Why it matters

A letter stating that a government entity "may" bring an enforcement action against the policyholder if it did not "voluntarily" cease specified activity was a claim under a directors and officers (D&O) liability insurance policy, a panel of the Second Circuit Court of Appeals has ruled, allowing an insurer to deny coverage based on a prior and pending litigation exclusion. In 2012, an executive was indicted in federal court on fraud and conspiracy charges and turned to the company's D&O insurer for defense coverage. But the insurer relied upon the prior and pending litigation exclusion for "any demand, suit or other proceeding pending" against an insured, arguing that a 2007 letter from the Maryland Attorney General to the company precluded coverage. The letter accused the company of making false and deceptive statements, adding that the AG "may" bring an action if the activity did not stop. The federal appellate panel agreed with the insurer, holding that the letter constituted a demand or "an imperative solicitation for that which is legally owed" under New York law.

Detailed discussion

Multivend LLC purchased a directors and officers (D&O) liability insurance policy from Axis Surplus Insurance. The policy excluded coverage for "any Claim … in any way involving … any demand, suit or other proceeding pending … against any Insured on or prior to [February 20, 2008], or any Wrongful Act, fact, circumstance or situation underlying or alleged therein."

In November 2007, the Securities Division of the Maryland Attorney General's Office sent a letter to Multivend. The letter required the company to provide certain documents and information to determine the extent of Multivend's compliance with the Maryland Business Opportunity Sales Act.

Although the letter did not affirmatively state that the company was in violation of the state law, it did ask the company to "acknowledge in writing that it will immediately cease all offers and sales of [a] business opportunity to Maryland residents." The AG's office explained that the request was being made pursuant to its authority "to investigate and take action against any person who violates" the Act, including by bringing a civil action.

Multivend's failure to respond to the letter "may result in more formal legal action," the letter cautioned. Several years later, Edward Morris Weaver, the former CEO of Multivend, was indicted in Florida federal court by the Department of Justice on counts of conspiracy and fraud. Weaver tendered defense of the action to Axis, but the insurer refused, relying upon the prior and pending litigation exclusion and pointing to the 2007 letter.

Weaver filed a breach of contract action seeking a declaratory judgment that Axis was required to provide him with a defense because the AG's letter was not a "demand" within the meaning of the exclusion.

Affirming a federal court judge, the Second Circuit Court of Appeals looked to the definition of the term under New York law. As distinguished from a request carrying no legal consequences, "a demand requires an imperative solicitation for that which is legally owed," the panel explained, and the November 2007 letter met these requirements.

The AG's letter not only insisted that Multivend provide certain documents and information but acknowledge in writing that the company would cease activity in violation of state law. The letter also noted the AG Office's "authority to investigate and take action against any person who violates" the Act and that a failure by Multivend to respond could result in formal legal action.

"This was sufficient to make the November 2007 Letter a 'demand' because it set forth the Division's request under a claim of right, including its entitlement to the documents identified therein, and put Multivend on notice of the legal consequences of any failure to comply," the panel said.

Because the November 2007 letter constituted a "demand" as a matter of New York law, the Second Circuit said the policy's prior and pending litigation provision "unambiguously excluded coverage for Weaver's defense of the DOJ action on the grounds that it involves the same facts and circumstances as the Letter, which predated Section IV's Pending and Prior Claims Date. Accordingly, the district court correctly awarded summary judgment to Axis on this basis."

To read the summary order in Weaver v. Axis Surplus Insurance Co., click here.