The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured . . . (c) arising out of, based upon or attributable to the committing of any deliberate criminal or deliberate fraudulent act by the Insured if a judgment or final adjudication or any binding arbitration proceeding adverse to the Insured(s) establishes that such deliberate criminal or deliberate fraudulent act was committed.
What happens when an insured has multiple criminal counts brought against him, goes to trial, and prevails as to some of the counts but is convicted as to others? Is there coverage in whole or in part for the defense costs incurred? In this setting, insurers often contend such an exclusion bars all coverage for the insured’s defense costs because of his conviction, irrespective of his exoneration on some of the counts. They are wrong, and a policyholder should not acquiesce to such a position of no coverage.
From an insurance perspective, a practical delineation can and should be made between covered and uncovered defense costs stemming from the criminal proceedings. Allocations are performed all of the time, and in this setting, unless policy language supports an argument for full coverage (see below), there should be no exception. The so-called personal conduct exclusion permits – - indeed, mandates – - at least an allocation as between costs incurred in connection with covered versus uncovered claims/counts and does not preclude coverage for “Loss” that does not arise out of established finally adjudicated “deliberate criminal or fraudulent act.” In a multiple count setting where the insured prevails as to at least some of the counts, at worst, a rough mathematical approximation would restrict the exclusion’s application to only those defense costs allocable to the counts as to which he was convicted — and nothing more.
An insured’s right to an allocated recovery of defense costs on no worse than a “count-by-count” basis has been endorsed by a number of courts properly construing application of exclusions for fraud or criminal acts. See, e.g., Fed. Ins. Co. v. Tyco Int’l Ltd., No. 600507/03, 2006 WL 6384078, at *3 (N.Y. Sup. Ct. Aug. 10, 2006) (reasoning an insured could recover defense costs for criminal counts for which he was “not convicted” upon a proper showing); Cont’l. Cas. Co. v. Bd. of Educ., 489 A.2d 536, 543 (Md. 1985) (holding that defense costs should be “apportioned between those counts of the suit against the insured for which there is insurance coverage and those counts for which there is no insurance coverage under the policy”); Trustees of Princeton Univ. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 650202/06, 2007 N.Y. Slip. Op. 50753U, at *5-*6 (Sup. Ct. Apr. 10, 2007) (holding an insured could recover for two of 10 causes of action within a civil complaint notwithstanding an exclusion); Federal Ins. Co. v. Hawaiian Elec. Indus., Inc., Civ. No. 94-00125 HG, 1996 U.S. Dist. LEXIS 22804 (D. Haw. Oct. 28, 1996) (holding the insured was entitled to an allocation between covered and uncovered “claims” within a civil complaint which resulted in one settlement).
In Tyco, the court analyzed the insured’s criminal conviction on 30 of 31 counts under a similar exclusion for fraudulent acts, noting “the Fraudulent Acts Provision excluded the defense costs connected with those thirty offenses.” However, the Court continued:
In theory, some of [the insureds’] defense costs would be payable if they could be apportioned to covered losses to which neither the Fraudulent Acts or Personal Profit Provisions apply. These include the cost of defending [the insureds] against Count #17 and the Dropped Charge for falsifying business records, for which they were not convicted.
2006 WL 6384078, at *3 (emphasis added). The court did not, however, perform any apportionment because the insureds made “no showing that any of their defense expenses can be allocated to covered losses.” Id. Thus, because there was no “evidentiary basis for apportioning . . . to covered expenses,” the Court made no such allocation. Id.
California law also allows policyholders to retain defense costs advanced by the insurer during the underlying defense after a final adjudication. See Buss v. Superior Court, 16 Cal. 4th 35, at 50-51 (1997) (“[a]s to claims that are at least potentially covered, the insurer gives, and the insured gets, just what they bargained for, namely, the mounting and funding of a defense.”). Applying Buss to the facts presented in a multi-criminal count setting, the insurer should be required first to advance defense costs to defend its insured against the criminal charges brought against him at least until a final adjudication of his criminal case (i.e., a conviction, sentencing and waiver of his appellate rights). Post adjudication, the insurer may recoup only advanced costs it can prove arose solely from the counts on which the insured was convicted. It may not recover any advancements of defense costs for any defense work in connection with the criminal charges as to which he was exonerated. Allocation is a “two-way street” under Buss, and if the insurer can recoup defense costs associated with uncovered matters, it follows that the insured may rely on the insurer’s promise to either defend or advance defense costs for clearly covered matters.
The plain language of the personal conduct exclusion also supports this result. It requires a causal connection between the criminal or fraudulent act and the components of “Loss” – - here the insured’s defense costs – - before the insurer can disclaim coverage. Furthermore, the exclusion’s causation requirement employs the phrase “arising out of” (and synonymous phrases) which typically must be narrowly construed against insurers and in favor of an insured’s allocated recovery. See, e.g., Charles E. Thomas Co. v. Transamerica Ins. Group, 62 Cal. App. 4th 379, 383-84 (1998) (noting the phrase “arising out of” is interpreted more broadly in a coverage provision versus an exclusion provision in a policy); Oakley Transp. v. Zurich Ins. Co., 648 N.E.2d 1099, 1103-04 (Ill. App. 1995) (“[T]he ‘arising out of’ provision at issue in this case appears in an exclusion . . . . A broad interpretation here would expand the exclusion to the advantage of the insurer. This . . . turn[s] on its head established judicial precedent regarding liberal construction of insurance policies.”) (emphasis in the original).
Finally, in this setting, the insured may have a strong argument for recovery of all defense costs from the insurer if the insurer does not meet its burden to show a reasonable allocation is possible. The law of many jurisdictions recognizes the “reasonably related” doctrine that supports coverage for 100% of defense costs incurred by an insured that are reasonably related to a covered claim, even when also useful or beneficial to the defense of an uncovered claim. See, e.g., Safeway Stores, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 64 F.3d 1282, 1289 (9th Cir. 1995) (“Defense Costs are thus covered by a D&O policy if they are reasonably related to the defense of the insured directors and officers, even though they may also have been useful in the defense of the uninsured corporation”); Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170, 1182-83 (N.D. Cal. 1994) (discussing the “reasonably related” test); Bd. Of Educ., 489 A.2d at 545. In other words, all legal fees and expenses that contributed in part to a defendant’s successful effort in defeating multiple criminal counts must be covered by an insurer, even if they also assisted in his defense against other counts as to which he was convicted. And the insured must receive the benefit of the doubt if the insurer cannot make the requisite showing. Raychem Corp., 853 F. Supp. at 1183 (reasoning insurer must show that defense costs incurred did not have “any reasonable relation” to covered matters and solely benefitted uncovered claims).
In sum, before acquiescing to an insurer’s denial of coverage based on a criminal conviction, be certain to examine the coverage available for any counts on which the insured was exonerated.
If you would like additional information on the topics addressed in this post, please contact Dave Steuber at email@example.com.