Insurer’s Duty to Advance Notwithstanding Coverage Defenses August 19, 2014

1. Insurer’s Duty to Advance NotwithstandingCoverage DefensesAugust 19, 2014 Sponsored by PLUS Diamond Sponsors:

2. Presenters: Laura E. Bange, Attorney, Edwards Wildman Palmer LLP M. Machua Millett, Senior Vice President, Marsh USA, Inc. Frederick M. Zauderer, Senior Vice President and Claim Manager, AXIS Professional Lines Moderator: John D. Hughes, Attorney, Edwards Wildman Palmer, LLP

3. A copy of the presentation slides will be available following this webinar, on the PLUS website at: http://plusweb.org/Education/PLUSMultimedia

4. Hypothetical: Facts • October 2005: • On October 10, 2005, two months after its IPO, ABC Company announces the uncollectibility of a $430M previously undisclosed receivable. • ABC Company’s stock plummets and it is de-listed by the New York Stock Exchange. • Result: Over $1 billion in lost market capitalization. • February 2006: • Class of shareholders brings securities class action against ABC Company and its CEO. • Securities Class Action complaint alleges negligence, common law fraud and violation of § 12(2) of the Securities Act of 1933. It seeks disgorgement, restitution of wrongfully acquired gains, and money damages.

5. Hypothetical: The Policy • In advance of its IPO, ABC Company obtained a D&O policy from Empire Insurance Company. The Policy contained the following “Duty to Advance” provisions: Insured Persons Individual Coverage The Insurer will pay to or on behalf of the Insured Persons Loss arising from Claims first made during the Policy Period against the Insured Persons for Wrongful Acts, except when and to the extent that the Company has paid such Loss to or on behalf of the Insured Persons as indemnification or advancement. Company Liability Coverage The Insurer will pay to or on behalf of the Insured Loss arising from Claims first made during the Policy Period against the Insured for Wrongful Acts. … The Insurer will have no duty under this Policy to defend any Claim. The Insureds must defend any Claim made against them. The Insureds may not admit or assume any liability, enter into any settlement agreement, stipulate to any judgment, or incur any Defense Costs without the Insurer’s prior written consent. Only those settlements, stipulated judgments and Defense Costs to which the Insurer has consented will be recoverable as Loss under this Policy. The Insurer’s consent may not be unreasonably withheld; provided, that the Insurer will be entitled to effectively associate in the defense and the negotiation of any settlement of any Claim. The Insurer will pay covered Defense Costs on an as-incurred basis. If it is finally determined that any Defense Costs paid by the Insurer are not covered under this Policy, the Insureds agree to repay such non-covered Defense Costs to the Insurer.

6. Hypothetical: The Policy • The Policy contained the following definition of “Loss”: Lossmeans the total amount which any Insured becomes legally obligated to pay on account of each Claim and for all Claims in each Policy Period . . . made against them for Wrongful Acts for which coverage applies, including, but not limited to, damages, judgments, settlements, costs and Defense Costs, but shall not include: … b. restitution or disgorgement of profits by Insureds, or the costs of complying with orders granting injunctive relief. • The Policy also defined “Defense Costs” as follows: that part of Loss consisting of reasonable and necessary costs, charges, fees (including attorneys’ fees, experts’ fees and mediators’ or arbitrators’ fees) and expenses (other than regular or overtime wages, salaries or fees of the directors, trustees, partners, principals, members of the board of managers, officers of employees of the Insurer, Company or Plan) incurred in defending a Claim, and the premium for appeal, attachment or similar bonds.

7. Hypothetical: The Policy • The Policy also contained the following exclusion: The Insurer shall not be liable for Loss on account of any Claim made against any Insured: 2. based upon, arising out of, or attributable to any dishonest or criminal act, fraudulent act or omission, or any willful violation of any statute or regulation, in fact committed by such Insured if an adverse finding, judgment, adjudication or admission in a judicial proceeding by such Insured establishes such dishonest or criminal act, fraudulent act or omission, or willful violation of statute or regulation. • The Policy contained the following provision concerning allocation: If Loss covered by this Policy and loss not covered by this Policy are both incurred in connection with a single Claim, the Insureds and the Insurer agree to use their best efforts to determine a fair and proper allocation of all such amounts. If there is an agreement on an allocation of defense costs, the Insurer shall advance on a current basis Defense Costs allocated to covered Loss. If there is no agreement on an allocation of costs, the Insurer shall advance on a current basis Defense Costs which the Insurer believes to be covered under the Policy until a different allocation is negotiated, arbitrated or judicially determined.

8. Hypothetical: Defense Counsel After the Securities Class Action was filed, ABC Company requested coverage under the D&O policy for its CEO and itself. ABC Company advised Empire that it wished to retain Smith & Louis LLP, a preeminent policyholder law firm headquartered in New York, New York, to defend its interests in the Securities Class Action. Smith & Louis advised Empire that it its hourly rate was $1,200, and that it was unwilling to adhere to Empire’s litigation management guidelines. After Empire inquired as to whether Smith & Louis would reduce its hourly rate to $800 per hour, Smith & Louis sent Empire a letter which threatened to bring an action against it for bad faith claims handling.

9. Hypothetical: Questions Presented Questions: • What are the key differences between duty to advance and duty to defend policies? • Notwithstanding the insured’s right to control the defense under a duty to advance policy, may an insurer withhold consent to defense counsel selected by the insured? If so, on what basis? • Rates? • Competency? • Representation of insured on bad faith claim? • Under what circumstances must defense counsel hired by the insured comply with the insurer’s litigation management guidelines? • How does an insurer’s ability to allocate between covered and uncovered loss differ under a duty to advance policy as compared to a duty to defend policy?

10. Duty to Defend vs. Duty to Advance: Defense Obligations • Duty to Defend • Policy expressly requires insurer to provide the insured with a defense. • Insurer must hire attorneys and is entitled to control the litigation strategy in the lawsuit against insured. • Duty to Advance Defense Costs • Policy states that insurer will pay insured’s defense costs, but usually disclaims any obligation to defend the insured. • Insured selects defense counsel and controls the defense of the underlying case.

11. Duty to Defend vs. Duty to Advance: Trigger Duty to Advance: Trigger • Nearly all courts that have addressed the issue have found that the allegations that trigger the insurer’s duty to advance defense costs are similar to those that trigger its duty to defend, insofar as the duty to advance arises when the allegations against the insured give rise to a potentially covered claim. Federal courts: • 8th Circuit: Liberty Mut. Ins. Co. v. Pella Corp., 650 F.3d 1161, 1170 (8th Cir. 2011) (Iowa law) • New York: Lowy v. Travelers Prop. and Cas. Co., 2000 U.S. Dist. LEXIS 5672 *5 (S.D.N.Y. 2000) • California: Acacia Research Corp. v. Nat'l Union Fire Ins. Co.,2008 U.S. Dist. LEXIS 96955 *33 (C.D. Cal. 2008) State courts: • Ohio: Am. Chem. Soc'y v. Leadscope, Inc., 2005-Ohio-2557, P22 (Ohio Ct. App. 2005) • Delaware: HLTH Corp. v. Agric. Excess & Surplus Ins. Co., 2008 Del. Super. LEXIS 280 *40 (Del. Super. Ct. 2008)

12. Duty to Defend vs. Duty to Advance • Must the insurer advance defense costs as they are incurred? • As is the case with duty to defend policies, many courts hold that an important aspect of the coverage offered by a duty to advance policy is an insurer's obligation to contemporaneously fund the defense of litigation, rather than pay defense expenses after the underlying action has concluded. • See, e.g., Assoc. Elec. & Gas Ins. Servs. v. Rigas, 382 F. Supp. 2d 685 (E.D. Pa. 2004); In re WorldCom, 354 F. Supp. 2d 455 (S.D.N.Y. 2005) • But see XL Specialty Ins. Co. v. Level Global Investors, L.P., 874 F. Supp. 2d 263 (S.D.N.Y. 2012) • Reimbursement of defense expenses • Duty to Defend: Policy generally does not provide that insurer is entitled to recover defense costs expended, if it is ultimately determined that claims fell outside the scope of coverage. • Duty to Advance: Policy typically provides that insurer is entitled to reimbursement of defense costs if it is ultimately determined that the claims were not covered. • Note: Policy may require written undertaking by insured concerning reimbursement before insurer’s duty to advance arises.

13. Defense Counsel Selected by Insured:Insurer’s Right to Withhold Consent • May the insurer withhold consent to defense counsel selected by the insured based on counsel’s hourly rate? Analogy: insured’s retention of independent counsel under duty to defend policy. • Statutory Law: • California: insurer must pay independent counsel “the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.” Cal. Civ. Code § 2860(c). • Alaska: unless otherwise provided in the insurance policy, “the fee charged by the independent counsel is limited to the rate that is actually paid by the insurer to an attorney in the ordinary course of business in the defense of a similar civil action in the community in which the claim arose or is being defended.” Alaska Stat. § 21.96.100(d). • Case Law: • In most jurisdictions, insurer must pay rate of insured’s retained counsel if the rate is “reasonable.” See, e.g.: • Northern Sec. Ins. Co. v. R.H. Realty Trust, 78 Mass. App. Ct. 691, 692 (2011) • PhotoMedex, Inc. v. St. Paul Fire & Marine Ins. Co., 2008 U.S. Dist. LEXIS 8526 *70 (E.D. Pa. Feb. 6, 2008).

14. Defense Counsel Selected by Insured:Insurer’s Right to Withhold Consent May the insurer withhold consent to defense counsel selected by the insured based on counsel’s competency? • Statutory Law: • California: Insurer may require that the counsel selected by the insured possess certain minimum qualifications, which may include “at least five years of civil litigation practice which includes substantial defense experience in the subject at issue in the litigation.” Cal. Civ. Code § 2860(c). • Alaska: Insurer may require that the independent counsel have “at least four years of experience in civil litigation, including defense experience in the general subject area at issue in the civil action.” Alaska Stat. § 21.96.100(d). • Case Law: • Most jurisdictions that have addressed the issue have found that an insurer has the right to require that counsel selected by the insured possess minimum qualifications. See, e.g.: • CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113 (Alaska 1993) • Center Foundation v. Chicago Ins. Co., 227 Cal. App. 3d 547 (Cal. App. 2d Dist. 1991) • Maddox v. St. Paul Fire & Marine Ins. Co., 2002 U.S. Dist. LEXIS 26686 *13 (W.D. Pa. 2002)

15. Defense Counsel Selected by Insured:Insurer’s Right to Withhold Consent • May the insurer withhold consent to defense counsel selected by the insured based on counsel’s representation of the insured in a bad faith claim against the insurer? • Those jurisdictions that have addressed the issue have found that counsel who represents the insured in a bad faith claim may not serve as insured’s counsel in underlying action. See, e.g.: • New York State Urban Dev. Corp. v. VSL Corp., 563 F. Supp. 187, (S.D.N.Y. 1983) • Maddox v. St. Paul Fire & Marine Ins. Co., 2002 U.S. Dist. LEXIS 26686 (W.D. Pa. 2002)

16. Defense Counsel Selected by Insured:Litigation Management Guidelines • Must counsel selected by the insured comply with insurer’s Litigation Management Guidelines? • Litigation Management Guidelines typically address: • Time increments in which matter should be billed • How a law firm staffs a file • Interoffice conferences • Pre-approval for pleadings, motions, and retention of expert witnesses • Pre-approval for time spent on research, travel, and the taking of depositions

17. Defense Counsel Selected by Insured:Litigation Management Guidelines • Must counsel selected by the insured comply with insurer’s Litigation Management Guidelines? • In some jurisdictions, ethical opinions have determined that an insurer’s litigation management guidelines are wholly or partially unenforceable, even with respect to panel counsel. See, e.g.: • Ohio Supreme Court Bd. of Comm'rs on Grievances and Discipline, Op. 2000-3 • West Virginia Lawyer Disciplinary Board, L.E.I. 2005-01 • Rhode Island Supreme Court Ethics Advisory Panel, Op. 99-18 • In re The Rules of Professional Conduct, 2000 MT 110, P47 (Mont. 2000) • Some sets of guidelines examined in these opinions mandated compliance with every requirement as a condition of payment (e.g., West Virginia), but other sets of guidelines were less stringent (e.g., Rhode Island). • Nonetheless, these guidelines were found to violate state rules of professional conduct providing that an attorney may not permit a person who employs or pays him to render legal services for another to direct or regulate the attorney’s professional judgment in rendering such legal services.

18. Defense Counsel Selected by Insured:Litigation Management Guidelines Must counsel selected by the insured comply with insurer’s Litigation Management Guidelines? • In those jurisdictions where it has been determined that litigation management guidelines inherently violate the rules of professional conduct applicable to attorneys, counsel selected by the insured may not be obligated to comply with such guidelines. • In other jurisdictions, counsel selected by the insured may be obligated to comply with litigation management guidelines to the extent they do not impede counsel’s professional judgment. See, e.g.: • Pepsi-Cola Metro. Bottling Co. v. Ins. Co. of N. Am., Inc., 2010 U.S. Dist. LEXIS 144401, 31-35 (C.D. Cal. 2010) • Wallis v. Centennial Ins. Co., 982 F. Supp. 2d 1114, 1123 (E.D. Cal. 2013)

19. AllocationBetween Covered and Uncovered Loss Returning to Hypothetical: • Securities Class Action complaint against ABC Company and its CEO • Alleges negligence, common law fraud and violation of § 12(2) of the Securities Act of 1933. • Seeks disgorgement, restitution of wrongfully acquired gains, and money damages. • ABC Company’s D&O Policy includes the following provisions: • Definition of “Loss” with carve-out for restitution or disgorgement of profits by Insureds; • Exclusion for “any dishonest or criminal act, fraudulent act or omission, or any willful violation of any statute or regulation,” if established by an adverse finding, judgment, adjudication or admission in a judicial proceeding; and • Allocation provision: Insurer is obligated to advance defense costs corresponding only to those claims that the Insurer believes are covered.

20. AllocationBetween Covered and Uncovered Loss • Where the policy does not contain express allocation language, does the insurer’s ability to allocate between covered and uncovered loss differ under a duty to advance policy versus a duty to defend policy? • Duty to Defend: If the insurer is obligated to defend any portion of suit against the insured, the insurer is generally required to defend entire suit against insured, including both covered and uncovered claims. • Duty to Advance: Most courts have held that, where the policy does not contain express allocation language, the insurer must advance defense costs for all claims. • Am. Chem. Soc'y v. Leadscope, Inc., 2005 Ohio 2557 (Ohio Ct. App. 2005)and Westpoint Intl., Inc. v. American Intl. S. Ins. Co.,71 A.D.3d 561, 563 (N.Y. App. Div. 1st Dep't 2010) • But seeHealth Net, Inc. v. RLI Ins. Co., 206 Cal. App. 4th 232, 259 (Cal. App. 2d Dist. 2012).

21. CONCLUSION

22. Contact Us Frederick M. Zauderer Senior Vice President and Claim Manager AXIS Professional Lines Berkeley Heights, NJ 908.508.4370 Fred.Zauderer@axiscapital.com John D. Hughes Partner Edwards Wildman Palmer LLP Boston, MA 617.951.3373 jhughes@edwardswildman.com Laura E. Bange Associate Edwards Wildman Palmer LLP Boston, MA 617.239.0481 lbange@edwardswildman.com M. Machua Millett Senior Vice President Marsh USA, Inc. Boston, MA 617.385.0308 Machua.Millett@marsh.com

23. Thank You Diamond Sponsors

24. Thank you for your time.A replay of this webinar will be available to PLUS Members on our website at: http://plusweb.org/Education/PLUSMultimedia