In determining whether to bring a lawsuit against an alleged wrongdoer, potential plaintiffs assess a number of factors, including whether the wrongdoer has any recoverable assets and whether pursuing the claim will be financially worthwhile. On the flipside, companies and their officers and directors attempt to manage risk by minimizing claims that may require the outlay of substantial defense costs and potentially significant indemnity payments through settlements or satisfaction of judgments. In a claim scenario where the defendant company is financially distressed and the individual directors and/or officers of the company are the only viable defendants, insurance may play a prominent role in resolving the claim dispute.

By way of example, in Intelligent Digital Systems, LLC, et al. v. Beazley Insurance Company, 2:12-cv-01209 (E.D.N.Y. Sept. 16, 2016), the Eastern District of New York joined a growing national trend by finding that, under New York law, claimants may enter into an agreement with individual defendants to resolve a claim by judgment where the claimants agree they will pursue satisfaction of that judgment only from the defendants' insurance company, not from the individual defendants' personal assets.

In Intelligent Digital Systems, plaintiffs sought coverage under a D&O policy sold by defendant Beazley Insurance Company ("Beazley Insurance") for claims against former directors of Visual Management Systems, Inc. alleging securities fraud and non-payment of promissory notes. The former directors had entered into settlements with plaintiffs under which the former directors stipulated to judgments and assigned to plaintiffs their rights under the policy. In exchange, plaintiffs agreed to "unconditionally forbear" collection of the judgments against the former directors. The stipulations also made clear that plaintiffs did not waive or release their right to assert any claim against Beazley Insurance.

In the coverage action, Beazley Insurance contended that these settlements were not covered under the policy. The policy provided coverage for "Loss" resulting from claims made against the former directors and defined "Loss," in relevant part, as "[T]he amounts which the Insureds become legally obligated to pay on account of a claim." Beazley Insurance argued that the settlements did not constitute "Loss" because the insured former directors were not "legally obligated to pay" any amount, given that plaintiffs had agreed not to execute their judgment against the former directors.

Consistent with the majority rule followed in Colorado, Kansas, New Jersey, Washington, and Washington, D.C., the court rejected the insurer's argument and ruled that, notwithstanding the agreement not to execute, the judgments constituted loss under the policy. The court considered precedent in New York and other jurisdictions which found that the phrase "legally obligated to pay" in insurance policies covers consent judgments, provided the assignment does not release the insurance company from liability. The court adopted the reasoning of other courts and permitted plaintiffs, as assignees under the policy, to pursue collection of the agreed-upon judgment from Beazley Insurance.

Intelligent Digital Systems represents an important victory for policyholders in New York and highlights some key considerations by any party contemplating a similar arrangement:

  • Insurance may be a source of recovery against defendants with limited assets. Even when faced with a likely judgment-proof defendant, claimants should consider the defendant's insurance policy as a potential source of recovery.

  • Obtaining an assignment of insurance rights may be a way to avoid costly and burdensome litigation. Policyholders faced with a lawsuit may find assigning their insurance rights to be an advantageous approach to resolve a lawsuit quickly and return to the important work of their businesses before incurring substantial litigation costs.

  • Consider all potentially applicable law. As the Intelligent Digital Systems court noted, the trend by courts that have considered the issue is that settlements with insurance assignments are permissible. However, there are still many jurisdictions where this issue is undecided, and a few courts have found that such settlements are not covered. Therefore, all potentially applicable law should be considered when deciding whether to enter into a similar settlement.

  • The insurance policy language matters. Intelligent Digital Systems distinguished an Eighth Circuit case in which the policy's definition of loss explicitly excluded "any amount . . . for which the Insured Person is absolved from payment by reason of any covenant, agreement or court order." If a policy has similar exclusionary language, a stipulated judgment with a covenant not to execute may not be covered. Policies also may contain other provisions, such as consent-to-settle provisions or non-assignment provisions, which need to be considered.

  • Avoid waiver or release. A settlement with assignment of insurance rights must not include a release of claims against the insurer. Rather, as a best practice, such settlements should explicitly state that nothing in them constitutes a waiver or release of the claimant's right to bring claims against the policyholder's insurer.

If you have any questions about this or any other matter, please contact the authors of this alert or any other Lowenstein Sandler attorney with whom you typically consult.