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Denver Investment Advisors, LLC v. St. Paul Mercury Insurance Co.

United States District Court, D. Colorado

July 24, 2017

DENVER INVESTMENT ADVISORS, LLC, Plaintiff,
v.
ST. PAUL MERCURY INSURANCE COMPANY, Defendant.

          ORDER ON MOTIONS FOR SUMMARY JUDGMENT

          Michael E. Hegarty, United States Magistrate Judge.

         In this “duty to defend and indemnify” action, Plaintiff Denver Investment Advisors, LLC (“DIA”) seeks damages from Defendant St. Paul Mercury Insurance Company (“Travelers”) for Travelers' alleged failure to pay insurance benefits with respect to two underlying claims against DIA. At a conference before the Court on May 4, 2017, the parties expressed their interest in moving for summary judgment on the issue of whether insurance coverage existed for the claims before proceeding with discovery in the case. The Court stayed the action, and the present motions followed. The Court finds no genuine issues of material fact exist as to DIA's second, third, and fourth claims for relief; however, factual issues exist as to a portion of DIA's first claim for relief and, thus, the Court will grant in part and deny in part the cross motions.

         FINDINGS OF FACT

         Cross-motions for summary judgment are examined under the usual Rule 56 standards, Saieg v. City of Dearborn, 641 F.3d 727, 733-34 (6th Cir. 2011), with the court viewing all facts and reasonable inferences in the light most favorable to the nonmoving party.[1] See Edwards v. Briggs & Stratton Ret. Plan, 639 F.3d 355, 359 (7th Cir. 2011).

         1. DIA is a Denver-based limited liability company that manages investment assets for clients. Affidavit of Glenn T. Rippey, May 25, 2017 (“Rippey Aff.”) ¶ 5. DIA's clients entrust DIA to invest their assets in stocks, bonds, and other financial investment vehicles. Id.

         2. Travelers issued its SelectOne for Investment Adviser and Funds Insurance Policy No. ZPL-14T25283-12-N2 (the “2012 Policy”) to DIA for the policy period of October 31, 2012 to October 31, 2013. ECF No. 46-1. Travelers also issued its SelectOne for Investment Adviser and Funds Insurance Policy No. ZPL-61M18413-14-N2 (the “2014 Policy”) to DIA for the policy period of October 31, 2014 to October 31, 2015. ECF Nos. 46-2, 46-3.

         3. On August 27, 2013, an attorney representing several retired members of DIA sent a demand letter to the Management Committee of DIA seeking damages for amounts allegedly due to the claimants for breach of contract, by changing the method in which the “Aggregate Payout Limit” (set forth in a governing Operating Agreement described below) may be calculated and by creating “false retirements” (the “Beserra Claim”). ECF No. 49-1. That is, “[s]tarting around 2007, certain active Members of DIA began to partially withdraw with respect to small percentages of their Membership Economic Interest” and “[a]s a result of these partial retirements by active Members of DIA, the Earnout Payments going to the active Members instead of the true retired Members, including Claimants, grew from 20% to over 50% of the aggregate Earnout Payments.” Beserra Amended Arbitration Demand ¶¶ 94, 99, 107, 113, ECF No. 49-3. The claimants also alleged that DIA breached its fiduciary duty to them in numerous ways, including failing to act with the utmost care to avoid self-dealing at the expense of the claimants. Id. ¶ 143(g).

         4. After arbitration of the claims by an American Arbitration Association (“AAA”) panel, the panel issued a final award in favor of the claimants concluding that (1) “DIA breached § 12.5.8 of the Operating Agreements in effect before the retirement of Claimants . . . when it applied the 50% Rule amendment to determine their shortfall payments. . . . DIA further breached by failing to pay [Claimants] their tangible capital accounts at the time of their last earnout payments.”; and (2) “DIA's disproportionate and methodical use of partial retirements and/or reductions for its incumbent members of less than .8% had the effect of severely compromising the ability of all of the Claimants to receive their shortfall payments and the repayment of their tangible capital accounts, ” which was “inconsistent with the reasonable expectations of the Claimants and constituted a contractual breach of the actual and implied duties of good faith in the Operating Agreements signed by all of the Claimants.” Final Award, ECF No. 49-5 at 14, 17.

         5. The panel awarded damages of $7, 791, 526.25, plus interest of $2, 768, 812, and claimants' attorney's fees and costs of $2, 335, 328.37, as well as AAA costs and fees of $135, 919.46, for a total of $13, 031, 586.88. Id. at 21-22.

         5. Thereafter, DIA and the remaining claimants entered into a settlement agreement for the exact amounts awarded by the panel.

         6. DIA incurred $1, 268, 429.00 in defense costs for the Beserra Claim, which Travelers refused to pay. Rippey Aff. ¶¶ 10, 27-28.

         7. In September 2015, the same attorney who represented the Beserra claimants made a second demand to DIA on behalf of four additional former members of DIA (the “Kidd Claim”). October 2015 email correspondence between Kris Kostolansky and DIA's defense counsel, ECF No. 49-6.

         8. After discussions and negotiations failed to resolve the Kidd Claim, two of the four claimants filed an arbitration demand against DIA on January 20, 2016. ECF No. 49-7. The Kidd claimants made substantially similar allegations as the Beserra claimants and brought claims for breach of contract and breach of fiduciary duty against DIA. Id.

         9. Shortly after the Kidd Arbitration Demand was filed, the parties agreed to settle the Kidd Claim for $3, 800, 000. Rippey Aff. ¶ 16. Of that amount, $3, 051, 715.05 was for damages and the remaining $748, 284.95 was for interest and the claimants' attorney's fees. Id.

         10. DIA incurred approximately $332, 000.00 in defense costs in connection with the Kidd Claim. Rippey Aff. ¶ 17.

         11. The 2012 and 2014 insurance policies at issue in this case (“Policies”) each include a “General Terms, Conditions and Limitations” section, as well as two Insuring Agreement Sections pertinent here: (1) the Management Liability Insuring Agreement for Privately Held Investment Advisers and Private Equity Firms (the “Management Liability Insuring Agreement”) (ECF No. 46-1 at 38-42; ECF No. 46-2 at 34-35; ECF No. 46-3 at 1-3); and (2) the Employment Practices Liability Insuring Agreement (the “EPL Insuring Agreement”) (ECF No. 46-1 at 44-46; ECF No. 46-3 at 4-6). 12. The Policies contain a number of endorsements that modify, amend, or replace certain provisions of the foregoing sections; however, the relevant provisions of the Policies are largely the same.

         13. The Management Liability Insuring Agreements have limits of liability of $10 million and the EPL Insurance Agreements have limits of liability of $1 million. ECF 46-1 at 18; 46-2 at 16.

         14. The “Company Liability Coverage Part” of the Management Liability Insuring Agreement provides as follows:

Company Liability Coverage
The Insurer shall pay on behalf of the Company Loss for which the Company becomes legally obligated to pay on account of any Claim first made against the Company during the Policy Period or, if exercised, the Additional Extended Discovery Period, for a Management Practices Act taking place before or during the Policy Period.

ECF No. 46-1 at 38.

         15. The term “Wrongful Act” noted generally in the Policies[2] is defined in the Management Liability Insuring Agreement to mean “Management Practices Act, ” which in turn is defined as follows:

Management Practices Act means:
(a) any error, misstatement, misleading statement, act, omission, neglect, or breach of duty actually or allegedly committed or attempted by any Insured Person in their capacity as such, or in an Outside Position or, with respect to the Company Liability Coverage, by the Company; or
(b) any matter claimed against the Insured Persons solely by reason of their serving in such capacity or in an Outside Position; provided that Management Practices Act does not include any Employment Practices Act, Fiduciary Act, or Errors and Omissions Act.
* * *

Id. at 39-40.

         16. Paragraph 9 of the “Exclusions Applicable to All Coverages of This Insuring Agreement” provides that Travelers “shall not be liable for Loss on account of any Claim made against any Insured” . . . “for dividends or distributions of profits of the Company; provided that this exclusion shall not apply to Defense Costs.” Id. at 40, 42.

         17. Paragraph 1 of the “Exclusions Applicable to Company Liability Coverage” provides that Travelers “shall not be liable under the Company Liability Coverage for Loss on account of any Claim made against the Company”:

for liability of the Company under any contract or agreement, either oral or written; provided that this exclusion shall not apply to the extent that the Company would have been liable for such Loss in the absence of such contract or agreement; . . .

Id. at 42.

         18. The EPL Insuring Agreement's sole Coverage Part provides as follows:

         Employment Practices Liability Coverage

The Insurer shall pay on behalf of the Insureds Loss for which the Insureds become legally obligated to pay on account of any Claim first made against them, individually or otherwise, during the Policy Period, or, if exercised, the Additional Extended Discovery Period, for an Employment Practices Act taking place before or during the Policy Period, provided that such Claim is brought by or on behalf of any federal, state, provincial or local governmental body, or any Employee, or Director or Officer.

Id. at 44.

19. “Employment Practices Act” is defined as “any actual or alleged”:
* * *
(d) wrongful discharge or termination, whether actual or constructive;
* * *
related to the actual or prospective employment of any person by the Company and: (i) committed or attempted by any of the Insureds, in their capacity as such, or (ii) for which any of the Insureds are held legally liable, in their capacity as such, or related to the actual or prospective employment of any person by any entity in which any Director or Officer services in an Outside Position and committed or attempted by such Director or Officer in their capacity in such Outside Position.
* * *

Id. at 44-45.

20. The Policies define “Claim” to include
(a) a written demand against any Insured for monetary damages;
* * *
(d) an arbitration proceeding against any Insured, which shall be deemed commenced by such Insured's receipt of an arbitration petition;
* * *

Id. at 23.

         21. Each Policy contains an “Allocation” provision providing:

If on account of any Claim . . . the Insureds incur an amount consisting of both Loss covered by this Policy and loss not covered by this Policy because the Claim includes both covered and uncovered matters, the Insureds and the Insurer shall allocate such amount between covered Loss and uncovered loss, including any defense costs and judgments, using their best efforts to determine a fair and proper allocation of all such amounts based upon the relative legal exposures of the parties to covered and uncovered matters.

Id. at 28.

         22. The Policies also state that the “Insurer shall advance, on behalf of the Insureds, Defense Costs which the Insureds have incurred in connection with Claims made against them, before disposition of such Claims, provided that to the extent that it is finally established that any such Defense Costs are not covered under this Policy, the Insureds . . . agree to repay the Insurer such Defense Costs.” Id. at 28.

         23. As referenced above, the Beserra and Kidd Claims arose from allegations related to an “Amended and Restated Operating Agreement” executed by DIA and its members, including the claimants (“Operating Agreement”).[3]

         24. Section 12 of the Operating Agreement, particularly subsections 12.4 and 12.5, pertained to the withdrawal of members from DIA and accompanying payments that would result therefrom.

         Section 12.4 provided as follows:

12.4 WITHDRAWAL OF MEMBER.
A Member is eligible to withdraw at any time, as long as such withdrawal does not constitute a breach of this Operating Agreement or any existing employment contract between the Member and the Company. A Member's Resignation3 or Retirement4 shall be a withdrawal from the Company. The Withdrawing Member's Membership Economic Interest and other Membership Rights will be terminated and the Withdrawing Member shall be entitled to the Earnout Payments according to the Member's Membership Earnout Interest as described in Section 12.5. A Member may partially withdraw and work a reduced work schedule with the prior consent of and upon terms determined by the Management Committee.

ECF No. 46-4 at DIA 00000200.

         25. Section 12.5 provided for payment of certain amounts to withdrawn/former members as follows, in pertinent part:

a. Section 12.5.6 provided for “Earnout Payments” to be made over sixteen quarters post-withdrawal, “calculated by multiplying the Member's Membership Earnout Interest or the reduction in the Member's Membership Earnout Interest by that period's Excess Earnings”;
b. Section 12.5.7 defined “Excess Earnings” as 45% of DIA's total quarterly revenue, to the extent that total quarterly revenue exceeded $6.25 million; and proportionately lower than 45% to the extent total quarterly revenue was less than $6.25 million;
c. Section 12.5.8 established an Aggregate Payout Limit, which placed a cap on the total amount of Earnout Payments that could be made in a given quarter of 20% of DIA's total quarterly revenue;
d. Section 12.5.9 established the process by which “Shortfall Payments” would be paid, where such payments reflected Earnout Payments that would have been paid in prior quarters but for exceeding the Aggregate Payout Limit during that quarter;
e. Section 12.5.10 provided for the return of the balance of a withdrawn member's Tangible Capital Account (containing the capital contribution of that member) at the time of the Final Earnout Payment; and
f. Section 12.5.11 stated that “[t]he Recipient of Earnout Payments shall have no Membership Economic Interest, no Membership Voting Interest and no other Membership Rights, including the ability to participate in the Company's profits or management in any way, except to ...

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