Earlier this summer, the U.S. District Court for the Central District of California, Western Division held that an arbitrator's determination in an underlying claim triggered the intentional acts and personal profit exclusions in both a D&O and E&O policy. The Court held that the arbitrator’s conclusions not only established the excluded behavior as a matter of fact, but also satisfied the D&O policy’s final adjudication requirement. The Court then concluded that the insured was required to reimburse defense costs paid by both the D&O and E&O insurers. Greenwich Ins. Co. v. Media Breakaway, LLC, No. 08-cv-00937 (C.D. Cal. July 22, 2009).

The Insureds, Media Breakaway, LLC and its CEO, were sued by MySpace, Inc., for allegedly sending spam mail through MySpace users’ accounts without the users’ knowledge, by a process called “phishing” (the misappropriation of users’ login names and passwords), or by acquiring “phished” information from other sources. The Insureds’ D&O and E&O insurers provided coverage for the defense of the “phishing” Claim pursuant to a reservation of rights. The “phishing” Claim was eventually arbitrated. In the arbitration award, the arbitrator determined that the Insured “permitted, encouraged, supported and benefited from spamming, illegal spamming on the MySpace network.” According to the District Court, “[t]he arbitrator [also] clearly found that defendants obtained profits from their phishing scheme to which they were not legally entitled.”

Based on the arbitrator’s findings, the D&O and E&O insurers sought a declaration from the District Court that the intentional acts exclusion and personal profit exclusion in both policies applied to exclude coverage for the “phishing” Claim. Of note, the D&O policy required a final adjudication in the underlying action or in a separate action or proceeding of the intentional act or personal profit in order for the exclusions to apply. The E&O policy did not contain similar limitations.

In granting summary judgment the Court first determined that the arbitration award had a preclusive effect on the declaratory judgment action as: (1) the issue at stake in the declaratory judgment action, the Insured’s dishonest acts and personal profit, was identical to the issued alleged in the “phishing” Claim; (2) the issue was actually litigated in the arbitration proceeding; and (3) the determination of the issue was a critical and necessary part of the judgment in the arbitration.

The Court next considered whether the arbitrator’s conclusions triggered the exclusions in both the D&O and E&O policies. With respect to the D&O policy, the Court determined that both exclusions should apply, citing the arbitrator’s conclusion that the Insured engaged in intentionally dishonest and illegal activity and that the Insured improperly gained from that activity. The Court also concluded that the D&O policy required Media Breakaway to repay defense costs once it was determined that there is no coverage. The Court also noted that Media Breakaway did not object when the D&O insurer reserved its right to recover such defense costs. The Court ruled, therefore, that Media Breakaway was required to reimburse the D&O insurer for those costs.

The Court similarly determined that the exclusions in the E&O policy applied to bar coverage. While the E&O policy did not contain the reimbursement language contained in the D&O policy, the Court nevertheless concluded that the E&O insurer was entitled to the reimbursement of defense costs because the insurer had tendered a defense to Media Breakaway with an express reservation of its right to seek reimbursement, to which Media Breakaway did not object.

Media Breakaway has appealed the Court's decision to the U.S. Court of Appeals for the Ninth Circuit.

A copy of the Court’s opinion can be found here.