Partnership Umbrella, Inc. v. Federal Insurance

Present: Carrico, C.J., Hassell, Keenan, Koontz, Kinser, and
Lemons, JJ., and Poff, Senior Justice

THE PARTNERSHIP UMBRELLA, INC., ET AL.
OPINION BY
v. Record No. 991876 JUSTICE LAWRENCE L. KOONTZ, JR.
June 9, 2000
FEDERAL INSURANCE COMPANY

FROM THE CIRCUIT COURT OF THE CITY OF ALEXANDRIA
Thomas A. Fortkort, Judge Designate

This appeal concerns the disputed interpretation of the

insuring clauses of an executive liability and indemnification

policy. The insurance company instituted the litigation as a

declaratory judgment action. The policy-owner counterclaimed

for breach of contract. The parties stipulated that a

determination by the trial court unfavorable to the policy-owner

on two questions of law concerning the insuring clauses would

result in an agreed dismissal of the policy-owner’s counterclaim

and entry of final judgment for the insurance company.

Accordingly, under this unusual procedural posture, the trial

court’s judgment and consequently our review of that judgment,

do not involve the merits of the policy-owner’s claim or any

defenses that the insurance company might assert at trial based

upon exclusions of the policy, the relevant statutory scheme, or

such other factors. Nonetheless, a full recitation of the facts

developed in the trial court is necessary in order to place the

legal issues under review in their proper context.
 BACKGROUND

On October 9, 1990, Federal Insurance Company (Federal)

issued an executive liability and indemnification policy (the

policy) with a policy limit of $1 million to The Partnership

Umbrella, Inc. (Partnership Umbrella), a Virginia corporation

affiliated with United Way of America, Inc. (United Way). The

policy provided two forms of coverage. As defined by the policy

in “Insuring Clause 1,” Federal was obligated under the

“Executive Liability Coverage” to

pay on behalf of each of the Insured Persons all Loss
for which the Insured Person is not indemnified by the
Insured Organization and which the Insured Person
becomes legally obligated to pay on account of any
claim first made against him, individually or
otherwise . . . for a Wrongful Act committed,
attempted, or allegedly committed or attempted, by the
Insured Person(s) before or during the Policy Period.

As defined by the policy in “Insuring Clause 2,” Federal was

obligated under the “Executive Indemnification Coverage” to

pay on behalf of the Insured Organization all Loss for
which the Insured Organization grants indemnification
to each Insured Person, as permitted or required by
law, which the Insured Person has become legally
obligated to pay on account of any claim first made
against him, individually or otherwise . . . for a
Wrongful Act committed, attempted, or allegedly
committed or attempted, by such Insured Person(s)
before or during the Policy Period.

Relevant to the issues in this appeal, Stephen J. Paulachak

was a director and president of Partnership Umbrella in early

1992, when a federal grand jury began an investigation into

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alleged malfeasance by William Aramony, president and chief

executive officer of United Way. In addition to his role as

president and director of Partnership Umbrella, in which

positions he had been installed by Aramony, Paulachak also

served as Aramony’s “personal assistant” and acted as a “paid

consultant” to United Way. Aramony was a director and chairman

of the board of Partnership Umbrella.

On April 9, 1992, Paulachak advised Federal through its

agent that “[t]here appear to be indications that United Way of

America intends to take legal actions against me and/or

Partnership Umbrella” and that “[t]here may also be a

governmental investigation arising due to allegations made by

United Way.” On April 10, 1992, Paulachak’s counsel requested a

formal opinion from Federal’s legal counsel on whether the

insurance policy would provide coverage to Paulachak in the

event that he was a target of a pending federal grand jury’s

investigation.

Federal requested that Paulachak provide it with a copy of

a report of an independent investigation conducted on behalf of

United Way. Although that report expressed concern about the

close relationship between Aramony and Paulachak and the

“lucrative consulting arrangements” between United Way and

Paulachak authorized by Aramony, Federal concluded that there

had not yet been a claim alleging a “Wrongful Act” as defined in

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the policy, and declined to provide coverage for Paulachak at

that time. 1

On May 19, 1992, Paulachak was subpoenaed to appear before

the federal grand jury. Federal was advised of this

development, but again stated that it would not provide coverage

for Paulachak in the absence of an allegation that he had

committed a “Wrongful Act.”

On July 14, 1992, Aramony and Hamp Coley, Partnership

Umbrella’s only other director, authorized the payment of

“advances for expenses” pursuant to Code § 13.1-878 to cover

Paulachak’s legal expenses arising from the federal grand jury’s

investigation. This action was undertaken upon the advice of

Partnership Umbrella’s special counsel and with Aramony and

Coley acting as a quorum of the board members eligible to decide

such matters. See Code § 13.1-878(C)(providing that decisions

to advance legal expenses “shall be made in the manner specified

in § 13.1-880” for making indemnification decisions). It was

agreed that if it were subsequently determined that the advances

to Paulachak would violate the relevant Code provisions, the

advances would constitute a loan to Paulachak repayable at 7%

interest.

1
It is undisputed that the policy provides only
reimbursement and indemnification coverage. Federal had no duty
to provide Paulachak with a defense.
4
 Paulachak signed a “statement of good faith belief pursuant

to Virginia Code Section 13.1-878” in which he stated that his

conduct as an officer and director of Partnership Umbrella was

both lawful and in the best interests of the organization. This

document is dated July 14, 1992, but a notary’s attestation form

at the foot of the document was never completed. 2 As a result of

the decision to advance expenses to Paulachak, Partnership

Umbrella alleges that it paid attorney’s fees on Paulachak’s

behalf for the period beginning in February 1992 until May 1994

exceeding $307,000 and that approximately $69,918 in fees

incurred during that time are still owed.

On May 3, 1994, Paulachak received a letter from the United

States Attorney for the Eastern District of Virginia indicating

that Paulachak was a target of the grand jury’s investigation.

Paulachak advised Federal of this development and contended that

the “target letter” was a “claim triggering coverage” under the

policy. Federal responded that this letter did not constitute a

2
Federal maintains that the required “Undertaking To Repay
Advances” obligating Paulachak to repay the advances if he was
not subsequently indemnified by Partnership Umbrella, which was
also prepared at this time, was not signed until several years
later and back-dated by Paulachak to reflect the July 14, 1992
decision date. As we have noted above, we are not here
concerned with whether Federal can successfully defend against
the claims made by Partnership Umbrella and Paulachak.
Accordingly, we will express no opinion on this issue.
5
claim of a “Wrongful Act” under the policy and declined to

provide coverage.

On September 13, 1994, Aramony, Paulachak, and another

United Way employee were named in a multi-count indictment

alleging that they were involved in a conspiracy to use

Partnership Umbrella “for illegitimate objectives . . .

including the spending of funds in the possession of

[Partnership Umbrella] for the personal use, benefit and

pleasure of the defendants and certain of their associates.”

Among the other crimes charged in the indictment were wire fraud

and filing false tax returns. Following Paulachak’s indictment,

Federal denied liability under Insuring Clause 1 of the policy

on the ground that Paulachak’s legal expenses were subject to a

“dishonesty exclusion” in the policy.

On April 3, 1995, Paulachak was convicted on eight counts

of the indictment including the conspiracy count, one count of

wire fraud, and six counts related to the filing of false tax

returns. 3 On April 7, 1995, Federal advised Partnership Umbrella

that no determination of liability under Insuring Clause 2 could

3
Paulachak was sentenced to 30 months imprisonment for these
crimes. His conviction and sentence were subsequently upheld on
appeal. See Aramony v. United States, 88 F.3d 1369, 1392 (4th
Cir. 1996).

6
be made until Partnership Umbrella decided whether it would

indemnify Paulachak.

On April 18, 1995, Coley, acting as de facto chairman of

the board of directors of Partnership Umbrella, convened a

meeting of the board. Paulachak, who was still a director,

attended the meeting with his personal attorney. Coley

“approved” the appointment of Preston Garrison as a new board

member. Coley and Garrison then approved Paulachak’s request

that “in the event of his involuntary termination due to legal

proceedings, that he be granted continued compensation and

benefits for a one year period.” Based upon the representation

of Paulachak’s counsel that Federal would require a formal

decision on indemnification, Coley and Garrison also approved a

proposal to indemnify Paulachak, which Coley was to have

reviewed by outside counsel. At the conclusion of the meeting,

Coley was formally elected as chairman of the board of

directors.

On May 25, 1995, Coley and Garrison approved a formal

resolution of indemnification “for attorney’s fees and expenses

which [Paulachak] incurred from May 3, 1994, the date of the

target letter, through the conclusion of any proceeding with

respect to the indictment, including any appeal.” The

resolution states that the indemnification was based upon a

determination that Paulachak “was not adjudged guilty on the

7
basis that any personal benefit was improperly received by him

from [Partnership Umbrella],” but, rather, that “the monies and

other benefits received by Mr. Paulachak which were the subject

of the indictment were intended to be fringe benefits.”

On March 18, 1996, following an extensive investigation by

Federal into the circumstances surrounding the decision to

indemnify Paulachak, Federal formally denied coverage under

Insuring Clause 2. Federal maintained that the indemnification

determination did not comport with the requirements for making

such determinations under Virginia law and that in any case the

determination was “unfounded and invalid.” Federal further

asserted that it was not liable under either of the insuring

clauses for any of Paulachak’s legal expenses, whether

indemnified or not, because those expenses arose from a risk not

insurable under Virginia law and were subject to exclusions

within the policy.

Thereafter, on March 18, 1996, Federal filed a declaratory

judgment action seeking a determination that it was not liable

under the policy to Partnership Umbrella or Paulachak.

Partnership Umbrella filed a counterclaim alleging breach of

contract. Partnership Umbrella sought to recover both the

monies it had advanced to Paulachak for legal expenses incurred

prior to May 3, 1994 under Insuring Clause 1 and for legal

expenses subject to the indemnification resolution under

8
Insuring Clause 2 up to the maximum limit of the policy. 4

Partnership Umbrella further contended that if it could not

recover the monies paid as indemnification under Insuring Clause

2 because its indemnification decision was unlawful, it should

nonetheless be able to recover these monies under Insuring

Clause 1.

It is not disputed that Paulachak is an “insured person” as

defined by the policy. Nor is it disputed that the policy was

in force at all times relevant to the claims made by Paulachak

and Partnership Umbrella for reimbursement and indemnification

under the insuring clauses of the policy. Rather, as stipulated

by the parties, the disputed issue of law in the trial court was

whether, under the language of the policy, Federal would remain

liable under Insuring Clause 1 after Partnership Umbrella made a

decision to indemnify Paulachak if that decision were

subsequently determined to have been unlawful. The parties

further disputed the standard of law to be applied in

determining whether the indemnification decision was lawful.

The parties agreed that if these issues were resolved “in a

manner unfavorable to Partnership Umbrella,” it would withdraw

4
There is some disagreement in the record over the amounts
of the legal expenses actually incurred by Paulachak and
advanced or indemnified by Partnership Umbrella; however, it is
not disputed that in total these expenses exceed Federal’s
maximum possible liability under the policy.
9
its counterclaim. Accordingly, on January 10, 1997, the two

following questions of law were submitted to the trial court.

1. If [Partnership Umbrella] cannot recover under
Insuring Clause 2 because of a determination that its
indemnification of Paulachak was not “as permitted
. . . by law,” may [Partnership Umbrella] recover
under Insuring Clause 1 either the amounts it has paid
for Paulachak’s defense, or the amounts Paulachak was
“legally obligated to pay?”

2. Can Federal argue to the jury in this case, based
on the substantive merits of [Partnership Umbrella’s]
decision to indemnify Paulachak, that the
indemnification did not meet the statutory standards
governing indemnification (including those attorney’s
fees for counts on which Paulachak was not convicted)?

The parties filed briefs addressing these two questions.

With respect to the first question, Federal maintained that once

a decision to indemnify an insured person is made by the insured

organization, coverage under Insuring Clause 1 ceases with

respect to all legal expenses incurred by an insured person,

even if the decision to indemnify was unlawful. Because Federal

further maintained that the indemnification decision had been

taken contrary to what was “permitted or required by law,” it

asserted it also had no liability under Insuring Clause 2.

Partnership Umbrella contended that the coverage of Insuring

Clause 1 applied to any loss sustained by an insured person that

was not actually indemnified by the insured organization. Thus,

it further contended that if its indemnification was not lawful,

there was no indemnification and it was entitled to coverage for

10
any funds disbursed by it as advances or under the

indemnification resolution.

In a letter opinion dated March 24, 1997 and subsequently

adopted by reference in the May 13, 1999 final order, the trial

court concluded that Partnership Umbrella, as a party to the

contract, could enforce Paulachak’s rights under Insuring Clause

1 and, citing Atlantic Permanent Fed. Savings & Loan Ass’n v.

American Casualty Company of Reading, Pennsylvania, 839 F.2d 212

(4th Cir. 1988), could also claim a right of equitable

subrogation. Thus, under either theory, and even if Partnership

Umbrella were barred from recovering under Insuring Clause 2,

the trial court concluded that Partnership Umbrella might still

recover under Insuring Clause 1. However, the trial court

further determined that Partnership Umbrella’s rights under

Insuring Clause 1 were limited to any rights Paulachak would

have had under that clause and, thus, “are limited to the

amounts of money for attorney fees which are due and owing but

not yet paid,” and for which Paulachak had not been indemnified.

Thus, the trial court ruled in its final order that Partnership

Umbrella could not “recover under Insuring Clause 1 for any of

the amounts it has paid on Paulachak’s behalf.” In effect, the

trial court determined that any monies advanced to Paulachak

constituted “indemnification” regardless of whether these

payments were made under the July 14, 1992 decision to advance

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legal expenses or under the May 25, 1995 indemnification

resolution, which applied only to those expenses incurred

following Paulachak’s receipt of the target letter.

With respect to the second question presented to the trial

court, Partnership Umbrella contended that the action of the

individual directors to indemnify Paulachak was subject to the

“business judgment rule” as codified in Code § 13.1-870 and,

thus, was not subject to review by a trial court or a jury for

compliance with requirements of Code § 13.1-876 which

authorizes indemnification under certain circumstances. Federal

contended that it should be entitled to argue that the decision

of Partnership Umbrella to indemnify Paulachak did not comport

with the provisions of Code § 13.1–876, even if the actions of

the individual directors were not violative of that statute.

The trial court agreed with Federal. The trial court noted

that the position taken by Partnership Umbrella would render

meaningless the provisions of Code § 13.1–876(D), which

prohibits indemnification in certain cases, if a decision in

violation of that prohibition were not subject to judicial

review. Accordingly, the trial court ruled that Federal could

“argue to the jury in this case, based on the substantive merits

of [Partnership Umbrella’s] decision to indemnify Paulachak,

that the statutory standards governing indemnification were not

met.”

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 Following receipt of the trial court’s letter opinion,

Partnership Umbrella, by motion, requested a clarification of

that opinion. In that motion, Partnership Umbrella inquired

whether the trial court’s opinion prohibited it from recovering

the monies paid as advances for legal expenses incurred by

Paulachak prior to his receiving the May 3, 1994 target letter.

In its final order, the trial court denied the motion for

clarification without comment. Determining that its resolution

of the two questions of law was “in a manner unfavorable to”

Partnership Umbrella, the trial court dismissed Partnership

Umbrella’s counterclaim with prejudice and entered judgment for

Federal. We awarded Partnership Umbrella this appeal.

DISCUSSION

Partnership Umbrella contends that the trial court erred in

ruling that Partnership Umbrella could not seek to recover under

Insuring Clause 1 of the policy all of the legal expenses which

it paid on behalf of Paulachak. 5 We will first consider whether

5
Partnership Umbrella notes on brief that Federal failed to
assign cross-error to the trial court’s determination that
Partnership Umbrella could seek to recover those amounts which
had not been indemnified and which are still “due and owing.”
We agree that this portion of the trial court’s ruling is not
subject to review because it is not the subject of an assignment
of cross-error. Rule 5:18(b). Similarly, although Federal
asserts on brief that “the doctrine of subrogation does not
support [Partnership Umbrella’s] argument,” it did not assign
cross-error to the trial court’s determination that Partnership
Umbrella could enforce the policy on behalf of Paulachak and
13
Partnership Umbrella is entitled to seek repayment from Federal

for the payments it made to Paulachak and his attorneys as

advances pursuant to Code § 13.1-878 which were not

subsequently confirmed under the indemnification resolution. We

will then consider whether Partnership Umbrella can seek to

recover from Federal those monies paid after May 3, 1994 and

ultimately confirmed under the indemnification resolution if

that resolution is determined to be unlawful. In this context,

we are not concerned with the viability of a claim under

Insuring Clause 2 of the policy.

In considering these issues, we apply the well established

rule that when the language in an insurance policy is clear and

unambiguous, courts do not employ rules of construction; rather,

they give the language its plain and ordinary meaning and

enforce the policy as written. Osborne v. National Union Fire

Ins. Co., 251 Va. 53, 56, 465 S.E.2d 835, 837 (1996); see also

Virginia Farm Bureau Mut. Ins. Co. v. Hodges, 238 Va. 692, 696,

recover directly those monies to which it was entitled under the
equitable doctrine of subrogation. Accordingly, we will affirm
the trial court’s ruling with respect to these issues. In doing
so, however, we express no opinion on the validity of the
arguments directed to these issues by the parties in the trial
court or on appeal. Rather, we simply recognize that Federal’s
failure to assign cross-error prevents relitigation of these
issues on remand as they are now “the law of the case.”
Lockheed Info. Mgmt. Systems v. Maximus, Inc., 259 Va. 92, 108,
524 S.E.2d 420, 429 (2000).

14
385 S.E.2d 612, 614 (1989); United Services Auto. Assoc. v.

Webb, 235 Va. 655, 657, 369 S.E.2d 196, 198 (1988); Atlas

Underwriters, Ltd. v. Meredith-Burda, Inc., 231 Va. 255, 259,

343 S.E.2d 65, 68 (1986). We are of opinion that the language

in Insuring Clause 1 of the policy is clear and unambiguous.

Under Insuring Clause 1, unless an exclusion in the policy

is found to apply, Federal would be obligated “to pay on behalf

of each of the Insured Persons all Loss for which the Insured

Person is not indemnified by the Insured Organization.” The

July 14, 1992 action by Partnership Umbrella’s board of

directors only authorized the payment of advances pursuant to

Code § 13.1-878 for Paulachak’s legal expenses incurred to that

date and in the future. It is self-evident that such advances

were not made as indemnification, since the decision to

indemnify requires a separate determination under Code § 13.1-

880. Moreover, unlike indemnification, advances must be subject

to a written undertaking by the director that they will be

repaid if it is ultimately determined that the director did not

meet the standard of conduct required under Code § 13.1-876 for

an indemnification decision.

By contrast, the May 25, 1995 indemnification resolution

was made pursuant to Code § 13.1-880. By its express terms,

that resolution applied only to “attorney’s fees and expenses

which [Paulachak] incurred from May 3, 1994.” Thus, while some

15
of the monies advanced to Paulachak or paid on his behalf to his

attorneys after May 3, 1994 subsequently were approved as

“indemnification,” the payments for expenses incurred prior to

May 3, 1994 were never so approved and indemnified and Paulachak

remained “legally obligated to pay” those expenses.

Accordingly, Paulachak, as an “Insured Person” is entitled

to seek recovery under Insuring Clause 1 for all of the expenses

he incurred that were not subject to indemnification by

Partnership Umbrella. Similarly, under the law of this case,

see note 5, supra, Partnership Umbrella may seek to recover

under that clause those funds which it paid on Paulachak’s

behalf as advances pursuant to Code § 13.1-878 and may seek to

enforce the policy on his behalf with respect to monies still

“due and owing.”

We now consider Partnership Umbrella’s further contention

that it should also be able to seek recovery of those funds it

paid as indemnification if it is determined that the May 25,

1995 indemnification resolution was unlawful. Partnership

Umbrella argues that the modifying language of Insuring Clause

2, “as permitted or required by law,” creates a condition

precedent that the decision to indemnify must be valid before

the coverage under Insuring Clause 1 will be terminated.

Federal responds that once the insured organization makes a

decision to indemnify an officer or director, coverage for the

16
expenses incurred by that officer or director under Insuring

Clause 1 terminates and any coverage that is available under the

policy must come under Insuring Clause 2.

Applying the same standard for interpreting an insurance

policy cited above, we are of opinion that when read together

the insuring clauses are clear and unambiguous as to the effect

of a decision by “the Insured Organization . . . [to] grant[]

indemnification to [an] Insured Person.” Once that decision has

been made, the coverage of Insuring Clause 2 becomes effective

and the “Insured Person,” by the express terms of Insuring

Clause 1, is no longer entitled to recover his indemnified

expenses.

The modifying language in Insuring Clause 2, “as permitted

or required by law,” does create a condition precedent; however,

it would be counterintuitive to hold that this condition applies

to coverage under Insuring Clause 1 where no such language is

found. Rather, when read in the context of both insuring

clauses, the validity of the indemnification decision is a

condition precedent only to recovery under Insuring Clause 2

where the limiting language occurs. It should be self-evident

that if a decision to indemnify is not “permitted . . . by law”

and, thus, payments made pursuant to it would not be subject to

reimbursement under Insuring Clause 2, neither would the loss

incurred by the insured person be subject to direct

17
reimbursement under Insuring Clause 1. Therefore, Partnership

Umbrella’s contention that what it may not be able to recover as

a result of an invalid or unlawful decision to indemnify

Paulachak, it should nonetheless be able to recover by

subrogation under Insuring Clause 1 is without merit.

Partnership Umbrella’s remaining assignment of error states

that “[t]he Trial Court erred by ruling, as a matter of law,

that Partnership Umbrella was prohibited from recovering

anything from [Federal] under either Clause 1 or Clause 2 of the

insurance policy if its indemnification decision is not valid.”

Partnership Umbrella does not relate this assignment of error to

either of its questions presented and offers no substantive

argument on the issue it presents. Moreover, the error assigned

does not correctly state the substance of the trial court’s

ruling. Rather, as expressly stated in the final order, the

trial court merely held, with regard to the second question

submitted to the court by the parties, that Federal “can argue

to the jury in this case, based on the substantive merits of

[Partnership Umbrella’s] decision to indemnify Paulachak, that

the statutory standards governing indemnification were not met.”

(Emphasis added.) In short, while it may be that the trial

court would ultimately rule as Partnership Umbrella implies in

its assignment of error, the trial court did not rule on the

effect of the failure to meet the statutory standard, but only

18
on whether that issue could be raised. Assuming that

Partnership Umbrella intended to challenge that ruling, we hold

that the trial court did not err in its ruling.

The question whether Partnership Umbrella met the required

statutory standard governing indemnification has yet to be

decided. The effect of the failure to meet that standard is one

of law, upon which the trial court has not yet ruled. As we

have stressed throughout this opinion, neither the

determinations of law made by the trial court nor our review of

that judgment in this opinion deals with the merits of

Partnership Umbrella’s claims, the potential defenses available

to Federal under the exclusions of the policy, or the

application of the indemnification statutes to any determination

of fact made as to Partnership Umbrella’s compliance with the

standard therein. Rather, those claims and defenses are yet to

be resolved in the trial court proceedings.

CONCLUSION

For these reasons, we will reverse that portion of the

trial court’s judgment that prohibits Partnership Umbrella from

seeking recovery under Insuring Clause 1 for those payments made

on behalf of Paulachak for legal expenses incurred by him prior

to May 3, 1994. We will affirm the trial court’s judgment in

all other respects, and the case will be remanded to the trial

19
court for further proceedings consistent with the views

expressed in this opinion.

Affirmed in part,
reversed in part,
and remanded.

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