Claims-Made Policies—Report Potential Claims Immediately

Facts of the Case

David Feldman lost his claim for defense and indemnity at summary judgment entered in favor of Illinois Union Insurance Company, which had declined to defend or indemnify Feldman or his company, ZF Micro Solutions, against a cross-action by a third party. Feldman contended that the superior court erroneously found no potential for coverage under the liability policy issued to him and ZF Micro Solutions and therefore no duty to defend or indemnify him and other insureds. The California Court of Appeal agreed with the superior court that the claims made by the third party during the policy period were excluded from coverage and affirmed the judgment.

Background

David Feldman is the president and chief executive officer of ZF Micro Solutions, Inc. ("ZF Solutions"). ZF Solutions is the successor company to ZF Micro Devices, Inc. ("ZF Devices"), replacing the latter as of March 1, 2002. ZF Solutions designs, markets, and sells semiconductor devices "into the embedded microprocessor market."

On April 25, 2002, ZF Solutions sued National Semiconductor Corporation (NSC) for failing to produce devices for ZF Solutions in accordance with the parties' contract. On May 28, 2002, NSC filed a cross-complaint against both ZF Devices and ZF Solutions (as successor) for failure to pay for custom integrated circuits (chips) it had produced and sent to ZF Devices in accordance with the same contract.

NSC filed a first amended cross-complaint a year later, on April 25, 2003. In this pleading, NSC added Feldman and two others as cross-defendants and asserted new causes of action against the cross-defendants, including breach of fiduciary duty and fraudulent transfer of assets from ZF Devices to ZF Solutions. In June 2004, the litigation between ZF Solutions and NSC culminated in a jury verdict finding both ZF Solutions and NSC liable to each other.

The Insurance Litigation

From November 23, 2001, to July 1, 2002, ZF Solutions was insured by a liability policy issued by "Certain Underwriters at Lloyd's, London" ("Underwriters"). That policy covered directors and officers as well as the corporation. Respondent Illinois Union Insurance Company covered ZF Solutions and its directors and officers from July 1, 2002, to July 1, 2003.

On or about March 28, 2003, Feldman tendered the defense of NSC's amended cross-complaint to Illinois Union through the insurance broker. Illinois Union denied coverage, asserting that NSC's claim had originally been made on May 28, 2002, before the inception date of the Illinois Union policy. Illinois Union also asserted exclusions for claims involving a contract and claims involving fraudulent acts by any of the insureds.

In a written request for reconsideration, the insurance broker pointed out that the claim that was tendered was not for breach of contract but only for breach of fiduciary duty and related allegations against new defendants, including Feldman. Illinois Union, however, adhered to its denial of defense and indemnity based on lack of coverage. This time, the company invoked a policy provision that deemed "Interrelated Wrongful Acts" to constitute a single claim and that required such a claim to be made during the policy period. Under this provision, Illinois Union explained, NSC's claim was made before the inception date of the policy.

The trial court determined that the policy definition of "Interrelated Wrongful Acts" encompassed both NSC's original cross-complaint and its subsequent pleading, the first amended cross-complaint.

Discussion

The Illinois Union policy was a "claims-made policy" covering ZF Solutions and its directors and officers. Under the "Directors & Officers" clause, Illinois Union agreed to pay "Loss resulting from any Claim first made against the Directors and Officers during the Policy Period for a Wrongful Act." The term "wrongful act" was defined as "any actual or alleged error, omission, misleading statement, neglect, breach of duty or act" by any director or officer acting in that capacity.

The California Court of Appeal was asked to determine whether the "interrelated wrongful acts" provision of the policy applied to the facts to deprive Feldman of coverage. That term was defined in the policy as "more than one Wrongful Act which have as a common nexus any fact, circumstance, situation, event or transaction or series of facts, circumstances, situations, events or transactions."

Examination of NSC's Claims

NSC's original cross-complaint stated that NSC twice agreed to an extension of the payment deadline for the products it had delivered to ZF Devices, because "ZF Devices was unable to pay the debt." NSC further alleged that the assignment of its contract and the transfer of assets from ZF Devices to ZF Solutions was made "for the fraudulent purpose of escaping liability for ZF Devices' debts, particularly the debt to [NSC] under the Agreement."

Notwithstanding its allegations of fraudulent transfer, NSC's cross-complaint contained only two causes of action: breach of contract against both ZF Devices and ZF Solutions and "successor liability" against ZF Solutions. The amended cross-complaint, however, expanded NSC's theories of recovery and added Feldman, Kennedy, and the Kennedy Trust as defendants. Again, NSC asserted that the "fraudulent transfer" of ZF Devices assets to Feldman and ZF Solutions, via the purported foreclosure and assignment to the Kennedy Trust, was made to "hinder, delay, or defraud" creditors, including NSC.

The court found it apparent from a comparison of the cross-complaint and amended cross-complaint that the later pleading included many new details of the events contributing to the alleged liability of Feldman, the Kennedy Trust, and Kennedy, as well as the ZF entities. But these details all pertained to the alleged fraudulent assignment and transfer of ZF Devices assets to ZF Solutions, made with the intent (and effect) of avoiding the former company's $833,715.92 obligation to NSC. Thus, while NSC expanded its theories of recovery, three of the four new causes of action asserted against Feldman—fraudulent conveyance and conspiracy, breach of fiduciary duty, and unfair business competition—had "as a common nexus any fact, circumstance, situation, event or transaction or series of facts, circumstances, situations, events or transactions" in relation to the original cross-complaint. These claims were therefore properly deemed to constitute a single claim, which was originally made in April 2002, before the inception of the Illinois Union policy.

The California Court of Appeal agreed with the superior court that none of the claims NSC asserted in its amended cross-complaint was potentially covered under the Illinois Union policy. Consequently, Illinois Union had no duty of defense or indemnity toward Feldman. In light of this conclusion, it was unnecessary for the court to determine the applicability of the policy's insolvency exclusion.

Lesson

If possible and if available, always buy an "occurrence" policy to avoid some of the problems raised by the claims-made policy. If an "occurrence" policy is not available (and such is the case for many risks), the insured and its risk manager must be careful to read and understand the policy wording and its requirements. If a claim is made or if the insured is aware of a potential claim that might be made in the future, it must be ready to advise all insurers of claims made or potential claims as soon as the insured learns of them. Failure to do so can place the insured into the same position as Mr. Feldman who was unable to obtain either defense or indemnity from his insurer.

Insurance is a contract, and both parties to the contract must fulfill its terms and conditions. Regardless of the creativity of the lawyer for the claimant, coverage cannot be made by argument but must be based on reality.