Companies buy directors & officers (“D&O”) insurance policies with the intention of providing protection for key individuals in a corporate structure. The recent decision BioChemics, Inc. v. AXIS Reinsurance Co., from the U.S. District Court for the District of Massachusetts, illustrates the importance of the terms of the policy in determining what is covered, what is not, and when you should notify the insurer of a potential claim.
As we’ve previously discussed, an insurance policy can provide more reliable protection for the indemnification rights of the directors and officers in times of financial distress, because corporations plagued by regulatory or other legal problems frequently suffer financial setbacks. However, when a corporation is the subject of an official investigation, determining exactly what constitutes the start of a covered “claim” may be a matter of some delicacy.
In BioChemics, the court held that an SEC investigation and enforcement action was a single “Claim” under the insurer’s policy, and that the “Claim” was not covered because it was “first made” before the policy period. The SEC investigation at issue had many stages. First, in May 2011, the SEC issued a non-public formal order and served document subpoenas on BioChemics. At the time, BioChemics had D&O insurance from a separate insurer, Greenwich, on a “claims made” basis – meaning that the policy would cover claims first made against the directors and officers during that time.
In November 2011, BioChemics bought a new policy from AXIS, which “covered claims first made between November 13, 2011, and November 13, 2012.” BioChemics received more deposition and document subpoenas in 2012, at which point it notified AXIS of the claim and sought coverage under its November 2011 policy. In December 2012, the SEC filed an enforcement action against BioChemics and its CEO, and BioChemics sought coverage for that as well.
AXIS denied coverage on the ground that all of these events constituted a single claim that related back to the commencement of the non-public investigation, which predated the inception of the policy. BioChemics and its CEO then sued for defense costs, but the district court granted summary judgment to AXIS. The court noted that the policy defined the term “Claim” broadly to include any “civil, arbitration, administrative or regulatory proceeding against any Insured commenced by . . . the filing of a notice of charge, investigative order, or like document.” Further, “Claims” arising from “Interrelated Wrongful Acts” were deemed “one Claim” arising when “first made against an Insured under this Policy or any prior policy.”
After parsing this language, the court held that the subpoenas and enforcement action were all “part of a single SEC Investigation under the Formal Order”; “[e]ach subpoena was issued under, and referred to, the original Formal Order, and investigated the same officers and company for the same pattern of security violations through public material misstatements.” Because the Formal Order issued in May 2011 – before the inception of the AXIS policy – AXIS was not obligated to cover the SEC proceedings under its policy.
This is not the first time that a court has defined the term “claim” broadly to relate back to the first step in an enforcement action. For example, in Polychron v. Crum & Forster Insurance Companies, the president of a bank was acquitted in December 1998 after a lengthy investigation and trial. He sought coverage from the bank’s D&O insurer, which had issued a claims-made policy for the period between July 11, 1978 until July 11, 1985. The U.S. Court of Appeals for the Eighth Circuit held that all of the fees and expenses incurred in the president’s defense were part of the same “claim” that encompassed both the grand jury investigation, of which he was a target, and the resulting indictment and criminal proceedings.
The main unanswered question in the recent decision in BioChemics is: What happened to Greenwich, the insurer at the time of the Formal Order (when the “Claim” was made, according to the court)? One need only look to BioChemics’ complaint to find the answer. BioChemics alleges that its broker negligently moved its D&O coverage from Greenwich to AXIS without discussing whether BioChemics should report a claim to Greenwich before its coverage expired, and whether it might be able to buy extended coverage for claims under the Greenwich policies. Based on these allegations, the ship appears to have sailed on BioChemics’s coverage from Greenwich, leaving only the unsuccessful claim for coverage from AXIS and the negligence claim against the broker.
BioChemics and Polychron offer a clear takeaway for companies, officers, and directors. If an SEC or grand jury subpoena shows up on your doorstep, you should immediately confer with your broker and check your policies to see if the subpoena is potentially a covered “Claim” requiring notice to the insurer. Some policies, as broker Kara Altenbaumer-Price has written, may even cover “pre-claim inquir[ies].” If you are proactive about identifying and notifying your insurer of these potential claims, you’ll increase the chances of coverage for investigations and the expensive enforcement actions that may follow.