Government Investigations: The Treacherous Path to Obtaining (and Keeping!) Defense Costs Paid Under D&O Policies

| Sara Alpert Lawson

"Bridge in disrepair"

For my first foray into blog-writing, allow me to tell a cautionary tale intersecting two of my favorite topics: defending companies and individuals in government investigations and Directors and Officers (D&O) Liability Coverage. As a contract junkie who enjoys reading, interpreting, and arguing contract language, parsing through various interrelated D&O policy provisions to glean favorable language for my white collar clients offers hours of amusement (lest ye be worried about me, I do have other hobbies).  D&O policies can be effectively used to defray defense costs incurred due to a government investigation.  The trick is keeping the money. 

The recent suit between Protection Strategies, Inc. (PSI) and Starr Indemnity & Liability Co. in the Eastern District of Virginia, case 1:13-cv-00763-LO-IDD, illustrates how difficult keeping the money can be. PSI is an Arlington, Va.-based defense contractor. In January 2012, PSI received a subpoena from the NASA Office of the Inspector General and a search warrant issued by the United States District Court for the Eastern District of Virginia.  On February 1, 2012, the NASA OIG executed the search warrant at PSI’s headquarters.  In addition to the company itself, several of PSI’s current and former officers were informed that they were also targets of the NASA OIG investigation. PSI retained Dickstein Shapiro to represent it and hired separate counsel to represent the individual targets and other company employees.

PSI’s D&O policy, issued by Starr, covered three categories (1) Losses incurred by an “Insured Person” (i.e. an executive of the company) in response to a Claim against that person, (2) Losses incurred by the “Insured” (PSI) to indemnify Insured Persons against Claims, and (3) Losses incurred by the Insured arising from Claims against the Insured itself. PSI sought coverage for defense costs incurred from indemnifying its Officers and for its own defense.  Starr initially took the position that the investigation did not constitute a “Claim” with respect to PSI because it did not meet the definition of Claim in the D&O Policy.  In a win for PSI, the court rejected that position and confirmed that the search warrant and subpoena did create a “Claim” against PSI as defined in the policy.  As a result, Starr began reimbursing PSI for its defense costs. Eventually, Starr advanced over $670,000 to PSI for defense costs incurred by PSI itself and by the corporate officers who were targets of the investigation.

But what the court giveth, the court may take away.  As the investigation concluded, PSI was not forced to take a guilty plea.  However, the four individual targets did plea to various crimes. Each guilty plea stipulated that the individual (an Insured Person under the Policy) knowingly and willfully took actions in furtherance of the alleged fraud. After Starr learned about the pleas, Starr sought declaratory judgment against PSI and its four Officers and recoupment of all defense costs on the basis that the guilty pleas rendered the entire investigation excluded from the insurance policy. The court agreed with Starr.  It concluded that certain policy exclusions applied, as a result of the Officers’ guilty pleas, and thus those exclusions completely barred coverage for the defense costs incurred to indemnify the Officers and defend PSI. 

Significantly, the Policy stated that in determining the applicability of the coverage exclusions, “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.” Thus, because the facts stipulated to in the plea agreement by the CEO barred coverage for the CEO, such coverage bar would also apply to PSI. The court thus granted summary judgment in Starr’s favor and held that Starr was entitled to recoup from PSI all funds advanced by Starr for the Officers’ and PSI’s defense.

What can we learn from PSI’s unfortunate journey? At least three points: (1) When negotiating a D&O policy, pay attention to the imputation of knowledge from the Insured Person to the Company and try to limit such imputation as much as possible; (2) when seeking defense costs under an insurance policy, keep the end game in mind because a favorable result for the company that leads to an unfavorable result for the former officers could result in returning funds to the insurance carrier, if you’re not careful; and (3) non-recourse settlements with the carrier are certainly the path of least resistance.