(Article from Insurance Law Alert, November 2024)
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Holding
A district court for the District of Columbia ruled that a subpoena issued to an employee does not trigger a duty to defend absent allegations of wrongful conduct against that employee, separate and apart from claims against the insured company. Fed. Home Loan Mortg. Corp. v. Twin City Fire Ins. Co., 2024 U.S. Dist. LEXIS 203703 (D.C. Dist. Ct. Nov. 8, 2024).
Background
Freddie Mac, a shareholder-owned, government-sponsored entity that buys and sells mortgages, was named as a defendant in a securities class action in 2007. Over the next few years, it was also the subject of numerous civil suits arising from alleged misrepresentations related to its exposure to subprime mortgages, capital adequacy, risk control, and other business practices. In 2008, the SEC initiated an investigation into Freddie Mac’s operations and in 2009 issued an “Order Directing Private Investigation and Designating Officers to Take Testimony in the Matter of Freddie Mac.” According to the pleadings, the SEC thereafter served subpoenas on Freddie Mac employees, seeking documents and interviews. Freddie Mac alleged that in March 2011, the SEC issued “Wells Notices” stating that the SEC was recommending enforcement proceedings against the company and three employees. In 2011, the SEC ended its investigation, reached a non-prosecution agreement with Freddie Mac and filed suit against the three Freddie Mac employees.
Freddie Mac sought coverage for over $145 million it allegedly spent defending the civil suits, the SEC investigation and the SEC lawsuit. The primary insurer as well as several excess insurers paid their policy limits, which amounted to approximately $85 million. Freddie Mac filed suit against certain higher level excess insurers, seeking a declaration of coverage and damages for breach of contract.
Freddie Mac filed a motion for partial judgment on the pleadings on two issues: (1) that the receipt of an SEC subpoena by a Freddie Mac employee is sufficient to trigger coverage regardless of whether the SEC is investigating the company or the employee individually, and (2) that the excess insurers cannot refuse to pay on the basis that underlying insurance was not properly exhausted by contesting a lower-layer insurer’s coverage determination. The court denied Freddie Mac’s motion as to the first issue but granted it as to the second.
Decision
The court agreed with the insurers that for an SEC subpoena to trigger coverage, Freddie Mac must demonstrate that the employee recipient of the subpoena was the subject of an SEC investigation for a wrongful act. The policies’ “Organization Insurance” section provided two types of coverage to Freddie Mac: (1) entity coverage, which pertained to claims made against Freddie Mac as a company, and (2) “indemnified employee coverage,” which applied to costs resulting from “a Claim made against an Insured Person . . . for any Wrongful Act of such Insured Person.”
The policies defined “Claim” as:
a civil, criminal, administrative or regulatory investigation of an Insured Person:
(i) Once such Insured Person is identified in writing by such investigating authority as a person against whom a proceeding described . . . [elsewhere] may be commenced; or
(ii) in the case of an investigation by the SEC or a similar state or foreign government authority, after the service of a subpoena upon such Insured Person.
Freddie Mac argued that the second sub-section should be interpreted to mean that an SEC subpoena of an employee is automatically a “Claim” that triggers coverage. Rejecting this assertion, the court ruled that absent an investigation of the employee who is the subject of the subpoena (separate and apart from any investigation of Freddie Mac as a company), there is no coverage under the indemnified employee coverage provision. The court reasoned that this interpretation comports with “the context of the entire policy, which distinguishes between investigations of Freddie Mac employees and Freddie Mac the entity.” In so ruling, the court also noted that on the pleadings alone, it was unclear whether the subpoenaed employees were themselves under investigation or whether the subpoenas even alleged a “Wrongful Act” so as to constitute a “Claim” in the first place.
With respect to the second issue, the court ruled that the higher-level excess insurers could not challenge a lower-layer insurer’s payment as outside the scope of coverage. Ruling on this matter of first impression under Virginia law, the court concluded that absent indications of fraud or bad faith, excess insurers generally cannot avoid liability by contesting payments made at lower levels of insurance coverage.
Comments
The defendant insurers argued that they were not actually second-guessing the decisions of the lower-level insurer, which made an “unallocated compromise payment” to Freddie Mac. Instead, they argued that they were contesting Freddie Mac’s decision to allocate that payment to certain uncovered losses. The court noted that the caselaw in this context is “less clear,” but concluded that “the same policy justifications bear on that situation as where an underlying insurer designates a specific purpose for a payment.”
Additionally, the court held that standard exhaustion-related policy language—such as the provision in one policy stating that the “coverage hereunder shall attach only after all Underlying Insurance has been exhausted by actual payment of claims or losses thereunder”—was insufficient to override the default rule that excess insurers cannot challenge underlying insurers’ payments.