement are the only ones applicable to that coverage, and the general policy's exclusions for deliberate fraud, illegal profit, and prior notice do not defeat coverage for the claims, nor does the insured v. insured exclusion apply to claims brought by a bankruptcy estate representative. The court found Endorsement 17 (Run-Off Coverage) to be unambiguous, structuring it as a "policy within a policy." It had a different named insured (CTFG vs. RAG), its own internal set of endorsements in Section XI (some duplicating earlier general endorsements), and a separate premium. The court reasoned that the repetition of certain general endorsements verbatim within Endorsement 17's Section XI indicated the parties' intent that the general endorsements (1-16) did not apply to the Run-Off Coverage, as applying both would render the repetitions superfluous. Furthermore, some general endorsements, such as the prior acts exclusion (Endorsement 5) and the cross-claim exclusion for CTFG claims (Endorsement 12), would be "flatly inconsistent" with the core purpose of the Run-Off Coverage, which was to cover acts occurring on or prior to the split-off date for CTFG's D&Os. The court rejected National Union's argument for a selective, "by implication" application of endorsements, stating, "A policy is a contract — not a puzzle." Regarding Exclusion 4(c) (deliberate fraud), the court held that applying it to explicitly covered "Securities Claims" would "eviscerate coverage for the majority of securities claims," rendering the policy illusory and contrary to the reasonable expectations of an insured purchasing a D&O policy. This interpretation was supported by similar cases where intentional act exclusions did not override specific grants of coverage. For Exclusion 4(a) (illegal profit or advantage), the court found that the securities fraud and breach of fiduciary duty complaints did not allege that the "profit or gain itself" was illegal, but rather that illegal acts (false disclosures, breach of duty) incidentally produced a profit. The exclusion requires a profit or gain that is inherently illegal (like insider trading), not merely a byproduct of illegal conduct. However, the court denied summary judgment on this exclusion for fraudulent transfer claims. Exclusion 4(d) (prior notice under prior policy) was found inapplicable because the National Union policy was not a "renewal, replacement, or successor in time" to the St. Paul program, as both policies ran concurrently for a period. Finally, Exclusion 4(i) (insured v. insured) was deemed inapplicable to claims brought by the RAG Estate Representative. The court found that the Estate Representative, acting on behalf of creditors, is a distinct and "genuinely adverse party" to the former directors and officers, thus negating the primary purpose of the exclusion, which is to prevent collusive lawsuits.
Analysis:
This case provides crucial guidance on interpreting complex D&O insurance policies, particularly those with layered coverage and specific endorsements for "run-off" liability. It reinforces the principle that courts will construe insurance contracts to uphold the reasonable expectations of the insured and avoid rendering explicit coverage grants illusory through overly broad exclusionary clauses. The decision also clarifies that a bankruptcy estate representative is generally considered an adverse party for "insured v. insured" exclusions, preventing insurers from denying coverage in insolvency contexts where collusion is not a threat. This approach protects D&O coverage for directors and officers facing claims in bankruptcy or securities litigation, potentially increasing the availability of funds for creditors and shareholders.
