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The insurer that provided directors and officers liability coverage to Tyco International Ltd. executives must continue to pay the legal bills for former chief executive officer L. Dennis Kozlowski but may be able to seek reimbursement of non-covered claims at a later date, a Manhattan appellate court has ruled. In a unanimous decision written by Justice Joseph P. Sullivan, the Appellate Division, 1st Department, held that Federal Insurance Co.’s policy exclusion for claims based on insured executives’ unauthorized personal enrichment may apply in the case of Kozlowski and other Tyco executives. But the court said the extent of the exclusions could not now be determined. “Federal must pay all defense costs as incurred, subject to recoupment when Kozlowski’s liabilities, if any, are determined,” Sullivan wrote in Federal Insurance Co. v. Kozlowski, 5109. Kozlowski, the former Tyco chief executive officer, and Mark Swartz, the former chief financial officer, are on trial before Manhattan Supreme Court Justice Michael Obus for allegedly stealing $170 million from the company in the form of unauthorized bonuses and loans. A previous trial on similar charges ended in a mistrial last April. The two executives and former Tyco general counsel Mark A. Belnick are also facing civil lawsuits over their actions at the company. Belnick was acquitted last July of charges that he stole more than $30 million in unauthorized loans and bonuses from Tyco. Federal Insurance Co., a subsidiary of the Chubb Group, had sought to void its director and officer liability policies with regard to Kozlowski, Swartz and Belnick. The insurer claimed it was entitled to unilateral rescission of its coverage because it had been misled by the three executives into providing them with coverage. Manhattan Supreme Court Justice Helen Freedman had ruled that Federal must continue to pay Kozlowski’s legal costs until the rescission issue had been litigated, a position the appellate court upheld. Unlike the appellate court, Freedman had found the personal profit exclusion did not apply to any of the underlying criminal or civil actions because covered and non-covered claims were intertwined. Among the criminal counts against Kozlowski are a number relating to falsifying records to facilitate other employees’ loans, actions from which Kozlowski did not personally profit. The appellate court distinguished between two policies Federal had issued to Tyco. One policy, which applied to claims arising from fiduciary duties imposed by ERISA plans, provided that the insurer had a “duty to defend” the insured. The other policy only required the insurer to pay legal costs. Sullivan wrote: “The obligation to defend is readily understood and its requirement is clear — the insurer must afford a defense to the insured for covered as well as non-covered claims if the latter are intertwined with covered claims. The obligation to pay defense expenses, on the other hand, is not as easily defined or applied.” “Under this type of defense coverage, the insurer is entitled to differentiate between covered and non-covered expenses, despite the fact that a promise to pay defense costs has been construed to require contemporaneous payment,” the judge continued. Federal was represented by David J. Hensler of Hogan & Hartson. Kozlowski was represented by William Passannante of Anderson Kill & Olick. The other executives were not party to this appeal. The unanimous panel also included Justices David B. Saxe, David Friedman, Eugene Nardelli and Milton L. Williams.

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