United States: Fourth Circuit Ruling Affirms Decision To Award Recoupment Of Defense Costs To D&O Liability Insurer

Last Updated: May 2 2013
Article by Harry Lee and Rebecca S. Liu

Insurance Coverage Case Advisory, Issue 44

In Farkas v. National Union Fire Insurance Company of Pittsburgh, PA, No. 12-1481, 2013 WL 1459248 (4th Cir. Apr. 11, 2013), the United States Court of Appeals for the Fourth Circuit affirmed the district court's summary judgment order and held that a Directors & Officers (D&O) liability insurer had no duty to defend the chairman of the policyholder after he was convicted of criminal fraud.1Id. at *1.  The appellate court also affirmed the district court's order allowing the insurer to recoup legal defense costs advanced to the policyholder prior to his criminal fraud conviction.  Id.

The policyholder in Farkas was a mortgage company whose chairman, an insured person under the company's D&O policy, was convicted of bank, wire, and securities fraud for hiding the company's financial problems.  Id.  Though the insurer advanced some of the chairman's criminal defense costs under the D&O policy, it stopped after a jury found the chairman guilty.  Id.  When the insured filed suit for the insurer to continue paying his defense costs, the insurer filed a counterclaim seeking recoupment of the advanced defense costs.  Id.  Ruling on cross-motions for summary judgment, the district court held that the "in fact" policy exclusions found in the D&O policy were triggered by the guilty verdict, and the unambiguous language of the policy did not require the insurer to make any payment for an excluded claim.  Farkas v. Nat'l Union Fire Ins. Co. of Pittsburgh, PA, 861 F.Supp.2d 716, 722 (E.D.Va. 2012).

The Fourth Circuit affirmed and explicitly adopted the district court's reasoning.  Farkas, 2013 WL 1459248 at *1 First, in reaching the conclusion that the "in fact" exclusions applied, the district court found that the D&O policy's "unambiguous language" excluded liability for payments connected with a claim "arising out of, based upon or attributable to" either 1) "the gaining in fact of any profit or advantage to which an Insured is not legally entitled" or 2) "the committing in fact of any criminal, fraudulent or dishonest act, or any willful violation of any statute, rule or law."  Farkas, 861 F.Supp.2d. at 720 (internal quotation and citation omitted) (emphasis added by Court).

Then, the district court held that the insured's conviction was "an objectively verified and pertinent factual finding," which triggered the policy exclusions. Id. at 720-21.  The district court also held that the policy language protected the insurer from making "any" payment at all for an excluded claim.  Id. at 722. 

Next, the district court reasoned that the insurer was entitled to recoupment based on the policy language that the defense costs "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 such Loss."  Id. (internal quotation and citation omitted).  The insured argued that the policy did not impose joint and several liability on the insured and the mortgage company, and that the insurer should not recoup because it had already initiated a separate claim for funds through bankruptcy court.  Id.  The district court reasoned, however, that the law did not prohibit the insurer from litigating both a bankruptcy proceeding and a civil action against the chairman.  Id. at 722-23.  Moreover, the policy "provide[d] for payment severally from the insured and the company according to their respective interest."  Id. at 723.  Thus, the insurer prevailed.  Id.

The Farkas decision is significant because it is a good example of a court applying unambiguous policy language as written to enforce the bargain that was struck between the policyholder and the insurer.  In the event that an insured pursues defense costs even though he or she is not entitled to such costs due to an applicable exclusion, Farkas serves as an instance where the court will uphold the policy's express terms and conditions.  In the D&O liability context, insured persons and insurers are both bound by the policy agreement, and it is unlikely that any party will be able to draw additional benefits that are not clearly articulated in the policy itself.


1. The district court opinion explained that the parties agreed there was no "material difference" between the applicable law from Florida and Illinois, and thus did not engage in a choice of law analysis. Farkas v. Nat'l Union Fire Ins. Co. of Pittsburgh, PA, 861 F.Supp.2d 716, 720 n.2 (E.D.Va. 2012).

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