Annual Survey of 2011 Developments in Insurance Coverage Law: of Ponzi Schemes and Pot Cakes

• Publication year: 2021
• Pages: 176

Connecticut Bar Journal Volume 86.

86 CBJ 176. ANNUAL SURVEY OF 2011 DEVELOPMENTS IN INSURANCE COVERAGE LAW: OF PONZI SCHEMES AND POT CAKES

Connecticut Bar Journal
Volume 86, No. 2, Pg. 176
June 2012

ANNUAL SURVEY OF 2011 DEVELOPMENTS IN INSURANCE COVERAGE LAW OF PONZI SCHEMES AND POT CAKES

By Charles T. Lee and Mandiey Winalski(fn*)

This article summarizes significant decisions by the state and federal courts of Connecticut in 2011 relating to commercial property/casualty insurance. The numerous decisions are consistent with the size of the insurance industry in Connecticut. On a national scale, Connecticut ranked first in 2011 in life insurance premiums written by its domiciled companies and second highest in total written premium for all lines of insurance.(fn1) These insurance cases deal with a wide variety of issues, from Ponzi schemes to a dessert baked with marijuana. Their holdings are discussed as follows: (1) appellate court decisions setting forth basic principles of insurance law; (2) coverage for Madoff-type losses; (3) splits of authority as to pleading bad faith; (4) splits of authority as to pleading general business practice as required by Section 38a-816(6) of the Connecticut Unfair Insurance Practices Act ("CUIPA"); (5) rights of subrogees and mortgagees; (6) the meaning of "vacant" property; (7) timeliness of notice; (8) various exclusions; and (9) procedural disputes. Finally, these decisions are summarized to determine whether there is any discernible bias towards insurers or insureds in the jurisprudence of the Insurance State.

I. The Connecticut Appellate Courts Speak on Basic Principles of Insurance

Last year, the Connecticut Supreme Court took the opportunity to review the general rules of insurance coverage law and reaffirmed one of the most basic principles of policy interpretation: an ambiguity will be construed in favor of coverage. In Johnson v. Connecticut Insurance Guaranty Association,(fn2) the question before the Court was whether certain medical malpractice claims were subject to a paramedical exclusion in a professional liability policy, which applied if a premium charge for the paramedic was listed on the declarations page. The Court first provided an overview of the rules of policy interpretation, explaining that the determinative question is what the parties intended:

If the terms of the policy are clear and unambiguous, then the language, from which the intention of the parties is to be deduced, must be accorded its natural and ordinary meaning .... Under those circumstances, the policy is to be given effect according to its terms.(fn3)

The Court continued:

As with contracts generally, a provision in an insurance policy is ambiguous when it is reasonably susceptible to more than one reading.... Under those circumstances, any ambiguity in the terms of an insurance policy must be construed in favor of the insured because the insurance company drafted the policy.(fn4)

Upon examining the paramedical exclusion and the declarations page, which stated "included" on the premium line for paramedics, the Court explained that, "despite the counterintuitive result that the association's construction yields, we would be bound to apply it if the policy terms unambiguously and inexorably led to the conclusion that the parties manifested such an intention."(fn5) However, because the exclusion was ambiguous, the rules of construction required that it be construed in favor of the policyholder, and the exclusion did not apply.(fn6)

The Appellate Court also has provided clear statements on insurance coverage law during the past year. In Cambridge Mutual Fire Insurance Company v. Sakon,(fn7) the court applied the business exclusion in a homeowner's policy to defeat the duties to defend or indemnify where a third party counterclaimed against the insured for abuse of process, intentional infliction of emotional distress, and violation of CUTPA, among other things, after the insured sued the third party for breach of a settlement agreement because the party spoke against a commercial development at a zoning hearing. The court observed that the duty to defend

. . . does not depend on whether the injured party will successfully maintain a cause of action against the insured but on whether he has, in his complaint, stated facts which bring the injury within the coverage. If the latter situation prevails, the policy requires the insurer to defend, irrespective of the insured's ultimate liability.... It necessarily follows that the insurer's duty to defend is measured by the allegations of the complaint.... Hence, if the complaint sets forth a cause of action within the coverage of the policy, the insurer must defend.(fn8)

However, because the conduct alleged in the counterclaim would not have arisen absent the policyholder's commercial development plan, the court held that the business exclusion barred coverage.(fn9) The court also held that the insurance company was not estopped from asserting the exclusion where it had issued a reservation of rights in connection with its investigation and defense of the claim.(fn10)

In Misiti, LLC v. Travelers Property Casualty Company of America,(fn11) the Appellate Court held that the duty to defend is not defeated even in the face of facts extrinsic to the complaint that demonstrate that the claim may not be covered. The court stated:

Because [t]he duty to defend has a broader aspect than the duty to indemnify and does not depend on whether the injured party will prevail against the insured ... [i]f an allegation of the complaint falls even possibly within the coverage, then the insurance company must defend the insureds. This is true "even [if] facts outside the four corners of those pleadings indicate that the claim may be mer-itless or not covered...."(fn12)

Thus, these cases serve as examples of how the rules of interpretation, discussed by the higher courts throughout the year, can tend to favor policyholders.

II. Coverage For Madoff-Type Losses

In recent years, as lawsuits have been filed against fraudulent actors and the firms that invested with them, the availability of insurance coverage for Ponzi-scheme related losses has become a fiercely litigated issue. Policyholders range from large investment entities investing hundreds of millions of their clients' dollars to individuals who lost their life savings. Connecticut courts dealt with this controversy in 2011 in various ways.(fn13)

Faced with suits from investors harmed by Ponzi schemes, investment professionals have turned to their errors and omissions/professional liability policies with varying results. The second Circuit Court of Appeals made this more difficult when it affirmed the negative decision of the trial court in Associated Community Bancorp, Inc. v. The Travelers Companies, Inc.(fn14) There, investors brought suit against a bank, which, as custodian of their investments, was directed to give Madoff "full discretionary authority" to invest. The bank and its parents sought coverage under both a Bankers Professional Services policy (E and O) and a Management Liability Insuring Agreement policy (D and O). The district court, as affirmed by the Second Circuit, found that the claims were within the grant of coverage of the E and O policy because the liability arose in connection with the provision of financial services. However, the court also found that the policy's insolvency exclusion barred coverage, reasoning that, "[h]ad Madoff not become insolvent and lost the investors' money, the investors would have had no damage and thus no reason to file suit against [the bank]."(fn15) The district court also found that D&O coverage was not available because of a professional services exclusion.(fn16)

The Second Circuit reached a different result in another fraud case, not involving Madoff. In MBIA Inc v. Federal Insurance Company,(fn17) an action seeking coverage under directors and officers insurance liability policies for costs associated with financial regulators' investigations, the Second Circuit found coverage for all claims.. Here, the policies covered "Securities Claims," which included "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" and "Securities Defense Costs," which included costs "incurred in defending or investigating Securities Claims."(fn18 )The court reviewed the standard rules of construction under Connecticut law, observing that "[d]oubts are resolved in favor of the insured."(fn19) The court then held that the policy provided coverage for the investigations by the SEC and the Attorney General of New York into certain of the insured's transactions, as well as for an independent consultant's investigation and related costs incurred by a special litigation committee.(fn20)

Approaching the problem from a different angle, in Orthopaedic Specialty Group, P.C. v. Pentec, Inc.,(fn21) a Connecticut superior court denied a pension advisor's motion to strike the negligence claim filed against him by the individual trustees of a pension plan for failing to advise them not to invest all of their funds with Madoff and failing to advise them to obtain professional liability insurance. The court...