The United States Court of Appeals for the Second Circuit recently issued a decision highlighting the significance of full disclosure in an insurance policy warranty statement and the critical importance of negotiating such warranty statements to define the specific persons whose knowledge may be considered knowledge of the company for purposes of its application.
In Patriarch Partners, LLC v. Axis Ins. Co., No. 17-3022, 2018 WL 6431024 (2d Cir. Dec. 6, 2018), the central question presented to the Second Circuit was whether a lengthy Securities and Exchange Commission (“SEC”) investigation into Patriarch Partners, LLC (“Patriarch”) ripened into a “claim” before the Axis insurance policy inception date, thereby excluding related defense costs from coverage under the terms of the policy and a related warranty provided by Patriarch to Axis.
In December 2009, Patriarch received a letter from the SEC, notifying the company that the SEC was conducting an informal “inquiry” into the company and requesting that Patriarch voluntarily provide certain information. Id. at *1. Represented by its outside counsel, Patriarch complied with the SEC’s request. Id. However, the SEC later contacted Patriarch’s outside counsel, notifying the company that an informal “investigation” had been commenced against the company. Id. at *2. This letter was followed by a formal Order of Investigation against Patriarch, and, as part of its investigation, the SEC requested interviews with two former executives, issued a subpoena to one of them, and also indicated that it would issue a subpoena to the company itself. Id.
Meanwhile, Patriarch was in the process of renewing its directors and officers (D&O) professional liability insurance. Id. at *3. Its existing D&O insurance was comprised of a primary policy and two excess policies. Id. Desiring to obtain a third excess layer of insurance, Patriarch received a quote from Axis, contingent upon Patriarch’s execution of a warranty statement (the “Warranty”), the purpose of which was to eliminate the potential for Axis to be hit with a claim that Patriarch was aware of but that had yet to be filed.
Patriarch’s founder, sole director, and sole officer, Lynn Tilton (“Tilton”), signed the Warranty:
The undersigned, on behalf of Patriarch and all of its directors and officers, hereby represents that as of the date of this letter neither the undersigned nor any other director or officer of Patriarch is aware of any facts or circumstances that would reasonably be expected to result in a Claim under the Captioned Policy. It is understood that the Captioned Policy and any renewal thereof does not provide coverage for Claims relating to facts or circumstances that, as of the date of this letter, Patriarch was aware of and would reasonably have expected to result in a Claim covered by such Captioned Policy (or future renewal thereof).
Six months later, the SEC served Patriarch with a subpoena as part of its existing investigation, and Patriarch tendered the matter to its D&O insurers as a new claim. Id. at *4. After the costs of defending the SEC proceeding had depleted nearly all of Patriarch’s underlying D&O coverage, Patriarch asked Axis to assume the obligation to cover defense costs, but Axis denied coverage on the basis (among others) of the Warranty, namely that the SEC investigation constituted “facts or circumstances” of which Patriarch was aware that could reasonably have been expected to result in the Claim. Id.
Although Patriarch conceded that the Warranty contained an exclusion, it argued that (i) the Warranty excluded coverage only for Claims relating to facts or circumstances of which Tilton herself was aware, since Tilton was the sole officer or director of Patriarch; and (ii) the Warranty phrases “Claim under the Captioned Policy” and “Claim covered by such Captioned Policy” referred only to Claims giving rise to losses in excess of $20 million because the Axis Policy provided coverage only after the underlying policies were exhausted by a particular Claim. Id. at *5. Thus, under Patriarch’s interpretation, the Warranty excluded coverage only for Claims relating to circumstances of which Tilton herself was aware and which Tilton would reasonably have expected to result in a Claim with losses exceeding $20 million. Id.
Applying New York law, the Second Circuit disagreed, noting that “Patriarch’s position that the Warranty applies only to facts or circumstances subjectively known by Tilton is unsupported by the text of the Warranty, which explicitly refers to facts or circumstances that ‘Patriarch was aware of.’” Id. In addition, under traditional agency principles, the Court considered the facts and circumstances that were known not only to Tilton, but to Patriarch’s outside counsel and Patriarch’s in-house counsel as well. Id. Further, the Court also held that the Warranty excluded claims arising from facts or circumstances of which Patriarch was aware and that Patriarch would reasonably have expected to result in a Claim as defined by the underlying primary policy, to this the Axis policy followed-form. Id. Accordingly, because Patriarch “was aware” of the SEC Order of Investigation and the escalating severity and focus of the SEC investigation at the time Tilton executed the Warranty, the Warranty excluded Patriarch’s losses arising from its defense of the SEC investigation from coverage under the Axis policy. Id. at *6.
For policyholders, the Second Circuit’s Patriarch Partners decision highlights the significance of full disclosure in an insurance policy warranty statement and the critical importance of negotiating such warranty statements to define the specific persons whose knowledge may be considered knowledge of the company for purposes of its application. Of course, as Cooley is regularly retained with respect to insurance policy application and warranty statements, the Patriarch Partners decision highlights the fundamental importance of adequate representation as to these issues.