Insolvency Exclusion Bars Coverage for Madoff Related Suit

ASSCIATED COMMUNITY BANCORP, INC. v. THE TRAVELERS CO., INC. (D. Conn., April 8, 2010)

Associated is a bank holding company incorporated in Delaware. CCB is a wholly owned subsidiary of Associated and is a nationally chartered bank. Dennis Clark is an officer at CCB. Westport is a division of CCB. Travelers, through a subsidiary, issued a professional liability policy to defendants Associated CCB and Westport under which Dennis Clark qualified as an insured.     

CCB, Westport, and Clark are defendants in four pending lawsuits arising out of the Ponzi scheme run by Bernie Madoff. The plaintiffs in the underlying suits allege that they entered into a custodial agreement with Westport in which the investors directed Westport to give Madoff full discretionary authority to invest their funds. As custodian, Westport transferred and redeemed funds and performed certain tasks such as recordkeeping and tax reporting. As a result of the Madoff scheme, the investors sought the return of their lost investments, along with fees paid to Westport. CCB, Westport and Clark, in turn, sought coverage under the policy issued by Travelers.

Travelers denied coverage asserting a number of policy exclusions, including the insolvency exclusion. With respect to this exclusion, the court noted that the policy excluded coverage for any loss resulting from a claim "made against any insured…based upon or arising out of…the insolvency …or financial inability to pay…by any investment company, broker, or dealer…in securities or commodities." The court noted that Connecticut courts have routinely applied a broad interpretation of the phrase "arising out of" and in applying the terms of the exclusion to the facts here, the court concluded that the underlying lawsuits were certainly connected with, incident to, or flow out of Madoff’s insolvency. Had Madoff not become insolvent and lost the investor’s money, the investors would have no damages and thus no reason to file suit against Westport.

In an effort to assert the provision was ambiguous, the plaintiffs argued that Madoff did not constitute an "investment company" or "broker or dealer in securities" as defined by the policy, but instead was a "criminal enterprise." Plaintiff’s sole source of law on this point was a district court case out of the State of New York. The court soundly rejected this proposition and held that Madoff fell within the plain meaning of any investment company or broker under the policy.

Finally, plaintiff also argued that the terms "insolvency," "bankruptcy," or "financial inability to pay" do not cover situations such as the one at issue here where Madoff engaged in a massive Ponzi scheme. The court noted that the insolvency exclusion was disjunctive, with "insolvency" being separated from "bankruptcy" and "financial inability to pay" with the word "or." Thus, even if the court were to accept plaintiff’s definition of insolvency, the claims are not covered under the plain and ordinary means of bankruptcy and financial inability to pay. Accordingly, the court did not view the exclusion ambiguous and held that it applied to bar coverage.

 Impact: Here, the insurer was successful in arguing that the underlying complaints fell wholly and completely within the scope of a policy exclusion. While the policyholder simply attempted to argue the exclusion ambiguous, it was clear that the plain language of the exclusion applied to bar coverage.