339 F.Supp.2d 336 (2004) | Cited 2 times | D. Massachusetts | October 19, 2004



Plaintiffs Melinda Brown ("Brown") and Treffle LaFleche("LaFleche") (together the "Plaintiffs") seek a declaration oftheir rights under a directors' and officers' liability policyissued by defendant National Union Fire Insurance Company ofPittsburgh, Pennsylvania ("National Union"). The Court, havingdenied the Plaintiffs' motion for summary judgment and proceededto a bench trial, renders the following findings of fact andconclusions of law. Fed.R. Civ. P. 52(a). II. BACKGROUND

A. Factual Background

The following facts, although drawn primarily from thePlaintiffs' Complaint and proposed findings, are essentiallyundisputed. Massachusetts residents Brown and LaFleche are eachformer directors of Computrex, Inc. ("Computrex"), a Delawarecorporation with its principal place of business in Kentucky.Pls.' Compl. [Doc. No. 1] ¶ 1; Pls.' Proposed Findings at 2. TheDefendant National Union, a Pennsylvania corporation with itsprincipal place of business in New York, issued to Computrex adirectors' and officers' liability policy extending coverage bothto individual insureds and to Computrex. See Trial Ex. 2(Directors, Officers and Private Company Liability InsurancePolicy No. 872-35-08) (the "Policy").1 As to theindividual insureds: This policy shall pay the Loss of each and every Director, Officer or Employee of the Company arising from a Claim first made against such Insureds during the Policy Period or the Discovery Period (if applicable) and reported to the Insurer pursuant to the terms of this policy for any actual or alleged Wrongful Act in their respective capacities as Directors, Officers or Employees of the Company except when and to the extent that the Company has indemnified such Insureds. The Insurer shall, in accordance with and subject to Clause 8, advance Defense Costs of such Claim prior to its final disposition.Policy, cl. 1.

1. Trustee's Complaint

On January 30, 2004, former directors and officers of Computrexwere served with an adversary complaint filed by the company'strustee in bankruptcy (the "Trustee"). Pls.' Compl. ¶ 12; TrialEx. 1 ("Trustee's Complaint"). The Trustee's Complaint explainsthat Computrex was formed in 1973 "for the purpose of auditingfreight bills," a service that involved receiving freight billsfrom carriers, auditing them for correct charges, invoicing andreceiving payments from clients, and transmitting the payments tocarriers. Trustee's Compl. ¶ 19. The Trustee contends that byDecember 20, 2001, Computrex had been driven into involuntarybankruptcy by its former directors and officers, who hadmisdirected client funds, distributed improper bonuses anddividends, and orchestrated a fraudulent spin-off of thecompany's successful logistics division. See id. ¶¶ 114, 121.

As to Brown and LaFleche more specifically, the Trustee'sComplaint alleges the following actions and — significantly forpresent purposes — indicates the following dates: Continuation of the company's business during insolvency. In an effort "to delay financial collapse," Computrex directors approved the implementation of a "Ponzi scheme": clients were invoiced in the usual manner, but the funds they remitted were applied to the freight bills of other clients, "whose money the defendants had already spent." Id. ¶¶ 74-75. As a result, by June 2000, Computrex faced a shortfall of more than $17 million. Id. ¶¶ 115-16. By June 2001, "other new clients had been solicited" and the shortfall had increased to more than $22 million. Id. ¶¶ 115-16. Settlement with Ronald LaFleche. In late July 2000, several directors agreed to settle a lawsuit initiated by Ronald LaFleche, the company's former majority shareholder.2 Id. ¶ 51. The settlement provided that Computrex, notwithstanding its insolvency, would repurchase Ronald LaFleche's shares and forgive his outstanding debt. Id. ¶¶ 56-57, 59-61. These terms were formally approved on September 6, 2000 and finalized on September 14, 2000. Id. ¶¶ 56, 59. Award of improper bonuses. On December 1, 2000, Computrex directors awarded bonuses to Edward Lindquist ("Lindquist") and Milton Collins ("Collins"), then the company's chief executive officer and chief operating officer, respectively. Id. ¶ 65. The bonuses — which were awarded and accepted despite "knowledge of the Debtor's true financial condition" — "were based in large part on false or inflated revenues." Id. ¶ 66. In July and August 2001, Lindquist and Collins were awarded second, more sizable bonuses "for the orchestrated spin-off of [the company's logistics division]." Id. ¶ 104. Distribution and receipt of unlawful shareholder dividends. From August 1997 to December 1999 — a period of "severe financial difficulties" — Computrex directors approved the payment of several cash dividends, which Brown and LaFleche received as individual and joint3 shareholders. Id. ¶ 112. In addition, on March 10, 2001, the company distributed a stock dividend, issuing one share of stock in its spin-off companies for each share of Computrex stock. Id. ¶¶ 87, 112. Consent to counsel's dual representation. By memorandum dated January 16, 2001, company counsel Ogden Newell & Welch disclosed that a "real conflict" could arise from its representation of both Computrex and its spin-off company. Id. ¶ 80, Ex. 13 (Mem. of 1/16/01). Counsel advised that the companies' "financially precarious position[s]" could "imperil[]" the intended loan from Computrex to its spin-off, rendering their interests adverse. Mem. of 1/16/01 at 1. Notwithstanding counsel's advice that one of the parties "secure [separate] transactions counsel," id. at 3, Computrex directors opted not to do so. See Trustee's Compl. ¶ 81. Spin-off of the logistics division. Preparations for the spin-off of the logistics division began in early September 2000. Id. ¶ 58. In memoranda transmitted on December 14, 2000 and January 5, 2001, Computrex officers Lindquist and Collins urged Brown and LaFleche to consider the "benefits of executing the spin off," id. ¶ 76, Ex. 11 ("Project Merlin" Mem.), and to select spin-off from among the company's "alternative strategic directions," id. ¶ 79, Ex. 12 (Draft Discussion Mem.). The company's directors, in spite of foreseeable "`fraudulent conveyance' claims," "Project Merlin" Mem., section II(C), apparently agreed. On March 10, 2001, Computrex spun off its logistics and technology divisions, issuing one share of stock in Computrex International, Inc. ("International") and CX-IT, Inc. ("CX-IT") for each share of Computrex stock. Trustee's Compl. ¶¶ 87-88.Based on the above, the Trustee's counts against Brown andLaFleche allege breaches of fiduciary duty (Counts I and II),fraudulent conveyances (Count IV), violations of the RacketeerInfluenced and Corrupt Organization Act, 18 U.S.C. § 1962 (CountV), negligence (Count VI), liability for the return of dividends(Count VIII), and fraud (Count IX). 2. Request for Coverage

By letter dated February 6, 2004, Brown and LaFleche providedNational Union with timely notice of the Trustee's Complaint.See Pls.' Compl. ¶ 16; Trial Ex. 3 (Letter from Kelly toNational Union of 2/6/04) ("Kelly Letter"); Policy, cl. 7. Brownand LaFleche sought coverage, including the assumption of theirdefense, as provided under Clause 8 of the Policy. Kelly Letterat 1. Clause 8, titled "DEFENSE COSTS, SETTLEMENTS, [AND]JUDGMENTS," provides, in relevant part: The Insurer does not assume any duty to defend. The Insureds shall defend and contest any Claim made against them. Notwithstanding the foregoing, the Insureds shall have the right to tender the defense of the Claim to the Insurer, which right shall be exercised in writing by the Named Entity on behalf of all Insureds to the Insurer pursuant to the notice provisions of Clause 7 of this policy [requiring appropriate notice "as a condition precedent to the obligations of the Insurer"]. . . . When the insurer has not assumed the defense of a Claim pursuant to this Clause 8, the Insurer shall advance nevertheless, at the written request of the Insured, Defense Costs prior to the final disposition of a Claim. Such advanced payments by the Insurer shall be repaid to the Insurer by the Insureds or the Company, severally according to their respective interests, in the event and to the extent that the Insureds or the Company shall not be entitled under the terms and conditions of this policy to payment of such Loss. The Insureds shall not admit or assume any liability, enter into any settlement agreement, stipulate to any judgment, or incur any Defense Costs without the prior written consent of the Insurer. Only those settlements, stipulated judgments and Defense Costs which have been consented to by the Insurer shall be recoverable as Loss under the terms of this policy. The Insurer's consent shall not be unreasonably withheld, provided that the Insurer, when it has not assumed the defense of a Claim pursuant to this Clause 8, shall be entitled to effectively associate in the defense and the negotiation of any settlement of any Claim, and provided further that in all events the Insurer may withhold consent to any settlement, stipulated judgment or Defense Costs, or any portion thereof, to the extent such Loss is not covered under the terms of this policy.Policy, cl. 8.

National Union denied the Plaintiffs' request, invoking theexclusion from coverage set forth in Endorsement 8. Pls.' Compl.¶¶ 17-18. Endorsement 8, titled "PRIOR ACTS EXCLUSION," provides: In consideration of the premium charged, it is hereby understood and agreed that the Insurer shall not be liable to make any payment for Loss arising from any Claim(s) alleging Wrongful Act(s) which occurred prior to the inception date of the Policy Period or after the end of the Policy Period. This policy only provides coverage for Loss arising from a Claim(s) for an alleged Wrongful Act(s) occurring on or after the inception date of the Policy Period and prior to the end of the Policy Period and otherwise covered by this policy. Loss(es) arising out of the same or Related Wrongful Act(s) shall be deemed to arise from the first such same or Related Wrongful Act.Policy, Endorse. 8. Based on his review of the Trustee'sComplaint, National Union's Complex Claims Director, John F.Varley, III ("Varley"), determined that the alleged wrongful actswere alternatively prior acts — that is, wrongful acts which"occurred prior to the inception date of the Policy" — or"Related Wrongful Acts" — that is, acts which were the "same" as, "related" to, or "continuous" with prior acts, or which"ar[o]se from a common nucleus of facts." Trial Ex. 5 (Letterfrom Varley to Kelly, Brittain, and Russell of 4/5/04) ("VarleyLetter") at 2 (quoting Policy, cl. 2, Endorse. 8). "As such,"Varley reasoned, "there can be no coverage for theClaim."4 Id.

B. Procedural Posture

The Plaintiffs initiated the present diversity action on April5, 2004. See Pls.' Compl. National Union, pursuant to anassented-to extension, filed its answer on May 10, 2004. [Doc.Nos. 4-5]. The Plaintiffs moved for summary judgment thefollowing day. [Doc. No. 6].

The Court, after hearing oral argument on June 21, 2004, deniedthe motion, instructing the parties to prepare for trial tocommence the following week. See Clerk's Note of 6/21/04. Theevidence presented at the subsequent bench trial included thetestimonies of Brown, LaFleche, and Varley. Brown and LaFlecheessentially confirmed that each was a director during the periodsdescribed by the Trustee's Complaint and was covered by thePolicy. Varley, testifying for National Union, explained itsdenial of benefits in greater detail. Varley maintained that neither of the conditions precedent to coverage had been met:Although counsel for the Trustee had provided National Union witha copy of the Trustee's Complaint, see Trial Ex. 6 (Letter fromIngram to Varley of 3/3/04), it had not "tender[ed] the defense."See Policy, cl. 8. Nor did the Trustee's Complaint reveal a"reasonable potential for coverage." Rather, the Trustee'sComplaint alleged a series of "Related Wrongful Acts," each ofwhich, in the Trustee's words, "raided the . . . coffers" of afailing company, Trustee's Compl. ¶ 121. Because losses arisingfrom related wrongful acts are "deemed to arise from the first. . . Related Wrongful Act," and the Plaintiffs' wrongful actsdated at least as far back as the year 2000, National Uniondetermined that they were excluded from coverage. See Policy,Endorse. 8.

At the trial's conclusion, the Court expressed skepticismregarding the Plaintiffs' purported tender of their defense.First, the tender made by Plaintiffs' counsel clearly was not "onbehalf of all Insureds," as required by Clause 8. See KellyLetter at 1 (referring exclusively to Brown and LaFleche andrequesting appointment of Gadsby Hannah LLP in part because Brownand LaFleche — unlike each of the other defendants named in theTrustee's Complaint — are "residents of Massachusetts"); cf.Pls.' Post-Trial Mem. at 26-27 (resisting joinder of the absentinsureds in part because the Plaintiffs' "prayer [regarding theduty to defend] is entirely specific to the parties named in the current proceeding"). Second, although the Plaintiffs urged theCourt to "eschew technical notice requirements," Pls.' ProposedFindings at 12 (quoting Johnson Controls, Inc. v. Bowes,381 Mass. 278, 280 (1980)) (alterations omitted), the Policyindicated that its notice requirements were more than merelytechnical. Clause 8 expressly disclosed that "[t]his right shallterminate" if not exercised "pursuant to the notice provisions ofClause 7," which clause expressly characterized proper notice "asa condition precedent to the obligations of the Insurer." Policy,cls. 7-8. Third, and most importantly, it appeared that enforcinga duty to defend would secure little additional benefit for thePlaintiffs. The Plaintiffs wished to control their defensethrough retention of personal counsel, see Kelly Letter at 1,and the Policy, somewhat unusually for a directors' and officers'policy, see Pls.' Post-Trial Mem., Ex. B (The D & O Book),indicated that defense costs were to be advanced "prior to thefinal disposition of a Claim," Policy, cl. 8.

For these reasons, the Court requested that the parties limitfurther briefing to the alleged duty to advance defense costs.See Defs.' Post-Trial Mem. [Doc. No. 28] at 1-2. In addition,the parties were to address whether joinder of absent directorsand officers was "[n]eeded for [j]ust [a]djudication." Seeid.; Fed.R. Civ. P. 19. The Court, having considered theparties' submissions, addresses these issues below. III. DISCUSSION

A. Joinder of Necessary Parties

Because the Trustee's Complaint names seven other defendants,at least some of whom are also "Individual Insured[s]," the Courtfirst must consider whether these persons are "necessary" to thisaction under Federal Rule of Civil Procedure 19(a). Rule 19(a)provides that if feasible, a personal "shall be joined as a partyin the action if": (1) in the person's absence complete relief cannot be accorded among those already parties, or (2) the person claims an interest relating to the subject of the action and is so situated that the disposition of the action in the person's absence may (i) as a practical matter impair or impede the person's ability to protect that interest or (ii) leave any of the persons already parties subject to a substantial risk of incurring double, multiple, or otherwise inconsistent obligations by reason of the claimed interest.Fed.R. Civ. P. 19(a). National Union asserts that the absentinsureds are necessary under both of the above definitions. SeeDefs.' Post-Trial Mem. 3-4. The Court considers each in turn.

National Union contends under Rule 19(a)(1) that it "cannotobtain complete relief without the added directors and/orofficer[s] being joined since the parties will not be bound byany decision in the case which favors NU's position." Id. at 3.Its argument, however, misapprehends the nature of the relief tobe granted. The relief sought here is not a general declarationof National Union's duties, but rather a specific determinationof its duties to the Plaintiffs. Pls.' Post-Trial Mem. at 26-27; see Allstate Ins. Co. v. Daniels, 87 F.R.D. 1, 3 (D. Okl.1978) ("Allstate brings this action for a declaratory judgment ofthe rights and liabilities of Allstate and Phelps under theparticular insurance policy involved. Both of the parties whoserights and liabilities are to be determined herein are presentlyparties in this action."). Accordingly, the absence of the otherindividual insureds poses no bar to according complete reliefamong those already parties. See Hill v. Liberty Mut. Ins.Co., 453 F. Supp. 1342, 1344 (D. Va. 1978); cf. Royal Ins.Co. of Am. v. Caleb V. Smith & Son, Inc., No. 3:90CV651(WWE),1997 WL 835058, *3 & n. 3 (D. Conn. June 16, 1997) (concluding,under Rule 19(b), which "look[s] at similar issues" as Rule19(a), that an absent insured was not indispensable because"[a]lthough allowing this action to proceed without the presenceof one of the Texas defendants does not completely resolveRoyal's duty to defend and indemnify, it does serve a usefulpurpose and fully disposes of the issue with respect to three ofthe Texas defendants that are parties to this action").

Under Rule 19(a)(2)(i), National Union argues that "[g]iven thelimited funds available from the D&O policy," the interests ofabsent directors and officers may be impaired by disposition ofthe present action. Defs.' Post-Trial Mem. at 6. Although thePolicy indeed defines an aggregate "Limit of Liability," Policy,Decls., the interests of absent directors and officers do not,"as a practical matter," appear impaired. As National Union suggests, absent directors and officers may have an interest inchallenging the Plaintiffs' claims (and thus ensuring that thePolicy's limit is not "exhausted by one or two directors at theexpense of others"). See Defs.' Post-Trial Mem. at 6. Thisinterest, however, may be effectively asserted in a subsequentaction. The Policy expressly requires insureds to repay advancedpayments "severally according to their respective interests, inthe event and to the extent that the Insureds or the Companyshall not be entitled under the terms and conditions of thispolicy to payment of such Loss." Policy, cl. 8. Alternatively,absent directors and officers may have an interest in supportingthe Plaintiffs' claims (and thus securing the benefit of a"favorable ruling"). See Pls.' Post-Trial Mem. at 27. But thisinterest is "virtually identical" to that of the Plaintiffs.Pujol v. Shearson Am. Express, Inc., 877 F.2d 132, 135 (1stCir. 1989) (reasoning that a subsidiary failed to satisfy the"test" of Rule 19(a)(2)(i) in part because its interests in thecase were "virtually identical" to those of the named defendant);see Ace Am. Ins. Co. v. Paradise Divers, Inc.,216 F.R.D. 537, 540 (S.D. Fla. 2003) (concluding that a party was notnecessary under Rule 19(a) where he and the named defendant"share[d] the ultimate objective of obtaining a declaration ofcoverage under the insurance policy").

Turning finally to Rule 19(a)(2)(ii), National Union suggeststhat the absent directors and officers subject it to a "risk of incurring double, multiple, or otherwise inconsistentobligations." See Defs.' Post-Trial Mem. at 6. As a generalmatter, this Court does not disagree. Yet National Union assumedprecisely this risk when it extended coverage to "each and everyDirector, Officer, or Employee of the Company." Policy, cl. 1. Itsurely was foreseeable that these individual insureds couldcommit multiple or inconsistent wrongful acts. See Okada v.MGIC Indem. Corp., 608 F. Supp. 383, 390 (D. Haw. 1985)(rejecting the insurer's arguments under Rule 19(a) in partbecause the absent "directors may have participated in differentacts, requiring separate determination of coverage based ondifferent factual allegations"), overruled on other grounds by823 F.2d 276 (9th Cir. 1986). Thus, National Union's risk ofinconsistent obligations is due not to the absence of the otherdirectors and officers, but to the terms of its Policy.

For these reasons — contrary to National Union's "position,"Defs.' Post-Trial Mem. at 2 — the absent directors and officersare not "`Rule 19(a) person[s]' who should be joined `iffeasible,' let alone [] Rule 19(b) `indispensable part[ies].'"Pujol, 877 F.2d at 135. Accordingly, the Court proceeds toresolve the issues among the parties before it.

B. Duty to Advance Defense Costs As the Court explained at trial, to determine National Union'sduty, it must reconcile these apparently contradictory paragraphsof Clause 8: When the insurer has not assumed the defense of a Claim pursuant to this Clause 8, the Insurer shall advance nevertheless, at the written request of the Insured, Defense Costs prior to the final disposition of a Claim. Such advanced payments by the Insurer shall be repaid to the Insurer by the Insureds or the Company, severally according to their respective interests, in the event and to the extent that the Insureds or the Company shall not be entitled under the terms and conditions of this policy to payment of such Loss. The Insureds shall not admit or assume any liability, enter into any settlement agreement, stipulate to any judgment, or incur any Defense Costs without the prior written consent of the Insurer. Only those settlements, stipulated judgments and Defense Costs which have been consented to by the Insurer shall be recoverable as Loss under the terms of this policy. The Insurer's consent shall not be unreasonably withheld, provided that the Insurer, when it has not assumed the defense of a Claim pursuant to this Clause 8, shall be entitled to effectively associate in the defense and the negotiation of any settlement of any Claim, and provided further that in all events the Insurer may withhold consent to any settlement, stipulated judgment or Defense Costs, or any portion thereof, to the extent such Loss is not covered under the terms of this policy.Policy, cl. 8. The Plaintiffs maintain that the first of theseparagraphs "is unambiguous and unequivocal" in imposing a duty toadvance defense costs. Pls.' Post-Trial Mem. at 17. In response,National Union emphasizes that "the first paragraph does notstand alone." Defs.' Post-Trial Mem. at 10. Rather, under thesecond paragraph, National Union may decline to advance defense costs where — as here — the "Loss is not covered underthe terms of this policy." Id. at 10. The Court examines thesearguments below, pausing first to survey directors' and officers'insurance more generally.

1. Directors' and Officers' Insurance

Historically, directors' and officers' liability policies havenot imposed a "duty to defend." Pls.' Post-Trial Mem., Ex. C.(Joseph P. Monteleone & Nicholas J. Conca, Directors & OfficersIndemnification and Liability Insurance, 51 Bus. Law. 573 (1996))at 593. As commentators have explained, "the policies wereintended to cover the very `brain trust' of the corporation andthese individuals did not wish to have such delicate matters astheir personal defense left to the control of an insurancecompany." Id. Rather than a "duty to defend," then, directors'and officers' policies typically impose a "duty to pay" — thatis, to advance or reimburse defense costs. Pls.' Post-Trial Mem.,Ex. A (Dan L. Goldwasser & Alan A. Harley, Directors' andOfficers' Liability Insurance) § 12A.05[7][A]. This feature ofdirectors' and officers' policies has had two consequences ofnote. First, it has encouraged insurers to specify the timing ofpayments, with most insurers providing for payment only afterresolution of the claim. See id. § 12A.05[C]; Monteleone &Conca, supra, at 593 ("While under the `duty to defend'language it is relatively clear that the duty . . . [is] to pay for the defense expenses as they are rendered and billed,the issue in D&O policies is whether that obligation exists orwhether the obligation to pay arises only after the claim matteris concluded."). Second, it has required insurers to "reimpose"control over costs, often through consent provisions, which limitcovered losses to defense costs incurred with the insurer'sconsent. Goldwasser & Harley, supra, § 12A.05[7][a][ii].

2. The Policy

As is typical of directors' and officers' insurance, NationalUnion's Policy expressly disclaims a duty to defend. SeePolicy, cl. 1. Somewhat unusually, though, the Policy alsoprovides that National Union "shall advance nevertheless . . .Defense Costs prior to the final disposition of a Claim." Id.,cl. 8; see The D & O Book, supra ("Some policies, however, docontain an affirmative promise by an insurer to providecontemporaneous reimbursement or payment on behalf of an insured.Such a promise is highly desirable. . . ."). At trial, thePlaintiffs argued that the foregoing language imposed an"absolute duty." See Pls.' Post-Trial Mem. at 17. The Court wasnot persuaded.

Were the Court to adopt the Plaintiffs' interpretation, itwould effectively "read out" the accompanying consent provision.The Plaintiffs contend that this result is neverthelessappropriate because "this Court should construe the Policy against the Defendants." Pls.' Post-Trial Mem. at 20; seeBrotherhood of R.R. Trainmen v. Wilkins, 78 S.W.2d 6, 8(Ky.App. 1935). As the Plaintiffs suggest, Kentucky's5general principles of contract construction provide thatambiguous terms "will be construed strictly against the insurerand liberally in favor of the insured." Wilkins,78 S.W.2d at 8. The Kentucky Court of Appeals has cautioned, however, thatthese principles "do not authorize courts to disregard plain,unambiguous, and easily understood terms or provisions of acontract exempting the insurer from liability under certainconditions." Id.

Nor is the Court convinced that the concerns motivating theconsent provision are "unwarranted" here. Pls.' Post-Trial 22. Although the Plaintiffs must eventually repay the advancesif their losses are not covered, id. (citing Policy, cl. 8),the value of such repayments is necessarily diminished by the passage of time. See Monteleone & Conca, supra, at 596("Claim matters, particularly in the professional liability area,oftentimes are not concluded by settlement, dismissal, or a finaladjudication until years after their inception."). In addition,if National Union were obligated to advance all costs, subjectonly to an ultimate right of repayment, then it could not"address the reasonableness of the costs incrementally," Pls.'Mem. at 8. It would thus be denied a primary benefit of advancingrather than reimbursing defense costs. See Monteleone & Conca,supra, at 596 ("It has been common experience that partiesbecome more intransigent as more money is at issue.").

For these reasons, the Court declines to adopt theinterpretation urged by the Plaintiffs. The Court instead appliesthe construction suggested by National Union: that it assumes aduty to advance defense costs only if the claim suggests a"reasonable potential for coverage." See Policy, cl. 8(permitting National Union to "withhold consent to . . . DefenseCosts, or any portion thereof, to the extent such Loss is notcovered under the terms of this policy"). This reading, offeredby Varley at trial, better accommodates the cited paragraphs ofClause 8, appropriately "giving effect" to both the duty and theconsent provisions. See City of Louisa v. Newland,705 S.W.2d 916, 919 (Ky. 1986). This does not end the Court's inquiry, however. To thecontrary, the Court must now determine whether the Trustee'sComplaint suggests "a reasonable potential for coverage." Asnoted above, Kentucky law requires that insurance policies "beliberally construed and any doubts resolved in favor of theinsured." State Farm Mut. Auto. Ins. Co. v. Shelton413 S.W.2d 344, 347 (Ky.App. 1967). In addition, "exceptions andexclusions should be strictly construed so as to make insuranceeffective." State Auto. Mut. Ins. Co. v. Trautwein,414 S.W.2d 587, 589 (Ky.App. 1967).

Here, the exclusion on which National Union relies is broad,but not boundless. National Union must demonstrate that each ofthe wrongful acts alleged during the policy period is related toa prior wrongful act — that is, that the acts are "the same,related or continuous" or "arise from a common nucleus of facts."Policy, cl. 2(p). Although these terms might otherwise be"liberally construed," they have been more strictly interpretedwhen used to define exclusions from coverage. See KentuckySchool Bds. Ins. Trust v. Bd. of Educ., No. 2002-CA-001748-MR,2003 WL 22520018, *8 (Ky.App. Nov. 7, 2003) (agreeing with theinsured's position that "`when a policy's general coverage orinsuring clause uses terms like `arising out of' and `basedupon,'' we must liberally construe those terms," but "whenexclusionary provisions are at issue we must narrowly construe those terms to accomplish the same controlling purpose ofrendering insurance effective" (citation omitted)); see alsoSt. Paul Fire & Marine Ins. Co. v. Chong, 787 F. Supp. 183,187-88 (D. Kan. 1992) ("Because the court finds that the term`related' and the phrase `series of related wrongful acts' areambiguous, the court will construe the policy in the way mostfavorable to the insured. The court therefore finds that the term`related' as used in the policy at issue should be defined solelyin terms of causation." (citation omitted)); Arizona Prop. &Cas. Ins. Guar. Fund v. Helme, 735 P.2d 451, 456 (Ariz. 1987)("We do not believe that the word `related' as used in the policycan be equated with the phrase `logical connection.' Logic, likebeauty, is in the eye of the beholder and greatly depends uponthe subjective mental process of the reviewer."); cf. BayCities Paving & Grading, Inc. v. Lawyers' Mutual Ins. Co.,855 P.2d 1263, 1275 (Cal. 1993) (declining to limit "related" tocausally related acts, but noting that "[a]t some point, arelationship between two claims, though perhaps `logical,' mightbe so attenuated or unusual that an objectively reasonableinsured could not have expected they would be treated as a singleclaim under the policy").

The Court concludes that National Union has failed to meet its"burden of proving the applicability of the exclusion." KentuckySch. Bd. Ins. Trust, 2003 WL 22520018, at *9 (quoting Bd. of Public Educ. of Sch. Dist. of Pittsburgh v. Nat'l UnionFire Ins. Co. of Pittsburgh, 709 A.2d 910, 913 (Pa.Super.Ct.1998)). Two allegations — which the Court notes as examples only— suggest that the wrongful acts alleged during the policy periodare not uniformly "related" to prior acts. First, the Trusteealleges that the Plaintiffs acquiesced in the jointrepresentation of Computrex and its spin-offs, notwithstandingcounsel's clearly disclosed conflict of interest. See Trustee'sCompl. ¶¶ 80-81. Yet corporate counsel did not disclose thisconflict until January 16, 2001, approximately two weeks afterthe effective date of the Policy. Moreover, counsel's memorandumsuggested that the conflict had not yet materialized: "[It is]reasonably foreseeable that in the future the interests of Newcoand Computrex may become adverse, or at least somewhatincompatible." Mem. of 1/16/01, at 1. Thus, the Trustee'sComplaint suggests that the alleged negligent act — Plaintiffs'failing to "seek separate counsel" or to "request that itscounsel cease representation of what would become the newcorporation," Trustee's Compl. ¶ 81 — occurred after disclosureof the conflict and during the Policy period.

Second, the Trustee alleges wrongful acts related to the"orchestrated spin-off" of International and CX-IT. See, e.g.,id. ¶¶ 58,76, 79, 87-88, 104. At trial, National Unionsuggested that each of these acts was broadly "related" to the"Project Merlin" memorandum transmitted to the Plaintiffs on December 14,2000. See id. ¶ 76; "Project Merlin" Mem. Because "exceptionsand exclusions should be strictly construed," Shelton,413 S.W.2d 344, 347, however, this Court must examine the allegationswith greater care. Closer inspection of the "Project Merlin"memorandum reveals that the spin-off was, at that time, merely"[r]ecommended." "Project Merlin" Mem., Part II. Indeed, in thefollow-up memorandum dated January 5, 2001, Lindquist and Collinsurged the directors "to set a time to discuss in detail thestrategic alternatives [including spin-off] presented in thisdocument." Draft Discussion Mem. at 8. It appears, then, that thePlaintiffs — whose actions must be examined independently ofLindquist's and Collins's, cf. Policy, cl. 4 — took no actionregarding spin-off until after receipt of the follow-upmemorandum. Because this occurred during the Policy period, theCourt concludes that these alleged wrongful acts fall outside thescope of the prior acts exclusion.

Accordingly, the Court concludes that at least some of thewrongful acts alleged by the Trustee present a "reasonablepotential for coverage." Under National Union's interpretation ofthe Policy, it therefore has a duty to advance defense costs,subject to its ultimate right of repayment.

IV. CONCLUSION For the foregoing reasons, the Court DECLARES that NationalUnion has a duty to advance defense costs to the Plaintiffs priorto the final disposition of the Trustee's Complaint. Consistentwith commercial practice, the parties are to allocate defensecosts to potentially covered claims by negotiation. See §12A.05[7][D].


1. As the Plaintiffs note, the Policy's attached CoverageDescription names National Union's parent company, AmericanInternational Group, Inc., as insurer. See Pls.' Compl. ¶ 2;Policy, Coverage Description. Because the remainder of the Policyrefers exclusively to National Union, however, the Court will dothe same.

2. Ronald LaFleche is also the co-founder of Computrex,Trustee's Compl. ¶ 19, and the father of defendant TreffleLaFleche.

3. As Brown testified at trial, she and LaFleche are husbandand wife.

4. Varley also made passing reference to the exclusionsprovided for claims "arising out of, based upon or attributableto": "the gaining in fact of any [unlawful] profit or advantage"or "the committing of any criminal, fraudulent or dishonest act."See Varley Letter at 2-3 (quoting Policy, cl. 4). BecauseNational Union has offered no further argument or evidenceregarding these exclusions, the Court declines to address them.

5. Although it does not explicitly contest the issue, NationalUnion cites a decision of the Massachusetts Appeals Court in itspost-trial memorandum, perhaps suggesting that Massachusetts lawought apply. See Defs.' Post-Trial Mem. at 11 (citing SterliteCorp. v. Cont'l Cas. Co., 17 Mass. App. Ct. 316, 318 (1983)).Massachusetts has adopted a "functional" choice-of-law approach"explicitly guided by the Restatement (Second) of Conflict ofLaws (1971)." Clarendon Nat. Ins. Co. v. Arbella Mut. Ins.Co., 60 Mass. App. Ct. 492, 496 (2004) (citing, inter alia,Bushkin Assocs., Inc. v. Raytheon Co., 393 Mass. 622, 631(1985)). Section 193 of the Restatement, which governs "variouskinds of casualty insurance, such as . . . liability insurance,"Restatement, supra, § 193 cmt. a, generally directs courts tothe "state which the parties understood was to be the principallocation of the insured risk." Id. § 193. Accordingly, theCourt applies the law of Kentucky, the state in which Computrexhad its principal place of business.

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