In the criminal action, the United States brought charges against the CEO based on his company’s bid to supply certain military equipment. Among the government’s allegations were that the CEO and other defendants committed fraud and made false statements to inflate the cost of a contract to supply equipment and also obstructed a federal audit. Following the criminal action, the CEO and other officers and directors were named as defendants in derivative and securities lawsuits based on the allegations set forth in the criminal action. In May 2008, the CEO pled guilty to failing to keep a company tax record as required by federal law. Furthermore, the company itself pled guilty to obstruction of a federal audit by withholding cost and pricing information.
Pursuant to an interim funding agreement containing a full reservation of rights, the insurer agreed to advance defense costs. Once the CEO and the company pled guilty in the criminal proceeding, however, the insurer stopped paying defense costs and took the position that the fraudulent acts/willful violation exclusion barred coverage. The Policy’s fraudulent acts/willful violation exclusion precluded 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 [an] Insured Person, if a judgment or other final adjudication establishes such a deliberately fraudulent act or omission or willful violation.” In addition to a declaration that there was no coverage, the insurer sought to recoup defense costs previously advanced, which were in excess of $2 million.
In holding that the fraudulent acts/willful violation exclusion applied, the court rejected the insured’s argument that the company’s guilty plea was distinct from a final adjudication on the merits. The court held that a guilty plea is equivalent to a conviction by trial and is conclusive evidence of criminal acts. Further, the court determined that the “arising out of” language in the exclusion requires a “but for” causation and held that but for the company’s deliberately fraudulent misconduct as evidenced in the criminal proceeding, the civil lawsuits would not have been filed.
In granting the insurer’s request to recoup defense costs advanced, the court noted that the Policy required the insured to repay defense costs to the insurer upon a determination that the defense costs were not insured. Since the court found that there was no coverage afforded by the Policy, the court ruled that the insured was required to repay any defense costs advanced by the insurer.
