A federal court in Virginia recently held that an insurer had no duty to defend its insured after the insured’s employees entered guilty pleas related to fraud committed by the company, and that the insurer could recoup defense costs previously incurred in defending the insured.Protection Strategies, Inc. v. Star Indemnity & Liability Co., 2014 WL 1655370 (E.D. Va. Apr. 23, 2014)

After the U.S. Attorney’s office began investigating the insured for allegations of fraud in connection with the insured’s participation in the Small Business Administration Section 8(a) program, the insurer began defending the insureds and its employees. The insured filed a declaratory judgment action to determine when the “claim” with regard to the investigation had first been made. Four of the employees later entered guilty pleas, and the insurer immediately amended its answer and asserted a counterclaim for declaratory relief, seeking a declaration it had no duty to defend the insured or its employees based on multiple policy exclusions related to the employee’s guilty pleas. 

Granting the insurer’s motion for summary judgment, the court held that, in light of the employees’ guilty pleas, the entire investigation fell within the policy’s exclusion for “improper or illegal remuneration” and “any deliberate or fraudulent act” and that the insurer was entitled to recoupment of defense costs already incurred. The court found that the claims were also precluded by the policy’s prior knowledge exclusion, and a separate warranty letter from the insured attesting that neither the insured nor its employees had any knowledge of any potential claim. The court further found that the insured was entitled to recoupment of past defense costs because the policy expressly so provided.