In a recent article relating to directors, officers and entity insurance, our June 18, 2019 article, “Eight Points Worth Knowing about Management Liability Insurance and D&O coverage” to be exact, Agency Checklists made the following point about claims-made Directors & Officer (“D&O”) policies:
Reporting potential claims during the policy period in which an insured first has any idea that circumstances involving an alleged wrongful act could develop into a subsequent claim is essential.”
This need for prompt reporting of any event that might be considered a claim in the policy period when received was brought home in a recent federal case, BioChemics, Inc. and John Masiz v. AXIS Reinsurance Company (“AXIS”).
BioChemics raises money and the problems begin
BioChemics was a bio-pharmaceutical company located in Danvers, Massachusetts. The company developed and marketed what it claimed were patented a unique, powerful and broadly applicable form of patch-less, gel-based transdermal drug delivery technology. The company described the technology as a “liquid needle,” able to deliver drugs through the skin and into the bloodstream including prescription, over the counter, and veterinary drugs.
John Masiz, a Massachusetts lawyer, was the founder, president, CEO, and Chairman of the Board of Directors of BioChemics.
Starting in 2009, Mr. Masiz and two promoters working with him sold $9,000,000 in BioChemics securities to 70 investors located in at least 19 different states, ostensibly to allow the company to develop its technology.
Subpoenas from the Securities & Exchange Commission and the failure to report a potential claim
On May 5, 2011, the United States Securities & Exchange Commission (“SEC”) began a “Non-Public Formal Investigation” captioned with a formal ordered titled: “In the Matter of BioChemics, Inc., B-02641.” This Order mentioned Mr. Masiz by name, described him as the sole officer of the company, and identified several “possible” securities violations. Among the “possible” violations cited included instances of fraud and misrepresentation, beginning as early as 2009, that were aimed at misrepresenting the value of BioChemics securities to investors.
In conjunction with the opening of the investigation in May, |the SEC served document subpoenas on BioChemics seeking documentation relating to the security sales. In September 2011, the SEC issued another subpoena to BioChemics seeking additional documents “In the Matter of BioChemics, Inc. (B-02461).”
BioChemics retained counsel who responded to the May and September 2011 SEC document subpoenas.
BioChemics D&O policy with the XL Group and a failure of notice
BioChemics had D&O coverage through a “Private Company Reimbursement Insurance Policy” issued by Greenwich Insurance Company, a member of the XL Group (“XL”), The policy coverage included the period from November 13, 2010, to November 13, 2011.
This coverage, like all similar D&O coverage, was written on a claims-made basis. Under this policy, the insured must report a claim within the policy period in which it was received.
The XL policy defined a D&O “Claim” to include “a formal civil, criminal, administrative, or regulatory investigation of an ‘Insured Person’ which is commenced by the filing or issuance of notice of charges, formal investigative order or similar document specifically identifying in writing such insured person as a person against whom [the proceeding] may be commenced.”
In October, BioChemics and its broker, Brown & Brown of New York, Inc. (“B&B”), discussed moving the XL policy to a new carrier at the expiration of the XL policy on November 13, 2011. XL had advised that on renewal it would raise the premium and restrict the coverage.
When BioChemics submitted its application to XL, BioChemics and Mr. Masiz represented that there were no legal claims pending against them.
On November 9, 2011, Brown & Brown sent BioChemics a proposal for a D&O policy with AXIS. Page 4 of the proposal stated under the heading “Requirements Prior To Binding:
The following items must be received and accepted by the underwriter(s) prior to binding…
CONFIRMATION THAT ALL KNOWN CLAIMS HAVE BEEN NOTICED TO PRIOR CARRIER”
The same requirement (“Confirmation That All Known Claims Have Been Noticed To Prior Carrier”) appeared again at page 7 of the proposal, under the heading “CONDITIONS.”
The next day BioChemics endorsed the proposal and AXIS issued a policy effective for claims-made from November 13, 2011, to November 13, 2012. Like the XL policy, the AXIS policy was issued on a claims-made basis.
However, neither BioChemics nor Mr. Masiz had noticed XL of the SEC formal investigation of the subpoenas during XL’s policy period or any applicable extended reporting period.
AXIS’ policy conditions and exclusion for interrelated wrongful acts
The D&O policy AXIS issued to BioChemics had a $46,000 premium that afforded $5,000,000 in D&O coverage. 
The policy definitions included the relatively standard definition of “Wrongful Acts” meaning “any actual or alleged error, misstatement, misleading statement, act, omission, neglect, or breach of duty by any Insured Individual in their capacity as such;”
The policy defined “Interrelated Wrongful Acts” as “any and all Wrongful Acts that have as a common nexus any fact, circumstance, situation, event, transaction, cause or series of causally or logically connected facts, circumstances, situations, events, transactions or causes.”
The policy also had, however, an important definitional provision about reporting under prior policies. Based on the policy, interrelated wrongful acts were deemed as one claim with that claim’s reporting date being “deemed to be first made on the earlier date that: (1) any of the Claims is first made against an Insured under this Policy, or any prior policy, or (2) valid notice was given by the Insureds under this Policy or any prior policy of any Wrongful Act.”
The condition then provided that coverage under XL’s policy only applied concerning “Claims deemed to have been first made during the Policy Period and reported in writing to the Insurer in accordance with the terms herein.”
Thus, for example, if an insured did not report what could be considered a claim under a policy with prior insurer, and the insured receives subsequent claims with a subsequent insurer that involves related facts, circumstances, or transactions, there is a good chance the new carrier will deny the claim as having been first made outside the present policy period.
BioChemics notices AXIS about new subpoenas, and AXIS denies coverage based on the 2011 subpoenas being interrelated wrongful acts
In January 2012, the SEC served deposition subpoenas on Mr. Masiz and BioChemics’ Executive Vice-President for Research & Development and Chief Scientific Officer; BioChemics’ Senior Vice-President for Business Development; BioChemics’ comptroller; and two of BioChemics’ board members.
The SEC deposition subpoenas all carried the matter number as the 2011 subpoenas and were served “In the Matter of BioChemics, Inc. (B-02461).”
In March 2012, the SEC served an additional document subpoena on BioChemics and a document subpoena on Mr. Masiz.
In April 2012, BioChemics put AXIS on notice of the various subpoenas served by the SEC, including the deposition subpoena served upon Mr. Masiz.
In a May 18, 2012 letter to BioChemics’ outside counsel, AXIS denied coverage for all of the subpoenas and related proceedings.
The ground for AXIS’s denial of coverage was that that the SEC subpoenas were part of a single claim that was first made in May 2011, several months before the AXIS policy took effect. BioChemics had the duty to report this claim in 2011, during XL’s policy period, according to AXIS.
Therefore, AXIS contended, none of the subpoenas constituted a claim “first made” during the AXIS policy period, as required for coverage to apply.
BioChemics sues AXIS for coverage and its broker, Brown & Brown, for negligence
After AXIS denied coverage, BioChemics and Mr. Masiz sued AXIS for the breach of its duty to defend them in underlying proceedings commenced by the SEC.
BioChemics and Mr. Masiz Plaintiffs also sued Brown & Brown and its producer alleging negligence in connection with the placement of the D&O coverage for BioChemics. They also alleged Brown & Brown had moved BioChemics’ D&O coverage from the XL Group) to AXIS without: (i) discussing with BioChemics whether there were any circumstances or matters that should be reported to XL before the XL coverage expired, and (ii) calling to BioChemics’ attention the availability of an extending reporting period under the XL policy.
BioChemics filed a suit in the Massachusetts state court. AXIS, exercising its right as a foreign insurer, removed the case to the United States District Court at Boston.
The District Court granted AXIS summary judgment finding that BioChemics should have reported the 2011 subpoenas to XL under that insurer’s claims-made and reported policy. The court also found that the 2012 SEC actions involved interrelated wrongful acts with the 2011 subpoenas, and, therefore, all were considered under the AXIS policy as one claim with that one claim deemed made in 2011.
The District Court also granted Brown & Brown summary judgment finding that BioChemics had failed to establish a higher duty of care. The court summed up her ruling as, “Thus, a broker is not generally required to ensure that the insured understands ‘the full import’ of a policy provision, and an insured remains responsible for ascertaining the terms of coverage obtained by the broker.”
BioChemics and Mr. Masiz appealed the judge’s ruling to the First Circuit Court of Appeals claiming that the judge had incorrectly failed to find that the 2012 proceedings were new claims and claims related to the 2011 subpoenas.
The First Circuit Court of Appeals rules for AXIS
On appeal, BioChemics argued several issues. The appellate court addressed all the issues but rejected them.
The main points that BioChemics argued were that:
- That the District Court erred because the policy defines a “D&O Claim” in a way that makes the 2011 Order, the various subpoenas issued in its wake, and the 2012 Action, each a “Claim” in its own right, rather than merely components of a “Claim” that encompasses the SEC investigation as a whole;
- The policy’s definition of a “D&O Claim” defines a “D&O Claim,” to include “a written demand. .. for. .. non-monetary relief.” BioChemics argued that the first component of this two-part definition of a “D&O Claim” — the “written demand. .. for. .. non-monetary relief” — encompasses each of the 2012 subpoenas and, therefore each subpoena was a “Claim” in its own right;
- The District Court erred in relying on the Interrelated Wrongful Acts Provision to conclude that there was a single “Claim” that was “first made” when the SEC issued the 2011 Order;
With regard to BioChemics first point, the court conceded and noted that the District Court appeared to have concluded that, under the policy’s definition of a “D&O Claim,” the 2012 Action constitutes a “Claim” that was distinct from the “Claim” of which the 2011 Order was a part. However, the District Court continued on to conclude that those two otherwise distinct “Claim[s]” must be deemed to be “one Claim” pursuant to the Interrelated Wrongful Acts Provision because they have “a common nexus any fact, circumstance, situation, event, transaction, cause or series of causally or logically connected facts, circumstances, situations, events, transactions or causes.”
On BioChemics attempt to redefine the subpoenas as “written demand[s] for non-monetary relief” and therefore separate “Claims,” the court noted that the legal definition of “relief” required a party ask a court for relief. Additionally, the court found, “The 2012 subpoenas were requests made of a party for information. They were not requests made of a court for equitable redress or benefit, such as specific performance.” Thus, the court concluded, “the text of the …definition on which [BioChemics] rely would appear to refute their position that the definition of a “D&O Claim” treats each subpoena as a “Claim” in its own right.”
On the question of whether the District Court had improperly concluded that there was a common nexus between the 2011 subpoenas and the 2012 subpoenas, the court analyzed the underlying differences alleged by BioChemics. The court concluded the District Court’s ruling was correct.
Final ruling
The following was the court’s conclusion:
For the foregoing reasons, we affirm the District Court’s decisions granting summary judgment in favor of AXIS…”
Comment of claims-made and reported policies
As this case shows, the failure to report a potential claim can be fatal to coverage. My rules are:
- If you do not report a claim in the policy period, you will have no coverage. There is no “prejudice to the insurer” rule. Failure to report within the policy period on a claims-made policy will invalidate any coverage.
- If you do not report a potential claim in one policy period, and a related claim is made in another policy period, you may have no coverage.
- If you report a potential claim, there is little downside, and you may preserve coverage.
- At the end of each policy period, consider working with your larger insureds who have D&O or other claims-made policies in creating a “laundry list” of potential claims for submission to the carriers.
