REVISED MARCH 16, 2010
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
March 15, 2010
No. 10-20069 Charles R. Fulbruge III
Clerk
LAURA PENDERGEST-HOLT; R. ALLEN STANFORD; GILBERT LOPEZ,
JR.; MARK KUHRT,
Plaintiffs – Appellees
v.
CERTAIN UNDERWRITERS AT LLOYD’S OF LONDON AND ARCH
SPECIALTY INSURANCE CO.,
Defendant – Appellant
Appeal from the United States District Court
for the Southern District of Texas
USDC No. 4:09-CV-3712
Before HIGGINBOTHAM, CLEMENT, and SOUTHWICK, Circuit Judges.
PATRICK E. HIGGINBOTHAM, Circuit Judge:
In this insurance coverage dispute, various insureds—each faced with civil
and criminal allegations that they engaged in a massive Ponzi scheme—seek
reimbursement of defense costs under a directors’ and officers’ liability policy
from the policy’s underwriters. The district court entered a preliminary
injunction ordering reimbursement of defense costs pending its further order.
We stayed the order; granted the underwriters’ request for expedited appeal;
heard oral argument; and now modify the preliminary injunction, affirm the
No. 10-20069
injunction insofar as it provides for coverage until judicial determination in a
separate coverage action, and remand for that determination with special
instructions.
I
One year ago last month, the SEC sued three companies founded by R.
Allen Stanford, and three individual defendants—James Davis, Laura
Pendergest-Holt, and Stanford himself—each an executive with one or more
Stanford company. The civil action alleged that the individual defendants
orchestrated a Ponzi scheme through the sale to investors of sham certificates
of deposit evidencing billions of dollars they invested. The SEC amended the
complaint two months ago to include two more Stanford executives—Mark
Kuhrt and Gilberto Lopez—as defendants.
The day the SEC brought suit, the district court appointed a receiver to
manage the affairs of the Stanford companies named in the SEC action and
ordered the seizure of assets in the possession of those entities and the
individual defendants. The receivership is meant to “prevent waste and
dissipation of the assets of Defendants to the detriment of the investors” and
empowers the receiver to take “all acts necessary to conserve, hold, manage, and
preserve the value” of the estate.
To that end, the receiver has sued various Stanford financial advisors to
recoup assets traceable to the alleged criminal conduct. In the course of those
suits, the receiver hired forensic accountant Karyl Van Tassel to detail the roles
the Stanford entities played in carrying out the alleged acts. Van Tassel
determined that new CD sales were not invested as represented, but were
instead used to pay CD interest and redemption payments to existing investors,
2
No. 10-20069
as well as to pay commissions and bonuses and make loans to Stanford financial
advisors—in short, that the CD sales represented a classic Ponzi scheme.
II
In June 2009, the government brought a parallel criminal case against
Stanford, Holt, Lopez, and Kuhrt in the Southern District of Texas. A twenty-
one count indictment charged the executives with conspiracy to commit mail,
wire, and securities fraud, wire fraud, mail fraud, conspiracy to obstruct an SEC
investigation, obstruction of an SEC investigation, and conspiracy to commit
money laundering.
James Davis, the former CFO of two Stanford companies, was separately
charged with mail fraud, conspiracy to violate the mail, wire, and securities
fraud law, and conspiracy to obstruct a proceeding before the SEC. He pled
guilty to all charges on August 27, 2009, signing a sworn plea agreement and
stating under oath in open court that, together with each of the other named
defendants, he had engaged in various acts in furtherance of a Ponzi scheme.
These acts included the creation of falsified financial statements, bribery, the
concealment of billions of dollars of fraudulent personal loans to Allen Stanford,
and the execution of bogus real estate transactions designed to artificially inflate
the value of company assets. The district court accepted Davis’s guilty plea after
finding a factual basis for it.1
Meanwhile, the other executives have pled not guilty. Jury selection in
their criminal cases, pending before Judge David Hittner in the Southern
District of Texas, is scheduled for January 2011. Discovery in the SEC action,
1
See FED. R. CRIM. P. 11(b)(3).
3
No. 10-20069
pending before Judge David Godbey in the Northern District of Texas, has been
stayed pending the resolution of the criminal trial.
III
The underwriters at Lloyd’s and Arch issued a directors’ and officers’
liability policy to certain Stanford companies, with a total policy limit of $100
million.2 This type of insurance is generally meant to protect corporate officers
and directors and the corporation itself from liabilities stemming from their
official conduct.3
The policy at issue here pays for, among other things, “[l]oss resulting from
any Claim first made during the Policy Period for a Wrongful Act.” “Loss” is
defined to include necessary legal fees and expenses incurred in defending any
judicial or administrative proceeding against a director or officer.
The D&O Policy does not impose a duty to defend.4 Rather, the executives
must defend claims themselves, though the underwriters are responsible for
covered defense costs, provided the executives notify the underwriters before
they are incurred. If the underwriters consent to payment of those costs, they
will pay them no more than once every 60 days.
2
While we refer to a single policy, there are actually two in play: a D&O policy
providing the potential for $10 million in coverage and an excess, follow-form policy that adds
another $90 million of potential coverage on the same terms as those found in the D&O policy.
3
Tom Baker & Sean J. Griffith, The Missing Monitor in Corporate Governance: The
Directors’ & Officers’ Liability Insurer, 95 GEO. L.J. 1795, 1801 (2007).
4
As the Texas Supreme Court has recognized, “[t]his is standard for D&O policies.”
Prodigy Comms. Corp. v. Agricultural Excess & Surplus Ins. Co., 288 S.W.3d 374, 376 n.3 (Tex.
2009) (citing 3 ROWLAND H. LONG, THE LAW OF LIABILITY INSURANCE § 12A.05[1] (2006)).
4
No. 10-20069
After the government filed SEC and criminal actions against them, the
executives sought coverage under the policy. The underwriters initially agreed
to advance defense costs for Stanford, Holt, and Lopez,5 pending a “final
coverage determination,” but expressly reserved the right to deny coverage at
any time based on the policy’s terms, including exclusions for fraud and money
laundering. Agreeing that the policy generally applies to the civil and criminal
actions brought against the executives, the parties dispute the applicability of
the money laundering exclusion.
The fraud exclusion—which is not at issue here—is useful for comparison.
It disclaims coverage for loss:
[R]esulting from any Claim . . . . brought about or contributed to in fact by
. . . any dishonest, fraudulent or criminal act or omission by the Directors
or Officers or the Company . . . as determined by a final adjudication.
In other words, the fraud exclusion does not apply until there is a “final
adjudication” that the insured engaged in fraudulent conduct. We have no
“final adjudication” here, so, as the underwriters concede, the D&O Policy’s
fraud exclusion cannot be a valid basis for withdrawing defense support.
The money laundering exclusion is different. It bars coverage for loss
(including defense costs) resulting from any claim “arising directly or indirectly
as a result of or in connection with any act or acts (or alleged act or acts) of
Money Laundering,” but then provides for qualified reimbursement of defense
costs, coupled with the ability to claw back reimbursed funds from the insureds
in certain instances:
5
The underwriters later agreed to reimburse Mark Kuhrt’s defense costs on the same
terms as the other executives.
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No. 10-20069
Notwithstanding the foregoing Exclusion, Underwriters shall pay Costs,
Charges and Expenses in the event of an alleged act or alleged acts until
such time that it is determined that the alleged act or alleged acts did in
fact occur. In such event the Directors and Officers and the Company will
reimburse Underwriters for such Costs, Charges and Expenses paid on
their behalf.6
The D&O Policy defines the term “Money Laundering” broadly, so that it
covers more than a violation of a money laundering statute.7 The policy’s
definition of Money Laundering includes:
(i) the concealment, or disguise, or conversion, or transfer, or removal
of Criminal Property, (including concealing or disguising its nature,
source, location, disposition, movement or ownership or any rights
relating thereto); or
(ii) the entering into or becoming in any way concerned in an
arrangement which is known or suspected to facilitate (by whatever
means) the acquisition, retention, use or control of Criminal
Property by or on behalf of another person; or
(iii) the acquisition, use or possession of Criminal Property; or
(iv) any act which constitutes an attempt, conspiracy or incitement to
commit any act or acts mentioned in the foregoing paragraphs (i),
(ii) or (iii); or
6
Emphasis added.
7
The provision also bars coverage for the eponymous crime: “any act or acts (or alleged
act or acts) which are in breach of and/or constitute an offence or offences under any money
laundering legislation (or any provisions and/or rules or regulations made by any Regulatory
Body or Authority thereunder).”
6
No. 10-20069
(v) any act which constitutes aiding, abetting, counselling or procuring
the commission of any act or acts mentioned in the foregoing
paragraphs (i), (ii) or (iii).
At its most basic, then, the definition of Money Laundering reduces to the
use or possession of Criminal Property, a term which is also broadly drawn to
include:
[P]roperty which constitutes a benefit obtained from or as a result of or in
connection with criminal conduct or represents such a benefit (in whole or
part and whether directly or indirectly) which the Directors or Officers or
the Company (or any person or entity acting on their behalf) knows or
suspects or reasonably should have known or suspected that it constitutes
or represents such a benefit.
IV
On November 16, 2009, the underwriters by letter advised the executives
that the underwriters would no longer provide coverage under the D&O Policy
because they had determined, based on the evidence available to them up to that
point, that Money Laundering, as defined by the policy, had occurred. Although
notice to the executives of this determination came in November, the
underwriters denied coverage as of August 27, 2009—the date of CFO James
Davis’s guilty plea. The underwriters contend that each allegation against the
executives in the SEC and criminal actions “aris[es] directly or indirectly as a
result of or in connection with any act . . . of Money Laundering.” The
underwriters urge this reading of the policy even though only one of twenty-one
counts charged in the criminal action alleges money laundering as defined by
law. In doing so, they rely on the policy’s definition of Money Laundering, which
is defined to cover much broader conduct than the violation of a money
7
No. 10-20069
laundering statute, and the fact that an act need only be “in connection with” an
alleged act of Money Laundering to preclude coverage.
To support their “in fact” determination, the underwriters cite the
following evidence:
(1) the SEC action’s preliminary finding of “good cause to believe that
[the executives] used improper means to obtain investor funds and
assets”;
(2) the TRO and preliminary injunction in the SEC action, which froze
personal and corporate assets and appointed a receiver;
(3) the SEC action’s preliminary injunction finding that “Stanford
engaged in fraudulent conduct, including misappropriating investor
funds”;
(4) the examination report and testimony of the receiver’s accounting
expert, Van Tassel, that investment proceeds were used to pay
interest on existing investment products, commissions, and bonuses,
and to make loans to employees; and
(5) the statements of alleged co-conspirator Davis that the executives
were behind a “massive Ponzi scheme.”
The executives filed suit against the underwriters in the Southern District
of Texas on November 17, 2009, seeking damages, a declaration that their
defense costs must be reimbursed under the D&O Policy, and a preliminary
injunction ordering the underwriters to pay their defense costs until a final
judgment on the merits of the coverage dispute. The suit was originally assigned
to Judge Gray Miller but was transferred to Judge Hittner, before whom the
criminal trial is pending. Judge Hittner heard oral argument on December 17,
8
No. 10-20069
2009, where the underwriters presented the evidence listed above, while the
executives invoked their Fifth Amendment right not to testify.
Finding that the “money laundering” exclusion most likely would not
preclude coverage, Judge Hittner granted the executives’ request and prohibited
the underwriters from “withholding payment” for all costs “already incurred” by
the executives and to be “incurred by them in the future . . . until a trial on the
merits in this case or such other time as this Court orders.”8
The underwriters successfully sought a stay pending expedited appeal in
this court and now seek reversal of the preliminary injunction.
V
“A plaintiff seeking a preliminary injunction must establish that he is
likely to succeed on the merits, that he is likely to suffer irreparable harm in the
absence of preliminary relief, that the balance of equities tips in his favor, and
that an injunction is in the public interest.”9 “‘Although the ultimate decision
whether to grant or deny a preliminary injunction is reviewed only for abuse of
discretion, a decision grounded in erroneous legal principles is reviewed de
novo.’”10 And, “when a preliminary injunction turns on a mixed question of law
and fact, it, too, is reviewed de novo.”11 We look first to the executives’ likelihood
8
Pendergest-Holt v. Certain Underwriters at Lloyd’s of London, ___ F. Supp. 2d ____,
2010 WL 317684, at *14 (S.D. Tex. Jan. 26, 2010).
9
Winter v. Natural Res. Def. Council, Inc., 129 S. Ct. 365, 374 (2008).
10
Byrum v. Landreth, 566 F.3d 442, 445 (5th Cir. 2009) (quoting Women’s Med. Ctr. of
Nw. Houston v. Bell, 248 F.3d 411, 419 (5th Cir. 2001)).
11
Id. (citing Speaks v. Kruse, 445 F.3d 396, 399 & n.8 (5th Cir. 2006)).
9
No. 10-20069
of success on the merits, but, as we explain below, we will not fully resolve the
matter.
A
By the D&O Policy’s terms, the underwriters are not liable for any
loss—including damages, judgments, settlements, and defense costs—“arising
. . . in connection” with acts or alleged acts of Money Laundering. That said,
when allegations of Money Laundering are leveled against the executives, the
underwriters may not immediately withdraw all coverage. They must instead
pay legal costs incurred by the executives in defending against those allegations
“until such time that it is determined that the alleged act or alleged acts did in
fact occur.”
Texas law applies; it requires us to construe insurance policies using the
same rules of construction applicable to contracts generally.12 “Effectuating the
parties’ expressed intent,” then, is our primary concern.13 If a policy uses
unambiguous language, it must be enforced as written.14 But, if a policy is
susceptible to more than one reasonable interpretation, “[t]his Court has clearly
identified that Texas law requires an insurance policy to be construed against
the insurer and in favor of the insured”—in other words, in favor of coverage.15
12
Don’s Bldg. Supply, Inc. v. OneBeacon Ins. Co., 267 S.W.3d 20, 23 (Tex. 2008).
13
Id.
14
Id.
15
National Union Fire Ins. Co. of Pittsburgh, Pa. v. Willis, 296 F.3d 336, 339 (5th Cir.
2002) (citing Lubbock County Hosp. Dist. v. Nat’l Union Fire Ins. Co., 143 F.3d 239, 242 (5th
Cir. 1998)); National Union Fire Ins. Co. v. Hudson Energy Co., 811 S.W.2d 552, 555 (Tex.
1991); Blaylock v. Am. Guarantee Bank Liab. Ins. Co., 632 S.W.2d 719, 721 (Tex. 1982)).
10
No. 10-20069
Where an exclusionary provision is ambiguous—that is, amenable to two or more
reasonable interpretations—the court must adopt the construction urged by the
insured so long as that construction is not unreasonable, even if the insurer’s
construction “appears to be more reasonable or a more accurate reflection of the
parties’ intent.”16
Before the district court and in their briefing here, the executives have
consistently pushed a reading of the Money Laundering exclusion that would
prevent any determination until a final adjudication in the underlying criminal
proceeding; they now, however, prudently concede that the “in fact”
determination may be made prior to resolution of either the criminal or SEC
action and may be heard as a parallel coverage matter.17 For their part, the
underwriters have urged that the policy empowers them to make a
determination of coverage at any time, hewing closely to rhetoric suggesting the
determination was theirs alone—unilateral. That rhetoric fell away in this court
and the underwriters—either softening their position or perhaps more clearly
articulating it—now accept that the “determination” is, at the very least,
judicially-reviewable and is subject to reconsideration should the executives be
cleared of all charges.
16
Balandran v. Safeco Ins. Co. of Am., 972 S.W.2d 738, 741 (Tex. 1998) (quoting
Hudson Energy, 811 S.W.2d at 555) (internal quotation marks omitted).
17
The executives also argue that the underwriters’ reading of the money laundering
exclusion “swallows up” the fraud exclusion. It is true that only one of twenty-one criminal
counts brought against the executives alleges “money laundering” as defined by law. But the
Money Laundering exclusion’s language is sufficiently broad to capture the other twenty
counts without rendering the fraud exclusion itself a nullity (each arises directly or indirectly
as a result of or in connection with acts or alleged acts of Money Laundering, as defined by the
policy). One example of a fraud claim safe from the Money Laundering exclusion would be an
alleged reckless failure to disclose material information—e.g., where the company operates an
otherwise legitimate business but is alleged to have overstated earnings in public filings.
11
No. 10-20069
For all practical purposes, this pending civil matter is that separate
coverage action and we treat it accordingly, though two legal issues remain
predicate to the ultimate question of coverage: (1) whether the underwriters’
duties end when they make an “in fact” determination (subject to judicial review)
or whether that determination can only be made in the first instance by a court;
and (2) whether a court may examine evidence in making its determination or
whether it is instead confined to the underlying complaint’s allegations and the
D&O Policy’s terms. Only after we resolve these questions can a court consider
whether the record is sufficient to support a determination that the alleged
Money Laundering acts in fact occurred.
B
As for who may make the “in fact” determination, the Money Laundering
exclusion is silent; it provides only that the underwriters may stop
reimbursement of defense costs when “it is determined that the alleged act or
alleged acts did in fact occur.” The underwriters maintain that they may make
this determination in the first instance, the obligation to advance defense costs
ends when they do so, and their decision is subject only to judicial reversal after
the fact. The executives assert that the “in fact” determination is not merely
judicially-reviewable but must be judicially-made in the first instance; in other
words, that the underwriters’ duties continue until they have a court judgment
in hand, decreeing that Money Laundering was “in fact” committed. The parties’
disagreement is subtle but important.
Texas courts give policy terms their “ordinary and commonly understood
meaning unless the policy itself shows the parties intended a different, technical
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No. 10-20069
meaning.”18 The D&O Policy leaves “determined” and “in fact” undefined.
Dictionaries define “determination” as “[a] final decision by a court or
administrative agency”19 and to “determine” as “to fix conclusively or
authoritatively,” “to decide by judicial sentence,” or “to settle or decide by choice
of alternatives or possibilities.”20 Black’s Law Dictionary tell us that “in fact”
means “[a]ctual or real” or “resulting from the acts of parties rather than by
operation of law.”21
None of these definitions provides a conclusive answer, though taken
together they favor a judicial decisionmaker over any other. In this void, the
underwriters—as drafters of the policy—could have unambiguously reserved a
unilateral right to determine that the alleged acts in fact occurred. Rather than
saying “until it is determined . . . in fact,” they could have avoided ambiguity
entirely by providing “until we have determined” or “until Underwriters
determined.” The parties’ word choice—“it is determined”—leaves us guessing,
but it hardly seems a drafting error, at least not an inadvertent one.
Because “[i]t would be possible for carriers issuing D & O policies to
explicitly reserve to themselves the unfettered discretion whether to advance
defense costs,” if an insurer “wants the unilateral right to refuse a payment
called for in the policy, the policy should clearly state that right.”22 As the
Eastern District of Pennsylvania put it, an insurer’s policy may be silent on this
18
Don’s Bldg. Supply, 267 S.W.3d at 23.
19
BLACK’S LAW DICTIONARY 480 (8th ed. 2004).
20
MERRIAM WEBSTER’S COLLEGIATE DICTIONARY 315 (10th ed. 1996).
21
BLACK’S LAW DICTIONARY 792 (8th ed. 2004).
22
Associated Elec. & Gas Ins. Servs. v. Rigas, 382 F. Supp. 2d 685, 701 (E.D. Pa. 2004)).
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No. 10-20069
issue for good reason: “a policy with such a draconian power [might be] difficult
to sell.”23 While there is nothing remarkable about an insurer reserving the
right to make a unilateral coverage decision, it is similarly unremarkable to
require an insurer to be explicit when doing so, rather than leaving the reader
to ponder the word “it.”24
Without clearer direction from the policy itself, the parties both offer
plausible interpretations. Neither is unreasonable: “From the point of view of
[the underwriters], to wait for a judicial determination of the elements listed in
the [exclusion] means that [they] may have to pay substantial sums for defense
costs even though it is later determined” the alleged acts did in fact occur, while
“[f]rom the point of view of [the executives], it is unfair to give an insurer the
ability to escape its duty to advance payment merely because it asserts the
[exclusion], without any judicial decision.”25
The underwriters nonetheless contend that “it is determined . . . in fact”
is not ambiguous because it stands in meaningful contrast to the language of the
fraud exclusion. That exclusion is triggered only by a “final adjudication” that
fraud “in fact” occurred. Because we must interpret the D&O Policy “in such a
way as to give effect to each term . . . so that none will be rendered
23
Id.
24
Our reading is consonant with the interpretation by other courts that have considered
a D&O policy’s use of the term “in fact”—without apparent exception these decisions assume
court involvement in the decision to cut off the insured from payment for litigation costs and
belie any notion of a unilateral right to determine coverage (in the absence of unambiguous
language granting such a right). See, e.g., Virginia Mason Med. Ctr. v. Executive Risk Indem.
Inc., 2007 WL 3473683, at *5 (W.D. Wash. Nov. 14, 2007) (unpublished).
25
Axis Reins Co. v. Bennett, 2008 WL 2600034, at *4 (S.D.N.Y. 2008) (unpublished)
(quoting Rigas, 382 F. Supp. 2d at 699) (internal quotation marks omitted).
14
No. 10-20069
meaningless,”26 the underwriters argue that “determined . . . in fact” must be
construed to mean something other than a “final adjudication.” They maintain
that only the latter requires a judicial decisionmaker.
None of the D&O Policy’s other exclusions—which undisputedly allow the
underwriters to make a coverage decision—use the terms “it is determined,” “in
fact,” or “final adjudication.” And, like the first two phrases, “final adjudication”
is left undefined. The underwriters note, however, that the Northern District
of California has examined—in an unpublished opinion—the meaning of the
term “in fact” from a D&O policy also containing the phrase “judicially
determined.”27 Here, though, we do not compare “in fact” with “judicially
determined,” but rather “determined . . . in fact” with “final adjudication,” and
the difference means an analogy between the pairs should not be drawn. For
one, the D&O Policy’s Money Laundering exclusion requires not only an act “in
26
See Willis, 296 F.3d at 339 (citing Lynch Props., Inc. v. Potomac Ins. Co. of Ill., 140
F.3d 622, 626 (5th Cir. 1998); Kelley-Coppedge, Inc. v. Highlands Ins. Co., 980 S.W.2d 462, 464
(Tex. 1998)).
27
In that case, PMI Mortgage, the court rejected the defendant’s contention that mere
allegations were sufficient to trigger the “in fact” exclusions, but noted that the policy’s use of
the term “judicially determined” placed limits on the meaning of “in fact”:
[W]hen read according to its ordinary and popular meaning, the phrase “judicially
determined” necessarily limits any final adjudication or factual determination to one
that is made by the judiciary, whereas the term “in fact” includes adjudications or
determinations that are not made judicially, and is therefore broader in scope. In short,
the court holds that the term “in fact” within the context of the exclusion here should
be read to require either a final adjudication, including a judicial adjudication, or at a
minimum, at least some evidentiary proof that the insured reaped an illegal profit or
gain.
PMI Mortgage Ins. Co. v. American Int’l Specialty Lines Ins. Co., 2006 WL 825266 (N.D. Cal.
Mar. 29, 2006) (unpublished). When confronting the latter possibility—a proffer of “some
evidentiary proof”—the court would then be tasked with “objectively verify[ing]” that the
condition is fulfilled. Id. at *5.
15
No. 10-20069
fact” but an act “determined” to be so—and, as we have explained, “determined”
can denote a legal decision. More important, courts have interpreted both “final
adjudication” and “in fact” to require a judicial decisionmaker: the question is
not whether a court makes the determination but in which judicial proceeding
that determination is made—i.e., whether it is made in the underlying case or
in a separate coverage action.
When a D&O policy requires a “final adjudication” to trigger an exclusion,
“courts have consistently held that the adjudication must occur in the underlying
D&O proceeding,” rather than in a parallel coverage action or other lawsuit.28
The distinction is important because under a “final adjudication” clause, some
courts bar insurers, after settlement of the underlying case, from litigating
“whether the settled claims were in fact attributable to defendants’ dishonest
acts.”29 Read this way, a final adjudication exclusion limits the insurer’s
recourse if the parties settle—the most likely outcome—or if the insured is
28
Dan A. Bailey, D&O Policy Commentary, 702 PLI/LIT 205, 215 (Feb. 17–18, 2004)
(“For those forms which require a final adjudication, courts have consistently held that the
adjudication must occur in the underlying D&O proceeding (not in coverage litigation) and
therefore the exclusion is inapplicable if the claim against the D&Os is settled. [I]f the
exclusion does not expressly require an adjudication, the exclusion can apply to settlements.”).
Accord Atlantic Permanent Fed. Sav. & Loan Ass’n v. American Cas. Co. of Reading, Pa., 839
F.2d 212, 216–17 (4th Cir. 1988) (holding that, given the policy of construing insurance policies
against the insurer, the words “a judgment or other final adjudication thereof’” could be
reasonably interpreted to refer to the underlying lawsuit for which coverage is sought) (citing
Pepsico, Inc. v. Continental Cas. Co., 640 F. Supp. 656 (S.D.N.Y. 1986)).
29
ERIC MILLS HOLMES, 23 HOLMES’ APPLEMAN ON INSURANCE 2D § 146.6 (2003) (quoting
Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Continental Illinois Corp., 666 F. Supp. 1180,
1198 (N.D. Ill. 1987)). See also Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Brown, 787 F.
Supp. 1424, 1429 (S.D. Fla. 1991), aff’d 963 F.2d 985 (11th Cir. 1992) (“[T]he exclusion does
not apply at this time because there has been no final adjudication establishing that the
Insureds engaged in fraud, dishonesty or criminal acts.”).
16
No. 10-20069
otherwise absolved of liability or guilt in the underlying action.30 As the district
court in the Enron case explained, “the ‘final adjudication’ requirement of [the]
exclusions implies that where the insured is not found guilty, there is coverage
for his costs and expenses in defending himself in a criminal action.”31
In contrast, courts have generally imbued “in fact” language with a
broader scope than “final adjudication,” holding, for example, that the term
requires a final decision on the merits in either the underlying case or a separate
coverage case, or an admission by the insured.32 These cases do not require a
final adjudication by the factfinder in the underlying case, but rather offer it as
a coequal alternative to having a court make the assessment in a separate
coverage proceeding.33 In bargaining for “in fact” language, then, the insurer
30
See In re Donald Sheldon & Co., Inc., 186 B.R. 364, 368–70 (Bankr. S.D.N.Y. 1995),
aff’d, 182 F.2d 899 (2d Cir. 1999) (holding that absent any indication the jury had actually
rendered a verdict based on the excluded conduct, there was no final adjudication of such
conduct, even though it worked some unfairness to the insurer who was obviously unable to
intervene in the underlying criminal case and pose the necessary, and more specific, question
to the jury).
31
In re Enron Corp. Sec., Derivatives & “ERISA” Litig., 391 F. Supp. 2d 541, 573 (S.D.
Tex. 2005).
32
See, e.g., Westport Ins. Corp. v. Hanft & Knight, P.C., 523 F. Supp. 2d 444, 454–55
(M.D. Pa. 2007); Virginia Mason Med. Ctr., 2007 WL 3473683, at *5.
33
See Westport, 523 F. Supp. 2d at 455 (finding sufficient evidence in the complaint to
make an “in fact” determination). See also PMI Mortgage, 2006 WL 825266 at *7 (holding
“that the term ‘in fact’ within the context of the exclusion here should be read to require either
a final adjudication, including a judicial adjudication, or at a minimum, at least some
evidentiary proof”); Federal Ins. Co. v. Cintas Corp., 2006 WL 1476206, at *7 (S.D. Ohio May
25, 2006) (unpublished) (holding exclusion did not absolve insurer of duty to defend because
“no factual or legal basis currently exists for applying the Exclusion”). Other courts see “in
fact,” standing alone and without contrasting “final adjudication” language, as essentially
meaning “final adjudication.” See, e.g., American Chem. Soc’y v. Leadscope, Inc., 2005 WL
1220746, at *11–12 (Ohio Ct. App. May 24, 2005) (unpublished) (finding “in fact” to require
a “final adjudication” in the underlying litigation).
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reserves the right to litigate the coverage question outside of the underlying
action for which insurance coverage is sought.
Here, the Money Laundering exclusion employs similar
language—“determined . . . in fact”—and so, in keeping with the weight of the
caselaw, implies that the coverage decision is to be made—not in the criminal or
SEC actions—but in a parallel and independent proceeding. In contrast, the
fraud exclusion’s use of the term “final adjudication” means it will not be
triggered until resolution of the underlying dispute. Despite these differences,
both exclusions leave the decision for the judiciary in the first instance.
Even if the Money Laundering exclusion is also amenable to the
underwriters’ interpretation, the parties’ chosen terms lend themselves to a
reasonable interpretation in favor of coverage and we must follow it:34 we
interpret a “determ[ination] . . . in fact”—absent language unambiguously
pointing to the underwriters as the decisionmakers—as requiring a judicial act.
And, given the contrasting language of the Money Laundering and fraud
exclusions, that act must be the result of a separate coverage proceeding.
C
As for the question of what evidence may be considered in making a
“determin[ation] . . . in fact,” the executives push another Texas
fundamental—the “eight corners” rule—which requires courts to measure an
insurer’s duty to defend by examining only the policy’s provisions and the
underlying complaint’s factual allegations, “without reference to the truth or
34
See Balandran, 972 S.W.2d at 741 (quoting Hudson Energy, 811 S.W.2d at 555).
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No. 10-20069
falsity of such allegations.”35 The executives contend this general rule prohibits
the underwriters’ attempt to put forth extrinsic evidence in support of an “in
fact” determination. The district court agreed.
The Texas Supreme Court has spoken of the eight corners rule only in the
context of duty-to-defend cases, and no Texas state court has applied the rule to
a case, like the present one, involving a duty to advance defense costs.36
Whatever the Texas Supreme Court might do to resolve the issue in a future
case, however, we need not venture a guess in this one: the D&O Policy’s terms
plainly state that the underwriters must advance defense costs “until it is
determined that the alleged act or alleged acts did in fact occur” and, in so doing,
require recourse to something more than mere allegations. The terms
contemplate the use of extrinsic evidence in making the determination. Thus,
we need not and hence do not pause to decide whether the eight corners rule
applies to the duty to advance costs as a general matter, for Texas prefers
freedom of contract37 and honors the well-worn prerogatives of parties to
override judge-made doctrines—like the eight corners rule—by contracting
around them.38 After all, it is a contract that we are construing. Assuming but
not deciding the eight corners rule would have applied, the parties chose—in
35
Argonaut Sw. Ins. Co. v. Maupin, 500 S.W.2d 633, 635 (Tex. 1973).
36
Julio & Sons Co. v. Travelers Cas. & Sur. Co. of Am., 591 F. Supp. 2d 651, 659
(S.D.N.Y. 2008) (“While there appears to be no dispute that defendant ‘has no duty to defend
any Claim’ against plaintiff, . . . the Court has found no decisions by the Texas courts
concerning a different standard for a duty to advance defense costs . . . .”).
37
See Fairfield Ins. Co. v. Stephens Martin Paving, LP, 246 S.W.3d 653, 664–65 (Tex.
2008).
38
Fortis Benefits v. Cantu, 234 S.W.3d 642, 648–49 (Tex. 2007).
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No. 10-20069
plain language—to displace it and to provide for the use of extrinsic evidence.
We must give effect to those bargained-for choices.
Our conclusion rings all the more true because the executives must agree
with it to some extent; they contend—rightly—that mere allegations are
insufficient to bar coverage under the D&O Policy. But, that is so only if the
parties opted out of the eight corners rule. If they did not, the allegations of
money laundering and other acts in the criminal and civil complaints, and the
policy’s broad definitions, might suffice to push the executives out of
coverage—undoubtedly a nuance the executives understand quite well.
D
Having concluded that the “in fact” determination must be made by a court
in a separate, parallel coverage action, in which all admissible evidence is
welcome, we decline to proceed with that action in this court. Rather we will
remand for further proceedings.
Because much gear shifting has gone on between Houston and New
Orleans, and because Judge Hittner did not have the benefit of the parties’
positions on appeal, we cannot read his order as accomplishing the task of a
separate coverage action. And as we have seen, the eight corners rule, which
found traction in the district court and on which the order relied in part, has
proved to be at best a red herring.
Nor can we ignore the awkwardness—readily recognized by Judge
Hittner—in putting the civil “cart” before the criminal “horse,” especially when
the judge who decides the question of coverage, with its demand for assessing
the strength of the government’s criminal case, is set to later preside over the
criminal trial. To extricate the able district judge from an awkwardness that
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No. 10-20069
was not of his choosing, any subsequent coverage proceedings must be before
another judge. The question, of course, is one of appearance, not of impartiality.
We remand, then, to the Southern District of Texas. There, the chief judge may
assign the case to another judge.
On remand this case will be the collateral vehicle for the “determin[ation]
. . . in fact” that the D&O Policy contemplates. The district court must decide
whether the underwriters are responsible thereafter for reimbursement of the
executives’ defense costs. We do not comment on the merits of the sought relief.
The underwriters are entitled to a decision in a separate coverage action,
for their bargain sought to mitigate the risk of advancing substantial fees on
behalf of policyholders should it be found that the insureds did in fact commit
Money Laundering as defined in the policy. By the bargain, they are not
compelled to remain aboard an aircraft that has lost its wings. Still, a
determination at this juncture cannot be final in the sense that, as the
underwriters concede, a determination of the facts on remand unfavorable to the
executives would have to be reconsidered should the executives be cleared of all
charges. That is, the judicial decision required by this coverage action remains
subject to modification. This wise concession—based on a calculation of the
executives’ long-term prospects at trial and of their ability to repay costs should
they be convicted—effectively limits the district court’s task on remand. The
district court will consider the underwriters’ future obligation to advance the
costs of defense, but its grant of relief from this obligation—if any—remains
subject to reconsideration should the executives be exonerated in either the
criminal or SEC proceeding. In that event, a court will be able to adduce all
facts and make a final coverage determination. This works a sensible
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No. 10-20069
construction of an awkwardly drafted instrument, aided by the equity power of
the court to grasp the realities of the situation at hand.
VI
As we have read the policy, the determination is a judicial act, not an
affirmation of a unilateral coverage decision. Because the policy remains silent
on the standard of proof to apply, whether that decision should be made by a
preponderance or only on clear and convincing evidence presents a substantial
issue. We need not and hence do not resolve the issue here. Rather, we leave
this matter to the district court who, on hearing the evidence, may find that the
answer is not outcome determinative.
VII
Necessary to our disposition of this appeal, which is properly before us
pursuant to 28 U.S.C. § 1292(a)(1), is the antecedent question of who makes the
“determination” that Money Laundering did or did not occur. Because our
interpretation of the policy is binding on the parties as a now-resolved matter of
law, and because we have decided that a court should weigh the evidence in the
first instance, the inescapable conclusion is that regardless of which parties are
likely to succeed on the merits, the underwriters are contractually bound to
reimburse reasonable defense costs until that merits decision is reached. The
practical effect of this legal conclusion is equivalent to the effect of the
preliminary injunction entered by the district court, at least insofar as it
required the reimbursement of reasonable defense costs until a judicial
determination in this coverage action. For that reason, we affirm the
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No. 10-20069
preliminary injunction as modified herein. This conclusion in no way controls
the ultimate coverage decision.
VIII
Our focus has been on the underwriters’ obligation to reimburse defense
costs, but the D&O Policy also imposes an obligation on the executives to repay
those costs if it is determined that they committed acts in connection with
Money Laundering. As we have read the policy, the underwriters may seek this
determination in a parallel action and, if successful, escape the obligation to
make future reimbursements, subject to reconsideration following a favorable
verdict in either proceeding.
It follows that the executives’ repayment obligations are triggered only by
the coverage determination after any reconsideration. Any other reading ignores
the realities of the underlying litigation and the purposes of the policy.
IX
We modify the district court’s injunction consistent with this opinion,
affirm the district court’s order only insofar as it provides for coverage until a
court determines otherwise, and remand for further proceedings on the coverage
question. The underwriters are enjoined from refusing to advance defense costs
as provided for in the D&O Policy unless and until a court determines “that the
alleged act or alleged acts [of Money Laundering] did in fact occur.” For these
costs, the amount of reimbursement found reasonable remains open for
determination and that also will lie with the judge on remand. Nothing herein
precludes on remand the filing of companion suits for declaratory and injunctive
relief or other relief, or, with leave of the district court, amendments to the
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No. 10-20069
parties’ pleadings. Given the effect the determination in this case may have on
the executives’ ability to secure criminal and civil counsel of their choosing, we
are confident that the district court assigned this action on remand will be one
able to proceed as expeditiously as is feasible under the circumstances.
MODIFIED, AFFIRMED as modified, and REMANDED with instructions.
24