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Tenth Circuit Holds that Governmental Investigation of Potential Criminal Violations is Not a “Claim” Under a D&O Policy

Would your directors and officers (D&O) liability insurance policy provide coverage for responding to government investigations under a new decision from the U.S. Circuit Court of Appeals for the Tenth Circuit?

As a starting point, D&O insurance policies are key components of a corporation’s risk transfer portfolio, purchased to protect it against lawsuits presenting significant liability exposure to itself and its key officers and directors. In recent years, as an alternative to targeted formal litigation and discovery in uncovering corporate wrongdoing, federal and state governments have increasingly utilized formal and informal investigations. This trend has created an expensive new financial exposure in the business world, particularly for the large corporations, which are often the targets of such inquiries, and corresponding questions about how D&O insurance policies cover such costs. Although many D&O policies have evolved to explicitly protect policyholders from the costs of responding to government investigations, many have not been amended, leading to questions about the scope of coverage provided under them for investigations.

A recent decision in the Tenth Circuit illustrates how some courts have determined that policy language commonly found in D&O policies may not be up to the task to protect policyholders from the costs of responding to government investigations. The coverage dispute in MusclePharm Corp. v. Liberty Insurance Underwriters, Inc., was an outgrowth of an investigation directed at MusclePharm, a nutritional supplement company, and several of its officers by the U.S. Securities and Exchange Commission (SEC).

In July 2013, MusclePharm received an order from the SEC directing the company to conduct a private investigation of potential violations of securities law. The order stated that “it should be understood that the [SEC] has not determined whether any of the persons or companies mentioned in the order have committed” any wrongful acts or violation of the law. Eventually, after MusclePharm incurred more than $3 million in costs in responding to SEC subpoenas and document requests, it settled with the SEC.

MusclePharm sought coverage of its costs in responding to the SEC investigation under its D&O policy issued by Liberty Insurance Underwriters, Inc. The Liberty policy defined a covered “claim” in part as either a “written demand for monetary or non-monetary relief” or a “formal administrative or regulatory proceeding against” an insured. Liberty denied coverage on the grounds that the July 2013 order was not a claim triggering coverage under the policy.

The Tenth Circuit agreed with the carrier. The court held that the order did not seek “relief,” and was not a “proceeding.” The court also noted that the order explicitly indicated it was not making allegations against any individual or company. Accordingly, the court determined that the order was not a claim triggering the carrier’s obligation to reimburse MusclePharm’s costs of responding to the order, which ultimately exceeded $3 million.

MusclePharm is a cautionary tale about how some courts might determine that expensive governmental investigations could elude the definition of “claim” in many D&O policies. Indeed, the very efforts of the government to reassure the company that there is no present allegation of wrongdoing may be the very factor that courts determine defeat efforts to obtain reimbursement of the investigation from a D&O insurance carrier. MusclePharm’s coverage simply did not reflect the reality that an information investigation implicating the company may last years and cost it a small fortune.

As investigations become more commonplace, a best practice for companies is to review their liability policies and consider how coverage might apply to the costs of responding to investigations at all stages.

© 2017 BARNES & THORNBURG LLP

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About this Author

John Corbett, Barnes Thornburg Law Firm, Insurance and Litigation Attorney
Of Counsel

John L. Corbett is of counsel in Barnes & Thornburg’s Dallas office and is a member of the Litigation Department and the Insurance Recovery and Counseling Practice Group.

Mr. Corbett concentrates his practice on insurance recovery matters and represents corporate policyholders in a wide variety of industries, including construction, transportation, telecommunications, and healthcare management. He has experience in obtaining recoveries under general liability, cyber insurance, director and officers (D&O) and professional errors and...

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