Hanson Law Gazett - December 22, 2011

The Hanson Law Gazette

December 22, 2011


In a victory for D&O insurers, the Eighth Circuit issued a ruling this month rejecting an insured’s creative attempt to circumvent an Insured versus Insured policy exclusion. The Court’s reasoning was based on an argument from Keith Hanson, Managing Partner of the Hanson Law Group, on behalf of the Old Republic Insurance Company.

In U.S. Bank Nat’l Ass’n. v. Fed. Ins. Co., No. 10-3472 slip op. (8th Cir. Dec. 13, 2011), an insured company’s assignee and its director settled claims of the director’s alleged breaches of fiduciary duty, but the settlement stated that the assignee could obtain the settlement amount only from the director’s insurance carriers. The 8th Circuit panel unanimously affirmed the district court’s issuance of summary judgment for the insureds and finding of no coverage because the director was “absolved from payment by . . . agreement,” making the settlement fall outside of the Policy’s definition of covered Loss.

The Court of Appeals Decision

The insured company Interstate Bakeries Corp. (“IBC”) filed for bankruptcy and later assigned its interest in its D&O insurance to the creditors’ trust.  U.S. Bank was the trustee of the trust. A former director of IBC, Mr. Paul Yarrick, had allegedly breached his fiduciary duty to IBC with regard to the accounting treatment of the Company’s workers’ compensation reserves. On behalf of the creditors’ trust, U.S. Bank settled its claim against Yarrick for $56 million. Importantly, the settlement required that U.S. Bank execute only against Yarrick’s (and IBC’s) D&O insurers. In other words, the settlement absolved director Yarrick of personal liability.

The insurers denied coverage. The two grounds at issue on appeal were that (1) Yarrick was “absolved from payment” and thus any loss did not constitute covered “Loss” under the Policy, and (2) the Insured vs. Insured (“IVI”) exclusion bars coverage. The trial court granted the insurers’ motion to dismiss based on the IVI exclusion. The Court of Appeals affirmed that decision on the basis of the Loss argument, which attorneys at the Hanson Law Group had featured in their motion papers filed on behalf of Old Republic. The Court did not announce a holding on the arguments advanced by other carriers with regard to the IVI exclusion or other Policy provisions.

The basic issue as determined by the 8th Circuit panel was whether there is a difference between an agreement not to execute a judgment against the insured and an agreement to release the insured. The traditional exclusionary language in this area is that a loss is not covered if the insured is not “legally obligated to pay” such loss. Some jurisdictions hold that one is still “legally obligated to pay” even if the claimant has agreed not to execute a settlement or judgment against the insured. The theory underlying this view is that an insured is still “legally obligated to pay” unless and until the insured has obtained a full release from judgment. When the law of these jurisdictions applies, the claimant and the insured may simply draft the settlement agreement appropriately in order to completely circumvent the “legally obligated to pay” exclusion.

The Court of Appeals noted the important (yet subtle) difference in the language of the Policy in the U.S. Bank case. The Policy excluded coverage for loss when an insured is “absolved from payment” rather than when an insured is not “legally obligated to pay.” In its opinion, the Court held that Yarrick was “absolved from payment” because of U.S. Bank’s agreement not to execute the settlement amount against Yarrick himself, even though Yarrick did not obtain a full release. The Court held that the Policy’s “absolved from payment” language was clearly different from the traditional language, and thus it could simply distinguish those other cases.

U.S. Bank argued that the term “absolved” is absolute and would only be satisfied if a full release was granted by the claimant. After all, its argument goes, Yarrick was not “absolved” from the stigma of having a judgment against him, and the settlement amount did erode his coverage program for use in future claims. However, the Court noted that the Insured needed only be “absolved from payment,” not absolved from any collateral consequences, in order for the exception to the definition of Loss to apply. Neither of the circumstances U.S. Bank mentioned was a “payment,” so the exclusion applied, according to the Court of Appeals.  It is on the strength of this argument that the Eighth Circuit Court of Appeals reached its decision in favor of the insurers.

The Court’s opinion was concise. It did not address the Insured vs. Insured (“IVI”) exclusion, the point that was most forcefully asserted by counsel for the primary carrier, Federal Insurance.

Impact Going Forward

The impact of this case on insurers going forward is positive but uncertain. Having this opinion on the books will be useful for its precedential value in the Eighth Circuit. Even outside of that circuit, the opinion has important persuasive value as the first Court of Appeals decision on the term “absolved from payment.” The Court’s minimalist approach in writing its opinion actually may make this point more persuasive. If the insurers had obtained a favorable ruling on both the Loss and IVI issues, other courts might find one or the other of the rationales to be unnecessary to the holding and thus mere dicta. This approach also implies that the Court of Appeals found this point to be the better of the two comments asserted by the insurers, making its decision still stronger. In this sense, this is the most favorable outcome of the case from the insurers’ point of view.

Still, there is no guarantee that other courts will in fact find the Eighth Circuit’s opinion persuasive. The difference between “absolved from payment” and “legally obligated to pay” may not be seen as absolutely clear. A different court may be persuaded by U.S. Bank’s argument in the instant case, that the term “absolved” is more absolute and thus should more likely require a full release rather than less.

Claims personnel should continue to be wary of the uncertainty in this area. Underwriters contemplating a change in language may consider not simply adopting the term “absolved from payment,” the phrase that was blessed by the Court in this case. More broadly, Underwriters could consider excluding coverage for loss which “a claimant may not execute against the insured” in order to provide even more certainty in this area.

Kyle Hanson is an attorney at Hanson Law Group LLP’s office in Madison, Wisconsin. Along with insurance coverage and monitoring, Kyle is a patent attorney and practices in the areas of business and intellectual property.

Copyright (c) 2011 Kyle Hanson, Hanson Law Group LLP