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Corporate fraud scandals and the recent wave of financial restatements are prompting insurance companies to balk at paying directors and officers liability insurance, as well as to file lawsuits seeking to rescind the policies. Lawyers say most rescission cases settle, but a recent federal court decision ordering an insurance company to make a $24 million liability payment to Popeyes Chicken & Biscuits’ franchisor and operator AFC Enterprises Inc. is headed to the 11th U.S. Circuit Court of Appeals. Executive Risk Indemnity Inc. v. AFC Enterprises Inc., No. 04-02523 (N.D. Ga.). If the Sept. 21 district court decision holds in the AFC case, the company expects to receive up to $10 million after funding a settlement of shareholder litigation stemming from the company’s financial restatement in 2003. The Popeyes case and an insurance rescission case connected to the Adelphia Communications Corp. bankruptcies illustrate the pitched battle between insurance companies and several types of policyholders who face hefty legal bills, including corporations, directors and officers. Lawyers say recent decisions are heartening to policyholders in an arena with little important case law. The Enron effect Corporate financial restatements have become erroneously associated with fraud since the Enron Corp. and WorldCom Inc. accounting scandals, but the mere existence of a restatement doesn’t indicate any nefarious activity at the company, said Neal Pope of Pope, McGlamry, Kilpatrick, Morrison & Norwood in Columbus, Ga., who was part of the AFC defense team. “The nature of the beast is that insurance companies don’t like to pay claims; they look for reasons not to pay claims,” Pope said. Although pleased by the court’s rejection of the insurers’ claim that AFC made misrepresentations on the insurance application, bad-faith damages would have helped discourage similar rescission lawsuits, said Richard Gill, a shareholder at Copeland, Franco, Screws & Gill of Montgomery, Ala., who also represented AFC in the case. “At the end of the day, [the insurers are] paying what they would have had to when the contract started,” Gill said. Executive Risk Indemnity Inc.’s lawyers at Ross, Dixon & Bell of Washington and Magill & Atkinson of Atlanta referred questions to Executive Risk’s corporate parent, The Chubb Corp. Chubb spokesman Mark Schussel declined to comment about AFC or its other rescission cases. Chubb recently sought rescissions of other directors and officers policies, but settled those cases before trial. One case against former officers and directors of Kleinert’s Inc. in Pennsylvania ended last year and another against current and former directors, officers and employees of Huffy Corp. in Ohio closed this year. Executive Risk Indemnity Inc. v. Brier, No. 05-1029 (E.D. Pa.); Federal Insurance Co. v. D’Aloia, No. 3:06-cv-0080 (S.D. Ohio.). A multifront war There have been a slew of cases since Enron that have tried to determine the scope of directors and officers liability policies and whether insurance companies have a unilateral right to rescind, said Christie Callahan Comerford, a partner at Philadelphia-based Dilworth Paxson. Comerford is representing James and Michael Rigas, two former executives and directors of the bankrupt Adelphia Communications Corp., in a case against insurance companies that covered them for directors and officers liability insurance during their time at Adelphia. Rigas v. Associated Electric & Gas Insurance Services Ltd., No. 07-168 (E.D. Pa.). The U.S. attorney for the Southern District of New York charged John and Timothy Rigas with bank securities and wire fraud for bilking the company. Michael Rigas faced lesser charges. The four Rigases, including James, and other directors also face securities lawsuits. In their lawsuit, James and Michael Rigas sought declaratory judgment that the insurance companies were required to advance defense costs in excess of the policy limits while the Rigases fought against a settlement between Adelphia and insurance companies. The suit also included a bad-faith claim against the insurance companies for excluding them from settlement talks and asked the court for attorney fees to cover their expenses for fighting the settlement. “So far we’ve been successful in stopping them from cutting us off from defense funds,” Comerford said. “We’ve had a multifront war, but luckily the law has been on our side and we’ve prevailed.” The district court case is stayed because Adelphia’s bankruptcy case is still winding down following the company’s emergence from bankruptcy and sale. But a partial summary judgment in an earlier insurance rescission case brought by three insurance carriers gave the four Rigases and another party the right to advances under the company’s directors and officers liability policies. Associated Electric & Gas Insurance Services Ltd. v. Rigas, No. 02-7444 (E.D. Pa.). So far, various former Adelphia executives and officers have received about $12.9 million, said Don Brown, a San Francisco attorney at Washington-based Covington & Burling who represents Adelphia on insurance coverage matters. The bankruptcy court has since sided with the Rigases and rejected the settlement, which called for the insurance companies to pay Adelphia $32.5 million, minus any advances, for the $50 million policies in exchange for a release from future claims to cover defense costs under the policies. In re Adelphia Communications Corp., No. 02-41729 (Bankr. S.D.N.Y.). Brown and Dilworth Paxson attorneys say a new settlement involving the Rigases is close to completion. Return advances? But Brown said the insurance companies may have cause to seek return of advances to John and Timothy Rigas, based on federal appeals court’s decision to uphold their securities and bank fraud convictions in May, Brown said. U.S. v. Rigas, 490 F.3d 208 (2d Cir.). Dilworth Paxson’s Lawrence McMichael, who chairs the firm’s litigation and bankruptcy and insolvency groups, disputed the claim that John and Timothy Rigas’ conviction negates their right to insurance. He also said the two are seeking to appeal their criminal conviction and are applying for certiorari with the U.S. Supreme Court. “Just because the Rigases were convicted with a crime doesn’t mean they’ve lost their right to the benefits of insurance,” McMichael said. Rescission in Virginia Like Chubb and Aegis, Great American Insurance Co. has also been seeking rescission. The company has a Virginia case against the now-defunct Reciprocal of America insurance company and various officers and directors. Great American Insurance Co. v. Gross, No. 05-cv-00159 (E.D. Va.). It also has a pending case in Illinois against Bally Total Fitness Holding Corp. Great American Insurance Co. v. Bally Total Fitness Holding Corp., No. 06-4554 (N.D. Ill.). In the Virginia case involving Reciprocal of America, the 4th U.S. Circuit Court of Appeals reversed a lower court’s dismissal of the rescission case, which allowed it to move forward simultaneously with civil lawsuits against some of the same parties. Great American Ins. Co. v. Gross, 468 F.3d 199 (4th Cir.). A Great American lawyer on the case, Peter Lovato of Chicago-based Boundas, Skarzynski, Walsh & Black, said the 4th Circuit decision broke new ground because it decided the rescission case wouldn’t unduly prejudice the other civil cases against the insureds. “One of the issues that courts had been struggling with is when and in what circumstances cases for rescission ought to move forward at the same time claims against the insureds were moving forward,” Lovato said. The lower court judge, James R. Spencer, expressed concern that the insureds would be “estopped from re-litigating the overlapping issues” in state court cases, which might frustrate the orderly progress of the state court proceedings. Great American, which had agreed to double Reciprocal of America directors and officers liability policy to $20 million from $10 million a couple of years before the collapse, brought its rescission lawsuit after two officers pleaded guilty to criminal charges associated with the company’s collapse. Early in the case, a judge ordered the company to advance defense costs to the two officers until the rescission case was resolved. Great American is seeking to rescind coverage to numerous defendants and get a declaration of no coverage for the two officers under the contract’s fraud-exclusion terms. Patrick Cantilo of Cantilo & Bennett in Austin, Texas, who represents a receiver managing Reciprocal of America’s assets during its liquidation, said insurance companies frequently try to determine if individual wrongdoing can be a basis for rejecting or rescinding directors and officers liability coverage. “When you go through a period like WorldCom and Enron, you’re likely to see more resistance by insurers and more scrutiny than normal,” Cantilo said. “There’s a direct correlation between coverage disputes and the number of large claims asserted for professional liability coverage,” he said.

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