Court finds fraud and contract exclusions in private corp. D&O policy inapplicable to judgment for fraud and contract breach arising from business sale

by Christopher Graham and Joseph Kelly

Rhode Island

A recent article from Business Insurance by Judy Greenwald — “Private Companies See Costs Rise for Management Liability Coverage” — concludes that EPL claims and increased mergers and acquisitions litigation are leading to higher private corp. D&O rates.

Coincidentally, Transched Systems, Ltd. v. Federal Ins. Co., Case No. 12-939-M (D. R.I. Aug. 2, 2013) is a recent case involving coverage under a private corp. D&O policy for an M&A gone bad. The United States District Court for Rhode Island denied Federal’s motion to dismiss, which was based on fraud and contract exclusions.

Federal issued a D&O policy to Versyss Transit Solutions, LLC, Versyss Commercial Systems, LLC, and Holbrook Systems, Inc. (“Versyss”). Transched Systems, Ltd. obtained a jury verdict against Versyss for: (1) breach of contract regarding misrepresentations and warranties in an asset purchase agreement (“APA”); (2) breach of the implied covenant of good faith and fair dealing; and (3) intentional misrepresentations. Federal defended Versyss, but denied any duty to indemnify, citing the policy’s fraud and contract exclusions. Versyss didn’t fulfill the judgment so Transched sued the D&O insurer under Rhode Island’s direct action statute for a declaration of coverage.

Fraud exclusion

The policy’s fraud exclusion excludes coverage for Claims:

based upon, arising from, or in consequence of any deliberately fraudulent act or omission or any willful violation of any statute or regulation by such Insured, if a final and non-appealable judgment or adjudication adverse to such Insured establishes such a deliberately fraudulent act or omission or willful violation. (emphasis added).

Federal argued the exclusion applies because there was a verdict against Versyss for deliberately fraudulent conduct. Transched countered that the fraud was by Versyss’s Vice President (who wasn’t a party and didn’t seek coverage), and, thus, it can’t be imputed to Versyss.

The court found that the fraud exclusion applies “only if ‘such Insureds’ committed a deliberately fraudulent act. By using the term ‘such Insured,’ the fraud exclusion is focused upon deliberate fraud committed by the particular Insured that is seeking coverage, in this case, Versyss.”

While the Vice President’s fraudulent conduct was imputed to Versyss for liability purposes; that wasn’t enough for the fraud exclusion to apply.

For purposes of the fraud exclusion, the Court looked to the policy’s “Severability of Exclusions” clause, which provides:

With respect to Exclusions (A)(10)[fraud exclusion]…: … (2) only facts pertaining to and knowledge possessed by any past, present or future Chief Financial Officer, President, Chief Executive Officer or Chairperson of any Insured Organization shall be imputed to any Insured Organization to determine if coverage is available.

The Vice President was not included in the list of individuals whose acts could be imputed to Versyss for purposes of the fraud exclusion, and, thus, the court found the fraud exclusion inapplicable.

Contract exclusion

The policy’s contract exclusion excludes coverage for Claims:

based upon, arising from, or in consequence of any actual or alleged liability of an Insured Organization under any written or oral contract or agreement, provided that this Exclusion (C)(2) shall not apply to the extent that an Insured Organization would have been liable in the absence of the contract or agreement[.]

Federal argued that “arising from” is broad and means “originating from, growing out of, flowing from, incident to or having connection with” a contract. Federal argued further that Versyss’s VP made intentional misrepresentations inducing Transched to enter into the APA and that the misrepresentations were in the APA and, thus, Transched’s intentional misrepresentation claim arose from the asset purchase agreement.

Transched argued the exception to the exclusion applied – namely, that the contract exclusion doesn’t apply if liability was independent of the contract.

The court rejected Federal’s contract exclusion argument finding that the misrepresentations here occurred months before execution of the asset purchase agreement and, thus, the misrepresentations were actionable independent of the APA.

Tags: Rhode Island, D&O insurance, EPL, fraud exclusion, contract exclusion, M&A

Category: D&O Digest Comment »

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