Fidelity insurance and Ponzi schemes

Posted by Gene Killian on March 19, 2012

Spring is a time of rebirth and hope, especially for baseball fans.  No matter how badly your team played last year, when March rolls around, you’re tied for first!  That is, unless (like me) you’re a fan of the woeful New York Mets.  After just a few weeks of spring training, their third baseman already has a rib injury; their first baseman (who missed most of last year after spraining his ankle by tripping over his own feet) has come down with some sort of weird desert fever; and one of their key relief pitchers is out for at least six weeks with a torn meniscus.  Oh, I almost forgot, their All-Star shortstop now plays for someone else.  

Can it get any worse?  When it comes to the Mets, yes, of course it can! There’s the little matter of Bernie Madoff.  Mets ownership has now been ordered to return $83 million to Madoff’s victims. 

Leaving the Mets and my baseball misery to one side, the Madoff situation in general has given rise to some interesting insurance coverage questions.  Recently, in Jacobson Family Investments v. National Union, a New York state court judge rejected efforts by carriers to lump named insureds together for the purpose of showing that on the whole, they were “net winners” in the Madoff fraud and therefore not entitled to insurance recovery for their losses from the Ponzi scheme.  The case involved a fidelity-type bond or policy, in part covering damages caused by “outside investment advisors.”  

The plaintiff-policyholders were investment vehicles set up by the heirs to the founders of industrial equipment supplier MSC Industrial Direct Co. Inc. and affiliated with Jacobson Family Investments, Inc.  The carriers argued that, because the investment vehicles were all listed in the policy under the heading “Complete Named Insured,” they were in essence one policyholder, and their net wins and losses had to be aggregated.  Because the aggregate amount of all of the policyholders’ net account balances with Madoff actually made them a “net” equity winner (together, they had withdrawn $5.9 million more than they invested with Madoff), the argument was that there was no compensable loss for insurance purposes.  

Based upon the clear terms of the policy, the judge wasn’t buying it.  The Court stated that the named insured rider “does not provide that [the] entities’ net wins and losses should be aggregated…it is [simply] an informational declaration of all the entities and individuals who may draw from the bond.”  

The carriers also tried to rely upon the “Single Loss” provision of the policy, which states:  “Subject to the Aggregate Limit of Liability, the Underwriter’s liability for each Single Loss shall not exceed the applicable Single Loss Limit of Liability…If a Single Loss is covered under more than one Insuring Agreement or Coverage, the maximum payable shall not exceed the largest applicable Single Loss Limit of Liability.”  “Single Loss” was defined as “all covered loss” resulting from a fraud.  Therefore, the carriers again argued, all of the policyholders’ wins and losses had to be aggregated to determine whether there was a compensable “Single Loss.”  

Again, the Court wasn’t buying.  First, the Court held that the purpose of the “Single Loss” provision was simply “to limit [the primary carrier’s] liability, under the Bond, for separate acts of malfeasance,” not to require aggregation of wins and losses.  Second, the Court held that a “Single Loss” was defined as “all covered losses, not all covered net losses.”  The Court stated:  “Courts should be extremely reluctant to interpret an agreement as impliedly stating something which the parties have neglected to specifically include.”  

Finally, the carriers cited a “Joint Insured Provision” in an effort to support the argument that all of the named insureds’ wins and loses had to be aggregated together.  The “Joint Insured Provision” states, in part:  “If two or more Insureds are covered under this bond, the first named Insured shall act for all Insureds.  Payment by the Underwriter to the first named Insured of loss sustained by any Insured shall fully release the Underwriter on the account of such loss…The liability of the Underwriter for loss or losses sustained by all Insureds shall not exceed the amount for which the underwriter would have been liable had all such loss or losses been sustained by one Insured.”  

The Court shot that argument down as well, writing:  “It is clear from the cited language that the main purpose of this Provision was to create an organized procedure to make claims under the Bond.  There are over 160 entities or individuals covered under this Bond…and if each entity had a claim…the insurance company would be processing significant amounts of paperwork.  Assigning one of the Insureds the power to act for others covered under the Bond resolves this issue.”  

This decision shows that, even in cases involving so-called “sophisticated” policyholders, some Courts will still apply strict rules of construction against carriers.  Interestingly, at no point did the Court say that the policy was ambiguous.  Rather, the Court essentially said that the carriers were attempting to engraft terms upon the policy that did not actually exist.  This is known in our business as “post-loss underwriting.”  

The excellent policyholder attorney Robin Cohen and her great team at Kasowitz Benson handled this case for the policyholders. 

Reformation of Insurance Policies Due To "Mutual Mistake"

Posted by Gene Killian on September 01, 2011

Back in the 1980s, when we were all fighting over the meaning of the “sudden and accidental” pollution exclusion, it became fashionable for coverage lawyers to quote “Alice in Wonderland.”  If memory serves, there was even a battle of law review articles (sponsored by the insurance industry on one side and corporate policyholders on the other) in which the dueling parties tried to out-Lewis-Carroll one another.  

The most favored quotation was the following exchange: 

“When I use a word,” Humpty Dumpty said in a rather scornful tone, “it means just what I choose it to mean – neither more nor less.”  

“The question is,” said Alice, “whether you can make words mean so many different things.”  

“The question is,” said Humpty Dumpty, “which is to be master - - that’s all.”  

I thought of that quote for the first time in a long time when I read the recent Third Circuit decision in Illinois National Insurance Co. v. Wyndham Worldwide Operations, Inc. 

First, the facts: Illinois National sold aircraft fleet management insurance coverage to an aircraft maintenance company called Jet Aviation for successive one-year periods from 2004 through 2008.  The policies provided coverage for Jet Aviation and some of Jet Aviation’s clients, so long as Jet Aviation managed the particular client’s aircraft and aircraft usage.  Wyndham was one of Jet Aviation’s clients (and a named insured under the policy).

In the 2008 renewal, the requirement that Jet Aviation manage the client’s aircraft was deleted and replaced by language stating that the aircraft simply had to be operated or used by a named insured  - not necessarily by Jet Aviation.

You can guess what’s coming next.  Plane crash, five dead, plane rented by Wyndham (a named insured under the policy) - but not managed by Jet Aviation.  Naturally, Humpty Dumpty – er, Illinois National – denied the resulting claim, on the ground that “a word means just what I choose it to mean – neither more nor less.”  Specifically, Illinois National contended that the reason for the wording change was “to make it more clear that entities affiliated with Jet Aviation were covered,” and not to delete the requirement that Jet Aviation manage the aircraft.

The trial court, able to read English, disagreed, holding that there could be no reformation of the contract based on “mutual mistake,” since Wyndham had not even been involved in the contract negotiations. 

Unfortunately, in a 2-1 decision, the appeals court reversed, and bought the Humpty Dumpty argument, writing:  “Jet Aviation and Illinois National agree that their intent, at the time the contract was drafted, was to limit coverage for non-owned aircraft to aircraft used by or at the direction of Jet Aviation.” 

Who cares what Jet Aviation (out to protect its policy limits and not wanting a premium increase) or Illinois National (out to protect its profits) “agreed”? To operate its business, Wyndham – a named insured - was relying on the coverage that Illinois National sold.  If it had known that the coverage was worthless in some circumstances, it might have gone out and bought other, supplemental coverage.  At least Wyndham should have had that opportunity.  But unless and until courts make insurance companies answer to a higher standard (and also make them behave like the fiduciaries they’re supposed to be), insurance companies will continue to make spurious arguments and get away with it.

On the positive side (such as it is), Justice Nygaard (also able to read English) dissented rather vociferously, writing that there “is simply no support in state law for the conclusion that the insurer’s failure to read the plain language of its own policy before issuing it to the insured justifies [disregarding the plain meaning of a contract].”  Sounds like he was inviting a petition for en banc review.

As for the logic of the majority decision, I guess the best thing to do is to quote from the Mock Turtle:  “Well, I never heard it before, but it sounds uncommon nonsense.”