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Mbia Inc v. Federal Insurance Company and Ace American Insurance Company

July 1, 2011


The opinion of the court was delivered by: Loretta A. Preska, Chief District Judge:

Argued: March 18, 2011

Before: SACK, LYNCH, Circuit Judges, and PRESKA, Chief District Judge.*fn1

The parties appeal and cross-appeal from a judgment entered December 30, 2009, in the United States District Court for the Southern District of New York (Berman, J.), granting in part and denying in part the motion for summary judgment made by plaintiff and granting in part and denying in part the motion for summary judgment made by defendant insurance companies in a breach of contract action to compel coverage for certain claims made under directors and officers liability insurance policies. The district court determined that plaintiff is entitled to coverage for losses associated with federal and state regulators' investigations of plaintiff and for losses associated with an investigation conducted by a special litigation committee after derivative litigation ensued. It also determined that plaintiff is not entitled to coverage for losses associated with the cost of an independent consultant review of two transactions. We

AFFIRM the judgment of the district court in part and REVERSE the judgment in part and REMAND the case for entry of judgment.

This insurance coverage dispute raises three issues arising out of financial regulators' investigations into alleged accounting misstatements by appellee and cross-appellant MBIA, Inc., ("MBIA") and related litigation. Based on these events, MBIA made claims under two $15 million director and officer ("D&O") insurance policies it had purchased from appellants and cross-appellees Federal Insurance Co. ("Federal") and ACE American Insurance Co. ("ACE"). It sought coverage for costs associated with these claims as losses under the policies. Federal and ACE did not believe they were liable for these claims, and, unsurprisingly, litigation ensued. Resolving crossmotions for summary judgment, the district court (Berman, J.) granted summary judgment in favor of MBIA on two of its three coverage claims but granted summary judgment in favor of Federal and ACE on one of MBIA's coverage claims. We affirm in part and reverse in part and remand a portion of the case to the district court for entry of judgment in favor of MBIA.


MBIA is a Connecticut corporation based in Armonk, New York. It provides municipalities and other government entities with financial guarantee insurance for their bonds or structured finance obligations; this insurance is a guarantee of payment of principal and interest due. Like many corporations, MBIA purchased D&O insurance coverage for its directors and officers, as well as MBIA itself for certain claims. MBIA's policies were purchased from Federal and ACE for the period between February 15, 2004, and August 15, 2005, including a six-month extension. These policies covered "Securities Claims," which include "a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document." J.A. at 158. The policies also cover "Securities Defense Costs," which include costs "incurred in defending or investigating Securities Claims." Id. The policies also contemplate that should MBIA seek to invoke coverage, MBIA must give the insurers "the opportunity to effectively associate . . . in the investigation, defense and settlement" of any claim against MBIA and then seek the insurers' consent before settling any covered claim or incurring any costs defending such a claim. Id. at 126. Both policies included $15 million worth of coverage and covered the same claims with the same terms and conditions except as delineated in the ACE policy. The coverage was two-tiered: only after the Federal policy limit was exhausted did the ACE policy provide additional coverage. Because the two policies and claims are parallel in nearly all respects, we will refer to Federal and ACE together as the "insurers" throughout, analyzing the policies together except where we note that the analysis differs with respect to one of the insurers.

The purchases proved prescient. As part of a larger investigation into certain accounting practices in the insurance industry, federal and state regulators targeted MBIA in November 2004. The Securities and Exchange Commission ("SEC") had issued a formal order of investigation on March 9, 2001, ordering an inquiry into certain companies' compliance with the securities laws, their financial recordkeeping, their financial reporting, and related matters. Specifically, the order initiated a private investigation into whether the subject companies "engaged, are engaged, or are about to engage in any of the aforesaid acts, practices, or courses of business, or in any acts, practices, or courses of business of similar purport or object." J.A. at 201.

The phrase "acts, practices, or courses of business" refers to the allegations of financial chicanery mentioned above.

Pursuant to that investigation, the SEC issued the first of several subpoenas to MBIA on November 12, 2004. The subpoena did not identify specific transactions, but it compelled MBIA to produce all documents concerning transactions involving "Non-Traditional Product[s]." Id. at 212. These were defined as, in relevant part, any product or service developed, marketed, distributed, offered, sold, or authorized for sale . . . that could be or was used to affect the timing or amount of revenue or expense recognized in any particular reporting period, including without limitation, transferring assets off of a Counter- Party's balance sheet, extinguishing liabilities, avoiding charges or credits to the Counter-Party's financial statements, [or] deferring the recognition of a known and quantifiable loss . . .

Id. (emphasis added). The subpoena also required production of MBIA's accounting treatment of payments in connection with these transactions and any developmental, training, or promotional materials for them, among other things. On November 18, 2004, the New York Attorney General ("NYAG") followed suit and issued its first subpoena, which mirrored the SEC's. Others from both the SEC and the NYAG followed through late 2004. MBIA produced documents to both regulators in tandem.

Ultimately, three of MBIA's transactions came under regulatory scrutiny. The first transaction was MBIA's purchase of reinsurance on its guarantee of bonds issued by a hospital group owned by Allegheny Health, Education and Research Foundation ("AHERF"). MBIA insured these bonds in 1996, and AHERF declared bankruptcy in 1998 and defaulted. Facing approximately $170 million of exposure on its guarantee, MBIA purchased reinsurance on the AHERF transaction whereby the reinsurers retroactively agreed to assume MBIA's already-realized loss in exchange for a nominal premium. MBIA agreed to give the reinsurers compensation in the form of future premiums from its other financial guarantee business yet continued to assume the risk of default on new loans guaranteed. The aim of this scheme was to allow MBIA to avoid recognizing a large, one-time insurance loss by disguising the loss and spreading payment for it over a longer period of time, increasing its stated earnings. The subpoenas caused MBIA to produce documents concerning the AHERF transaction.

Later, in the summer of 2005, at least two other transactions were subjected to regulatory scrutiny. The first involved MBIA's purchase of an interest in Capital Asset Holdings GP, Inc. ("Capital Asset"), a company that bought delinquent tax liens. After Capital Asset's lender choked off funding for its operations, MBIA provided more capital for the company. Then MBIA, through a subsidiary, guaranteed Capital Asset's securitization of the liens it purchased, thereby transferring the risk of loss on MBIA's investment from MBIA to the subsidiary. These machinations were designed to avoid MBIA's recognizing a loss on the Capital Asset deal immediately, instead spreading the loss out over time because of the way the guarantee was structured.

The second transaction involved MBIA's guarantee of securities used to purchase airplanes for US Airways. When US Airways declared bankruptcy in 2002, rather than wait for a claim on the guarantee, MBIA foreclosed on the airplanes and treated this transaction as an "investment," not an "insurance loss." Here again, MBIA took these steps to avoid recognizing a loss. In the summer of 2005, the SEC and the NYAG considered issuing additional subpoenas. However, in these instances, MBIA asked the regulators whether they would accept voluntary compliance with their demands for records in lieu of subpoenas to avoid adverse publicity for MBIA. The regulators agreed to those requests, and MBIA complied with their demands for documents concerning the Capital Asset and US Airways transactions. In May 2005, MBIA initiated the claims process by informing the insurers that it was the target of a regulatory investigation and by providing them with the subpoenas. MBIA asked the insurers for their consent to retain counsel and to incur defense costs. The insurers did not view the subpoenas as sufficient to trigger coverage but accepted the subpoenas as notice of a potential claim under the policies. MBIA proceeded to hire attorneys and defend, respond to, and discuss the regulatory inquiries.

Nevertheless, in August 2005, the regulators advised MBIA that they would take action against it for securities law violations. Apparently, discussions about settling the potential charges were ongoing because on September 27, 2005, MBIA sought consent from the insurers to settle with the regulators. MBIA also met with Federal in person to discuss settlement. By letter dated October 11, 2005, Federal responded to MBIA and said that it understood a settlement for the AHERF transaction requiring payment of approximately $75 million in total to state and federal regulators was under consideration. Federal stated that it did not believe a settlement would be covered, but it allowed MBIA to proceed with settlement, saying that it would not "raise the lack of its written consent to [the] settlements as a defense to coverage." Id. at 1044. Retroactively, ACE took essentially the same approach in December.

MBIA signed an offer of settlement for both the state and federal claims on October 28, 2005, but that offer was preliminary, as the regulators had not completed their investigation into the Capital Asset and US Airways transactions at that time. To allow settlement talks to proceed despite this loose end, MBIA and the regulators agreed that an independent consultant, paid by MBIA, could complete a review of those transactions and report on a proposed remedy if misconduct was uncovered. MBIA first informed the insurers of this development in September 2006. Meanwhile, the independent consultant had begun work. MBIA offered an assurance of discontinuance to the NYAG in November 2005 that would result in MBIA's payment of a $15 million civil penalty and $10 million in disgorgement upon acceptance by the New York Superintendent of Insurance. By December 2006, the SEC and MBIA reached an agreement in principle under which MBIA would pay a $50 million civil penalty for the AHERF transaction. Both offers of settlement to regulators contained a provision for an independent consultant review of the two outstanding investigations. The settlements were executed and accepted by both regulators in late January 2007. Ultimately, the independent consultant exonerated MBIA of any wrongdoing for the Capital Asset and US Airways transactions. The investigations were closed in 2007.

After these investigations came to light, lawsuits against MBIA alleging financial wrongdoing were filed. Two actions are relevant here, one filed in the United States District Court for the Southern District of New York and one filed in the New York Supreme Court. On the way to filing suit, two shareholders sent separate demand letters to MBIA asking the board to file suit against directors and officers for the alleged wrongdoing being investigated by regulators at the time. In due course, MBIA set up a committee of independent directors (the "Demand Investigation Committee" or "DIC") to investigate these demands.*fn3 MBIA did not act on the shareholder demands, which is effectively a rejection of the demand under governing Connecticut law, but the shareholders persisted and filed two derivative lawsuits. When the lawsuits were filed, MBIA reconstituted the DIC as the "Special Litigation Committee" ("SLC") to determine whether maintaining these suits was in the best interests of MBIA. The SLC determined, after an investigation by outside counsel hired by the SLC, that it was not and filed a motion to dismiss the complaints. The lawsuits were terminated. Following all of this turmoil, Federal agreed to pay approximately $6.4 million to cover losses from the SEC's AHERF transaction investigation and related lawsuits, including $200,000 for the DIC's investigation. But it refused to cover losses related to the Capital Asset and US Airways transactions and to the NYAG's AHERF transaction investigation. Because the Federal policy limit was not breeched, ACE paid nothing. MBIA disagreed with the insurers' interpretation of what the policies covered. It filed suit to compel the insurers to cover costs related to (1) both regulators' investigations of all three transactions, (2) the independent consultant's investigation pursuant to the settlement, and (3) the work of the SLC. The district court granted summary judgment in favor of MBIA with respect to costs related to the investigation of the transactions and the costs incurred by the SLC. MBIA, Inc. v. Fed. Ins. Co.,No. 08 Civ. 4313, 2009 WL 6635307, at *7-9 (S.D.N.Y. Dec. 30, 2009). It granted summary judgment in favor of the insurers, however, with respect to costs related to the independent consultant's investigation. Id. at *8-9. These appeals followed.


The applicable law is straightforward. We review de novo the district court's grant of summary judgment. Costello v. City of Burlington, 632 F.3d 41, 45 (2d Cir. 2011). In so doing, we construe the facts in the light most favorable to the nonmoving party and, drawing all reasonable inferences in its favor, affirm when "'there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.'" Id. (quoting Fed. R. Civ. P. 56(a)).

In this diversity case, the issues are governed by either New York or Connecticut state law. See Wilson v. Nw. Mut. Ins. Co., 625 F.3d 54, 60 (2d Cir. 2010). We need not make a choice-of-law determination because under both states' regimes, the applicable legal principles are aligned. An insurance contract is interpreted under ordinary common-law contract principles, and we "give effect to the intent of the parties as expressed in the clear language of the contract." Morgan Stanley Grp., Inc. v. New Eng. Ins. Co., 225 F.3d 270, 275 (2d Cir. 2000) (internal quotation marks omitted) (applying New York law); accord Griswold v. Union Labor Life Ins. Co., 442 A.2d 920, 923 (Conn. 1982). We agree with the district court and the parties that the contract is unambiguous, so the plain meaning of its terms control. Cont'l Ins. Co. v. Atl. Cas. Ins. Co., 603 F.3d 169, 180 (2d Cir. 2010). In the end, the insured bears the burden of showing that an insurance coverage covers the loss, but the insurer bears the burden of showing that an exclusion applies to exempt it from covering a claim. Morgan Stanley Grp., 225 F.3d at 276 & n.1. Doubts are resolved in favor of the insured. See id. at 276.

On appeal, the insurers argue that the district court erred in two ways. First, they argue that it erred because both the SEC's and the NYAG's investigations into the Capital Asset and US Airways transactions are not covered "Securities Claim[s]" under the policies and because the NYAG's investigation of the AHERF transaction is likewise not covered. Second, they argue that it erred because costs incurred by the SLC were either not covered or subject to the $200,000 policy sublimit. In its cross-appeal, MBIA argues that the district court erred in its analysis denying it coverage for the costs of the independent auditor. We address these arguments sequentially.

A. Investigation Costs Coverage

The insurers' first argument involves the scope of coverage provided in Insuring Clause 3, which states: "The Company [i.e., the insurers] shall pay on behalf of any Organization [i.e., MBIA and subsidiaries] all Securities Loss for which it becomes legally obligated to pay on account of any Securities Claim first made against it during the Policy Period ." A "Securities Claim" is defined as, in relevant part, "a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document." J.A. at 158. The question here is whether the expenses claimed in connection with the regulators' investigations fall within this definition.*fn4 To answer this question, we analyze the various items ...

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