In a victory for policyholders, a New York trial court rejected insurers’ summary judgment arguments, ruling that an insurer must establish a common “fact, circumstance, situation, transaction or event” underlying an investigation before it can rely on a prior and pending litigation and investigation (“PPLI”) exclusion based on that earlier investigation. The court further ruled that the insurer cannot base its coverage denial on a common “fact, circumstance, situation, transaction or event” learned during the investigation.

In Freedom Specialty Insurance Co. v. Platinum Management (NY), LLC, the policyholder, Platinum Management, sought insurance coverage for an SEC proceeding and criminal prosecution arising out of its alleged involvement in a Ponzi-like scheme (along with coverage for related entities and officers and owners). The insurers filed suit seeking a declaration that they had no duty to defend or indemnify, and moved for summary judgment based on a PPLI exclusion, which provided in pertinent part:

The Insurer shall not be liable to make any payment for Loss in connection with a Claim made against any Insured based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving:

(1) any prior or pending litigation, administrative or arbitration proceeding, or investigation as of November 20, 2015, or

(2) any fact, circumstance, situation, transaction or event underlying or alleged in such litigation, administrative or arbitration proceeding or investigation,

regardless of the legal theory upon which such Claim is predicated.

There, the operative “prior or pending litigation … or investigation” was an investigation and prosecution of Platinum’s founder for allegedly bribing the president of the Correction Officers Benevolent Association in order to secure an investment

The parties agreed that to determine whether the exclusion applied, the court was obligated to undertake a “side-by-side review,” comparing facts that occurred before November 20, 2015, with facts alleged in the underlying Ponzi-scheme prosecution, “[i]n order to ascertain whether a sufficient factual nexus exists.”

The court, however, disagreed that it was obligated to take such a “side-by-side review.” The court ruled that in New York state court (as opposed to next door in federal court), a “side-by-side review” is appropriate only where allegations made in a prior pending litigation bear on the exclusion provision. In a case like this, where the insurer sought to deny coverage based on a prior investigation, “to allow an insurer to establish facts regarding an investigation through (as [the insurers] seek[] to do here) subsequent allegations based on that investigation, would circumvent the insurer’s burden on summary judgment.” Rather, to deny insurance coverage based on a nexus with a “fact, circumstance, situation, transaction or event underlying … [a prior] investigation,” the insurer must at minimum show, as a matter of law, that (a) there existed an investigation prior to the operative date, (b) there was a common “fact, circumstance, situation, transaction or event” between that investigation and the subsequent litigation, and (c) this common “fact, circumstance, situation, transaction or event” was one that was “underlying” the prior investigation, under a strict and narrow interpretation of that term. The court concluded that it would be necessary for the insurer to show that a sufficiently common “fact, circumstance, situation, transaction or event” underlies both the Government’s earlier bribery investigation and the alleged Ponzi-like scheme prosecutions and proceedings

Turning to the evidence submitted, the court determined there were no indications that, as of the operative date, the investigation in any way included a fact, circumstance, situation, transaction or event concerning a Ponzi-like scheme within Platinum, as the prosecution ultimately charged. Thus, the court determined that the insurers had not met their burden of showing that a sufficiently common “fact, circumstance, situation, transaction or event” underlies both the Government’s earlier bribery investigation and the alleged Ponzi-like scheme prosecutions and proceedings

The Freedom Specialty decision underscores the strict application that should be afforded to exclusions such as the PPLI exclusion at issue here. Under that proper construction and application, insurers should not be able to broadly rely on subsequent allegations arising out of an investigation to meet their burden of showing a common “fact, circumstance, situation, transaction or event” to deny coverage. Rather, insurers should be required to establish that the common “fact, circumstance, situation, transaction or event” actually underlies the prior investigation.