The Law

Legal Spotlight

A look at the latest decisions impacting the industry.
By: | March 3, 2017 • 4 min read

Insured-Vs.-Insured Exclusion Cited in Dismissal

Cheryl Sullivan became a member of the JEI board of directors in April 2013, upon the death of her father, Jerry Paulson, who had expanded a small butcher shop into JEI, a retail and grocery store chain in Minnesota, Wisconsin and Florida. Sullivan redeemed her 28 percent of all company shares a few months later, after which she and her daughters sued the company, saying that JEI’s directors “designed to lower the value of their shares.”


Sullivan and her daughters reached a confidential settlement with JEI. The company sought coverage for the payment under a directors and officers policy issued by U.S. Specialty Insurance Co.

The insurer rejected the claim and JEI filed suit. After the U.S. District Court for the District of Minnesota ruled against JEI, it appealed to the U.S. 8th Circuit Court of Appeals.

On Jan. 11, the appeals court agreed with U.S. Specialty. The two main issues related to the policy’s insured-versus-insured exclusion and its allocation clause. The insured-versus-insured exclusion barred coverage for any suit brought by a former director of the company.

But Sullivan’s daughters were not former directors, and the allocation clause provided that losses should be allocated between covered and uncovered claims. The appeals court ruled that Sullivan was “an active participant” in the lawsuit as well as its “driving force.” Because of that, the policy’s allocation provision for coverage as long as a director or officer “did not solicit, assist or actively participate in the lawsuit” did not apply to Sullivan or her daughters.

Scorecard: The insurance company does not need to indemnify JEI for the settlement payment.

Takeaway: The allocation clause “does not restore coverage for a suit brought with the active participation of an insured person,” the court ruled.

Bird Flu Transmission is Crucial to Case

Farms in minnesota from eight to 20 miles away from rembrandt Enterprises’ egg-producing facilities euthanized their chickens due to avian bird flu in 2015. In April and May of that year, Rembrandt’s flock was infected and a month later, more than 9 million birds were euthanized.

Rembrandt filed a claim with Illinois Union Insurance Co., which had issued a premises pollution liability insurance policy. The policy insured Rembrandt’s farms from the “discharge, dispersal, release, escape, migration or seepage of any … irritant, contaminant, or pollutant … on, in, into, or upon [covered] land and structures.”

The carrier denied the claim, saying the flu was not a contaminant and that coverage excluded losses relating to “naturally occurring materials” unless they were present because of human activities. Illinois Union Insurance later conceded the flu was a contaminant, but said there was no proof that human activities led to the bird flu being transmitted to Rembrandt’s farms. Rembrandt filed suit, claiming the carrier breached its policy. The carrier sought to dismiss the case.

An infectious diseases expert on behalf of Rembrandt said the bird flu was “detected in air samples taken inside and outside infected poultry houses,” and that the flock depopulations at nearby farms created a “virus cloud” that carried the flu to Rembrandt’s farms.

On Jan. 12, the U.S. District Court for the District of Minnesota refused to dismiss the case, ruling further hearings were needed.


“Despite extensive briefing, on this record, the Court is simply not in a position to determine as a matter of law how the bird flu spread to Rembrandt’s farms and, accordingly, neither party is entitled to summary judgment,” the court ruled.

Scorecard: No decision was issued on whether the farms will collect for the loss of more than 9 million birds.

Takeaway: While the disease may be spread by air, it is not clear whether it was aided by human activity.

Court: Policy Excludes $64 Million Claim

Imprudent loans, resulting in more than $64 million in losses, caused the California Department of Financial Institutions to close Security Pacific Bank.

The Federal Deposit Insurance Corp. (FDIC), which was named receiver, filed suit against BancInsure Inc., seeking coverage for losses “arising from the negligence, gross negligence and breach of fiduciary duty allegedly committed by” the failed bank’s former directors and officers.

The U.S. District Court for the Central District of California concluded that the D&O policy issued by BancInsure covered the FDIC’s claims. The U.S. 9th Circuit Court of Appeals reversed that decision on Jan. 10.

The D&O policy excluded coverage for losses arising from legal actions brought by “any successor, trustee, assignee or receiver” of the bank. The FDIC argued that it is “not a ‘receiver’ within the meaning of the insured-versus-insured exclusion because, by statute, it has a ‘unique role’ representing ‘multiple interests,’ ”including shareholders and depositors. It pointed to an exception to the exclusion for “a shareholder’s derivative action,” which could be filed against the failed bank by shareholders who are not insureds under the D&O policy.

The appeals court rejected that argument. “We think the term ‘receiver’ is clear and unambiguous and includes the FDIC in its role as receiver of Security Pacific,” it ruled, ordering the lower court to dismiss the case.

Scorecard: The FDIC will not be able to collect more than $64 million in losses from BancInsure.

Takeaway: The right of the FDIC to bring a shareholder derivative action was secondary to the FDIC’s right to bring the same claims directly as the failed bank’s receiver.

Anne Freedman is managing editor of Risk & Insurance. She can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Risk Focus: Cyber

Expanding Cyber BI

Cyber business interruption insurance is a thriving market, but growth carries the threat of a mega-loss. 
By: | March 5, 2018 • 7 min read

Lingering hopes that large-scale cyber attack might be a once-in-a-lifetime event were dashed last year. The four-day WannaCry ransomware strike in May across 150 countries targeted more than 300,000 computers running Microsoft Windows. A month later, NotPetya hit multinationals ranging from Danish shipping firm Maersk to pharmaceutical giant Merck.


Maersk’s chairman, Jim Hagemann Snabe, revealed at this year’s Davos summit that NotPetya shut down most of the group’s network. While it was replacing 45,000 PCs and 4,000 servers, freight transactions had to be completed manually. The combined cost of business interruption and rebuilding the system was up to $300 million.

Merck’s CFO Robert Davis told investors that its NotPetya bill included $135 million in lost sales plus $175 million in additional costs. Fellow victims FedEx and French construction group Saint Gobain reported similar financial hits from lost business and clean-up costs.

The fast-expanding world of cryptocurrencies is also increasingly targeted. Echoes of the 2014 hack that triggered the collapse of Bitcoin exchange Mt. Gox emerged this January when Japanese cryptocurrency exchange Coincheck pledged to repay customers $500 million stolen by hackers in a cyber heist.

The size and scope of last summer’s attacks accelerated discussions on both sides of the Atlantic, between risk managers and brokers seeking more comprehensive cyber business interruption insurance products.

It also recently persuaded Pool Re, the UK’s terrorism reinsurance pool set up 25 years ago after bomb attacks in London’s financial quarter, to announce that from April its cover will extend to include material damage and direct BI resulting from acts of terrorism using a cyber trigger.

“The threat from a cyber attack is evident, and businesses have become increasingly concerned about the extensive repercussions these types of attacks could have on them,” said Pool Re’s chief, Julian Enoizi. “This was a clear gap in our coverage which left businesses potentially exposed.”

Shifting Focus

Development of cyber BI insurance to date reveals something of a transatlantic divide, said Hans Allnutt, head of cyber and data risk at international law firm DAC Beachcroft. The first U.S. mainstream cyber insurance products were a response to California’s data security and breach notification legislation in 2003.

Jimaan Sané, technology underwriter, Beazley

Of more recent vintage, Europe’s first cyber policies’ wordings initially reflected U.S. wordings, with the focus on data breaches. “So underwriters had to innovate and push hard on other areas of cyber cover, particularly BI and cyber crimes such as ransomware demands and distributed denial of service attacks,” said Allnut.

“Europe now has regulation coming up this May in the form of the General Data Protection Regulation across the EU, so the focus has essentially come full circle.”

Cyber insurance policies also provide a degree of cover for BI resulting from one of three main triggers, said Jimaan Sané, technology underwriter for specialist insurer Beazley. “First is the malicious-type trigger, where the system goes down or an outage results directly from a hack.

“Second is any incident involving negligence — the so-called ‘fat finger’ — where human or operational error causes a loss or there has been failure to upgrade or maintain the system. Third is any broader unplanned outage that hits either the company or anyone on which it relies, such as a service provider.”

The importance of cyber BI covering negligent acts in addition to phishing and social engineering attacks was underlined by last May’s IT meltdown suffered by airline BA.

This was triggered by a technician who switched off and then reconnected the power supply to BA’s data center, physically damaging servers and distribution panels.

Compensating delayed passengers cost the company around $80 million, although the bill fell short of the $461 million operational error loss suffered by Knight Capital in 2012, which pushed it close to bankruptcy and decimated its share price.

Mistaken Assumption

Awareness of potentially huge BI losses resulting from cyber attack was heightened by well-publicized hacks suffered by retailers such as Target and Home Depot in late 2013 and 2014, said Matt Kletzli, SVP and head of management liability at Victor O. Schinnerer & Company.


However, the incidents didn’t initially alarm smaller, less high-profile businesses, which assumed they wouldn’t be similarly targeted.

“But perpetrators employing bots and ransomware set out to expose any firms with weaknesses in their system,” he added.

“Suddenly, smaller firms found that even when they weren’t themselves targeted, many of those around them had fallen victim to attacks. Awareness started to lift, as the focus moved from large, headline-grabbing attacks to more everyday incidents.”

Publications such as the Director’s Handbook of Cyber-Risk Oversight, issued by the National Association of Corporate Directors and the Internet Security Alliance fixed the issue firmly on boardroom agendas.

“What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.” — Jimaan Sané, technology underwriter, Beazley

Reformed ex-hackers were recruited to offer board members their insights into the most vulnerable points across the company’s systems — in much the same way as forger-turned-security-expert Frank Abagnale Jr., subject of the Spielberg biopic “Catch Me If You Can.”

There also has been an increasing focus on systemic risk related to cyber attacks. Allnutt cites “Business Blackout,” a July 2015 study by Lloyd’s of London and the Cambridge University’s Centre for Risk Studies.

This detailed analysis of what could result from a major cyber attack on America’s power grid predicted a cost to the U.S. economy of hundreds of billions and claims to the insurance industry totalling upwards of $21.4 billion.

Lloyd’s described the scenario as both “technologically possible” and “improbable.” Three years on, however, it appears less fanciful.

In January, the head of the UK’s National Cyber Security Centre, Ciaran Martin, said the UK had been fortunate in so far averting a ‘category one’ attack. A C1 would shut down the financial services sector on which the country relies heavily and other vital infrastructure. It was a case of “when, not if” such an assault would be launched, he warned.

AI: Friend or Foe?

Despite daunting potential financial losses, pioneers of cyber BI insurance such as Beazley, Zurich, AIG and Chubb now see new competitors in the market. Capacity is growing steadily, said Allnutt.

“Not only is cyber insurance a new product, it also offers a new source of premium revenue so there is considerable appetite for taking it on,” he added. “However, whilst most insurers are comfortable with the liability aspects of cyber risk; not all insurers are covering loss of income.”

Matt Kletzli, SVP and head of management liability, Victor O. Schinnerer & Company

Kletzli added that available products include several well-written, broad cyber coverages that take into account all types of potential cyber attack and don’t attempt to limit cover by applying a narrow definition of BI loss.

“It’s a rapidly-evolving coverage — and needs to be — in order to keep up with changing circumstances,” he said.

The good news, according to a Fitch report, is that the cyber loss ratio has been reduced to 45 percent as more companies buy cover and the market continues to expand, bringing down the size of the average loss.

“The bad news is that at cyber events, talk is regularly turning to ‘what will be the Hurricane Katrina-type event’ for the cyber market?” said Kletzli.

“What’s worse is that with hurricane losses, underwriters know which regions are most at risk, whereas cyber is a global risk and insurers potentially face huge aggregation.”


Nor is the advent of robotics and artificial intelligence (AI) necessarily cause for optimism. As Allnutt noted, while AI can potentially be used to decode malware, by the same token sophisticated criminals can employ it to develop new malware and escalate the ‘computer versus computer’ battle.

“The trend towards greater automation of business means that we can expect more incidents involving loss of income,” said Sané. “What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.

“We’re likely to see a growing number of attacks where the aim is to cause disruption, rather than demand a ransom.

“The paradox of cyber BI is that the more sophisticated your organization and the more it embraces automation, the bigger the potential impact when an outage does occur. Those old-fashioned businesses still reliant on traditional processes generally aren’t affected as much and incur smaller losses.” &

Graham Buck is editor of He can be reached at