New York Court Holds Insurer Can Recoup Defense Costs, Appealable Conviction of Former Bank CEO Is “Final” Adjudication of D&O Claim
A New York federal court recently held that an insurance company was entitled to recoup legal fees paid under a directors and officers liability policy in defense of a criminal action against an ex-CEO who was convicted of bribery. On a motion for reconsideration, the court affirmed its earlier ruling that the CEO’s conduct fell within the policy’s “Dishonest and Willful Acts Exclusion,” reasoning that the criminal case had been finally adjudicated despite a pending appeal. Because there was no coverage, the insurer could seek repayment of all defense costs it had paid to date. Not only is the court’s recoupment decision potentially inconsistent with New York law, but it also raises thorny questions regarding just when a judgment is “final” for the purpose of triggering D&O policy exclusions.
Defendant Alan Kaufman, who had served as CEO of a credit union, was insured under a Management & Professional Liability policy issued by CUMIS Specialty Insurance. During his tenure as CEO, Kaufman accepted gifts in exchange for favorable loans and advertising purchases. A jury in the Southern District of New York convicted Kaufman of two counts of bribery stemming from these activities. Kaufman was sentenced to 46 months in prison.
Kaufman appealed his conviction and sentencing. He had also sought coverage from CUMIS for the associated costs in defending the criminal action against him, including legal fees and expenses incurred in appealing his conviction. Although CUMIS maintained that the fees were excluded under the dishonest and willful acts exclusion—barring coverage for claims based upon any deliberately dishonest, fraudulent, intentional, or willful misconduct, once established by a “final adjudication”—it agreed to provide coverage subject to Kaufman’s agreement to repay the fees if they were determined to be excluded under the policy. Kaufman agreed to CUMIS’s proposal, and CUMIS funded his defense. After he was convicted, however, CUMIS filed a coverage action seeking a declaration that Kaufman’s legal fees were excluded and that it could recoup any post-sentencing legal fees it paid.
The court ruled in CUMIS’s favor. First, the court held Kaufman’s acts fell within the policy’s dishonest and willful acts exclusion. Second, the court determined that Kaufman’s conviction and sentencing constituted a “final adjudication” despite the pendency of his appeal. The court rejected Kaufman’s position that the policy’s use of the phrase “final adjudication,” rather than the phrase “final judgment,” was meaningful. Because New York law considers a criminal trial to be finally adjudicated upon conviction, and because New York courts use the terms “final judgment” and “final adjudication” interchangeably, the exclusion applied at the time Kaufman was convicted.
The determination that a case pending appeal has been finally adjudicated raises significant concerns in the context of D&O policies. For one thing, D&O policies include final adjudication provisions because many of the claims brought under such policies concern criminal misconduct or other fraudulent activity that would otherwise be excluded. In addition, allowing an insurer to renege on its coverage obligations in the midst of an appeal leaves the insured in a tenuous position if the insurer withdraws from the defense at the time a non-final, appealable conviction leaving the insured to fund the appeal without the benefits of the policy.
In this case, the impact of the court’s no-coverage ruling was amplified because not only was the CEO stuck with paying the costs of his own criminal appeal, but the premature application of exclusions with a “final adjudication” trigger allowed CUMIS to seek recoupment of all defense costs that it had already paid.
However, the court’s was noticeably silent with respect to whether the policy itself entitled CUMIS to any recoupment rights in the first place. Rather, the court made clear in its prior coverage ruling that Kaufman accepted the insurer’s offer to repay any advanced fees if it was later determined that the claim was not covered.
In the absence of a policy provision allowing for recoupment, however, the court’s (and perhaps the policyholder’s) recognition that CUMIS could recover defense costs is inconsistent with New York law. In one 2020 decision, for example, the Second Department held that an insurer was not entitled to recoupment absent an express policy provision to that effect, even where the insurer was defending under a reservation of rights and had reserved its rights to recoup defense costs. Am. Western Home Ins. Co. v. Gjonaj Realy & Mgmt. Co., 192 A.D.3d 28, 40 (N.Y. App. Div. 2d Dep’t 2020). There, the court reasoned that allowing recoupment subject to a reservation of rights “flies in the face of basic contract principles and allows an insurer to impose a condition on its defense that was not bargained for.” Id.
Moreover, the Kaufman decision once again highlights potential risks associated with insurer recoupment. From carefully reviewing pertinent policy language to understanding governing law and diligently evaluating an insurer’s recoupment rights through the claim process, we have previously discussed several steps policyholders can take to mitigate these risks. Doing so can not only help maximize defense coverage in the first instance but also minimize the risk of insurer recoupment in the event of an adverse finding.