In Protection Strategies, Inc. v. Starr Indemnity & Liability Co., the U.S. District Court for the Eastern District of Virginia allowed an insurer to recoup more than $670,000 in costs paid for the insured first to respond to government subpoenas and then for the insured and its key employees to defend themselves against claims for governmental fraud and conspiracy.
Protection Strategies, Inc. (the insured) is a global security management and consulting company. In 2003, the insured formed a shell company to obtain certifications and win government contracts that the insured would not otherwise be qualified to receive. As a result of this scheme, the shell company received more than $31 million in U.S. government contracts, with more than $5 million of those funds flowing to the insured.
In January 2012, the insured received both a subpoena and a search and seizure warrant, which noted that the U.S. government was seeking evidence of violations of 18 U.S.C. Section 287 for false claims, conspiracy, false statements, major government fraud, mail fraud and false statements to the Small Business Administration. In February 2012, several of the insured’s officers were told they also were targets of the investigation. The insured reported the claim to its D&O carrier, Starr Indemnity & Liability Co. (Starr). Starr sent the insured a reservation of rights letter and began reimbursing the insured for its costs of defense. As the insured was obligated to indemnify its officers for their defense costs, Starr also reimbursed those monies.
In 2013, four of the insured’s officers entered plea agreements to crimes including major fraud against the United States, conspiracy to commit fraud and bribery. As part of the plea agreements, the officers admitted to setting up the shell corporation and further stipulated that each “knowingly and willfully took actions in furtherance of this fraud from 2003 until the investigation began in 2012.” [Emphasis in opinion.] After final judgment was entered, each of the officers was sentenced to a term of incarceration.
Starr Seeks Recoupment of Fees
After the officers entered the plea agreements, Starr filed a claim for recoupment against the insured, contending that no coverage existed for the investigation and defense costs incurred by the insured and its officers. Starr cited to three specific exclusions and the insurance application submitted by the insured. Those exclusions are as follows:
This policy shall not cover any loss in connection with any Claim
(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;
(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;
(d) alleging, arising out of, based on, or attributable to any facts or circumstances of which an Insured Person had actual knowledge of, as of the Pending or Prior Date set forth in Item 6 of the Declarations as respects this coverage section, and that he or she reasonably believed may give rise to a Claim under this policy.
Importantly, the policy also stated that for purposes of applying exclusions (a) and (b), “the knowledge possessed by, or any Wrongful Act committed by, an Insured Person who is a past or current [chief executive officer] … shall be imputed to the Company.”
Guilty Pleas Trigger All Cited Coverage Exclusions
The court held that the admissions contained within the guilty pleas triggered all of the above-cited coverage exclusions. The plea agreement admissions established that the insured and its officers “knowingly, intentionally and improperly gained an advantage and illegal remuneration of at least $31 million by fraudulently creating” a shell corporation. The admission that the bad acts stretched back as far as 2003 demonstrated that the claim arose out of facts and circumstances about which the insured and its officers were aware at the time the policy was issued.
Additionally, the insured provided a warranty letter in connection with the application for insurance that represented that “[n]o person or entity proposed for insurance under the policy … has knowledge or information of any act … which might give rise to a claim(s), suit(s), or action(s) under such proposed policy” and further stated that if any such “knowledge or information exists, then … any claim(s), suit(s) or action(s) arising from or related to such knowledge or information is excluded from coverage.” [Emphasis in opinion.] The court ruled that Starr relied on this representation in issuing the policy, and that the terms of the warranty letter constituted a material misrepresentation.
Recoupment of All Costs Held To Be the Appropriate Remedy
The insured attempted to avoid payment of recoupment costs by arguing that recoupment, categorically, was improper in a duty to defend policy. Alternatively, the insured argued that recoupment should be limited to only those payments made after the guilty pleas were entered. The court rejected both arguments and held that Starr could recoup all defense costs paid in connection with both the original investigation and then the defense of the insured and its officers.
The court noted that a split of opinion existed regarding whether a reservation of rights letter was sufficient to reserve a right to recoupment, but noted that Starr’s policy contained a specific provision allowing recoupment in its General Terms & Conditions. That provision stated that “… in the event and to the extent that the Insureds shall not be entitled to payment … such payments by the Insurer shall be repaid to the Insurer by the Insureds.” [Emphasis in opinion.] The court noted similar holdings by numerous other courts, each of which enforced recoupment as a remedy when specifically included in an insurance policy. The court further opined that recoupment of all costs was appropriate, as the policy unambiguously stated the cited exclusions applied to “any Loss in connection with” an excluded claim. Thus, while the exclusions required a “final judgment or adjudication” to be triggered, nothing about the policy language suggested that the timing of such a “final judgment or adjudication” would impact Starr’s payment obligation.
The insured finally argued that other employees and officers were investigated, making some portion of the incurred defense costs allocable to those persons. The court rejected the premise of this argument, holding that the other persons were not the subject of any “claim” as defined by the policy and were simply questioned as part of the investigation against the insured and the charged officers. Further, even if some claim existed as to these persons, all losses flowing from such claims would be “in connection with,” “arising out of,” and “attributable to” the uncovered claims and would therefore be similarly uncovered.
Protection Strategies, Inc. highlights several issues for both carriers and policyholders dealing with government investigations and prosecutions. First, carriers and policyholders should carefully analyze the terms of coverage and exclusions to ascertain the conditions under which coverage might be negated. This is particularly true in the context of a criminal investigation, where the applicability of “crime/fraud” exclusions will be determined at a future point in time. Second, carriers and policyholders need to examine carefully the contractual remedies for a later-established coverage exclusion. Under some policies, recoupment may be a remedy created within the policy. In some jurisdictions, recoupment may be an available remedy, even when not included in the policy.