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Axis Reinsurance Co. v. Bennett

June 18, 2008

AXIS REINSURANCE COMPANY, PLAINTIFF,
v.
PHILLIP R. BENNETT ET AL., DEFENDANTS.



The opinion of the court was delivered by: Gerard E. Lynch, District Judge

OPINION AND ORDER

Certain former officers and directors of Refco (collectively, the "insureds")*fn1 move for summary judgment dismissing the complaint against them in Axis Reinsurance Company v. Bennett et al., No. 07 Civ. 7924 (GEL) (S.D.N.Y.) (the "district court action"), which seeks a declaration that plaintiff Axis Reinsurance Company ("Axis") has no obligation to the insureds under the terms of a 2005-2006 Directors and Officers ("D&O") liability insurance policy it issued to Refco. Five of the insureds (the "counterclaim plaintiffs")*fn2 also move for summary judgment on their counterclaims in Axis Reinsurance Company v. Bennett et al., 08 Civ. 3242 (GEL) (S.D.N.Y.) (the "Axis adversary proceeding"), which was originally commenced by Axis in the bankruptcy court, see Adv. Proc. No. 07-1712 (RDD), before this Court withdrew the bankruptcy reference. (Doc. #5, No. 07 Civ. 7924.) The counterclaim plaintiffs in the Axis adversary proceeding seek the mirror image of the relief sought by Axis in the district court action - i.e., a declaration that Axis's 2005-2006 D&O policy covers them for losses arising out of various proceedings related to the collapse of Refco. Axis contends that both motions are premature because no discovery has occurred in either the district court action or the Axis adversary proceeding and that, in any event, numerous issues of material fact exist that preclude summary judgment. For the reasons stated below, the motions will be granted in part, and denied in part.*fn3

BACKGROUND

I. Refco's Collapse and Bankruptcy

Prior to its implosion in the fall of 2005, Refco was one of the world's largest providers of brokerage and clearing services in the international derivatives, currency, and futures markets. See In re Refco, Inc. Secs. Litig., No. 07 Civ. 11604, 2008 WL 1827644, at *1 (S.D.N.Y. April 21, 2008). On October 10, 2005, two months after its initial public offering ("IPO"), Refco announced that it had discovered an undisclosed $430 million receivable due from an entity controlled by Refco's CEO, Phillip R. Bennett. (Adv. Pro. Compl. ¶¶ 56-57, 59.*fn4 ) As a result, the company announced that its financial statements for the preceding four years could no longer be relied upon. (Id. ¶ 57.) Following these disclosures, Refco's stock plummeted and was de-listed by the New York Stock Exchange, leading to over $1 billion in lost market capitalization. See In re Refco, 2008 WL 1827644, at *1.

On or about October 17, 2005, Refco Inc. and many of its subsidiaries (collectively, "Refco") filed for protection under Chapter 11 of Title 11 of the United States Code. (Adv. Pro. Compl. ¶ 61.)

II. The Underlying Actions

The collapse and ensuing bankruptcy of Refco in October 2005 triggered an onslaught of litigation against certain Refco officers and directors (the "Underlying Actions"). Many of the Underlying Actions remain pending before this Court, including In re Refco, Inc. Securities Litigation, No. 05 Civ. 8626 (GEL) (S.D.N.Y.); American Financial International Group et al. v. Bennett et al., No. 05 Civ. 8988 (GEL) (S.D.N.Y); In re Refco Capital Markets, Ltd. Brokerage Customer Securities Litigation, No. 06 Civ. 643 (GEL) (S.D.N.Y.); V.R. Global Partners, L.P. v. Bennett et al., No. 07 Civ. 8686 (GEL) (S.D.N.Y.); Capital Management Select Fund Ltd. v. Bennett et al., No. 07 Civ. 8688 (GEL) (S.D.N.Y.); Kirschner v. Thomas H. Lee Partners, L.P. et al., No. 07 Civ. 7074 (GEL) (S.D.N.Y.); Kirschner v. Bennett et al., No. 07 Civ. 8165 (GEL) (S.D.N.Y.); and Kirschner v. Grant Thornton LLP et al., No. 07 Civ. 11604 (GEL) (S.D.N.Y.). The government has also initiated criminal proceedings against several Refco officers, securing three guilty pleas and a conviction following a criminal trial.*fn5

III. Refco's D&O Liability Insurance

A. The 2004-2005 Policy Period

For the period from August 5, 2004, to August 11, 2005 (the "2004-2005 Policy Period"), Refco Group Ltd. ("RGL"), then Refco's parent company, obtained a "tower" of D&O liability insurance consisting of a primary policy and two excess policies totaling $30 million of coverage (the "2004-2005 Program"). Specifically, U.S. Specialty Insurance Company ("U.S. Specialty") provided $10 million of primary coverage (the "2004-2005 Primary Policy"); Greenwich Insurance Company provided the first excess layer of $10 million in excess of $10 million; and Axis provided the second excess layer of $10 million in excess of $20 million (the "2004-2005 Axis Policy"). (Sylwestrzak Decl. ¶ 3.)

1. The 2004-2005 Primary Policy

In connection with the 2004-2005 Primary Policy and pursuant to U.S. Specialty's August 5, 2004, policy binder (id. Ex. A), RGL submitted a "long form" application to U.S. Specialty that was executed by Bennett on behalf of RGL (the "Application").*fn6 (Id. ¶ 6 and Ex. C.) U.S. Specialty issued the 2004-2005 Primary Policy to RGL on or about October 23, 2004. (Id. ¶ 5.)

2. The 2004-2005 Axis Policy

As noted above, Axis provided the second excess layer of coverage to RGL. In issuing the 2004-2005 Axis Policy, Axis did not require an application of its own, relying instead on the Application that RGL had submitted to U.S. Specialty. (Id. ¶ 9.) The Axis policy binder issued to Refco, dated August 5, 2004, expressly conditioned the validity of the binder on the receipt of, inter alia, a "[s]igned Axis warranty." (Id. Ex. D; see id. ¶ 8). According to the insureds, a "Warranty Letter" executed by Bennett and submitted to Axis on or about January 21, 2005, "on behalf of all Insureds under the Policy" served to satisfy this condition. (Id. ¶ 10 and Ex. E; see Brooks Decl. ¶ 3.) The Warranty Letter stated:

No person(s) or entity(ies) proposed for this insurance is cognizant of any fact, circumstance, situation, act, error or omission which he/she/it has reason to suppose might afford grounds for any Claim, as such term is defined within the Policy, such as would fall within the scope of the proposed insurance . . . . [I]f such knowledge exists, any claim arising therefrom is excluded from the proposed insurance. (Sylwestrzak Decl. Ex. E.) Refco did not submit the Warranty Letter to U.S. Specialty, nor was it ever made a part of the Application. (Id. ¶ 11.)

On or about April 25, 2005, Axis issued the 2004-2005 Axis Policy to RGL. (Id. ¶ 12 and Ex. F.) None of the insureds has requested coverage under the 2004-2005 Axis Policy.

B. The 2005-2006 Policy Period

In advance of its August 2005 IPO, Refco obtained D&O insurance for the period from August 11, 2005, to August 11, 2006 (the "2005-2006 Policy Period"). Refco's insurance was again structured as a tower, consisting of a primary policy and five excess policies totaling $70 million in coverage (the "2005-2006 Program"). (Id. ¶ 14.) U.S. Specialty again provided $10 million of primary coverage (the "2005-2006 Primary Policy"); Lexington Insurance Company ("Lexington") provided the first excess layer of $7.5 million in excess of $10 million (the "Lexington Policy"); Axis provided the second excess layer of $10 million in excess of $17.5 million (the "2005-2006 Axis Policy"); Allied World Assurance Company provided the third excess layer of $12.5 million in excess of $27.5 million; Arch Insurance Company provided the fourth excess layer of $10 million in excess of $40 million; and XL Specialty Insurance Company provided the fifth excess layer of $20 million in excess of $50 million. (Id.)

1. The 2005-2006 Primary Policy

In issuing the 2005-2006 Primary Policy, U.S. Specialty did not require a new application from Refco, but instead relied upon the Application submitted by RGL for the 2004-2005 Policy Period. (Id. ¶ 16.) The 2005-2006 Primary Policy defines an "Insured Person" as "any past, present or future director or officer" of Refco Inc. "and any Subsidiary thereof." (Id. Ex. G, at Definitions (C), (F).) The Policy provides Insured Persons with coverage for "Loss arising from Claims . . . against the Insured Persons for Wrongful Acts." (Id. Ex. G, at Insuring Agreement (A)). "Loss" is defined under the Policy to include, inter alia, "[d]efense [c]osts and any damages, settlements, judgments or other amounts" that "an Insured Person is legally obligated to pay as a result of any Claim." (Id. Ex. G, at Definition (G).) Axis concedes that "most" of the Underlying Actions are "Claims" for "Wrongful Acts" as defined in the 2005-2006 Primary Policy. (P. Rule 56.1 Stmt. ¶ 24.)

The 2005-2006 Primary Policy also contains two severability provisions. With regard to exclusions, the Policy states, in relevant part:

For purposes of determining the application of the above EXCLUSIONS, no Wrongful Act of any Insured Person will be imputed to any other Insured Person who did not have actual knowledge of, or directly participate in the commission of, such Wrongful Act . . . .

(Sylwestrzak Decl. Ex. G, at 5.) The 2005-2006 Primary Policy also contains a "Full Severability" Endorsement, which provides:

The Insureds represent that the particulars and statements contained in the Application are true, accurate and complete and are deemed material to the acceptance of the risk assumed by the Insurer under this Policy. This Policy is issued in reliance upon the truth of such representations. No knowledge or information possessed by any Insured will be imputed to any other Insured. If any of the particulars or statements in the Application is untrue, this Policy will be void with respect to any Insured who knew of such untruth. (Id. Ex. G, at Endorsement No. 10.)

Following the initiation of the Underlying Actions following Refco's collapse, the insureds requested coverage from U.S. Specialty under the 2005-2006 Primary Policy. U.S. Specialty agreed to advance their defense costs, subject to full repayment should it be determined that no coverage exists under the 2005-2006 Primary Policy. (See Adv. Pro. Compl. ¶ 8; Gilbride Decl. Ex. D.) The $10 million liability limit of the 2005-2006 Primary Policy was exhausted in 2007. (See Adv. Pro. Compl. ¶ 9.)

2. The Lexington Policy

After the 2005-2006 Primary Policy was exhausted, Lexington, the first excess insurer, also agreed to advance the defense costs of the insureds, subject to repayment if appropriate after a final determination of coverage. (See Gilbride Decl. Ex. D.) The $7.5 million limit in the Lexington Policy was exhausted in July 2007. (See Kim Decl. Ex. 3.)

3. The 2005-2006 Axis Policy

As with the 2004-2005 Axis Policy, Axis did not require its own application for the 2005-2006 Axis Policy, but instead relied on the Application that RGL had previously submitted to U.S. Specialty in connection with the 2004-2005 Primary Policy. (Sylwestrzak Decl. Ex. J at Endorsement 5.) Axis provided Refco with a policy binder on August 11, 2005, pursuant to which Axis agreed to provide $10 million in coverage in excess of the liability limits in the 2005-2006 Primary Policy and the Lexington Policy. (Sylwestrzak Dec. ¶ 18 and Ex. I.) Axis subsequently issued the 2005-2006 Axis Policy on March 1, 2006. (Id. ¶¶ 19-20.)

The 2005-2006 Axis Policy "follows the form" of the underlying insurance policies (i.e., the 2005-2006 Primary Policy and the Lexington Policy), meaning that it provides coverage "in conformance with the provisions of" the underlying insurance, except to the extent that the 2005-2006 Axis Policy contains limitations or restrictions on coverage beyond the underlying insurance. (Id. Ex. J, at (I) (Insuring Agreement).) The 2005-2006 Axis Policy specifically defines "Insureds" as the same persons who may be entitled to insurance under the 2005-2006 Primary Policy and defines "Claim(s)" as "event(s) which take place during the Policy Period and which trigger(s) coverage under the insuring agreement(s) of the Underlying Insurance." (Id. Ex. J at (II), Definitions (A) and (C).) Accordingly, a "Claim" for a "Wrongful Act" brought against the insureds that falls within the 2005-2006 Primary Policy also falls within the 2005-2006 Axis policy.

The 2005-2006 Axis Policy (as issued in March 2006) added as a final endorsement a "Knowledge ...


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