(Article from Insurance Law Alert, April 2023)
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Holding
The Third Circuit ruled that a Delaware district court erred in granting a D&O insurer’s summary judgment motion as to its duty to pay defense costs incurred in complying with a subpoena issued by the Securities and Exchange Commission. Liberty Ins. Underwriters, Inc. v. Cocrystal Pharma, Inc., No. 22-2242 (3d Cir. Apr. 25, 2023).
Background
Cocrystal was formed in 2014 following the merger of Biozone Pharmaceutical and Cocrystal Discovery. After the merger, Biozone ceased to exist. Cocrystal purchased D&O coverage from Liberty that covered claims made between 2015 and 2018. In 2015, the SEC subpoenaed Cocrystal requesting various documents about both Cocrystal and Biozone. While the SEC did not indicate which entity was the target of its investigation, it appeared that the SEC was primarily interested in Biozone. Liberty denied coverage for the costs of complying with the subpoena, arguing that there was no “Claim” under the policy. However, in 2017, after receiving more information about the SEC’s investigation, Liberty paid Cocrystal $1.1 million to cover its defense costs.
In 2018, after Liberty’s policy expired, the SEC filed an enforcement action against former Biozone officers and directors. Thereafter, private plaintiffs brought derivative actions and a securities class action against Cocrystal, alleging that Cocrystal’s officers made false and misleading statements following the merger. Cocrystal sought coverage for these suits based on an “Interrelated Wrongful Acts” provision, under which all claims arising from acts that have a “common nexus” are deemed to have been made on the date the earliest claim was made. Liberty denied coverage, and also sought reimbursement of the defense costs it paid based on the SEC enforcement action against only Biozone executives. The district court granted Liberty’s summary judgment motion and the Third Circuit reversed.
Decision
The Third Circuit ruled that issues of fact existed as to whether Liberty was obligated to pay Cocrystal’s costs of complying with the subpoena because the subpoena established the “possibility of wrongful acts” being investigated by the SEC. In so ruling, the court noted that various document requests related to the actions and operations of Cocrystal following the merger.
In addition, the Third Circuit concluded that summary judgment could not be issued as to Liberty’s duty to pay the costs of defending the three private lawsuits filed after expiration of its policy. The court explained: “If it is found that the SEC investigated a Wrongful Act by Cocrystal—making the subpoena a proper claim under the policy, then the 2018 Lawsuits may relate back and be covered.”
Comments
The scope of a D&O insurer’s duty to pay the costs of complying with an SEC subpoena is a frequently litigated issue. Outcomes are highly fact specific, turning on both applicable policy language and the particular nature of the SEC’s requests. Importantly, in Cocrystal, the Third Circuit held that the ultimate outcome of SEC investigations was not relevant to defense cost analysis. In finding that Liberty had no duty to cover Cocrystal’s costs of complying with the subpoena, the district court had relied upon the fact that the eventual SEC enforcement action charged only former Biozone executives and did not implicate any Cocrystal directors or officers. The Third Circuit rejected this reasoning, emphasizing that the subpoena at issue raised the possibility of wrongful acts by Cocrystal and explaining that the duty to defend is based on the possibility of liability “at the beginning of the case, not based on its outcome.”