Judgments against fraudster and his company uninsurable under Minnesota law, and D&O policy’s contract exclusion was inapplicable

by Chris Graham and Joseph Kelly

Zayed v. Arch Ins. Co., Case No. 11-CV-1319 (PJS/TNL) (D. Minn. March 20, 2013)

Right before being shut down by the government for ponzi schemes, Trevor Cook sued Edward Baker and several Baker-affiliated companies, including Mesa Holdings, Inc. for fraud. Cook’s court-appointed receiver pursued the suit against Baker and Mesa. D&O insurer Arch refused to defend or indemnify Baker or Mesa for that suit. The case resulted in a Miller-Shugart settlement under which $1 million and $500,000 judgments were entered against Baker and Mesa, respectively, and Baker and Mesa assigned any claims against Arch to Receiver. Receiver sued Arch for the $1.5 million in judgments and about $70,000 in attorneys’ fees incurred by Baker and Mesa in defending Receiver’s suit.

Court granted Arch’s motion for summary judgment that Arch had no duty to indemnify Baker or Mesa because the amounts sought were “uninsurable” as a matter of law. The Policy defines “Loss” as “the amount the Insureds are legally obligated to pay resulting from a Claim”; but that definition also excludes “matters that are uninsurable under the law pursuant to which this Policy shall be construed.” When deciding whether a Minnesota claim is insurable, courts first look to the substance of the claim rather than labels; and then look to moral hazard and whether if a particular type of wrongdoing is insured, people will engage in more of that wrongdoing. Court found this suit uninsurable because Baker and Mesa’s conduct was fraudulent and insuring such conduct would lead to more fraud.

Arch unsuccessfully argued that the contractual liability exclusion excluded coverage. The policy excluded coverage for “Loss for any claim . . . arising from, based upon, or attributable to any liability under any contract or agreement, provided that this exclusion shall not apply to the extent that liability would have been incurred in the absence of such contract or agreement.” Arch argued that “but for” the contracts between Cook and Mesa, Mesa (and Baker) wouldn’t be liable for fraud. Court found that the Policy doesn’t exclude coverage for claims that wouldn’t exist “but for” a contract; rather, the Policy excludes coverage for claims that wouldn’t exist but for contractual liability (breach of contract).

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