Bear Stearns' Double Whammy
All in all, it hasn't been a good month for the folks at Bear Stearns. First, a run on the bank results in a takeover by JP Morgan at $2 a share and the prospect of endless shareholder litigation. Then, the New York Court of Appeals holds that it blew any chance at $50 million in excess E&O coverage for a 2002 settlement of conflict of interest claims.
The dispute in Vigilant Ins. Co. v. The Bear Stearns Co., No. 25 (N.Y. March 13, 2008) arose out of a joint investigation by the SEC and various states attorney-general (hello, Eliot) of claimed conflicts of interest between in-house research and investment banking at ten major financial service firms on Wall Street. Following meetings with regulators, Bear Stearns signed a settlement in principle on December 20, 2002 wherein it committed to pay $50 million in retrospective relief, together with $25 million to fund independent research and $5 million for investor education. The document stated that it was subject to final approval by the SEC and state regulators. In April 2003, the parties entered into a final consent agreement memorializing these terms. This agreement was filed with a U.S. District Court in Manhattan which approved it in October 2003. Under the terms of the final agreement, Bear Stearns paid a $25 million penalty to the SEC; disgorged $25 million in past profits and agreed to fund $25 milion for research and $5 million for investor education. Bears Stearns agreed as part of the settlement not to seek insurance coverage for the $25 million penalty.
Three days after signing the consent agreement, Bear Stearns had belatedly given notice of the settlement to its excess professional liability insurers: Vigilant, Gulf and Federal. Vigilant had written a $10 million layer excess of a $10 million self-insured layer. Federal and Gulf (now Travelers) underwrote a $40 million following form excess layer over that.
These carriers disclaimed coverage due to the insured's failure to give notice to them before settling. Additionally, the insurers noted that their policies contained an exclusion for claims arising out of investment banking. Finally, issues were raised with respect to whether the disgorgement penalty or sums paid for investment research or education were a covered loss.
In the ensuing coverage litigation, a state trial declined to grant summary judgment to the carriers, finding issues of fact with respect to whether the settlement in principle constituted a breach or whether the investment banking exclusion applied. The Supreme Court also ruled that the insurers could not look beyond the terms of the settlement to determine whether the $25 million payment was for disgorged ill-gotten gains. The court also rejected the insurers' "loss" argument.
In 2006, the Appellate Division agreed that issues of fact precluded summary resolution of the insured's claimed breach of the policies' consent to settle condition but granted summary judgment against the carriers on their alternative defenses to coverage. The Appellate Division subsequently agreed to certifiy its ruling to the New York Court of Appeals.
In its analysis, the Court of Appeals focused on the consent to settle clause, which stated that Bear Stearns would not enter into any settlement or confess liability for an amount over a $5 million threshold without first obtaining its insurers' consent, said consent not to be unreasonably withheld. The court concluded that Bear Stearns clearly breached this condition to coverage when it signed the consent agreement in April 2003 agreeing to pay $80 million to state and federal authorities. Unlike the lower courts, the Court of Appeals declined to assign any significance to the fact that the consent agreement did not become final until it was approved by a U.S. District Court the following October. The court noted that even though court approval was required, Bear Stearns was not free to walk away from its committments in the interim, nor was the consent agreement drafted so as to be subject to final approval by the insurers. In light of its sophistication as a business entity, the court concluded that Bear Stearns could not on the one hand enter into insurance contracts stating that its insurers would not be liable for settlements entered into without their consent and then execute a consent agreement calling for the payment of millions of dollars without informing the insurers of the terms of the settlement.
The Court of Appeals therefore directed that judgment enter for the insurers on the basis of the insured's breach of the consent to settle clause. As a result, the court did not reach the issue of whether portions of the settlement payment that called for payments into an investor educational fund or for disgorgement of profits would otherwise be a covered loss.
In light of the swirl of political and legal events now going on in New York state concerning conditions to coverage, this opinion is perhaps as surprising for what is not contained in it as for what is stated. Nowhere in the opinion is there any discussion of whether this was a "material" breach or one that prejudiced the insurers. Nowhere is there any argument that, given the District Court's holding that the settlement was reasonable, the insurers might have obtained a windfall due to the insured's negligence since they might well have given their assent to the settlement otherwise. Nor is there any questioning of whether the the insured knew that it had coverage for such claims or whether its E&O carriers, who are all large sophisticated insurers who may well have read press reports at the time of the December 2002 settlement in principle, had actual knowledge of this agreement. Indeed, none of the arguments that insureds have typically made in late notice cases appears in this opinion, nor does the court make any reference to notice issues beyond the specific condition at issue.
One may well surmise that the court's attitude was hardened by the inexcusable negligence of Bear Stearns in waiting months after signing the settlement in principle to notify its insurers. The court's willingness to take the case and the absence of any dissents may also reflect the sense that much if not all of the settlement was also not covered by these policies. Finally, the court may well be sending a signal to the legislature with respect to the fact that it continues to believe that New York businesses should stand by the terms of their written agreements.
