United States District Court, S.D. New York
February 3, 2005.
IN RE WORLDCOM, INC. SECURITIES LITIGATION. This Document Relates to: 03 Civ. 652 03 Civ. 758 03 Civ. 7927 03 Civ. 9460 04 Civ. 4089 04 Civ. 4546 04 Civ. 4567.
The opinion of the court was delivered by: DENISE COTE, District Judge
OPINION & ORDER
This motion addresses the right of a member of a board of
directors to receive from his insurer payment of the costs of
defending himself against litigation when the insurer contends
that the insurance policy has been rescinded due to a submission
of allegedly false financial statements with an application for
insurance. Bert C. Roberts, Jr. ("Roberts"), a former chairman of
the board of directors of WorldCom, Inc. ("WorldCom") seeks an
order compelling Continental Casualty Company ("Continental") to
honor an excess directors and officers ("D & O") liability policy
that it issued and to advance immediately the costs of defending
Roberts against claims filed in a host of lawsuits arising from
the collapse of WorldCom which allege principally violations of
federal securities laws. Continental asserts that it rescinded
the D & O policy for fraud, that it is void ab initio, and that
as a result, it has no present obligation to pay defense costs.
For the reasons stated below, Roberts' motion is granted.
On June 25, 2002, WorldCom announced a massive restatement of
its financial statements. The first class action lawsuit to
anticipate that announcement had been filed in this district on
April 25, 2002. Many more followed. The litigation concerning
WorldCom filed in federal court, or successfully removed to
federal court, has been consolidated for pretrial purposes in the
Southern District of New York by the Judicial Panel on
Multi-District Litigation and assigned to this Court. Roberts is
named as a defendant in the consolidated WorldCom securities
class action as well as in numerous other related lawsuits. The
issues in and the history of the consolidated WorldCom securities
litigation ("Securities Litigation") have been described in
many previous Opinions.*fn1
WorldCom and its officers and directors were insured under a D
& O liability policy issued by National Union Fire Insurance
Company of Pittsburgh, Pennsylvania ("National Union"). The
National Union policy provided primary coverage.
The first page of the National Union renewal policy for 2002
states in bold letters "NOTICE: . . . THE INSURER MUST ADVANCE
DEFENSE COSTS PAYMENTS PURSUANT TO THE TERMS HEREIN PRIOR TO THE
FINAL DISPOSITION OF A CLAIM." The National Union policy
provision that defines the coverage for directors is contained in
Clause 1, entitled "Insuring Agreements. Coverage A: Directors
and Officers Insurance," and provides as follows:
This policy shall pay the Loss of each and every
Director or Officer arising from a Claim first made
against the Directors or Officers during the Policy
Period or the Discovery Period (if applicable) and
reported to the Insurer pursuant to the terms of this
policy for any actual or alleged Wrongful Act in
their respective capacities as Directors or Officers
of the Company, except when and to the extent that
Company has indemnified the Directors or Officers.
The Insurer shall, in accordance with and subject to
Clause 8, advance Defense Costs of such Claim prior
to its final disposition.
(Emphasis supplied.) Clause 8 of the policy provides:
Under both Coverage A and Coverage B of this policy,
except as hereinafter stated, the Insurer shall
advance, at the written request of the Insured,
Defense Costs prior to the final disposition of a
Claim. Such advanced payments by the Insurer shall
be repaid to the Insurer by the Insureds or the
Company severally according to their respective
interests, in the event and to the extent that the
Insureds or the Company shall not be entitled under
the terms and conditions of this policy to payment of
The National Union policy provides for limited severability for
individual directors in connection with three questions. National
Union did not require the questions to be answered since they
were included as part of a renewal program, and they were
not answered. Of particular interest here, one question stated
"9. (a) No Executive has knowledge or information of any act,
error or omission that might give rise to a Claim . . . under the
proposed policy, except as follows:. . . ." (Emphasis supplied.)
The National Union policy continued with the statement that
[i]t is agreed that with respect to Questions 8, 9
and 10 above, that if such claim, proceeding,
action, knowledge, information or involvement
exists, then such Claim, proceeding or action and
any Claim or action arising from such claim,
proceeding, action, knowledge, information or
involvement is excluded from the proposed coverage.
Endorsement No. 1 of the policy provides that "[i]f this policy
has been in effect for thirty (30) days or more, the Insurer may
cancel this policy only if one or more of the following reasons
apply: . . . 2) . . . a material or willful misstatement or
omission of fact . . . in connection with any application ?, or
claim. . . ." Such a cancellation occurs thirty days after
notification of cancellation.
On July 21, 2002, WorldCom filed for bankruptcy protection. On
November 8, 2002, WorldCom filed an Emergency Motion Pursuant to
Bankruptcy Rule 9019(a) for Approval of Debtors' Settlement
Agreement with National Union. As part of the terms of this
agreement, the National Union D & O policy was rescinded and
voided ab initio as to WorldCom only. The agreement provides
the following as to directors:
The Policies provide rights and coverage to the
directors, officers, and employees of WorldCom as
insureds under the Policies severally, and not
jointly or with imputation of knowledge or conduct,
respect to the applications for the Policies and the
exclusions in the Policies, and the Policies are not
rescinded as to any directors, officers, and
employees of WorldCom as insureds under the Policies.
On November 26, 2002, the bankruptcy court approved this
settlement agreement. National Union acknowledged the coverage
obligations of its policy as to the WorldCom directors and
officers and its coverage has been paid in full and is exhausted.
This suit concerns the rights of the insureds vis a vis the
excess carriers. After being contacted by the New York office of
an insurance agent acting on behalf of WorldCom, in December
2001, Continental sold an excess directors, officers, and
corporate liability insurance policy to WorldCom. Altogether,
WorldCom and its officers and directors were insured for D & O
liability coverage under seven tiers of excess D & O policies
issued by Continental; Twin City Fire Insurance Company ("Twin
City"); Associated Electric & Gas Insurance Service Limited
("AEGIS"); Gulf Insurance Company ("Gulf"); SR International
Business Insurance Company ("Swiss Re"); Starr Excess Liability
Insurance International Limited ("Starr"); and in a final tier,
National Union (collectively, the "Excess Insurers"). With one
apparent exception that is not relevant to the instant
motion,*fn2 all of the excess D & O policies follow the
form, including the
terms, conditions, and exclusions, of the underlying National
Union D & O policy.
As part of the application for the Continental policy, WorldCom
submitted WorldCom's 10-K for the year ending December 21, 2000;
WorldCom's 10-Qs for the second and third quarter of 2001;
WorldCom's annual report for 2000; and various registration
statements filed with the Securities and Exchange Commission.
Together, the seven tiers of excess insurance provided $85
million in coverage in addition to $15 million in coverage
provided under National Union's primary policy for a total of
$100 million in insurance coverage.*fn3
The first lawsuit arising from the WorldCom debacle was
apparently filed on March 26, 2002, in Mississippi. WorldCom, on
behalf of Roberts, timely notified the National Union and the
Excess Insurers of the litigation, and complied with all
conditions precedent in the excess D & O policies, or is
otherwise excused from doing so. WorldCom demanded that the
Excess Insurers acknowledge that the D & O policies are required
to pay the defense costs incurred in connection with what is now
known as the Securities Litigation.
In a September 12, 2002 letter to WorldCom,*fn4
Continental indicated that based on the material
omissions by WorldCom and its officers and directors, it
considered its excess D & O policy to be void ab initio and
viewed the policy as rescinded. In the September 12 letter,
Continental stated that it would "next week return the premium
payment of $1,300,000 together with interest required by
On January 28, 2003, Continental filed a declaratory judgment
action in the Southern District of New York seeking a judicial
determination that it had properly rescinded its policy.*fn6
An August 1, 2003 order ("August 1 Order") of the Bankruptcy
Court stayed that action, captioned Continental Cas. Co. v.
Ebbers, No. 03 Civ. 652 (DLC). The August 1 Order concluded that
the action, as well as a parallel action brought by Twin City,
No. 03 Civ. 758 (DLC), were void ab initio as they should not
have been brought without first seeking relief from the automatic
stay.*fn7 Meanwhile, on January 29, 2003, WorldCom filed an
adversary proceeding in the Bankruptcy Court on behalf of itself
and its directors seeking a declaration of rights under the
excess D & O policies. Continental opposed WorldCom's motion for
partial summary judgment in the adversary proceeding by arguing
that its policy was void ab initio and rescinded. On April 20,
2004, WorldCom emerged from bankruptcy. A May 14, 2004
order of the Bankruptcy Court concluded that it was no longer the
proper forum to address disputes about the WorldCom insurance
policies and proceeds. Having confirmed a plan which resolved
WorldCom's rights and duties under the insurance policies, the
court concluded that the resolution of the dispute between the
Excess Insurers and non-debtor officers and directors "would have
a de minimus" effect on the estate and did not warrant its
On May 28, 2004, Roberts filed the instant action, No. 04 Civ.
4089 (DLC), seeking a declaration of the rights, duties, and
responsibilities of the Excess Insurers. In particular, Roberts
seeks a declaration that the purported rescission of the
Continental policy and other D & O policies issued to WorldCom
was without good or sufficient cause. On June 4, 2004, Roberts
made a written demand for coverage of defense costs to
Continental. None of the Excess Insurers has advanced defense
costs to Roberts or the other director defendants in the
On June 30, Roberts submitted an order to show cause why an
order should not be entered compelling Continental immediately to
advance defense costs to Roberts for the Securities Litigation.
At a conference on July 7 a briefing schedule was set.
Continental and Twin City have opposed the June 30 application;
Gulf and Swiss Re have joined in that opposition. Former WorldCom
director Francesco Galesi ("Galesi") has filed an amicus curiae
brief in support of Roberts' application.
On July 19, oral argument on this application was held. The
Court indicated that it would be granting Roberts' motion. The
issuance of this Opinion has been delayed based on the
representation of the Excess Insurers and counsel for all of the
WorldCom director defendants except Roberts and Galesi that a
settlement had been negotiated between them and the Lead
Plaintiff in the WorldCom securities class action ("Settlement").
On January 6, 2005, the Settlement was formalized and presented
to the Court. A revised Stipulation of Settlement was submitted
to the Court on January 18. Various parties to the class action
and others objected to the Settlement. An Order of February 2,
2005 advised the parties that the judgment reduction formula in
the Settlement violated Subsection 21D(f) of the Private
Securities Litigation Reform Act, 15 U.S.C. § 78u-4(f)(7)(B)(i).
That same day, the Lead Plaintiff gave notice that it was
terminating the Stipulation of Settlement on the ground that it
refused to risk "a substantial reduction in any judgment against
the remaining Defendants."
Meanwhile, WorldCom had created a $25 million indemnification
fund ("Indemnification Fund"), which was approved by the
bankruptcy court in January 2004, as part of WorldCom's plan of
bankruptcy, to pay the reasonable legal expenses of current and
former directors, officers, and employees. More
recently, WorldCom proposed a plan of allocation for the
Indemnification Fund in consultation with Roberts. This plan of
allocation was approved by the Honorable Jed B. Rakoff of this
District on December 21, 2004. Under the plan, any person seeking
reimbursement from the Indemnification Fund "must have made good
faith efforts to obtain reimbursement through any potentially
available insurance coverage." Roberts stated recently that he
was "optimistic" that his legal expenses would be fully
reimbursed by the Indemnification Fund. With the failure of the
Settlement, it is now highly improbable that the attorney's fees
and litigation expenses incurred by Roberts will be paid through
a limited fund that can now expect substantial claims to be made
as well by all of the other WorldCom directors.
Roberts seeks a preliminary injunction requiring Continental to
advance the costs he has spent and continues to spend defending
himself in the Securities Litigation. Roberts contends that
under the terms of the National Union and Continental policies
and under New York law,*fn9 he is entitled to these defense
costs prior to the adjudication of whether the Excess Insurers
have effectively rescinded or are able to rescind their policies
as to him. For its part, Continental does not dispute that the
claims against WorldCom and its directors fall within the
policies' definition of covered claims. Nor does it contest that
the insurance policies entitle Roberts to defense costs.
Continental argues, however, that the policies were issued in
reliance on WorldCom's false financial statements and were
therefore properly rescinded and are void ab initio. It
contends that New York law demands Roberts to show that he can
defeat Continental's rescission defense before it can be required
to provide him with defense costs.
A party seeking a preliminary injunction under Rule 65,
Fed.R.Civ.P., is ordinarily required to demonstrate that absent
injunctive relief, it will suffer irreparable harm, and that
either (a) it is likely to succeed on the merits, or (b) there
are sufficiently serious questions going to the merits to make
them a fair ground for litigation, and that the balance of
hardships tips decidedly in its favor. Sunward Electronics, Inc.
v. McDonald, 362 F.3d 17, 24 (2d Cir. 2004). To obtain an
injunction which alters, rather than maintains, the status quo, a
movant must establish a clear or substantial likelihood of
success on the merits, as well as irreparable injury. See No
Spray Coalition, Inc. v. City of New York, 252 F.3d 148, 150 (2d
Where a preliminary injunction grants only part of the relief
to which a movant would be entitled on the merits and requires a
party "to do what it should have done earlier," then it is judged
under the standard for prohibiting injunctions, and not the
heightened standard for mandatory injunctions. Johnson
v. Kay, 860 F.2d 529, 541 (2d Cir. 1988). See also Brewer
v. W. Irondequoit Sch. Dist., 212 F.3d 738, 744 (2d Cir. 2000)
(heightened standard appropriate where injunction will "provide
the movant with substantially all the relief sought"); Alcatel
Space, S.A. v. Loral Space & Communications Ltd.,
154 F. Supp. 2d 570, 580 (S.D.N.Y. 2001). The heightened standard should only
apply "if a preliminary injunction would make it difficult or
impossible to render a meaningful remedy to a defendant who
prevails on the merits at trial." Tom Doherty Associates, Inc.
v. Saban Entertainment, Inc., 60 F.3d 27, 35 (2d Cir. 1995).
The heightened standard for a preliminary injunction does not
apply to Roberts' motion. He seeks only part of the benefits to
which he is entitled under the policy, the policy language
strongly supports his argument that Continental should already
have been advancing defense costs, and the injunction will not
substantially interfere with Continental's right to obtain a
meaningful remedy if it prevails on the merits. If it succeeds on
the merits, Continental will have no obligation to pay any
judgments against Roberts, and, as the policy itself recognizes,
it has the right to recoup the defense costs. Nevertheless, even
if the heightened standard applies, Roberts has established a
clear and substantial likelihood of showing that he is entitled
to defense costs prior to the adjudication of the rescission
issues, and irreparable injury if those costs are not paid as
they are incurred.*fn10
A. Success on the Merits
The starting point for any analysis of the merits must be the
text of the insurance agreement. A court must determine if the
parties contemplated and resolved the issue. Their contract is
the best evidence of their intentions. Seabury Const. Corp. v.
Jeffrey Chain Corp., 289 F.3d 63, 68 (2d Cir. 2002). Under New
York law, "an insurance contract is interpreted to give effect to
the intent of the parties as expressed in the clear language of
the contract. The initial interpretation of a contract is a
matter of law for the court to decide." Bowman v. Allstate Ins.
Co., 238 F.3d 468, 470 (2d Cir. 2001) (citation omitted). To the
extent an ambiguity exists and is unresolved by extrinsic
evidence, such ambiguity is read against the insurer. See,
e.g., Int'l Multifoods Corp. v. Commercial Union Ins. Co.,
309 F.3d 76, 83, 88 n. 7 (2d Cir. 2002); Morgan Stanley Group Inc.
v. New England Ins. Co., 225 F.3d 270, 276 (2d Cir. 2000);
McCostis v. Home Ins. Co. of Indiana, 31 F.3d 110, 113 (2d Cir.
1994) (addressing dispute regarding the duty to defend). "The
rule that insurance policies are to be construed in favor of the
insured is most rigorously applied in construing the meaning of
exclusions incorporated into a policy of insurance or provisions
seeking to narrow the insurer's liability." Ingersoll Mill.
Mach. Co. v. M/V Bodena, 829 F.2d 293, 306 (2d Cir. 1987).
See also L. William Caraccio, Void Ab Initio: Application
Fraud As Grounds For Avoiding Directors' And Officers' Liability
Insurance Coverage, 74 Cal. L. Rev. 929, 930 (May 1986) (courts
should "take a jaundiced view of insurers' use of [preexisting
knowledge clauses] to avoid coverage").
Under New York law, where a contract of insurance includes the
duty to defend or to pay for the defense of its insured, that
duty is a "heavy" one.*fn11 McGinniss v. Employers
Reinsurance Corp., 648 F. Supp. 1263, 1271 (S.D.N.Y. 1986)
(citing Int'l Paper Co. v. Continental Cas. Co., 35 N.Y.2d 322,
326 (1974)). This duty is independent of the ultimate success of
the suit against the insured. Id. (citing Spoor-Lasher Co. v.
Aetna Cas. and Sur. Co., 39 N.Y.2d 875, 876 (1976)). The duty of
an insurer to pay an insured's defense costs "is distinct from
and broader than its duty to indemnify." Federal Ins. Co. v.
Tyco Int'l Ltd., Index No. 6005007/03, 2004 WL 583829, at *6
(N.Y. Sup. Mar. 5, 2004); see also Little v. MGIC Indem.
Corp., 836 F.2d 789, 793 (3d Cir. 1987). The duty to pay defense
costs "exists whenever a complaint against the insured alleges
claims that may be covered under the insurer's policy." Tyco,
2004 WL 583829, at *6; see Wedtech Corp. v. Federal Ins. Co.,
740 F. Supp. 214, 221 (S.D.N.Y. 1990); Pepsico, Inc. v.
Continental Cas. Co.,
640 F. Supp. 656, 660 (S.D.N.Y. 1986). In sum, the duty to pay defense
costs is "construed liberally and any doubts about coverage are
resolved in the insured's favor." Tyco, 2004 WL 583829, at *6.
It is a general principle under insurance law, that the
obligation to pay under a liability policy arises as soon as the
insured incurs the liability for the loss, in contrast to an
indemnity policy where the obligation is to reimburse the insured
for a loss that the insured has already satisfied. See McCuen
v. American Cas. Co. Of Reading Pennsylvania, 946 F.2d 1401,
1406-07 (8th Cir. 1991); Little, 836 F.2d at 793; Nat'l Union
Fire Ins. Co. of Pitt. v. Brown, 787 F. Supp. 1424, 1429 (S.D.
Fla. 1991), aff'd, 963 F.2d 385 (11th Cir. 1992); 11 G. Couch,
Cyclopedia of Insurance Law 2d § 44:4, at 187-88 (M. Rhodes ed.
1984). Thus, under a D & O policy with a duty to pay defense
costs provision, "the insurance company's obligation to reimburse
the directors attaches as soon as the attorneys' fees are
incurred." Wedtech Corp., 740 F. Supp. 214 at 221 (collecting
cases); see Pepsico, 640 F. Supp. at 659; see also
McCuen, 946 F.2d at 1407 (applying Iowa law); Okada v. MGIC
Indem. Corp., 823 F.2d 276, 282 (9th Cir. 1987) (applying Hawaii
law); Little, 836 F.2d at 794 (applying Pennsylvania law);
FDIC v. Booth, 824 F. Supp. 76, 81 (M.D. La. 1993) (applying
Louisiana law). As the Honorable Harold Baer has observed, "to
hold otherwise would not provide insureds with protection from
financial harm that insurance policies are presumed to give."
Nu-Way Environmental, Inc. v. Planet Ins. Co., No. 95 Civ. 573
(HB), 1997 WL 462010, at *3
(S.D.N.Y. Aug. 12, 1997) (construing policy that was silent as to
timing of payment of defense costs).
Under New York law, "[a]n insurer may avoid an insurance
contract if the insured made a false statement of fact as an
inducement to making the contract and the misrepresentation was
material." Curanovic v. New York Cent. Mut. Fire Ins. Co.,
762 N.Y.S. 2d 148, 150 (3d Dep't 2003); N.Y. Ins. Law §§ 3105(a),
(b). If an insurer can show that it was induced to accept an
application that it might otherwise have refused it is entitled
to rescind the policy. See Republic Ins. Co. v. Masters, Mates
& Pilots Pension Plan, 77 F.3d 48, 52 (2d Cir. 1996); Mutual
Benefit Life Ins. Co. v. JMR Elecs. Corp., 848 F.2d 30, 32 (2d
Cir. 1988). Even an innocent misrepresentation, if material, will
support rescission. Vella v. Equitable Life Assur. Soc. of
U.S., 887 F.2d 388, 391 (2d Cir. 1989); McLaughlin v.
Nationwide Mut. Fire Ins. Co., 777 N.Y.2d 773, 774 (3d Dep't
2004). The burden of establishing the existence of a material
misrepresentation is on the insurer. First Financial Ins. Co. v.
Allstate Interior Demolition Corp., 193 F.3d 109, 119 (2d Cir.
New York courts have consistently held that to meet
the burden of proof on materiality, an insurer must
submit evidence of its underwriting practices with
respect to similar applicants. A court may not rely
merely on statements by representatives of the
insurer that it would not have issued the policy but
for the representation.
Id. (citation omitted). In addition, to effect rescission, the
insurer must repudiate the contract and return the insurance
premium. See Assoc. Electric & Gas Ins. Serv. Ltd. v. Rigas,
Civ. A. 02-7444, 2004 WL 540451, at *5 (E.D. Pa. Mar. 17, 2004);
Allan D. Windt, Insurance Claims & Disputes, § 2:26 at 138
(West 2001) (hereinafter "Windt"). An untimely delay in a
denial of coverage may bar the denial. First Fin. Ins. Co. v.
Jetco Contr. Corp., 1 N.Y.3d 64, 68-70 (2003); see also
Chicago Insurance Co. v. Kreitzer & Vogelman, No. 97 Civ. 8619,
2000 WL 16949, at *9 (S.D.N.Y. Jan. 10, 2000) (right to rescind
must be promptly exercised). A severability clause or similar
provisions in an insurance policy may entitle directors to
coverage even when a policy is properly rescinded against the
corporation. See Wedtech Corp., 740 F. Supp. at 218.
Until the issue of rescission is adjudicated, a contract of
insurance remains in effect and the duty to pay defense costs is
enforceable. In Wedtech, the Honorable Leonard Sand required an
insurer to reimburse attorneys' fees as they were incurred by
directors pending litigation of its right to rescind the policy
as to each director. Wedtech, 740 F. Supp. at 221 (applying New
York law). Relying on the policy's severability clause, the court
found that the policy was not necessarily void ab initio with
respect to each director. Id. at 218-19. Even more recently,
the Honorable Helen Freedman held in insurance litigation arising
from the criminal and civil lawsuits pending against Tyco
officers that under New York law the duty to pay defense costs is
unaffected by an unproven claim for rescission. Tyco, 2004 WL
583829, at *5. After surveying the law of several jurisdictions
she found that where an insured has challenged the right of an
insurer to rescind its policies and has sought an
adjudication that the policies are binding, courts have enforced
the obligation of the insurers to perform under the policies and
to defend or to pay defense costs. Id. at *6. See also
Pepsico, 640 F. Supp. at 659, 664 (finding ongoing duty to pay
defense costs where insurance company had asserted a right to
terminate the policy at will).
The law of other jurisdictions is consistent with these
principles. In Rigas, 2004 WL 540451, the court in the Adelphia
litigation granted a partial summary judgment motion for payment
of defense costs despite the claim of the insurance company that
the policy was properly rescinded, reasoning "because a contract
is in effect until the issue of rescission is adjudicated, an
insurer is bound by the obligations in that contract to advance
defense costs until the contract is found to be rescinded." Id.
at *5. The Rigas court was unable to reach the issue of
rescission because of a bankruptcy stay. Id. at *4. In Brown,
787 F. Supp. 1424, the court granted the defendants' expedited
partial summary judgment motion and found that there was a duty
under Florida law to pay defense costs as they were incurred.
Id. at 1430. It deferred ruling on the plaintiff-insurer's
rescission claims. Id.
The National Union policy imposes the obligation upon National
Union, and through its follow form policy upon Continental, to
pay Roberts the costs of his defense as those costs are incurred.
The National Union policy is a liability policy and contains
explicit language requiring the insurer to
advance costs of the defense and to do so prior to the final
disposition of a claim brought against the insured.*fn12
Continental contends that it is under no continuing obligation
to pay defense costs since it gave notice to WorldCom that it
regarded its policy as void ab initio and rescinded, and
advised WorldCom that it "would" return the premium. It contends
that Roberts has not shown a sufficient likelihood of success in
defeating Continental's rescission argument.
Roberts is not, at this stage of the litigation, required to
show that he will succeed in defeating Continental's rescission
argument.*fn13 What Roberts must show is that, under the
terms of the policies, he is entitled to payment of defense costs
are incurred, and that as a matter of law, that obligation exists
until the rescission issues have been litigated and resolved. He
has carried that burden. Continental's effort to avoid payment of
defense costs before the legality of the rescission has been
litigated must fail. Continental's preemptive filing of a
declaratory judgment action in this district was held to be in
violation of the bankruptcy stay. The adversary proceeding in the
bankruptcy court addressed to the rescission issues was never
resolved. Despite this Court's offer, repeated on July 7 and 19,
2004, to resolve the rescission issue on an expedited basis, the
Excess Insurers have never requested that discovery in Roberts'
action begin. It bears noting that the agreement between National
Union and WorldCom explicitly declared that the policies at issue
there were not rescinded as to any director.*fn14
Anglo-American Insurance Co. v. Molin, 547 Pa. 504 (1997),
does not require a different result. The Supreme Court of
Pennsylvania reversed an injunction requiring an insurance
company to pay defense costs because the insured had not shown
that its right to relief was clear. Id. at 514. Specifically,
it had not shown that it was entitled to insurance coverage in
the face of a policy exclusion. Id. The Molin court did not
describe the policy language providing a right to defense costs
or address the law regarding the duty to pay such costs as they
are incurred. There is no basis from which to conclude,
therefore, that the policy at issue in Molin is comparable to
the one at issue here.
The other cases upon which Continental relies also do not
require a different result. Continental has pointed to no cases
that undermine the conclusion that National Union's policy
requires payment of defense costs as they are incurred. Any cases
interpreting New York law and arriving at a different conclusion
are readily distinguishable based on their specific policy
language. In Stonewall Ins. Co. v. Asbestos Claims Management,
73 F.3d 1178 (2d Cir. 1995), the policies were indemnification
policies that imposed a duty to reimburse defense costs only for
those claims that were established to be covered through a
judgment or a settlement. Id. at 1219. In In re Kenai,
136 B.R. 59 (S.D.N.Y. 1992), the policy provided that the insurer
would pay for a claim made against the insureds, including costs
"incurred in the defense of actions." Id. at 64. The policy did
not include the provision at issue here, which requires the
insurer to "advance" defense costs "prior to" the disposition of
a claim against the insured. In In re Ambassador Group,
738 F. Supp. 57, the policy established a priority system for payment
out of limited insurance proceeds that "necessarily preclude[d]
contemporaneous payment of legal fees." Id. at 63.
Continental, as does Twin City, relies heavily on Chicago Ins.
Co. v. Kreitzer & Vogelman, No. 97 Civ. 8619 (RWS), 2000 WL
16949 (S.D.N.Y. Jan. 10, 2000), an opinion in which the Honorable
Robert W. Sweet analyzed and denied an insurer's motion for
summary judgment on whether it had properly rescinded its policy.
In one sentence and without analysis, Kreitzer denied the
insureds' cross-motion for a summary judgment on the insurer's
duty to defend, to indemnify, and to reimburse defense costs.
Id. at *10. It is impossible to determine the significance of
this holding for the National Union policy since the Kreitzer
opinion did not include the policy language at issue that may
have triggered those obligations. It is interesting to note,
however, that Judge Sweet also authored McGinniss,
648 F. Supp. 1263. As noted above, McGinniss stated that an insurer "has a
heavy duty" to pay for the defense of its insured. Id. at 1271.
McGinniss also asserted that "once the action against the
insurer has been found to be within the coverage of the policy
the insurer must pay the insured's defense costs as they are
incurred." Id. There is no dispute that the securities actions
against Roberts are within the coverage of Continental's policy.
Continental also relies on Bogatin v. Fed. Ins. Co., No.
99-4441, 2000 WL 804433 (E.D. Pa. June 21, 2003). Bogatin is
inapposite. In Bogatin, following a trial on rescission issues,
the court determined that an insurance contract was rescinded
before addressing the purported duty to advance defense costs to
the insureds. Id. at *25. Bogatin did not state that a
rescission issue must be determined first; nor did it find that
the insureds would not have been entitled to contemporaneous
payment of defense costs had they petitioned for it prior to
trial. Bogatin stated simply that after determining that a
contract was rescinded, it is not appropriate to award defense
costs. Id. at *30-31.
Finally, Continental relies on a treatise on insurance.
According to Continental, Windt states that when an insurer
gives notice of rescission, it is not obligated to "provid[e] [a]
defense [for the insured] while the rescission action is
pending." (Alterations as given by Continental.) The passage from
Windt cited by Continental describes two options when an
insurer believes a policy was procured by a misrepresentation.
The insurer can either unilaterally rescind the policy and risk
being sued for breach and additional liability for breaching its
duty to settle; or file suit. It explains the adverse
consequences of that latter strategy as follows:
The disadvantage of filing a lawsuit and not
rescinding absent a favorable judicial determination
are: (1) that if the insurer has a duty to defend,
it will have to incur the cost of providing that
defense while the rescission action is pending,
which expense will not be reimbursable even if the
policy is later rescinded; (2) that even if the
policy has only a cost reimbursement provision, the
insured may be able to demand nonreimbursable interim
payments to fund his or her defense while the
rescission action is pending;. . . .
Windt, § 2:26 at 153 (emphasis supplied). This passage does not
opine that insurers can escape the duty to pay defense costs as
they are incurred prior to a determination of rescission issues
when a D & O liability policy specifically provides for the
advancement of defense costs. Indeed, if anything, the passage
recognizes that a court may require the payment of defense costs
as rescission issues are litigated. Later, in the context of
discussing the indemnification of defense costs, Windt states
that where a claim is encompassed by the policy, "[c]ourts can be
expected to interpret the policy in a manner favorable to the
insured and hold that interim payments [to reimburse defense
costs) at reasonable intervals are required." Windt, § 6:20 at
B. Irreparable Harm
"The showing of irreparable harm is perhaps the single most
important prerequisite for the issuance of a preliminary
injunction." Kamerling v. Massanari, 295 F.3d 206, 214 (2d Cir.
2002) (citation omitted). To establish irreparable harm, a party
must show that "there is a continuing harm which cannot be
adequately redressed by final relief on the merits and for which
money damages cannot provide adequate compensation. Id.
Irreparable harm must be shown to be "actual and imminent, not
remote or speculative." Id. (citation omitted). Proof of a
monetary loss will not suffice. The movant must show "evidence of
damage that cannot be rectified by financial compensation."
Tucker Anthony Realty Corp. v. Schlesinger, 888 F.2d 969, 975
(2d Cir. 1989). Irreparable harm is found where, "but for the
grant of equitable relief, there is a substantial chance that
upon final resolution of the action the parties cannot be
returned to the positions they previously occupied." Brenntag
Int'l Chemicals, Inc. v. Bank of India, 175 F.3d 245, 249 (2d
The failure to receive defense costs when they are incurred
constitutes "an immediate and direct injury." Wedtech,
740 F. Supp. at 221. To hold otherwise, "would not provide insureds with
protection from financial harm that insurance policies are
presumed to give." Nu-Way, 1997 WL 462010, at *3.*fn15
Roberts has shown irreparable injury. The Securities
Litigation is proceeding apace. The class action trial begins on
February 28, 2005. Every party, including each director
defendant, requires effective representation. It is impossible to
predict or quantify the impact on a litigant of a failure to have
adequate representation at this critical stage of litigation. The
ability to mount a successful defense requires competent and
diligent representation. The impact of an adverse judgment will
have ramifications beyond the money that will necessarily be
involved. There is the damage to reputation, the stress of
litigation, and the risk of financial ruin each of which is an
intangible but very real burden.
D & O insurance is not only designed to provide financial
security for the individual insureds, but also plays an important
role in corporate governance in America. Unless directors can
rely on the protections given by D & O policies, good and
competent men and women will be reluctant to serve on corporate
boards. As the Third Circuit has observed, a primary purpose of
Delaware indemnification provisions is "to encourage capable men
to serve as corporate directors, secure in the knowledge that
expenses incurred by them in upholding their honesty and
integrity as directors will be borne by the corporation they
serve." Witco Corp. v. Beekhuis, 38 F.3d 682, 691 (3d Cir.
1994) (citation omitted); see McLean v. Int'l Harvester Co.,
817 F.2d 1214, 1222 (5th Cir 1987).
Continental and Twin City argue that Roberts has failed show
irreparable injury because he has not shown that he is unable to
retain counsel from his own funds.*fn16 The issues here
surmount whether an individual director has or does not have
sufficient funds to pay counsel when confronted with litigation
stemming from service as a corporate director. In some cases the
litigation will be minor; here it is massive. In some cases a
director will have great personal wealth; in other cases she will
not. The issue here is whether every director protected by a
policy equivalent to National Union's is entitled to ongoing
payment of defense costs until there is a judicial determination
that that right does not exist. Under the terms of the National
Union policy, and for the reasons set forth here, the answer is
Twin City contends that Mongelli v. Chicago Ins. Co., No. 99
Civ. 8149 (SJ), 2002 WL 32096578 (E.D.N.Y. Jan. 15, 2002), and
***ILLEGIBLE TEXT*** Steel Co., Inc. v. Hartford Accident &
Indemnity Co., 806 F. Supp. 63 (E.D. Pa. 1992), require a
finding that Roberts has failed to show irreparable injury. They
do not. Dover Steel did not address a D & O policy; it focused
on the duty to defend and indemnify a corporation. Mongelli
addressed the obligation to defend the insured when both parties
were in agreement that the policy did not cover the claim against
the insured. Mongelli, 2002 WL 32096578, at *2.
Continental argues that as a policy matter it should not be
compelled to reimburse defense costs as they are incurred when it
its refusal is based on a right to rescind. It explains that it
will be forced to litigate every rescission case to its
conclusion instead of giving due consideration to a reasonable
settlement of the underlying case. It further argues that while
there may be a duty to defend until a decision is reached on the
rescission issue, it need not await a judgment determination when
there is only a duty to pay defense costs. There is no reasoned
basis in law for the distinction advanced by Continental between
a duty to defend and to pay defense costs, and absolutely no
basis in the National Union policy language. As for its "policy"
argument, the existence of leverage with its insureds or its
insured's adversaries premised on a breach of its legal
obligations to its insureds is leverage gained improperly, and
provides no basis for a ruling in its favor on this motion.
Rule 65(c), Fed.R.Civ.P., provides, in pertinent part, that
No restraining order or preliminary injunction shall
issue except upon the giving of security by the
applicant, in such sum as the court deems proper, for
the payment of such costs and damages as may be
incurred or suffered by any party who is found to
have been wrongfully enjoined or restrained.
Rule 65(c), Fed.R.Civ.P. This Rule "thus allows a preliminary
injunction to become effective only upon the applicant's positing
of an amount that the district court determines adequate."
Corning Inc. v. PicVue Electronics, Ltd., 365 F.3d 156
, 158 (2d
Cir. 2002). It is in the discretion of the district court to
decide that, under the circumstances, no security is required.
See Doctor's Assocs., Inc. v. Distajo, 107 F.3d 126
, 136 (2d
Continental has requested that, if Roberts is granted defense
costs prior to an assessment of its rescission claim, he be
compelled to post a security bond for such costs. This request
must be denied. Paying Roberts' defense costs places no undue
hardship on the Continental as its liability is capped. In
addition, the excess policies require defense costs to be repaid
if Roberts is ultimately not entitled to such payments. Finally,
the posting of a bond would undermine the very protection the
Excess Insurers offered to directors when they followed the
National Union form.
The motion by Bert C. Roberts, Jr. in 04 Civ. 4089 for a
preliminary injunction against Continental Casualty Company
requiring it to pay his costs of defense as they are incurred
pursuant to the D & O policy it issued to WorldCom is granted.