Miller & Schroeder, Inc. (“M&S”) was a securities underwriter and broker that was acquired in 1997 by MI Acquisition Corporation (“MI”). In connection with that transaction, MI bought a three-year policy “Directors and Officers Liability Insurance Policy Including Employer’s Liability Coverage” (the “Policy”) from Executive Risk Indemnity, Inc. (“ERII”). The Policy was later renewed for an additional three years. Between 1996 and 1999, M&S underwrote $140,000,000 worth of “Heritage Bonds”, all of which eventually defaulted. Purchasers of the bonds sued M&S and its directors and officers, alleging a number of theories of liability including violations of federal securities laws. In 2001, M&S tendered the claims to ERII, which denied coverage on the grounds that coverage was precluded by an endorsement to the Policy, providing that coverage did not apply to any claims arising out of the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940 or other federal or state laws, rules or regulations with respect to the regulation of securities. M&S defended itself against the claims, which resulted in millions of dollars in damages and ultimately caused M&S to file for bankruptcy protection under Chapter 7.
The trustee of M&S’s bankruptcy estate initiated adversary proceedings against ERII in October 2003 in the United States Bankruptcy Court for the District of Minnesota, alleging that ERII breached its contract with M&S by failing to defend and indemnify it for claims made in the Heritage Bond litigation. The bankruptcy court granted the trustee’s motion for partial summary judgment, concluding that the insurance policy did not preclude coverage of some of the claims, and ERII was obligated to defend M&S against all of the claims brought in the Heritage Bond litigation. ERII appealed the judgment to the United States District Court for the District of Minnesota, which affirmed the bankruptcy court’s judgment. ERII appealed that judgment to the Eighth Circuit.
The Eighth Circuit found that the language of the endorsement was unambiguous and that the bankruptcy court erred by relying on extrinsic evidence–the deposition testimony of the insurance broker who sold the Policy who testified that the securities exclusion was intended to exclude coverage for liability resulting from M&S’s sales of its own stock. The appeals court noted that the lower courts’ determination that only M&S’ interpretation “made sense” was irrelevant, as “freely contracting actors in the marketplace, particularly sophisticated business entities who rely on experts to advise them, are best suited to determine what makes the most economic sense, and the language they have mutually negotiated and agreed to is the best evidence of what those parties intended.” Moreover, the fact that the policy contained other exclusions that substantially overlapped with the endorsement did not create an ambiguity, as “[n]othing prevents the parties from using a ‘belt and suspenders’ approach in drafting the exclusions, in order to be ‘doubly sure.’”
The Eighth Circuit also rejected M&S’ argument that, since the endorsement did not list NASD rules among the securities laws, ERII’s duty to defend was triggered by NASD claims in the underlying suits. The endorsement excluded “any Claim based on, arising out of . . . or in any way involving any actual or alleged violation” of the securities laws. Thus, explained the court, the exclusion “is tied to the insured’s allegedly wrongful conduct and the operative facts underlying that conduct.” In other words, “if the same set of operative facts underlies both the federal- and state-law securities violations and the alleged violations of the unenumerated legal authority, such as the NASD rules, the broad, plain language of [the endorsement] excludes coverage for all of those violations.” Therefore, because the purportedly non-excluded claims arose out of the same operative set of facts as the claims explicitly excluded by the endorsement, the court ruled that those claims were “related claims” that would be treated as a single claim under the language of the policy and coverage was likewise precluded.
The Eighth Circuit’s decision affirms the time honored rule that extrinsic evidence will not be considered by a court in construing the meaning of a contract unless and until the court first find that the contract language is ambiguous. Unfortunately, some courts have abandoned this general principle when the contract to be construed is an insurance policy. No sound reason exists for such an exception.
