Insurer Must Pay Defense Expenses in Appeal of Fraud Conviction

The California Court of Appeal has held that an exclusion requiring repayment to the insurer upon a “final determination” of the insured’s culpability applies only after the insured’s direct appeals have been exhausted, and therefore the insurer was obligated to pay the insured’s litigation expenses in an appeal of the underlying litigation.  Stein v. AXIS Ins. Co., 2017 WL 914623 (Cal. Ct. App. Mar. 8, 2017).

The insured, an officer of a medical device company, was convicted of securities fraud in federal court.  He tendered his appeal of that conviction to one of the company’s insurers.  However, the policy included an exclusion for any claim involving willful misconduct, which was triggered by “a final adjudication adverse to [the] Insured Person in the underlying action . . . establishing that the Insured Person” committed willful misconduct.  The exclusion also provided that “[i]f it is finally determined that [the exclusion] applies,” the insured would be obligated to repay the insurer any defense expenses paid on his or her behalf.  The insurer denied coverage because it considered the conviction to be a “final determination” of the officer’s willful misconduct for purposes of the exclusion.

The officer sued the insurer, alleging that it had defrauded him and breached the policy by failing to pay his litigation expenses on appeal of the conviction.  After finding that the willful misconduct exclusion precluded coverage because the insured’s criminal conviction was “final under federal law until it is reversed,” the trial court sustained the insurer’s demurrer without leave to amend and dismissed the case.  The officer appealed.

The Court of Appeal reversed and held that the insurer was obligated under the policy language to cover the insured’s defense expenses incurred as a result of an appeal from a civil or criminal proceeding, even if a trial court determined that the insured was guilty of or liable for fraud.  The court specifically pointed to the willful misconduct exclusion, noting that, while it barred coverage for losses brought about by fraud or criminal acts, the exclusion did not apply to defense expenses.  The court rejected the insurer’s argument that, under federal law, a trial court judgment is deemed to be a final adjudication until reversed on appeal.  In rejecting that argument, the court noted that nothing in the policy indicated that the parties intended the phrase “final adjudication” to carry the same meaning as in federal law.  The court also noted that an appellate court can render an adjudication with greater finality than a trial court.  Finally, the court explained that the policy only provides one trigger for the exclusion:  a final adjudication.  Thus, the court concluded that, any trial court judgment against the officer would not trigger the exclusion so long as the judgment could be appealed.


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