Insureds Entitled to Advancement of Defense Costs But Not Equitable Reallocation of Policy Proceeds

The United States District Court for the Northern District of Texas, applying Texas law, has held that the directors and officers of a corporation in receivership were entitled to advancement of defense costs despite the receiver’s objections.  SEC v. Faulkner, 2018 WL 2761850 (N.D. Tex. June 6, 2018).  The court declined, however, to reallocate the insurer’s prior payments based on the objections of one insured who contended he had not received a sufficient share of the policy proceeds.

The SEC sued the insured energy exploration company and its directors and officers.  The company was placed in receivership and subjected to an asset freeze.  The court ordered, however, that the directors and officers be given access to D&O policy proceeds to fund their defense pending full briefing and a decision on the issue of the receivership estate’s rights to the policy proceeds.

Most of the $1 million policy limit was paid on behalf of several insureds.  Subsequently, another director submitted a claim for defense costs greatly exceeding the remaining policy limit.  The insurer denied coverage for pre-tender defense costs but agreed to pay covered post-tender defense costs on a pro rata basis along with defense costs submitted by the other insureds.  The director argued that the past payments should be reallocated because the other insureds had, he alleged, concealed the existence of the policy.

The court first confirmed that the directors and officers, as a group, had a superior right to payment based on the policy’s priority of payments provision.  The receiver, standing in the shoes of the company, had only a contingent interest in the policy proceeds.  Because the directors and officers faced a “clear, immediate, and ongoing” need to fund a defense and the receiver could only claim that the policy proceeds might hypothetically “one day be paid into … the estate,” the balance of harms also favored the individuals.

The court then denied the request to reallocate the insurer’s payments.  The court noted there was fact dispute about why the director had tendered his claim late but recognized that the insurer was not obligated to pay pre-tender defense costs to which it had not consented.  While the court agreed that it had “broad equitable power” to fashion relief in securities cases, it held that the power did not extend to reallocating amounts that were already paid according to the terms of the insurance contract.

Wiley Executive Summary

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