The US District Court for the District of Connecticut recently dismissed a customer suit against an insurer, based upon its determination that all of the underlying claims were excluded by the policy’s Insolvency Exclusion.1 Associated Community Bancorp, Inc., et al. v. The Travelers Companies, Inc., et al. [Click here for a copy of the decision] The insureds alleged that the insurer had wrongfully denied coverage for several lawsuits against the insureds related to their involvement with Bernard L. Madoff Investment Securities, LLC (“Madoff”).
The Policy provided coverage, with certain exclusions, for losses incurred on claims made or discovered during the policy period (6/1/2008 through 9/1/2009) against Connecticut Community Bank, N.A. (“CB”); Westport National Bank (“WNB”); and certain WNB officers and directors, including Mr. Dennis Clark (“Clark”) (all together “Insureds”). Suits were filed against the Insureds by investors who had lost money in the infamous Ponzi scheme run by Madoff. The investors in the underlying suits had entered into custodian agreements with WNB, directing WNB to give Madoff full discretionary authority to invest their funds. The underlying suits sought return of the investors’ lost investments and fees paid to WNB, as custodian.
The Insureds notified their insurer of the underlying suits (all of which were filed during the policy period) and argued that they were entitled to coverage for the suits, including reimbursement for defense costs incurred in defending the underlying suits. The insurer, however, argued that there was no coverage under the Policy because the suits were excluded by the following exclusions contained in the Policy’s Professional Services Liability Coverage Part:
- The Insolvency Exclusion;
- The Written Representation of Prior Performance Exclusion; and
- The Fee Exclusion.
The court agreed that the Insolvency Exclusion excluded coverage for the underlying suits, and, therefore, did not deal with the applicability of the remaining exclusions.
The Insolvency Exclusion provided that the Policy did not cover “Loss [including Defense Costs] on the [sic] account of any claim made against any Insured … based upon, arising out of or attributable to insolvency … receivership, bankruptcy, or liquidation of, or financial inability to pay … by, any … investment company, … or any broker or dealer in securities or commodities.” The insurer argued that the underlying suits all “‘arose out of’ Madoff’s insolvency or inability to pay” because the suits against the Insureds would not have been filed if the investors had been able to recover their funds from Madoff. Accordingly, the insurer argued that coverage was excluded under the Insolvency Exclusion.
The court agreed that the underlying suits were excluded by the Insolvency Exclusion because they were “connected with, incident to, or flow[ed] out of Madoff’s insolvency.” The court found support for its holding under various cases interpreting similar exclusions in other jurisdictions, including one case involving investments in the Evergreen ponzi scheme (Smith v. Continental Casualty Company, 2008 WL 4462120 (M.D. Pa. 2008)).
The Insureds argued that if the Policy were intended to exclude coverage in situations that arose due to the acts of a third party, and not due to acts of the insured itself, the Policy should explicitly provide for that. The court, however, held that the language of the Insolvency Exclusion was unambiguous because the phrase “any claim” meant “just that – any claim,” and reading ambiguity in the exclusion would be torturing the words of the exclusion.
The court also rejected the Insureds’ argument that the Insolvency Exclusion should not apply because “Madoff was not an ‘investment company’ or ‘broker or dealer in securities,’ as defined by the Policy, but instead was a ‘criminal enterprise.’” The court held that the Insolvency Exclusion covered even “sham investment companies” due to the fact that the exclusion applies to claims arising out of the insolvency of “any … investment company.”
Finally, the court rejected the Insureds’ argument that the Insolvency Exclusion did not apply because the terms “insolvency,” “bankruptcy,” and “financial inability to pay” were not meant to cover massive frauds, such as Madoff’s Ponzi scheme. The court, however, held that the underlying suits arose out of Madoff’s bankruptcy, as well as Madoff’s financial inability to pay, and, therefore, there was no ambiguity in the language of the exclusion as applied to the underlying suits.
Based upon this analysis, the court granted the insurer’s motion to dismiss. In addition, the court denied the insureds the right to replead based upon the court’s finding that such repleading would be futile.
1 After determining that the Insolvency Exclusion, contained in the Professional Services Coverage Part, applied to exclude coverage for the underlying suits, the court also held that coverage was excluded under the Professional Services Exclusion, contained in the Management Liability Coverage Part.
