Texas District Court Applies Eight Corners Rule to Duty to Pay Policy
On January 26, 2010, in Pendergest-Holt, et al. v. Certain Underwriters at Lloyd’s of London, et al., No. H-09-3712 (S.D. Tex.), the United States District Court for the Southern District of Texas granted Robert Allen Stanford, Chairman of the Board of Directors of Stanford International Bank, Ltd., and related insureds a preliminary injunction requiring Certain Underwriters at Lloyd’s of London (“Underwriters”) and Arch Specialty Insurance Company (“Arch”) to pay defense costs under D&O policies in connection with criminal and SEC proceedings pending against the insureds. The Court rejected the insurers’ argument that the Money Laundering Exclusion applied, holding that the eight corners rule precluded the insurers from examining evidence outside the complaint to attempt to enforce the exclusion.
In February 2009, the SEC filed a civil action against Mr. Stanford, three Stanford entities and various of their officers, alleging that the insureds orchestrated a multi-billion dollar ponzi scheme in which they conspired to deceive investors and sold sham certificates of deposits. The insureds sought coverage under a primary D&O policy issued by Underwriters and an excess policy issued by Arch. Underwriters initially agreed to pay defense costs under a reservation of rights. In June 2009, a twenty-one count indictment was issued against the insureds, alleging that they conspired to commit and did commit mail fraud and wire fraud, conspired to commit securities fraud and money laundering, and conspired to obstruct and did obstruct an SEC investigation. On August 27, 2009, James Davis, the CFO for some of Stanford’s companies, pled guilty to various charges and made statements implicating the insureds in a wide range of illegal activity.
In November 2009, Underwriters issued denial letters to the insureds, declining to extend coverage for defense costs incurred after the date when Davis entered his guilty plea, based on a Money Laundering Exclusion contained in its policy. The Money Laundering Exclusion does not require a “final adjudication” that the insureds had engaged in money laundering but, rather, applies when “it is determined that the alleged act or alleged acts did in fact occur.” The insurer argued that it, therefore, was entitled to make the decision on its own as to whether the exclusion applied. Relying on the evidence that supported a TRO and a preliminary injunction in the SEC proceedings against the companies, the declaration of an accountant hired by the companies’ Receiver, and the statements of Davis at his plea allocution, Underwriters concluded that money laundering, in fact, had occurred.
The Court rejected Underwriters’ evidence on the basis of the “eight corners rule,” which the Court held applies to duty to pay policies under Texas law without exception. The Court observed that, if the insurer was allowed to examine evidence outside of the complaint, “the Policies [would] afford Underwriters absolute discretion to withhold payments whenever charges of intentional dishonesty are leveled against directors and officers, [and] insurers [would] be able to withhold payment in virtually every case at their sole discretion.” That, according to the Court, “would leave directors and officers in an extremely vulnerable position, as any allegations of dishonesty, no matter how groundless, could bring financial ruin on a director or officer.” The Court also rejected Underwriters’ contention that the insureds had the burden to prove that money laundering did not occur, holding instead that an insurer has the burden to prove the application of an exclusion.
The Court elaborated that the “in fact” condition to the Money Laundering Exclusion “may mean something less than a judicial determination but also may mean much more than an insurer’s own determination based on nothing more than mere allegations supplemented by the self-serving statements of an indicted co-defendant who elects to plead guilty and cooperate with the prosecution.” The Court continued that it “need not decide at this time what level of factual determination must be made to satisfy the language of the Money Laundering Exclusion – indeed, that goes to the very heart of the merits of this case; a conclusion to be reached after ‘more deliberate investigation’ and a full trial on the merits.”
Ultimately satisfied that the insureds had a substantial likelihood of succeeding on the merits of their coverage argument, the Court issued a preliminary injunction in favor of the insureds and denied the insurers’ motion to dismiss.