Federal Insurance Co v. Raytheon Company
2005 U.S. App. LEXIS 22742, 426 F.3d 491, 36 Employee Benefits Cas. (BNA) 1333 (2005)
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Rule of Law:
An insurance policy's prior and pending litigation exclusion, which applies to claims 'based upon, arising from, or in consequence of ... the same or any substantially similar fact, circumstance or situation underlying or alleged' in a prior proceeding, excludes coverage when there is a substantial overlap in the factual allegations between the subsequent complaint and the prior complaint.
Facts:
- On October 12, 1999, the Wall Street Journal published an article reporting that Raytheon Company (Raytheon) experienced undisclosed cost overruns and delays on many defense-related contracts.
- Later that day, Raytheon reported one-off charges totaling $638 million and reduced earnings expectations, which caused a sharp decline in Raytheon’s stock price.
- On October 19, 1999, a class action (the 'Securities action') was filed against Raytheon and several of its senior officers, alleging that Raytheon issued materially false and misleading statements regarding its financial performance from October 7, 1998, to October 12, 1999, including undisclosed losses on major contracts and cost overruns on defense projects.
- In May 2003, a second class action (the 'ERISA action') was filed against Raytheon and several of its officers and employees, alleging breach of fiduciary duty related to Raytheon’s Savings and Investment Plan.
- The ERISA complaint included factual allegations mirroring those of the Securities complaint regarding pre-October 12, 1999, misdeeds, such as Raytheon stock being overvalued due to cost overruns and improper accounting for losses and revenues.
- The ERISA complaint also included substantial allegations not found in the Securities complaint, such as post-October 12, 1999, accounting irregularities, SEC investigations, and specific ERISA-related facts like the defendants' fiduciary status and communication with Plan beneficiaries.
Procedural Posture:
- On October 19, 1999, a class action (the Securities action) was filed against Raytheon Company and several of its senior officers in the District of Massachusetts.
- In May 2003, a second class action (the ERISA action) was filed against Raytheon and several of its officers and employees in the District of Massachusetts.
- After the ERISA action was filed, Raytheon sought coverage from Federal Insurance Company and Axis Surplus Insurance Company under their respective liability insurance policies.
- The insurers denied coverage and subsequently filed suits for declaratory judgment of non-coverage against Raytheon in the District of Massachusetts (trial court), invoking diversity jurisdiction.
- The District Court (trial court) granted the insurers' motion for judgment on the pleadings, holding in an oral decision that coverage was excluded under the prior and pending litigation exclusion clauses of both policies due to overlapping allegations.
- Raytheon appealed the final judgment of the District Court to the United States Court of Appeals for the First Circuit.
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Issue:
Does an insurance policy's prior and pending litigation exclusion, which applies to claims 'based upon ... the same or any substantially similar fact, circumstance or situation underlying or alleged therein,' exclude coverage for a subsequent class action when there is substantial factual overlap between the allegations of the subsequent complaint and those of a prior class action, even if parties and legal theories differ and the subsequent complaint includes some new allegations?
Opinions:
Majority - Dyk, Circuit Judge
Yes, an insurance policy's prior and pending litigation exclusion applies to exclude coverage for a subsequent class action if there is a substantial overlap in the factual allegations between the two complaints. The court held that the phrase 'based upon, arising from, or in consequence of ... the same or any substantially similar fact, circumstance or situation underlying or alleged therein' means that the allegations in the second complaint must find substantial support in the first complaint, implying a substantial factual overlap. Consulting dictionary definitions, 'based' signifies using something as a foundation or logical basis, which necessitates a significant, though not complete, overlap. This interpretation supports the policy's objective of preventing adverse selection, where an insured seeks coverage for an already known risk. Despite differences in legal theories, parties, and the inclusion of some new allegations in the ERISA complaint, the court found 'little doubt' that a substantial part of the operative facts alleged in the ERISA complaint mirrored those in the Securities complaint. Raytheon's counsel even conceded that ERISA plaintiffs 'cut and pasted a lot of the factual allegations from the securities lawsuit.' Therefore, coverage under the Federal policy, and consequently the Axis excess policy, was properly excluded.
Dissenting - Howard, Circuit Judge
No, the majority's interpretation of the exclusion is flawed because it is both over-inclusive and under-inclusive, leading to an inequitable outcome. Judge Howard argued that the majority's formulation denies the insured defense and indemnification for claims made within the policy period that were never the subject of a prior demand or suit, even if asserted in a complaint containing some overlapping facts. Conversely, it could, in other cases, force the insurer to indemnify for claims entirely based on pre-policy purchase allegations if the overall 'overlap' isn't deemed 'substantial' by the majority's standard. The dissent contended that while the policy defines 'claim' as an entire lawsuit, this applies best when a lawsuit is based on a single 'Wrongful Act.' In situations with multiple alleged 'Wrongful Acts,' only some of which were previously asserted (as in this case, where only one of four categories of 'Wrongful Acts' from the ERISA complaint was in the Securities complaint), the definition should regard individual liability theories arising from each 'Wrongful Act' as the relevant 'claim.' This approach would better reflect the parties' reasonable expectations and would, in this case, trigger a duty to defend for the non-overlapping ERISA claims, such as those related to post-1999 conduct or specific ERISA fiduciary duties.
Analysis:
This case provides crucial precedent for interpreting 'prior and pending litigation' exclusions in liability insurance policies, especially regarding the 'substantially similar fact, circumstance or situation' language. By establishing a 'substantial overlap' standard for factual allegations, the court sought to balance insurer protections against adverse selection with insureds' reasonable expectations of coverage. The decision highlights that even with different legal theories and parties, significant factual commonality can trigger the exclusion. Future litigation will likely focus on the quantitative and qualitative aspects of what constitutes 'substantial overlap,' making this a highly fact-intensive inquiry. The dissent's argument for differentiating 'claims' by 'wrongful acts' rather than viewing the 'entire lawsuit' as a single claim remains a significant alternative interpretive approach in this area of insurance law.
