Why it matters

When four executives accused of fraud entered guilty pleas, a Virginia federal district court held those pleas triggered four policy exclusions in the D&O policy and entitled the insurer to recoup defense fees it had advanced. The lesson for policyholders: be sure to consider all the possible ramifications of a guilty plea.

Detailed Discussion

Protection Strategies Inc. (PSI) is a global security management and consulting company. In 2012, the NASA Office of the Inspector General served a subpoena in conjunction with a search and seizure warrant from the local federal court. In addition to the company itself, several PSI executives were also targeted in the investigation, which revealed that executives created shell companies to win government contracts PSI would not otherwise have qualified for, yielding more than $31 million from the federal government.

As the investigation continued, four executives reached plea agreements for crimes ranging from major fraud against the United States to conspiracy to commit fraud to bribery. Each guilty plea stipulated that the officer knowingly and willfully took actions in furtherance of the fraud.

After the guilty pleas were entered, Starr Indemnity & Liability Co. sought a declaration that coverage for both the company and the executives was precluded by policy exclusions and sought recoupment of the over $670,000 already paid in defense costs.

The court granted Starr’s motion, ruling that the entire investigation fell within the policy’s exclusions and that the insurer was entitled to recoupment.

Four exclusions were triggered by the guilty pleas:

Section 3 of the policy contained three relevant exclusions, for claims: “(a) arising out of, based upon or attributable to the gaining of any profit or advantage or improper or illegal remuneration if a final judgment or adjudication establishes that such Insured was not legally entitled to such profit or advantage or that such remuneration was improper or illegal,” the profit exclusion; “(b) arising out of, based upon or attributable to any deliberate fraudulent act or any willful violation of law by an Insured if a final judgment or adjudication establishes that such act or violation occurred,” the fraud exclusion; and “(d) alleging, arising out of, based on or attributable to any facts or circumstances of which an Insured Person had actual knowledge or information of…and that he or she reasonably believed may give rise to a Claim under this policy,” the prior knowledge exclusion.

The plea agreements made clear that PSI executives “knowingly, intentionally, and improperly gained an advantage and illegal remuneration of at least $31 million,” the court held, and committed fraud against the U.S. government, triggering both the profit and fraud exclusions.

Turning to the prior knowledge exclusion, the court again found it “evident that each of the four PSI officers charged had actual knowledge…of an ongoing scheme to defraud the government.” Given this undisputed knowledge, “it can be said that the officers should reasonably have believed that a claim would result under the D&O policy.”

The final exclusion was found in a warranty and representation letter executed by the company CEO, in which he represented that “[n]o person or entity proposed for insurance under the policy referenced above has knowledge or information of any act…which might give rise to a claim(s), suit(s) or action(s) under such proposed policy.” Starr relied upon this misrepresentation when it granted the policy, the court said, and multiple officers clearly had knowledge of their fraudulent acts that would have given rise to claims under the policy.

The court dealt a final blow by ordering a full repayment of all defense costs advanced by Starr. By its express terms, the policy itself provided for recoupment as a remedy in the General Terms and Conditions.

To read the decision in Protection Strategies, Inc. v. Starr Indemnity & Liability Co., click here.