Insurance Coverage and the Financial CrisisFebruary 26, 2009

Thomas E. Birsic Peter N. FlocosPartner, Pittsburgh Partner, New York

Thomas M. Reiter Donald W. KielPartner, Pittsburgh Partner, Newark

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Presenters

Thomas E. Birsic, Moderator, a partner at K&L Gates, maintains an active trial, arbitration and counseling practice focused principally on insurance coverage and commercial disputes.

Donald W. Kiel, Presenter, a partner at K&L Gates, concentrates his practice on complex commercial litigation, including commercial insurance coverage litigation and counseling.

Thomas M. Reiter, Presenter, a partner at K&L Gates, concentrates his practice on representing businesses, with a particular emphasis on financial institutions, in complex insurance coverage matters and claims disputes.

Peter N. Flocos, Presenter, a partner at K&L Gates, whose practice concentrates on business and commercial disputes, including insurance coverage litigation and "deal litigation" disputes.

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Outline of Presentation

Types of investigations, lawsuits and losses faced by companies as a result of the financial crisis

Coverage afforded by Directors and Officers (D&O) policies

Coverage afforded by Errors and Omissions (E&O) policies

A discussion of selected “hot button” insurer coverage defenses with some thoughts on how to overcome these defenses

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Worldwide Financial Crisis Headlines

“Stanford Financial: SEC Accuses Texas Firm of CD Fraud,” U.S. News and World Report (Feb. 17, 2009)

“Worldwide Crisis Could Destroy Globalization,” The Herald (Glasgow) (Jan. 16, 2009)

“Madoff Investors to Sue UBS, HSBC, Medici, E&Y,” Reuters (Feb. 4, 2009)

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Worldwide Financial Crisis Headlines

"Livid Investors Launch a Volley of Lawsuits: Class Actions Mount Despite Uncertain Payouts for Those Who Lost Money," The Washington Post (Jan. 18, 2009)

"Criminal Crackdowns Brewing in Financial Services Sector Mess," Chicago Tribune (Jan. 12, 2009)

"Financial Crisis Spawning Lawsuits," Business Insurance (Nov. 17, 2008)

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What is the Financial Crisis?

Significant write-down of the value of corporate assets Dramatic declines in market values of major corporations Increased delinquencies, defaults and foreclosures Significant bankruptcies in financial services, retail and other

sectors Collapse of corporate deals resulting from credit crunch or

other circumstances Madoff (and other Ponzi scheme) fraud resulting in claims

against investment managers, advisors, etc.

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Who are the Parties suffering losses and liabilities?

Borrowers and investors Investment managers and advisers Hedge funds, mutual funds and other investment

vehicles Virtually all of corporate America Private equity firms Underwriters Auditors

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What are the actions being pursued?

Administrative enforcement actions Shareholder class actions Individual consumer and investor class actions “Commercial” disputes between industry

participants over failed deals, etc.

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Directors and Officers (D&O) Insurance

D&O coverage is a first line of defense for a host of claims and actions

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D&O Grant of Coverage PART A:

The Company shall pay, on behalf of the Insured Persons, Loss for which the Insured Person is not indemnified by the Organization and which the Insured Person becomes legally obligated to pay on account of any Claim first made against the Insured Person during the Policy Period for a Wrongful Act.

PART B: The Company shall pay, on behalf of the Organization, Loss for which the

Organization grants indemnification to an Insured Person, as permitted or required by law, and which the Insured Person becomes legally obligated to pay on account of any Claim first made against the Insured Person during the Policy Period for a Wrongful Act.

PART C: The Company shall pay, on behalf of the Organization, Loss which the

Organization becomes legally obligated to pay on account of any Securities Claim first made against the Organization during the Policy Period for a Wrongful Act.

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Private Company D&O Insurance Coverage

Part C — “Entity Coverage” — may be expanded to cover all “Claims” as defined by Policy.

Part C coverage may not be limited “Securities Claims.”

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Definition of “Wrongful Act”

Wrongful Act means:(a) any error, misstatement, misleading statement,

act, omission, neglect, or breach of duty committed, attempted, or allegedly committed or attempted by an Insured Person in his or her Insured Capacity, or for purposes of coverage under Part C, by the Organization; or

(b) any other matter claimed against an Insured Person solely by reason of his or her serving in an Insured Capacity.

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Definition of Loss

Loss means the amount the Insured Person (for purposes of Part A and B) or the Organization (for purposes of Part C) becomes legally obligated to pay on account of any covered Claim, including but not limited to damages, judgments, settlements, pre-judgment and post-judgment interest and Defense Costs.

Typically “Loss” will not include punitive damages, taxes, fines, penalty and the multiplied portions of damage awards. To the extent these items are insurable, they may be included by negotiation. Restitution may not be insurable.

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Definition of Defense Costs

Defense Costs means that part of Loss consisting of reasonable costs, charges, fees (including but not limited to attorneys’ fees and experts’ fees) and expenses incurred in defending any Claim and the premium for appeal, attachment and similar bonds.

Defense Costs in a D&O policy typically reduce the available policy limits.

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Potentially Applicable D&O Exclusions

Fraudulent/dishonest conduct Personal profit Known claims

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Errors and Omissions (E&O) Insurance

The wave of claims and actions also may trigger coverage under E&O insurance policies.

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E&O Overview

Overview of E&O Terms Differences between E&O and D&O Potential Claims that May Trigger E&O Coverage Potential Defenses

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What is E&O Coverage?

E&O is the “general rubric” used to describe many types of insurance that protect persons or entities that render “professional services” for liabilities arising from errors or omissions committed while rendering such services, usually for a fee or commission.

Terms vary widely by industry and often are narrowly tailored to “professional services” of particular industry.

Terms vary widely not only by industry, but also by insurer within an industry group.

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Typical E&O Insuring Agreement

“To pay on behalf of the Insured all sums which the Insured shall become legally obligated to pay as Damages resulting from any Claims first made against the Insured and reported to the Insurer during the Policy Period … for any Wrongful Act of the Insured or any other person for whose actions the Insured is legally responsible, but only if such Wrongful Act … occurs solely in the rendering or failure to render Professional Services.”

AIG, Mortgage Bankers/Mortgage Brokers E&O Insurance, 63530 (3/96).

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E&O v. D&O

The line between D&O and E&O is not always clear, and certain lawsuits may potentially trigger coverage under both lines of coverage.

“Professional Services” D&O policies generally exclude claims related to rendering of

“professional services.” E&O policies expressly afford coverage for “professional services.”

“Insured” D&O (directors and officers and, in limited circumstances, company

and/or employees). E&O policies often define “Insured” more broadly to include the

company itself, as well as directors, officers, employees, and third-parties for whose actions the Insured is legally responsible.

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Definition of “Professional Services”

Some policies define “professional services” generically: One policy defines Wrongful Act as certain errors or

omissions committed by the Insured “solely in the performance of or failure to perform professional services for others in the Insured’s Profession as stated in Item 1.A. of the Declarations.” London, Specimen SUA MCPL 04.

Many policies specifically define “professional services” based on industry of policyholder.

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Definition of “Professional Services”

Lenders (“the origination, sale, pooling and servicing of mortgage loans secured by real property …”).

Financial Services firms (“services that an Insured renders pursuant to an agreement with a customer or client, as long as the customer pays a fee, commission, or other compensation …”).

Investment Banks (“those services performed … by the Insured (or by any other person or entity for whose acts, errors, or omissions the Insured is … legally responsible) for, for the benefit of, or on behalf of a Customer … for a fee, commission or other consideration”).

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Claims That May Trigger E&O Coverage

Given wide array of potential claims and potential defendants, it is difficult to even begin to list the potential types of claims.

Imperative to compare specific allegations against specific policy language.

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Other Potentially Relevant Insurance Policies

DON’T FORGET ABOUT OTHER TYPES OF COVERAGE

General Liability Fiduciary Liability Employment Practices Liability Blanket Bonds Others

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Pathway To Accessing Insurance Coverage

Overview (6 Critical Areas) Is there an Insured? Is the standard of conduct covered? Is the type of conduct (sphere of business activity)

covered? Is the type of alleged injury covered? Is it a “Claim” and, if so, how many claims? Does the policyholder’s claims-related conduct limit

or eliminate coverage?

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THREE SELECTED ISSUES1. Standard Of Conduct

Is the Insured’s Conduct Sufficiently Egregious to Fall Outside Coverage?

Fraud/Dishonesty Exclusions/Limitations “Alleging” “In Fact” Final Adjudication (underlying claim v. coverage

action) Defense Costs (return thereof) The Adjectives (“deliberate,” “intentional,” “willful,”

“active” & “deliberate”)

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Standard Of Conduct

Imputation Public Policy/Uninsurable As A Matter of Law Misrepresentation/Recission

Common Law Severability/Scienter Policy Applications

Wrongful Act (Negligence) Continuity Date

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2. Disgorgement/Restitution

Common Law Policy Wording

Loss Definition Exclusions

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3. Claim-Related Issue

Do the facts surrounding the coercive action bring it within coverage?

Is it a “claim”? Investigations Proceedings Criminal Matters Foreign Pre-Claim Cost of Correction

Relatedness

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Claim-Related Issue

Why the Issue Matters Per Claim Self-Insurance Per Claim Limits/Sub-Limits Trigger Issue Telescoping Provisions Notice of Circumstance Stacking

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Claim-Related Issue

Exclusions Prior Notice Prior Made

Tests Policy Language Definitions (“Interrelated”/ “Related”) Wrongful Act vs. Claim Case Law Common Cause Other

Mixed Claims Insured v. Insured Exclusion

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Certain Purported “Conditions” to Coverage and Other Policy Provisions – D&O/E&O Policies Generally

“Notice” – insurer may claim that under the policy notice of the “Claim” itself must be given within some

time frame (promptly, as soon as practicable or some other formula)

notice of circumstances that may reasonably be expected to give rise to a “Claim” must be given within some time frame (promptly, as soon as practicable, some other formula)

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Certain Purported “Conditions” to Coverage and Other Policy Provisions – D&O/E&O Policies Generally

“Notice” Many jurisdictions, by statute or decisional law, will

not necessarily enforce “notice” provisions as written e.g., will not permit coverage to be forfeited unless the

insurer was materially prejudiced by the supposedly “late” notice

Easier if the policyholder simply avoids any insurer claims about “notice” by giving prompt notice under all potentially implicated policies

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Certain Purported “Conditions” to Coverage and Other Policy Provisions – D&O/E&O Policies Generally

Insurer may claim that under the policy, it has the right to approve incurrence of defense costs or approve insured’s defense counsel Insurer may claim that the insured is required to use pre-

approved “panel counsel” (at least for certain types of claims, e.g. “Securities Claims”)

Insurer may claim that “litigation guidelines” must be followed Insurer may claim that under the policy, it has the right to

“effectively associate” in the defense and/or settlement negotiations

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Certain Purported “Conditions” to Coverage and Other Policy Provisions – D&O/E&O Policies Generally

Insurer may claim that under the policy, the insured must “cooperate” with the insurer in connection with the defense Insurer may claim that under the policy, information requested

by the insurer must be provided by the insured Insurer may claim that under the policy, it has the right to

consent to any settlement Even if insurer consent is required, it is often the case that the

consent cannot unreasonably be withheld, at least so long as the insurer was given the right to “effectively associate” in the defense and/or settlement negotiation

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Certain Purported “Conditions” to Coverage and Other Policy Provisions – D&O/E&O Policies Generally

Potential issues regarding waiver of attorney-client privilege or work product in claims handling contexts Insurers contend that privilege or work product is

waived if communications between insured and its attorneys are shared with a broker– easier to avoid the debate simply by exercising caution about what is shared with a broker

Waiver issues also may exist if privileged or work product material about the underlying case is shared with the insurer itself

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Certain Purported “Conditions” to Coverage and Other Policy Provisions – D&O/E&O Policies Generally

ADR provisions mandatory mediation before suit binding arbitration

Governing law provisions Jurisdiction or venue provisions

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Other “Best Practices” – D&O and E&O Policies Generally Be able to show lack of prejudice to insurer from any purportedly

“late” notice (even though insurer may have the burden of proof) Protect the record so that insurer cannot plausibly accuse insured

of failing to provide reasonable cooperation or to provide legitimate information (being mindful of privilege-work product waiver issues)

Adequate documentation to support the necessity and reasonableness of the defense costs expended attorney bills expert witness bills other invoices (e.g., mock trial expenses) some type of record generated by counsel as to why the fees and

expenses were incurred (again being mindful of privilege-work product waiver issues)

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Conclusion

This presentation is necessarily summary in nature. Specific situations require careful consideration of

the facts, policy language and the law.

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Contact Information

To contact Thomas E. Birsic:

thomas.birsic@klgates.com

412.355.6538

To contact Donald W. Kiel:donald.kiel@klgates.com973.848.4064

To contact Thomas M. Reiter:

thomas.reiter@klgates.com

412.355.8274

To contact Peter N. Flocos:

peter.flocos@klgates.com

212.536.4025

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