Law enforcement, workshops, and reports from the Federal Trade Commission (FTC) have yielded five “lessons” for lead generation advertisers, according to an article that was published last month in Law360 by Andrew Smith, director of the FTC Bureau of Consumer Protection. In it, he suggests that companies that purchase lead generation advertising must manage lead generators responsibly, just like manufacturers that make supply chain management a top priority.
The article drew attention from members of the lead generation advertising sector and their lawyers and compliance departments. Some commentators called it a tutorial on how to reduce risk in using lead generation advertising. For others the article was a cautionary tale of recent enforcement actions taken against a buyer of lead generation advertising and the lead generators spotlighted in the article. In any event, the article was certainly reflective of the FTC’s work in the lead generation area and reminder of the importance of legal compliance in the lead generation ecosystem.
According to Smith: “The complexity of the lead generation ecosystem isn’t a shield against liability, nor does it exempt you from honoring fundamental consumer protection principles. Advertisers should take the lead in ensuring the leads they use weren’t the product of deception.”
The article highlights lessons from a recent series of cases that allege deceptive marketing, including the first time the FTC has held an education company liable for the tactics of lead generators under the FTC Act and Telemarketing Sales Rule (TSR).
As alleged by the FTC, an education company used sales leads from lead generators that falsely told consumers they were affiliated with the U.S. military, and that used other unlawful tactics to generate leads. The company’s lead generators also allegedly induced consumers to submit their information under the guise of providing job or benefits assistance. The FTC also alleged that the lead generators falsely told consumers that their information would not be shared, and that both the education company and its lead generators illegally called consumers registered on the National Do Not Call (DNC) Registry. The education company agreed to a settlement with conduct prohibitions and a $30 million penalty.
The five “lessons” for users of leads from lead generators are:
While what passes for compliance with federal consumer protection law enforced by the FTC depends on the specific facts, the article does drill down on each of the five areas, providing insights into the lessons from recent law enforcement actions, FTC Workshop on Lead Generation, and reports involving the lead generation industry show that advertisers should consider when they buy consumer leads. For example, within the “due diligence” category, the article noted that an advertiser shouldn’t “hire any lead generator or aggregator that is fuzzy on the details” about how leads are obtained.
The article also suggested that buyers of leads could spell out compliance and performance standards in contracts, and audit against the law and performance standards. From our experience, we’d add that these standards should be updated as there are changes in the law and new legal interpretations, and as facts evolve.
In addition, it’s notable that the proposed settlement in the education company enforcement action requires the company to launch a system to review all materials that lead generators use to market its schools, to investigate complaints about lead generators, and to not use or purchase leads obtained deceptively or in violation of the TSR. The order also prohibits misrepresentations about any other benefits of any post-secondary school or any other of the defendants’ products or services.
In 2015, the FTC held a workshop on lead generation advertising (where this author was a panelist). “Lead generation is the process of identifying and cultivating individual consumers who are potentially interested in purchasing a product or service,” according to the FTC Bureau of Consumer Protection staff report on the workshop published in 2016. In addition, the Consumer Financial Protection Bureau, state Attorneys General, and state regulatory agencies, have scrutinized lead generation advertising.
We have frequently discussed the heightened government scrutiny of online lead generation advertising, including in webinars and at LeadsCon conferences, for example, “Ensuring Effective Compliance in Lead Generation,” and “Staying Current with Consumer Protection: Practical Lessons from Recent Enforcement Actions.” (For a write-up on the session, see What lead gen firms need to know about consumer protection laws.)
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Given the vast number of lead generators, aggregators, and buyers that fall under the jurisdiction of the FTC, advertisers and markets should assess their policies, procedures, and practices, as well the industry’s response, to make sure they continue to refine their compliance programs.
Jonathan L. Pompan, partner and co-chair of Venable’s Consumer Financial Protection Bureau Task Force, advises on advertising and marketing and consumer financial services matters. He represents clients in investigations and enforcement actions brought by the CFPB, FTC, state attorneys general, and regulatory agencies. He was a panelist at the 2015 FTC Workshop: Follow The Lead.
This article is not intended to provide legal advice or opinion and should not be relied on as such. Legal advice can be provided only in response to a specific fact situation.
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D&O insurance policies sometimes contain Major Shareholder Exclusions, precluding coverage for claims brought by shareholders’ with ownership percentages above a certain specified ownership threshold. But when is the shareholder’s ownership percentage to be determined – at the time of policy inception or at the time of the claim? This issue was among the D&O insurance coverage question presented in a recent case before the Third Circuit. The appellate court, applying Delaware law, found that the exclusionary language involved was ambiguous, and therefore resolved the issue in the policyholder’s assignee’s favor. As discussed below, the appellate court’s ruling is interesting in a number of different respects.
EMSI-Acquisition (“Acquisition) purchased 100% of EMSI. After the transaction closed, Acquisition concluded that EMSI officials had misrepresented EMSI’s financials during the transaction negotiations. Acquisition sued the EMSI officials. Acquisition’s suit against EMSI ultimately settled for a cash payment by the defendant officials and an assignment of their rights under EMSI’s D&O insurance policy.
Based on the assignment, Acquisition sought indemnification from the D&O insurer. The D&O insurer contended that Acquisition could not recover under the policy, citing several policy terms, including in particular the policy’s Major Shareholder Exclusion and the policy’s definition of Loss. Acquisition sued the insurer seeking to enforce the policy. The parties filed cross-motions for judgment. The district court ruled in Acquisition’s favor. The insurer appealed.
Relevant Policy Language
The Major Shareholder Exclusion provides that the insurer shall not be liable for any claim “brought by or on behalf of individuals or entities that own, beneficially or directly, five percent (5%) or more of the outstanding stock of the Insured Organization.”
The policy defines Loss as “damages (including back pay and front pay), settlements, judgments (including pre- and post-judgment interest on a covered judgment) and Defense Expenses.” The definition also excludes some forms of loss, such as “amounts owed under any employment contract, partnership, stock or other ownership agreement, or any other type of contract” and “matters that may be uninsurable under the law pursuant to which this policy shall be construed.”
The September 19, 2019 Opinion
In a September 19, 2019 opinion designated “Not Precedential” and written by Judge Julio Fuentes, the Third Circuit, applying Delaware law, affirmed the judgment of the district court in favor of Acquisition.
The insurer had argued on appeal that because Acquisition acquired 100% ownership of EMSI in the acquisition transaction, coverage for Acquisition’s claim against the EMSI officials was barred by the Major Shareholder Exclusion. The insurer argued that the time to determine the ownership interest for purpose of the exclusion’s applicability was at the time of the claim. Acquisition argued that the time to determine ownership interests for determining the exclusion’s applicability was at the time of policy inception. In making this argument, Acquisition relied on the fact that in connection with the placement of the policy, the insured had given the insurer an ownership table, and the insurer had not required the insured to update the ownership table.
In interpreting these issues, the appellate court applied several rules of insurance policy interpretation under Delaware law, including that Delaware law resolves ambiguity in insurance contracts in favor of coverage, and that contract provisions are ambiguous when they are “reasonably or fairly susceptible to different interpretations or may have two or more different meanings.”
The appellate court agreed with the district court that the Major Shareholder Exclusion was reasonably or fairly susceptible to different interpretations with respect to the issue of when a shareholder’s ownership percentage is to be determined. Because, the appellate court said, under Delaware law “ambiguity resolves in favor of coverage,” the court affirmed the district court’s judgment in Acquisition’s favor with respect to the Major Shareholder Exclusion.
The appellate court also rejected the insurer’s arguments based on the policy’s definition of “Loss” because they simply represented amounts owed under contract. The insurer had tried to argue that all of the underlying claims fundamentally were claims based on the indemnification provisions in the transaction documents, and therefor that the claims “are so intertwined with a contract claim that they cannot be separated.”
The District Court in the coverage action had concluded based on its review of the underlying complaint that the settlement payments were “in part payments made due to alleged tortious misrepresentations made by EMSI officers.” The District Court concluded that since some of those misrepresentations were made during the acquisition’s due diligence period, claims based on those misrepresentations at least might not give rise to indemnification under the acquisition contract, and therefore the settlement payments were not excluded under the policy. The appellate court agreed with the District Court’s analysis.
Finally, the appellate court rejected the insurer’s argument that the amounts paid in settlement were not insurable because the EMSI officers were never legally entitled to the money they received as a result of their misrepresentations, and therefore that the amounts paid in settlement cannot be an insurable loss. The appellate court noted that the insurer admitted that no Delaware decision supports their theory, and so the appellate court affirmed the district court’s holding on this ground as well.
This decision arguably is a direct reflection of the fact that the coverage dispute was governed by Delaware law. The outcome of the dispute regarding the Major Shareholder Exclusion clearly reflected the Delaware policy interpretation principles regarding ambiguity in insurance policies. The outcome of the final issue about the un-insurability of the return of amounts to which the insured was not entitled turned completely on the absence of Delaware law on the issue. It is possible that the outcome of this case, or at least of some of the issues involved, could well have been different had the law of another jurisdiction had applied.
(In that regard, it is worth noting that I recently published a guest post on this site in which the authors expressed alarm about the Delaware courts’ recent increased willingness to reach out and apply Delaware law to insurance coverage disputes, along the way giving rise to a series of policyholder friendly decisions.)
The value of this ruling for other insurance disputes is limited not only by its arguably outcome-determinative reliance on Delaware law, it is also limited by its designation as “Not Precedential.” In a footnote, the appellate court specifically noted that it “does not constitute binding precedent.”
But while the opinion may not have value as precedent, it still arguably has instructional value. The fact that both the district court and the appellate court found the Major Shareholder Exclusion to be ambiguous is interesting and represents a conclusion that both insurers and policyholders may want to consider.
I can certainly see that from the insurer’s perspective, the insurer would want a shareholder’s ownership percentage to be considered is at the time of the claim. The insurer’s concerns about the possibility for collusive or conflicted claims makes the time of the claim the relevant moment when the ownership percentage should be considered.
Indeed, there may be circumstances when from policyholder’s perspective the time of the claim would be the preferred time for ownership percentages to be determined. Imagine a situation in which a shareholder has a greater than 5% ownership interest at policy inception but then subsequently brings a claim after reducing his or her ownership interest. The policyholder in that circumstance would want to be able to argue that the Major Shareholder exclusion does not apply.
To be sure, one could come up with any number of scenarios when the insurers or the policyholder’s interest might be advanced depending on when the ownership percentages are determined. The lesson here is that it is generally in the interests of both insurers and policyholders to eliminate potential ambiguities in the policy. That means that it may be in the parties’ mutual interest for the Major Shareholder Exclusion to address the time at which the ownership interest is to be determined. In that regard, it is worth noting that in a prior post (here), I discussed an insurance coverage dispute that arose in Australia that also involved the question of when ownership percentages are to be determined for purposed of determining the applicability of a major shareholder exclusion. In other words, this is a recurring issue.
I will say that I interpret the insurer’s request of an ownership table during the policy placement differently that the court did. Insurers ask for an ownership table for a number of reasons, among which is to determine whether or not it wants to include a major shareholder exclusion on the policy at all. In many if not most instances where there is no shareholder with more than, say, a 5% ownership interest at the time of the policy placement, the insurer will not include a Major Shareholder Exclusion on the policy at all. (There is an entirely separate blog post that could be written about whether and/or when an insurance buyer should accept a coverage proposal that includes a major shareholder exclusion.) Based on my knowledge of these standard industry practices, I do not interpret the insurer’s request of an ownership table during the policy placement process as suggesting that the time to determine a shareholder’s ownership interest for purposes of evaluating whether or not the major shareholder exclusion applies is at policy inception. Again, however, this just underscores the fact that an exclusion that specifies when ownership interest is to be determined will eliminate these kinds of questions.
The district court and appellate court’s conclusion that at least a part of the settlement amount represented a payment in resolution of claims that did not sound in contract is interesting and even important. The curious thing about this conclusion is that though determining that a part of the settlement represented amounts that were not outside the policy’s definition of loss, both the district court and the appellate court found that the entire settlement amount was covered. However, the clear implication of the both courts’ analysis is that at least a part of the settlement amount represented amounts due under contract and therefore would fall outside the policy’s definition of loss; to that extent, it would seem, the settlement amount was not covered loss within the meaning of the policy.
This analysis would seem to suggest that the settlement amount needs to be allocated between covered and non-covered loss. The appellate court’s opinion makes no allusion to the possibilities for an allocation. It may be that that the insurer itself did not seek an allocation; indeed, in seeking to argue that the entire amount of the settlement was non-covered loss, the insurer argued, as the appellate court noted, that the portion of the settlement amount reflecting the misrepresentation claims “are so intertwined with a contract claim that they cannot be separated.” It may well be that having argued that the various amount paid are inseparably intertwined, the insurer felt it could not argue in the alternative in favor of an allocation.
Securities Litigation Reform: On Thursday October 31, 2019, I will be participating as a panelist at an event to be held in New York City on the topic of securities litigation reform. The event, which is sponsored by AIG, Chubb, Marsh JLT Specialty, Seyfarth Shaw, and The Center for Corporate Governance at NYCLA, and entitled “Securities Litigation Reform: Time for a Change,” will be held at the Yale Club, 50 Vanderbilt Street, in New York City, and will begin with breakfast at 8 am, with the panel discussion to begin at 8:30 am.
There were actually be two panels; the first will focus on the insurance industry perspective on recent securities litigation trends and the need for securities litigation reform, and the second panel will include securities litigation practitioners who will discuss the current securities litigation landscape.
The participants on the first panel will include Anthony Tatulli of AIG; Jack Flug of Marsh JLT Specialty; Scott Meyer of Chubb, and myself, and will be chaired by Greg Markel of the Seyfarth Shaw law firm. The participants on the second panel will include Adam Hakki of Sherman Sterling; Brad Karp of Paul Weiss; Darren Robbins of the Robbins Geller law firm; and Tom Goldstein of Goldstein & Russell. The second panel will be moderated by Giovanna Ferrari of the Seyfarth Shaw law firm.
More information about this event can be found here.
This event is free but registration in advance is required. In order to register for this event, please contact Greg Markel at the Seyfarth Shaw law firm, GMarkel@seyfarth.com Space is limited and registration is on a first come/first served basis.
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On September 18, 2019, the FTC prevailed in its long-waged battle against Hi-Tech Pharmaceuticals. In a per curiam opinion, the Eleventh Circuit affirmed the district court’s decision, holding the defendants in contempt for violating the court’s prior order, which enjoined the defendants from making certain claims about health products without “competent and reliable scientific evidence.” Fed. Trade Comm’n v. Nat’l Urological Grp., Inc., No. 17-15695, 2019 WL 4463503, at *1 (11th Cir. Sept. 18, 2019). The Eleventh Circuit also upheld a $40 million sanction for the defendants’ violation of the order. The case provides a good example of how the FTC views substantiation for dietary supplement claims and the consequences of lacking that substantiation.
In its ruling, the Eleventh Circuit affirmed the district court’s stringent interpretation of “competent and reliable scientific evidence” to mean randomized controlled trials (“RCTs”) because the defendants had fair (and repeated) notice for nearly a decade that the FTC and the district court interpreted “competent and reliable scientific evidence” to mean RCTs.
The Eleventh Circuit ruled in favor of the FTC for two main reasons. The Eleventh Circuit first held that the defendants waived their objections to the clarity of the injunction enjoining them from making certain advertising claims. Specifically, the defendants did not object that the phrase “competent and reliable scientific evidence” was unduly ambiguous when the order was being proposed to the court. Furthermore, the defendants could not show that the district court clearly erred when it found that they lacked “competent and reliable scientific evidence.”
The Eleventh Circuit’s ruling stands in contrast to two other cases involving dietary supplements where the FTC failed in its efforts to have the defendants found in contempt. In United States v. Bayer Corp., CV 07-01(JLL), 2015 WL 5822595 (D.N.J. Sept. 24, 2015), the District of New Jersey held that RCTs are not the sole type of evidence that can constitute “competent and reliable scientific evidence” to substantiate the defendant’s specific claims. In that case, the Consent Decree that bound the defendant did not define “competent and reliable scientific evidence” as RCTs, and the government had not otherwise provided notice to the defendant that it would be held to an RCT-level standard of “competent and reliable scientific evidence.” Similarly, in F.T.C. v. Garden of Life, Inc., 516 Fed. Appx. 852, 856 (11th Cir. 2013), the Eleventh Circuit rejected the FTC’s contention that the phrase “competent and reliable scientific evidence” meant RCTs because the FTC provided the defendant with no prior notice of its interpretation of the phrase.
Outside of the dietary supplement context, Nat’l Urological Grp. also stands in contrast to the Eleventh Circuit’s opinion in LabMD, Inc. v. Fed. Trade Comm’n, 894 F.3d 1221, 1236–37 (11th Cir. 2018) where the FTC’s cease and desist order issued to a medical laboratory was “insufficiently specific” to address the laboratory’s unfair trade practice arising out of its failure to protect sensitive consumer information on its computer network. The order was “insufficiently specific” because it required a complete overhaul of the laboratory’s data security program without instructing how such an overhaul was to be accomplished. Moreover, the cease and desist order commanded LabMD to overhaul and replace its data-security program to meet an “indeterminable standard of reasonableness.”
The facts of Fed. Trade Comm’n v. Nat’l Urological Grp., Inc. are in stark contrast to the above. As the district court highlighted, unlike in Bayer, before the injunctions were entered, the court made extensive findings of fact surrounding the defendants’ advertising practices. Additionally, in the nine years after the summary judgment order and injunctions were entered, the FTC repeatedly told defendants that RCTs were required. Finally, and arguably most important, the FTC alleged that the RCT standard applied before the FTC moved for summary judgment. LabMD is inapplicable for the same reasons, namely that in Nat’l Urological Grp. the defendants were explicitly notified that RCTs were needed.
In recent years, FTC orders involving dietary supplements have generally specified that competent and reliable scientific evidence requires at least one RCT. Further, the defendants in National Urological had ample notice, and internal documents acknowledging, that RCTs were required. The consequence for ignoring all of this for the defendants here was $40 million. This serves as a good lesson to pay attention.
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Whistleblowing has a long and respected tradition in the United States. In more recent times, whistleblowing and its protections have been part of several legislative schemes, including, for example, the creation in the Dodd-Frank Act of the SEC Whistleblower Program. The recent whistleblower complaint about President Trump’s July 2019 phone call with Turkish President Erdoğan underscores the continued important role of whistleblowing in the our political and business culture. As the events surrounding the recent whistleblowing complaint also show, whistleblowing is often regarded as a provocative act, and that, at a minimum, whistleblowing can be highly divisive.
A recently published book, “Crisis of Conscience: Whistleblowing in the Age of Fraud,” written by journalist Tom Mueller, takes a detailed look at the role of whistleblowing in our culture, and the ways in which, despite all of the surrounding controversy, whistleblowing remains an indispensable part of maintaining order and enforcing our values and expectations.
Mueller begins his book with several examples of whistleblowing from earlier times, including a whistleblowing incident in which abuses were alleged against a U.S. military official in our country’s earliest days. After an interesting account of a whistleblower who raised allegations of payoffs and corruption involving a major pharmaceutical company, Mueller then reviews some higher profile examples of whistleblowing from the recent past, including the story of Ernest Fitzgerald, who in the late 60s and early 70s famously blew the whistle on egregious cost overruns in the Lockheed C-5 cargo plane program, and Daniel Ellsberg, who passed the Pentagon Papers — detailing the deeply-flawed U.S. involvement in Vietnam — to the New York Times and the Washington Post.
The book also recounts a number of other whistleblower incidents with which I was less familiar, including in particular the truly disturbing account of the numerous whistleblowers that have come forward over the years to denounce dangerous waste and mismanagement at the Hanford Nuclear Reservation in the state of Washington. The accounts relating to the problems are particularly alarming because of the clear suggestion that health and safety issues were routinely compromised.
Another incident with which I was not familiar was the sordid story of the Harvard Project, a U.S.-government supported effort led by the Harvard Institute for International Development that was intended to lead post-Soviet Russia to a democratic government and a market-based economy but instead became known for conflicts of interest and misuse of U.S. government funds.
While many of the whistleblower incidents Mueller describes involve governmental misconduct, finance, he suggests, is whistleblowing’s “new frontier.” He recounts numerous incidents of (frequently disregarded at the time) whistleblowing in the lead-up to the global financial crisis. By the same token, whistleblower revelations “have been central” to many of the regulatory enforcement actions brought against the financial services industry in the last decade, in the U.S. and elsewhere. Various financial frauds arose only because of whistleblower reports, including foreign exchange and commodities fraud, money laundering, and violation of banking integrity and tax laws. Among the disturbing feature of this account is the disturbing frequency with which certain names recur: Citigroup, JP Morgan, Barclays, UBS, and the Royal Bank of Scotland, among others. As Mueller reports, “wrongdoing at the big banks is massive and repeated.”
With these and many other more recent examples, Mueller shows a recurrent pattern, where highly-principled individuals, motivated by outrage at or even horror of misconduct they have witnessed, are motivated to become a whistleblower, in order to try to draw attention to and to end perceived misconduct. In the recurrent pattern, this first step is followed by several almost inevitable steps, including a massive campaign by the accused individuals and organizations to try to identify, silence, undercut and retaliate against the whistleblower (rather than addressing the underlying misconduct alleged), and, then, next, an almost always years-long period where the whistleblower is subject to ostracism, social isolation, loss of employment, and financial ruin. In some cases, the whistleblower ultimately achieves some form of vindication, although one disturbing feature of many of these incidents is the frequency with which the wrongdoers not only retain their positions but even prosper despite the extent of the misconduct revealed.
Mueller’s book is at its strongest when he recounts the recurring efforts of those subject to a whistleblower report to try to contain, neutralize, and discredit whistleblowers. There is a very good reason why statutory whistleblower programs usually incorporate strict anti-retaliation provisions.
The story of what happened after the Pentagon Papers’ release is particularly interesting in that regard. Once then-President Nixon learned about the documents’ release, he authorized and launched a massive and no-holds barred effort, first, to identify who released the documents, and then to retaliate, by attempting to discredit Ellsberg. I had forgotten that among other things Nixon did was that he authorized a break-in of Ellsberg’s psychiatrist’s office, in order to try to obtain dirt or compromising information in order to discredit Ellsberg. The break-in was one of the things that ultimately resulted in the dismissal of the criminal charges against Ellsberg. I thought about these things in recent days as I heard news reports that our current President has organized a team to identify the Erdoğan phone call whistleblower – and even before the whistleblower has been identified to try to discredit him or her, by suggesting that whistleblowers are spies that should be executed.
The rise of whistleblowers over the last five decades is, Mueller suggests, the result of several inter-related factors: the rise and normalization of fraud; the growing interpenetration of corporations and the government; and the spread of secrecy. For example, Mueller returns again and again to the problems created by the revolving door between government regulators and industry. Insiders who can earn significant credibility by serving in a high-profile government role can hope to cash in by then working in the industry they were previously regulating. These individuals have a significant financial incentive not to make waves, but instead to keep relationships smooth.
The only way the casual corruption of these cozy relationships can be exposed and addressed is the action of a whistleblower that is willing to risk the security of their own position by calling out the excesses. There is a reason why the reaction to whistleblower is usually so strong and defensive; the whistleblower threatens the tacit assumptions underlying and mutual benefits that are available to those that support the status quo. There is a reason why whistleblowers often are outsiders; “Outsiders alone retain the freedom of spirit to recognize, and sometimes to renounce, corruption concealed beneath the mantle of authority, status, wealth. “
I recommend Mueller’s book. It is very detailed, ambitious, and interesting. His accounts of the crises of conscience that caused the whistleblowers to act, and of the consequences they then face, are both fascinating and inspiring.
However, the book is not without its flaws. Mueller is at his best when he is describing specific whistleblower incidents, detailing the misconduct the whistleblowers witnessed and the agonizing process the whistleblowers go through before deciding to blow the whistle. These parts of the book are very compelling. Unfortunately, periodically, the book gets sidetracked by excursions into psychology, sociology, and behavioral economics; these sections are less compelling.
Also, one of the Mueller’s missions in the book is to show that the rise of whistleblowing has become necessary because of what he perceives as the rise of fraud. (The subtitle of his book is “Whistleblowing in the Age of Fraud.”) One of the bogeymen that Mueller frequently invokes in trying to make this case is the Chicago School of Economics and the pervasiveness of market-based models in economics and politics. Whatever else one might make of Mueller’s attack on a school of economic thought, it represents a diversion from his stated mission of detailing the importance of whistleblowing. His recurring critique on the Chicago school represents one of several ways in which the book occasionally sets aside its journalistic approach and takes a polemic tone.
The book is also really long. It is long because in many places it is unnecessarily over-written. For example, the book’s chapter about the problems at the Hanford nuclear facility, overall a particularly interesting chapter in the book, begins with a long description of the area surrounding the facility that starts like this: “Mergansers and pelicans feed in the shallows on stonefly larva and freshwater clams. A great blue heron stalks the waterline, pauses, spears a glistening fish with its javelin beak. A mule deer, grazing among the mulberry trees and cottonwoods by the riverbank, raises it head to watch us slip by.” On and on and on like that, for several paragraphs. There are unfortunately too many wordy detours in the book like this. The book could have been at least a third shorter, without any loss. Indeed, it would be a better book if it were a third shorter.
All of that said, the book is very interesting, and in the end, Mueller does present a persuasive case for the importance of whistleblowers in our society. His accounts of the courageous individuals who have dared to step forward and call out misconduct make for interesting reading. He also establishes the importance for all of us of encouraging whistleblowers to come forward and protecting them when they do. These seem like particularly important points to remember just now.
Whistleblowers, Mueller writes,” take the responsibility for seeing with their own eyes and following their individual conscience, cutting through cant and rationalization to comprehend things as they really are.” They also “prove the power of the righteous voice.” They may even “lend us the courage we will need to reclaim entire realms of civic life.”
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Just about everyone who has been active in the D&O insurance arena for a while knows that every now and then one industrial segment or another will suddenly find itself in the midst of a securities litigation blitz. Years ago after the Internet bubble burst, it was the doc com companies. Further back than that, as at least some of us can remember, there were all of the failed banks in the S&L Crisis (and, again, in the wake of the global financial crisis). More recently, companies in the opioid pharmaceuticals space have drawn the unwanted attention of the plaintiffs’ securities lawyers. Often these kinds of securities suits and other D&O claims follow after some industry-wide event or sector slide.
Now, it appears, another sector is drawing heat. The e-cigarette business has found itself in the headlines recently as health-related issues have been raised about the product. These health questions have been followed, almost inevitably as things go in this country, by lawsuits. As discussed below, these lawsuits now include, in at least some instances, securities class action lawsuits.
The first of these securities suits involving e-cigarette industry companies was filed against Greenlane Holdings, Inc., a company that distributes e-cigarettes, vaporizers and accessories through its subsidiaries. The company also distributes products containing hemp-derived cannabidiol (CBD).The company completed its IPO in April 2019. According to the company’s registration statement filed in connection with the offering, the company is “one of the largest distributors of products made by JUUL Labs,” an e-cigarette manufacturer. Among other things, the registration statement emphasized that “a significant percentage of our revenue is dependent on sales of products … that we purchase from a number of our key suppliers, including PAX Labs and JUUL Labs.”
The securities class action complaint that was later filed against Greenlane alleges that on June 18, 2019, the San Francisco Board of Supervisors unanimously approved a ban on the sale and distribution of e-cigarette products within the city. It also endorsed a ban on the manufacturing of e-cigarette products on city property. According to the complaint, on this news, Greenlane’s share price declined 17%, and in subsequent trading days, declined another 15%, falling a total of nearly 68% by the time the complaint was filed.
The securities complaint against Greenlane was filed in the Southern District of Florida on September 11, 2019, just five months after the company’s IPO. A copy of the complaint can be found here. The complaint names as defendants the company itself; certain of its directors and officers; and the offering underwriters. The complaint alleges that the offering documents prepared in connection with the company’s IPO contain material misrepresentations and omissions. The complaint purports to be filed on behalf of investors who purchased the company’s securities pursuant to or traceable to the company’s offering, and seeks to recover on behalf of the class damages under the liability provisions of the Securities Act of 1933.
According to the Complaint, the company’s offering documents were false and misleading because the defendants failed to disclose to investors “(1) that the City of San Francisco had introduced a major initiative to ban the sale of e-cigarette product across three major cities and prohibit the manufacture of products at the headquarters of Greenlane’s key partner, JUUL Labs; (2) that, if approved, the initiative would materially and adversely impact the Company’s financial results and prospects; and (3) that, as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
On October 16, 2019, a second lawsuit was filed in the Southern District of Florida against Greenlane in connection with the company’s IPO. The complaint in the second lawsuit does not name the offering underwriters as defendants and updates the stock price information, but otherwise is substantially identical to the initial complaint. A copy of the second complaint can be found here.
Altria Group, Inc.
The second company to be caught up in this e-cigarette industry-related litigation is the major tobacco-product manufacturer and distributor, Altria Group, Inc. In December 2018, Altria announced that it had agreed to invest $12.8 million in JUUL Labs, the top U.S. maker of e-vapor products, including e-cigarettes. As announced Altria Labs investment of JUUL represented a 35% economic interest in JUUL.
According to the securities class action lawsuit complaint that was subsequently filed against Altria, after Altria invested in JUUL, there were a series of media articles and other reports that the Food and Drug Administration (FDA) was, among other things, investigating e-cigarette companies sales practices, including the companies’ sales practices in connection with sales to minors, as well as other media articles that the FDA was investigating reports of respiratory health issues purportedly associated with e-cigarettes and other e-vapor products. Altria’s share price declines on these news reports. Finally, in September 2019, Altria announced that Phillip Morris was calling off discussions of a possible $200 billion merger with Altria due to concerns about the scrutiny of the vaping industry and with the Company’s 35% stake in JUUL.
On October 2, 2019, an Altria shareholder filed a securities class action lawsuit against the company in the Eastern District of New York. A copy of the complaint can be found here. The complaint names as defendants the company itself and two of its executives. The complaint purports to be filed on behalf of a class of persons who purchase Altria securities between December 20, 2018 and September 24, 2019. The complaint seeks to recover damages on behalf of the class based on alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
The complaint alleges that the defendants made false or misleading statements or failed to disclose that “(i) Altria had conducted insufficient due diligence into JUUL prior to the Company’s $12.8 billion investment, or 35% stake, in JUUL; (ii) Altria consequently failed to inform investors, or account for, material risks associated with JUUL’s products and marketing practices and the true value of JUUL, and its products; (iii) all of the foregoing, as well as mounting public scrutiny, negative publicity, and governmental pressure on e-vapor products and JUUL made it reasonably likely that Altria’s investment in JUUL would have a material negative impact on the Company’s reputation and operations; and (iv) as a result, the Company’s public statements were materially false and misleading at all relevant times.”
These complaints have only just been filed and it remains to be seen whether and to what extent that will be successful. The complaints have not yet been tested by motions to dismiss. In that regard, it is worth noting that the scienter allegations in the Altria complaint, which purports to state ’34 Act claims, are, shall we say scarce. The Greenlane Holdings complaint not only tries to boostrap regulatory developments into a ’33 Act claim, but it tries to do so based actions that clearly took place well after the offering. In connection with both sets of cases, the complaints purport to allege that, because of developments after significant corporate transactions, the disclosures made in connection with the prior transactions were misleading.
In connection with the claims against both of the companies, the plaintiffs are trying to convert the cascade of negative regulatory developments and adverse press reports involving e-cigarettes and other vaping products into violations of the federal securities laws. In that respect both of sets of litigation represent examples of what I have described as event-driven securities litigation, in which plaintiffs allege supposed securities law violations based not on accounting or financial misrepresentations but rather based on adverse developments in the company’s business operations that result in a share price decline.
Both sets of litigation also represent examples of how an industry sector can suddenly find itself thrust into the securities litigation maelstrom. The advent of sector-targeting does not necessarily mean any of the companies in fact committed securities fraud; rather, it means that the sector has managed to move its way to the center of the target in the plaintiffs’ lawyers’ shooting gallery. Given the amount of difficult press and adverse publicity that has developed about the industry and its products, it is hardly surprising that the industry has drawn the attention of the plaintiff securities lawyers.
It is worth noting that many of the companies in the industry are privately-held. These companies are not going to draw securities class action lawsuits and are less likely (arguably much less likely) to attract D&O litigation. That is not to say that, given the current tone of publicity surrounding the industry, that this could be a very long slog for many of the companies in the industry. And given the tone of much of the recent press, this could go on for a while.
Again, just because lawsuits may be filed does not mean the lawsuits are meritorious. Plaintiffs’ lawyers may be rushing into this space, attracted by the adverse media reports. But that does not necessarily mean these lawsuits will be successful from the plaintiffs’ perspective.
Again, just because lawsuits may be filed does not mean the lawsuits are meritorious. Plaintiffs’ lawyers may be rushing into this space, attracted by the adverse media reports. But that does not necessarily mean these lawsuits will be successful from the plaintiffs’ perspective.
The post Securities Suits Filed Against Companies Involved in E-Cigarette Business appeared first on The D&O Diary.
via Tumblr Securities Suits Filed Against Companies Involved in E-Cigarette Business
Two Executive Orders Continue Trump Administration Efforts to Restrain Agency Policymaking
Last week, President Trump signed two executive orders designed to limit the ability of federal agencies to make and enforce policy through the use of guidance documents. While this may seem like a mere technical issue, the ramifications could be significant.
A federal agency may issue a guidance document for a variety of reasons. Some agencies, such as the U.S. Food and Drug Administration (“FDA”), use it as the primary instrument for announcing and explaining significant policies. Many FDA guidance documents clarify agency positions regarding complex and ambiguous laws and regulations governing the broad range of companies it regulates. This includes manufacturers and marketers of food, dietary supplements, cosmetics, drugs and medical devices.
Some question whether agencies (including FDA) have gone too far. Agencies are supposed to promulgate a regulation when creating a new rule. In contrast, an agency may convey an interpretation of a currently existing rule through the issuance of a guidance document or other, less formal means. While it is often challenging to distinguish a new rule from an interpretation, the distinction has serious implications. The cost, time and effort required to publish a guidance document are far lower. Notably, a regulation may only be finalized after the agency has received and addressed all public comments. No such requirement exists for guidance documents.
The latest executive orders are generally designed to increase the accountability and transparency of federal agencies. The “Executive Order on Promoting the Rule of Law Through Transparency and Fairness in Civil Administrative Enforcement and Adjudication” is meant to curb the use of guidance documents as the basis for a statutory or regulatory violation in an agency enforcement action. The “Executive Order on Promoting the Rule of Law Through Improved Agency Guidance Documents” is meant to halt the creation of guidance documents without a public notice and comment period and mandate agencies to publicize these documents on a searchable website.
It is helpful to assess these executive orders in their historical context, where they can be seen as part of a larger strategy by President Trump to limit the size and authority of the federal bureaucracy. For example, President Trump in early 2017 issued Executive Order 13771, which required agencies to: (1) repeal two existing regulations for every proposed new regulation; and (2) offset costs from new regulations by eliminating costs from at least two existing regulations. One year later, the Department of Justice issued the Brand Memorandum, which barred the use of an agency guidance document as a basis for liability in affirmative civil enforcement cases.
It is not clear whether the executive orders will have any practical impact on the FDA’s use of guidance documents. Indeed, it is possible that neither will have any impact at all. However, given the significant public health issues that are the FDA’s responsibility, this is something worth watching. The clarity provided by a guidance document is often appreciated by FDA-regulated stakeholders, even if they do not necessarily agree with the policy. The agency routinely is required to resolve novel questions regarding the applicability of a rule to a new technology that has just emerged. A guidance document often is critical for the development of these technologies to proceed. Regulations can take several years to finalize.
This comes at an interesting time for the FDA stakeholders. There are a number of high profile issues that many are anxiously waiting for FDA to address, including vaping, CBD and drug importation. Did President Trump just make it more difficult for FDA — an agency that soon will likely have a new leader — to proceed on critical matters of public health? It may take years to fully understand the answer, but we will be watching closely.
via Tumblr A New Challenge for FDA?
Subscription merchants that take payment by Visa cards will have new acceptance, disclosure, and cancellation requirements imposed on their transactions beginning April 18, 2020. As Visa recently announced, the card brand is updating its rules for merchants that offer free trials or introductory offers as part of an ongoing subscription program.
The Visa rules follow on the heels of similar Mastercard rules that became effective earlier this year. However, while MasterCard’s rules focus on merchants selling subscriptions for physical goods, Visa’s rules apply to merchants selling either physical or digital products if the merchant offers a free trial or introductory offer that rolls into an ongoing subscription arrangement.
The new requirements are more specific than what the Restore Online Shoppers’ Confidence Act (ROSCA) prescribes, and while they don’t have the force of law, noncompliance could put a merchant’s credit card processing capabilities at risk. Here are some of the components of the new Visa rules:
Although it is unclear how and to what extent the card brands will enforce their rules, Visa has announced that, to ensure compliance with the new requirements and policies, Visa will undertake proactive monitoring and mystery shopping. And though card brand rules do not have the force of law, violating them may result in losing card processing capabilities.
In addition to the changes in card brand rules, the Federal Trade Commission recently called for public comment on ways to improve current requirements for subscription and recurring billing programs, indicating that the FTC might tighten the reins on these programs. And an increasing number of states have passed laws that specifically regulate subscription and automatic renewal programs, including California, D.C., North Dakota, Vermont, and Virginia. As a result, companies offering these programs should take steps to come into compliance with these requirements, and be on the lookout for new developments.
To learn more about the new requirements and other updates affecting negative option programs, join Venable attorneys Ari Rothman and Shahin Rothermel for a webinar discussing these topics on October 29. Click here to register.
via Tumblr New Requirements for Subscription Merchants Accepting Visa Cards
The Federal Trade Commission’s “Negative Option Rule” is up for review, and the FTC is steering toward stricter regulations for automatic renewal plans and subscription programs. The FTC completed its last regulatory review of the Negative Option Rule in 2014 and decided then to retain the rule in its current form. But, will this time be different?
The Rule Under Review
The rule under review is the “Rule Concerning the Use of Prenotification Negative Option Plans,” also referred to as the “Negative Option Rule.” However, the scope of the Negative Option Rule only covers prenotification plans, like book-of-the-month clubs, where the seller sends notice of a book to be shipped and charges for the book only if the consumer takes no action to decline the offer, such as sending back a postcard or rejecting the selection through an online account.
In its current form, the Negative Option Rule does not cover negative option programs as typically defined to encompass continuity plans, automatic renewals, and free-to-pay plans or nominal-free-to-pay plans, where a trial period rolls into an automatic renewal program unless the consumer cancels.
According to the FTC, since the last regulatory review of the Negative Option Rule, “evidence strongly suggests that negative option marketing continues to harm consumers.” In its notice announcing the rule review, the FTC referenced more than 20 recent FTC cases involving negative option marketing as well as state cases challenging negative option marketing. Additionally, the FTC said it received thousands of complaints each year related to negative option marketing, suggesting there is “prevalent, unabated consumer harm in the marketplace.”
Existing Legal Framework for Negative Option Marketing
Notwithstanding the limited scope of the Negative Option Rule, there is an existing, comprehensive framework of laws and regulations that the FTC uses against marketers of membership clubs, automatic renewal plans, subscriptions, and other such arrangements that the FTC deems to be unfair or deceptive. For telephone sales, the Telemarketing Sales Rule (TSR) has long specified disclosures for free trials and automatic renewal offers made by phone. The Restore Online Shoppers’ Confidence Act (ROSCA) notably covers online sales. The Electronic Fund Transfer Act (EFTA) applies when consumers use debit cards for recurring charges and requires the consumer’s written authorization for such charges. Section 5 of the Federal Trade Commission Act, which generally prohibits unfair or deceptive acts and practices, provides an extra, all-encompassing layer that can easily be applied to any aspect of negative option marketing. And, the plentiful collection of stipulated FTC orders in this space provide a roadmap of the FTC’s evolving views about compliance.
The FTC characterizes these various existing components as a “patchwork of regulations” that does not provide consistent guidance to industry or consumers across different media and different offers. Some might differ with the FTC’s view on this point, as the regulations seem quite consistent in providing a solid structure for negative option marketers based on three core principles: making clear and conspicuous disclosures about the material terms of the offer; obtaining explicit, informed consent to the automatic renewal offer; and, providing a simple and easy method for the consumer to cancel out of the negative option offer.
It may be that the FTC is seeking a more prescriptive instruction to marketers on making disclosures, dictating specific words or disclosure placement that would likely remove at least some business judgment, creativity, and differentiation from marketing practices. The FTC specifically raised ROSCA’s requirement of a “simple mechanism” to cancel as problematic because it does not specify which methods would suffice. In enacting ROSCA, Congress concluded that it need not further specify how cancellation should be effected, but the FTC clearly views this rule review proceeding as a way to make such a pronouncement.
Would an Expanded Negative Option Rule Address the FTC’s Concerns?
In our view, no. Many of the companies sued by the FTC for ROSCA and other violations allegedly engaged in practices that no additional laws or regulations would have stopped. For example, as described by the FTC in many recent complaints, those practices included using fake web sites with ROSCA-compliant disclosures and consent mechanisms to obtain payment processing from banks, yet making actual sales through other web pages that had no disclosures at all.
In other words, companies that want to dupe consumers into buying their products and services do not need further instruction on what not to do. Meanwhile, those striving to create long-standing customer relationships and sell useful products and services through the convenience of automatic renewal programs would likely be hindered by more regulations, at significant additional compliance costs and expense with no material benefit to consumers.
An expanded Negative Option Rule also would not serve to preempt the various, often disparate state laws that have cropped up since 2014, including those in California, Virginia, Vermont, the District of Columbia, and others. To the extent there is a “patchwork of regulations,” it is happening at the state level, where things like different font-face requirements and renewal notice timeframes are cropping up. Moreover, there are new MasterCard “regulations” and forthcoming Visa rules that impose additional, new compliance requirements. Failure to comply with those rules runs the risk of losing processing relationships.
There may be other reasons the FTC wants to expand the Negative Option Rule, such as to require pre-billing notices for recurring payments or order confirmation notices like those required by some states. Or, the FTC may be considering whether it could use an expanded rule to obtain enhanced civil penalties for violations. All possibilities should be considered.
The general public, including companies and industry groups, have until December 2, 2019 to comment on the FTC’s proposal to expand the Negative Option Rule. Please let us know if you are interested in this topic or participating in the proceeding.
via Tumblr The FTC’s Negative View of Negative Options – Are Expanded Regulations Coming?
Co-authors Lydia Webb and Rusty Tucker
Until Monarch Midstream v. Badlands Energy, midstream companies facing rejection of their contracts in a producer’s bankruptcy were left with Abraham Lincoln’s last favorite negotiating option: If the both law and the facts are against you, pound on the table. Under Sabine (which we covered here, here, and here) gathering agreements are not covenants running with the land and can be rejected in the producer’s bankruptcy. Sabine was the only law on the books, but now a Colorado bankruptcy court has determined that a gathering agreement was a covenant running with the land.
This opinion makes for a fair fight and gives midstream companies legal authority that agreements dedicating oil and gas reserves should survive bankruptcy unscathed. Still following Mr. Lincoln, they can now pound the law and not the table.
Different venue, different result
E&P debtor Badlands sought to sell its Utah assets in bankruptcy. Midstream company Monarch objected to the sale free and clear of its gathering agreement, arguing that it could not be rejected in bankruptcy because its dedication was a covenant running with the land. Badlands responded with Sabine, but the court was not persuaded. Sabine involved Texas law (albeit construed by a New York court); these assets were located in Utah, and although the two states’ law on covenants was similar, it was different enough to allow for a different conclusion. As with Sabine, the two elements at issue were “touch and concern” and “horizontal privity”.
Touch and concern
The dedication satisfied touch and concern because it burdened Badlands’ interest in the dedicated leases and reserves in place, which are real property interests under Utah law. In Sabine a similar dedication failed to touch and concern real property because the court concluded that it burdened gas “produced and saved,” which the court said was personal property. Although Utah has a slightly broader definition of touch and concern, the court implied that a dedication of reserves, leases, and related lands would satisfy the analysis under Sabine.
Horizontal privity was satisfied. Badlands granted Monarch an easement across its leases and adjoining land for the purposes of installing and operating a gathering system. The parties’ simultaneous ownership of property interests on the same land satisfied privity to the extent that it was required under Utah law. Contrast this with Sabine, which construed Texas law as requiring the covenant be created in a conveyance of real property. The Badlands court held the dedication itself—although not a fee estate—constituted a conveyance that burdens Badlands’ real property interest (the leases and reserves), thereby satisfying Sabine if it applied.
Our Gray Reed attorneys have been at the forefront of this fight since the beginning. They can guide you through the uncertainties that remain in these situations. And here is a more detailed discussion of the case.
If you’ve ever been forced to litigate in a venue not to your liking, this musical interlude is for you.
via Tumblr Midstream Dedications – Colorado Bankruptcy Court Levels the Playing Field
The insured vs. insured exclusion is a standard exclusion in most management liability insurance policies. The exclusion precludes coverage for claims brought by one insured against another. The IvI exclusions in most management liability insurance policies typically include a number of exceptions to the exclusion preserving coverage for claims that otherwise would be excluded. In a recent decision, a Texas intermediate appellate court found that the IvI exclusion in an investment management firm’s policy did not preclude coverage for an arbitration award because the underlying dispute arose out of an employment practices claim and therefore the dispute – including even the derivative claims the claimant asserted in the arbitration – came within the exclusion’s coverage carve-back for wrongful employment practices claims. As discussed below, the court’s opinion has a number of interesting features.
The Underlying Dispute
In 2008, Russ Gatlin and George Stelling formed an investment management firm and several related entities, Prophet Management. Stelling and Gatlin were the firm’s only two members. As partners, they each had rights to year-end profit distributions and to the firm’s carried interests.
In October 2011, Gatlin removed Stelling as Prophet’s COO and as president of a Prophet portfolio company. Stelling sent Gatlin a demand letter alleging wrongful termination and that Prophet and Gatlin were spreading rumors to harm his reputation and damage his career. Stelling’s claims were initially the subject of mediation, which was unsuccessful. Stelling then submitted his claims to arbitration.
In the arbitration, Stelling contended that his termination was wrongful. He also asserted derivative claims on behalf of the various Prophet entities. As the appellate court later said in its opinion in the subsequent coverage lawsuit, each count in Stelling’s statement of claim in the arbitration “is rooted in Stelling’s termination or its consequences.” The arbitration resulted in a substantial award in favor of Stelling.
The Insurance Coverage
At the relevant times, Prophet maintained a program of management liability insurance that consisted to a primary $5 million layer and two $5 million excess layers. When Stelling first sent his demand letter, Prophet submitted the letter to its management liability insurance carriers. All three carriers initially denied coverage. However, the primary and first level excess carriers ultimately paid their limits of liability in payment of various defense expenses and indemnity amounts. The second level excess carrier (hereafter, the Insurer) declined to pay Prophet’s remaining defense expenses and indemnity amounts.
Among other things, the insurer argued that coverage for Stelling’s claims under the management liability insurance policy’s EPL coverage part was precluded by the policy’s insured vs. insured exclusion. The insurer also argued that even if coverage was not entirely precluded by the IvI exclusion, coverage was at least precluded under the exclusion for the derivative claims Stelling had asserted in the arbitration, and therefore that the various defense fees and indemnity amounts had to be allocated between covered and non-covered amounts. The insurer also argued that if the various amounts were properly allocated, it would be apparent that the underlying policies had not been exhausted by payment of covered loss, and therefore that it excess coverage had not been triggered.
Prophet filed a coverage lawsuit against the insurer in Texas state court. The parties filed cross-motions for summary judgment. The trial court entered summary judgment in favor of the insurer. Prophet appealed the trial court’s ruling.
The August 19, 2019 Opinion
In a detailed opinion written by Justice Bill Whitehill for a unanimous three judge panel, the Texas intermediate appellate court reversed the trial court’s ruling with respect to the IvI exclusion and allocation issues.
In addressing the appeal, the appellate court presented the issues involving in a neat and smart flow chart:
The court found that because the underlying dispute involved a claim by one insured person against another insured person, the IvI exclusion was triggered. However, the parties disagreed about whether the wrongful employment practices claim coverage carve-back in the exclusion preserved coverage for the claim. The court described the parties’ positions as “ships passing in the night.”
Among other things, the insurer argued that the carve-back could not apply to preserve coverage for the entire underlying dispute because in the arbitration Stelling had presented derivative claims on behalf of Prophet itself that were not wrongful employment practices claims.
In rejecting the insurer’s position, the appellate court found that all of the substantive counts in Stelling’s arbitration statement of claim involved Interrelated Wrongful Acts within meaning of the policy. The court also noted that the policy provides that more than one claim involving Interrelated Wrongful Acts constitute a single Claim — which Claim, the court further found, began when Stelling first sent his October 2011 demand letter to Prophet.
The court further noted that the exclusion’s carve-back preserved coverage for “Claims for Wrongful Acts in connection with Wrongful Employment Practices,” observing that the Claim for which the carve-back preserves coverage is not limited only to those acts specifically identified as Wrongful Employment Practices , it also includes Interrelated Wrongful Acts “in connection with” such practices.
The court concluded that the Stelling Claim “arose out of” Prophet’s termination of Stelling’s employment. That the claim initially labeled as wrongful termination was subsequently expanded or refined “is of no consequence” because “the substance of all of Stelling’s assertions “was interrelated and made in connection with his Wrongful Employment Practices Assertions.”
The court found that “all requisites” of the Wrongful Employment Practices exception to the exclusion had been met, and therefore concluded that Prophet has “satisfied its burden that this exception negates the IvI exclusion.”
Finally, with respect to the insurer’s argument based on the need for an allocation between covered and noncovered amounts, the court held that the insurer had failed to carry its burden to distinguish between covered and noncovered amounts.
It is important to note with respect to the court’s conclusions that the court was applying Texas law, including Texas legal principles governing the interpretation of insurance contracts. These rules of construction were a key part of the court’s analysis. In connection with several policy interpretation issues, the Court, applying Texas rules of construction, held that the policyholder was entitled to prevail because the policyholder had offered “at least one reasonable interpretation” of the relevant terms. The importance of these Texas rules of construction to the court’s analysis may limit the extent to which the Texas court’s interpretations may be persuasive to courts in other jurisdictions that have different rules of construction.
There is another aspect of this insurance dispute’s context that arguably is also relevant — that is that the insurer in this dispute was the second level excess insurer that was contesting its obligation to pay even though the two underlying insurers had fully paid out their limits. An excess insurer in this position is never going to be perceived as occupying the high ground and in fact will likely be portrayed as trying to dodge the coverage obligations that the other insurer had fulfilled. And whether or not these kinds of considerations had any effect on the appellate court’s views of this dispute, they certainly are relevant for those of us in advisory positions when counseling insurance buyers about the various insurer’s claims paying reputations.
The court’s conclusion that the coverage carve-back preserved coverage for all of Stelling’s claims, including even the derivative claims he asserted in the arbitration proceeding, is interesting for a number of reasons, most importantly because of the way the appellate court read the policy as a whole in order to determine the meaning and scope of the coverage carve-back. The relevance of the policy’s various Interrelated Wrongful Act provisions were instrumental in the court’s conclusion that the coverage carve-back preserved coverage for Stelling’s entire claim. The court’s analysis provides an interesting illustration of the often-stated principle that insurance contracts are to be read as a whole.
The court’s conclusion with respect to the coverage carve-back is interesting in another, more general way – that is, that while the IvI exclusion often comes into play, the exclusion has a number of exceptions in the form of the coverage carve-backs that may operate to preserve coverage notwithstanding the exclusion. The carve-backs are not always relevant and therefore may not always apply to preserve coverage. But as this case shows, the exclusion’s coverage carve-backs can be critical in preserving coverage in certain instances. In addition, the court’s analysis shows how important the wording of these exceptions to the exclusions can be.
There is an interesting post on the Sua Sponte Dallas Appellate Blog about the Texas appellate court’s opinion, here.
For a prior post discussing another one of the standard IvI exclusion coverage carve-backs, please refer here.
The post IvI Exclusion’s Carve-Back Preserves Coverage for Entire Claim appeared first on The D&O Diary.
via Tumblr IvI Exclusion’s Carve-Back Preserves Coverage for Entire Claim
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