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Court Grants Preliminary Injunction Directing Excess Insurers to Advance Defense Costs in Prosecution for Alleged Securities Fraud

On December 27, 2017, Justice Sherwood of the New York County Commercial Division issued a decision in Freedom Specialty Ins. Co. v. Platinum Mgt. (NY), LLC, 2017 NY Slip Op 32728(U), granting a preliminary injunction directing three excess D&O insurers to advance defense costs for the defense of a federal securities fraud prosecution, and related civil actions (N.B. I represented one of the insureds in this case, and I argued the preliminary injunction motion on behalf of all the insureds. See Law360’s coverage of the oral argument on the preliminary injunction motion here).

The insureds in Freedom Specialty are former officers and employees of Platinum Partners, a New York hedge fund, who sought advancement of defense costs under Platinum’s D&O policy and four excess policies (each for $5 million) for a securities fraud prosecution in the EDNY, and a related SEC enforcement proceeding. The primary insurer and the first-tier excess insurer acknowledged coverage and advanced defense costs up to the limits of those policies. However, the insurers responsible for the top three excess tiers (the “Excess Insurers”) filed suit, seeking a declaratory judgment that they had no obligation to provide coverage. Among other defenses, the Excess Insurers claimed breaches of “Warranty Statements” signed in connection with the applications for the policies, which stated, in substance, that “No Insured has knowledge . . . of any wrongful act of any Insured,” or of any “fact, circumstances or situation which (s)he has reason to suppose might result in a claim being made against any of the Insureds.” The Excess Insurers alleged that the Warranty Statements were breached because the Insureds did not disclose “information contained in the EDNY Indictment and SEC Proceeding” – that is, the very allegations of wrongdoing that the insureds deny and for which they seek insurance coverage to mount their defense.

The insureds filed counterclaims, and moved for (1) a preliminary injunction directing the Excess Insurers to advance their defense costs, and (2) a stay of discovery in the coverage action pending the resolution of the underlying criminal proceedings. Justice Sherwood granted the insureds’ motion in full. Citing the First Department’s seminal decision in Federal Ins. Co. v. Kozlowski, 18 A.D.3d 33 (1st Dep’t 2005), Justice Sherwood explained that, “under a directors and officers liability policy calling for the reimbursement of defense expenses . . . insurers are required to make contemporaneous interim advances of defense expenses where coverage is disputed, subject to recoupment in the event it is ultimately determined no coverage was afforded.”

The Court found that the Insureds had shown a likelihood of success on their claim for advancement because the Excess Insurers could not rely on the Government’s unproven allegations to establish a breach of the Warranty Statements, or any other purported defenses to coverage. As Justice Sherwood explained, “[t]he Insureds have not been found guilty of any of the charges contained in either the EDNY Indictment or the SEC Complaint,” and “until there has been a final adjudication of wrongdoing by the Insureds, the Excess Policies remain in effect and the Excess Insurers are required to pay the legal defense costs of their insureds.” Justice Sherwood further concluded that the Insureds “face irreparable harm without advancement of Defense Costs,” in that they “will be unable to mount adequate defenses, particularly in the EDNY criminal proceedings, where . . . the government has already produced approximately 15 million pages of documents with discovery still ongoing, and the Insureds are in need of funds to pay for the expert witnesses and consultants that are essential to their defense.” The Court also found that the balance of equities favored granting the injunction because “[t]he harm that the Insureds may suffer stemming from being unable to adequately defend themselves, including personally losing their liberty, outweighs any possible economic loss that the Excess Insurers may experience.”

Finally, the Court granted the Insureds’ motion to stay discovery, holding that “the demand for discovery in furtherance of the Excess Insurers’ putative defenses against coverage” was “premature” because “[a] declaratory judgment action cannot be used to conduct discovery regarding the very facts at issue in the EDNY Indictment and the SEC Complaint.” This decision illustrates the important distinction between the duty to advance defense costs, and the ultimate duty to indemnify. The duty to advance attaches whenever there is a “possibility of coverage.” Westpoint Int’l, Inc. v. Am. Int’l S. Ins. Co., 71 A.D.3d 561, 563 (1st Dep’t 2010). Thus, the fact that the insurer asserts coverage defenses does not relieve it of the duty to advance – particularly where the purported defenses depend on facts that are at issue in the underlying proceedings for which the insured seeks coverage.

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