Will Fiduciary Liability Insurance Cover Severance Agreement Payments If The Company Can’t Make Them?

| William A. Schreiner, Jr.

We write frequently about severance pay for executives – a subject near and dear to the hearts, and wallets, of executives and the companies that hire and fire them.  Today, we’re going to take this a step further – beyond the severance agreement itself – and look at an interesting case that raises the question of whether a company’s severance payments to an executive are covered losses under that company’s fiduciary liability insurance if the company becomes unable to make those payments. 

It’s a neat case from a lot of perspectives, even if there aren’t too many clear answers.  It’s an interesting issue for companies that enter into severance agreements and then can’t follow through with the money due to a bankruptcy.  Today’s case is especially relevant for us at Suits by Suits because the policyholder is a law firm that – gasp! – went into liquidation, and the executive claiming the severance benefits is a former partner at the firm.  Personally, I like it because the focus of my work is insurance coverage disputes like this – figuring out what’s covered (or not) under insurance policies.

The basic alleged facts, as set out in the law firm’s suit against its fiduciary liability insurer, are these.  Michael Budin left the WolfBlock law firm in 2003, with a severance package that required the firm to pay him almost $27,000 per year for fifteen years.  Everything was fine until 2009 – when WolfBlock, hammered by the Great Recession, voted to liquidate itself after over 100 years in the business, and stopped making the payments.  Budin filed suit against the firm in Pennsylvania state court. 

WolfBlock made a claim under its fiduciary liability policy, seeking coverage – a defense against Budin’s suit and indemnity against any settlement or judgment in it (defense and indemnity are the hallmarks of liability insurance) – of the suit.  The fiduciary liability insurer, Federal Insurance Company, declined coverage.

The insurer’s denial relied on two key phrases in its policy with WolfBlock.  At its core, fiduciary liability policies protect a business for accidents or negligence – “Wrongful Acts” – in its management of employee benefit, retirement, profit-sharing, or health and welfare plans.  The policies necessarily rely in part on how these plans are defined in the Employee Retirement Income Security Act (ERISA), which governs many – but not all – of these types of plans.  Here, Federal Insurance denied the claim because, in its view, the policy’s coverage only includes claims arising out of “Sponsored Plans” that fall under ERISA, and it doesn’t think Budin’s agreement qualifies.  Additionally, Federal contends that even if Budin’s severance agreement was a “Sponsored Plan” under the policy, there wasn’t a “Wrongful Act” – again, an accident or negligence – on WolfBlock’s part: the firm simply chose not to continue making payments it had agreed to make.  Based on this denial, the insurer hasn’t paid the lawyers defending WolfBlock against Budin’s suit, and it says it won’t pay any settlement or judgment in the case. 

WolfBlock, of course, disagreed with Federal.  The law-firm-in-liquidation spent a few years in a letter-writing battle with the insurer before filing suit against it in Pennsylvania state court. 

Who will win?  Well, we never like to predict outcomes here at Suits by Suits, but we can build a little bit on the issue framing the parties have already done.  The policy’s definition of “Sponsored Plan” – which is not set out in WolfBlock’s complaint – will be critical here.  The law firm argues that its severance agreement with Budin, coupled with the fact that he was four years’ shy of being eligible for the firm’s partner retirement plan, makes the severance agreement “capable of interpretation as a pension benefit plan sponsored by WolfBlock” and therefore subject to ERISA.  While it’s true as a general matter that phrases in an insurance contract that are ambiguous will be construed in favor of coverage and against the insurer, there are limits – applied on a case-by-case basis – to how far a policy’s terms can be stretched by “capable” interpretations. 

Much will depend on the exact policy language here, and how it addresses severance agreements – if it does at all.  Even outside of the insurance field, whether a severance agreement is a “plan” under ERISA is often in dispute.  In Fort Halifax Packing Co. v. Coyne, the Supreme Court tried to provide some clarity by holding that a one-time severance payment after a plant closure was not a plan under ERISA because it didn’t have an ongoing administrative component – but it’s not at all clear if that’s the only test for a covered plan. 

Until we know how this case turns out, the takeaway for executives concerned about getting their severance pay in the event of a corporate meltdown, and the companies that want to avoid disputes like WolfBlock is having, is this: as you think about the risks your business faces and how to insure, mitigate, or ignore those risks, talk to your insurance broker or agent about coverage for severance agreements.  As with anything to do with insurance policies, the time to have that conversation is before you are faced with a claim.  

If you are interested in more information about legal issues involving executives and their employers, on December 10, 2013, Zuckerman Spaeder LLP partners and Suits by Suits contributing editors Ellen D. Marcus and Jason M. Knott will present a webinar titled “Whistleblower Watch: Big Issues in the Latest Whistleblower Cases Under Dodd-Frank, Sarbanes-Oxley, and the Internal Revenue Code.”  In the session, Ms. Marcus and Mr. Knott will discuss the basics of these whistleblower and anti-retaliation provisions and address new developments in the law, including the Sarbanes-Oxley case currently pending before the U.S. Supreme Court.  To register, click here.