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Saturday, March 20, 2010

Insurance Companies Must Fund Former Stanford Executives' Defense Until Court Rules

A three-judge panel of the 5th U.S. Circuit Court of Appeals held March 15 that a court -- not insurance companies -- will determine whether two insurance companies have to pay defense costs for R. Allen Stanford and three other former Stanford Financial Group (SFG) executives who face criminal charges and civil litigation.

The civil litigation filed by the U.S. Securities and Exchange Commission and the federal criminal charges stem from allegations that the former SFG executives conspired to defraud investors who bought about $7 million in certificates of deposit sold through Stanford International Bank Ltd. The criminal case, United States v. Robert Allen Stanford, et al. is pending in U.S. District Judge David Hittner's court in the Southern District of Texas in Houston. The civil case, Securities and Exchange Commission v. Stanford International Bank Ltd., et al., is pending before U.S. District Judge David Godbey of the Northern District of Texas in Dallas. Stanford and the other three executives, Laura Pendergest-Holt, Gilberto Lopez Jr. and Mark Kuhrt, have pleaded not guilty to the criminal charges against them and deny the allegations in the civil suit.

The insurance companies had appealed a Jan. 25 preliminary injunction Hittner issued in Laura Pendergest-Holt, et al. v. Certain Underwriters at Lloyds of London, et al. Hittner ordered Certain Underwriters at Lloyds of London and Arch Specialty Insurance Co. to advance defense costs to the four former SFG executives. The two insurance companies contended that they should not have to pay under the SFG directors-and-officers policy because they determined in November 2009 that the former executives engaged in "money laundering."

According to the 5th Circuit's opinion, written by Senior Judge Patrick Higginbotham, the liability policy limit is $100 million. But, as noted in the opinion, a money-laundering exclusion in the policy bars coverage for loss from any claim "arising directly or indirectly as a result of or in connection with any act or acts (or alleged act or acts) of Money Laundering."

The policy also provides that the insurance companies must pay the costs in the event that money laundering is alleged "until such time that it is determined that the alleged act or acts did in fact occur." As the 5th Circuit reads the policy, "the determination is a judicial act" and that act must occur in a separate coverage proceeding.

The 5th Circuit modified Hittner's injunction, affirming the order "only insofar as it provides for coverage until a court determines otherwise." But to avoid any "awkwardness" for Hittner, who presides over the criminal case against the SFG executives, the 5th Circuit remanded the case to the Southern District so that the chief judge might assign it to another judge. Higginbotham wrote that the 5th Circuit cannot "ignore the awkwardness -- readily recognized by Judge Hittner -- in putting the civil 'cart' before the criminal 'horse,' especially when the judge who decides the question of coverage, with its demand for assessing the strength of the government's criminal case, is set to later preside over the criminal trial."

Lee Shidlofsky, attorney for the executives and a partner in Austin's Visser Shidlofsky, writes in an e-mail, "We are pleased that the 5th Circuit concluded that Underwriters does not have the unilateral right to act as the judge and jury. Under the court's holding, Underwriters are obligated to pay defense costs until a court determines that money laundering has in fact occurred."

Neel Lane and Rex Heinke, attorneys representing the insurance companies and partners in Akin Gump Strauss Hauer & Feld in San Antonio and Los Angeles, respectively, each did not return a telephone call seeking comment before press time on Thursday.

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