A family that invested in Bernard Madoff’s Ponzi scheme through multiple entities can recover some of its losses under insurance policies, a state appellate panel ruled yesterday, but the recovery will be based on the difference between what each entity put into the scheme and what it got out, not the losses recorded in Madoff’s fraudulent statements.

At the same time, the Appellate Division, First Department, decision in Jacobson Family Investments v. National Union, 601325/10, held that the insurers can’t lump all of the entities’ losses together, which would result in no coverage, since the family as a whole emerged from the fraud a net winner.

The panel largely affirmed a decision earlier this year by Manhattan Supreme Court Justice Richard Lowe III (See Profile). But it reversed Lowe on one issue: whether the insurers could apply a $3 million deductible to each entity individually, or whether it could apply it only once for the whole family. Lowe had ruled that the deductible could be applied only once, but the First Department ruled that it should be applied to each entity. The reversal means that some of the 10 net loser entities will not receive any coverage (NYLJ, March 6).

The decision was written by Justice Angela Mazzarelli (See Profile) and joined by Justices David Saxe (See Profile), Leland DeGrasse (See Profile), Rosalyn Richter (See Profile) and Sheila Abdus-Salaam (See Profile).

The suit was filed in 2010 by Jacobson Family Investments, which manages 16 other investment entities for the benefit of one family. Those entities were also plaintiffs in the suit.

The plaintiffs sought to collect coverage under a primary insurance policy issued by National Union Fire Insurance Co. of Pittsburgh as well as under a series of excess policies issued by Continental Casualty Co., Fidelity & Deposit Co. of Maryland and Great American Insurance Co. All the insurers are defendants in the case.

The policies all together offered coverage up to $50 million. The primary policy named Jacobson Family Investment as the insured but contained a rider, called Rider 8, naming all the other plaintiffs under the heading “Complete Named Insured.” The excess policies were issued under the same terms as the primary policy.

The insurers moved for summary judgment, arguing that, when all the plaintiffs’ investments were considered together, they were actually net winners in the scheme, withdrawing about $5.9 million more from Madoff’s fund than they put in. Under Rider 8, they argued, the plaintiffs should all be considered together, meaning they were not entitled to any coverage.

The insurers further noted that the plaintiffs had submitted a single claim of loss to Irving Picard of Baker & Hostetler, the trustee charged with liquidating Madoff’s securities firm, and that they had reached a settlement with the trustee under which the net loser entities agreed to release their claims on the trustee for recovery in exchange for the trustee releasing “clawback” claims against the net winner entities.

The plaintiffs, on the other hand, argued that not only should they not be lumped together, but their recovery should be based on the amount shown by Madoff’s fake books. In support of that claim, they noted that they agreed to pay premiums to the insurers based on the amount of assets they believed they were insuring, even though those assets later proved illusory. They also said that they paid taxes on the profits they believed they were making. Finally, they pointed to another rider, Rider 9, which incorporated their application materials—including a Madoff statement—into the policy.

The appeals panel agreed with Lowe that the plaintiffs are entitled to recovery only on their real losses.

“Rider 9 is an especially slim reed to hang on,” Mazzarelli wrote. “It is true that it technically makes the most recent [Madoff] statement part of the bond. Nevertheless, this offers no guidance on how to define the term ‘loss.’ Moreover, it hardly serves as an estoppel against defendants taking the position that only ‘real’ losses are covered.”

Mazzarelli also pointed out that the Jacobson family had taken advantage of Internal Revenue Service procedures set up to provide relief to people who paid taxes on fictitious profits.

The panel concluded that “no reasonable interpretation of the term ‘loss’ in the context of the bond allows for coverage of fictitious Madoff gains.”

However, like Lowe, the panel agreed with the plaintiffs’ argument that the various entities’ losses could not be lumped together.

“Rider 8 is a definitional, as opposed to an operative, section of the bond,” Mazzarelli wrote. “As such, it is impossible to conclude that it has anything to do with whether claims by the individual insureds are to be considered separately or aggregated together.”

Unlike Lowe, the panel said that the insurers could apply a $3 million deductible to each entity, not only once.

Mazzarelli wrote that “consistency dictates that, if each net loser is seeking coverage for its own loss, each individual claim is subject to the $3 million Single Loss Deductible.”

Adam Ziffer of Kasowitz, Benson, Torres & Friedman, who represented the plaintiffs, said he was pleased with the First Department’s decision that the plaintiffs’ losses must be calculated separately, but disappointed with the rest.

He said that, even with the $3 million deductible applied to each plaintiff, some plaintiffs still expect to see some recovery.

Joseph McNulty of Carroll McNulty & Kull represents Continental Casualty.

Robert Novack of Bressler, Amery & Ross represents National Union.

Geraldine Cheverko of Eckert Seamans Cherin & Mellott represents Fidelity and Great American.

The insurers’ attorneys could not be reached for comment.

@|Brendan Pierson can be reached at bpierson@alm.com.