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PARTNERSHIP UMBRELLA, INC., et al. v. FEDERAL INSURANCE CO.



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PARTNERSHIP UMBRELLA, INC., et al.

v.

FEDERAL INSURANCE CO.


June 9, 2000

Record No. 991876

THE PARTNERSHIP UMBRELLA, INC., ET AL.

v. .

FEDERAL INSURANCE COMPANY

From the Circuit court of the City of Alexandria

Thomas A. Fortkort, Judge Designate

Present: Carrico, C.J., Hassell, Keenan, Koontz, Kinser, and
Lemons, JJ., and Poff, Senior Justice


OPINION BY JUSTICE LAWRENCE L. KOONTZ, JR

This appeal concerns the disputed interpretation of the
insuring clauses of an executive liability and indemnification
policy. The insurance company instituted the litigation as a
declaratory judgment action. The policy-owner counterclaimed for
breach of contract. The parties stipulated that a determination
by the trial court unfavorable to the policy-owner on two
questions of law concerning the insuring clauses would result in
an agreed dismissal of the policy-owner’s counterclaim and
entry of final judgment for the insurance company. Accordingly,
under this unusual procedural posture, the trial court’s
judgment and consequently our review of that judgment, do not
involve the merits of the policy-owner’s claim or any
defenses that the insurance company might assert at trial based
upon exclusions of the policy, the relevant statutory scheme, or
such other factors. Nonetheless, a full recitation of the facts
developed in the trial court is necessary in order to place the
legal issues under review in their proper context.

BACKGROUND

On October 9, 1990, Federal Insurance Company (Federal) issued
an executive liability and indemnification policy (the policy)
with a policy limit of $1 million to The Partnership Umbrella,
Inc. (Partnership Umbrella), a Virginia corporation affiliated
with United Way of America, Inc. (United Way). The policy
provided two forms of coverage. As defined by the policy in
"Insuring Clause 1," Federal was obligated under the
"Executive Liability Coverage" to pay on behalf of each
of the Insured Persons all Loss for which the Insured Person is
not indemnified by the Insured Organization and which the Insured
Person becomes legally obligated to pay on account of any claim
first made against him, individually or otherwise . . .
for a Wrongful Act committed, attempted, or allegedly committed
or attempted, by the Insured Person(s) before or during the
Policy Period.

As defined by the policy in "Insuring Clause 2,"
Federal was obligated under the "Executive Indemnification
Coverage" to pay on behalf of the Insured Organization all
Loss for which the Insured Organization grants indemnification to
each Insured Person, as permitted or required by law, which the
Insured Person has become legally obligated to pay on account of
any claim first made against him, individually or otherwise
. . . for a Wrongful Act committed, attempted, or
allegedly committed or attempted, by such Insured Person(s)
before or during the Policy Period.

Relevant to the issues in this appeal, Stephen J. Paulachak
was a director and president of Partnership Umbrella in early
1992, when a federal grand jury began an investigation into
alleged malfeasance by William Aramony, president and chief
executive officer of United Way. In addition to his role as
president and director of Partnership Umbrella, in which
positions he had been installed by Aramony, Paulachak also served
as Aramony’s "personal assistant" and acted as a
"paid consultant" to United Way. Aramony was a director
and chairman of the board of Partnership Umbrella.

On April 9, 1992, Paulachak advised Federal through its agent
that "[t]here appear to be indications that United Way of
America intends to take legal actions against me and/or
Partnership Umbrella" and that "[t]here may also be a
governmental investigation arising due to allegations made by
United Way." On April 10, 1992, Paulachak’s counsel
requested a formal opinion from Federal’s legal counsel on
whether the insurance policy would provide coverage to Paulachak
in the event that he was a target of a pending federal grand
jury’s investigation.

Federal requested that Paulachak provide it with a copy of a
report of an independent investigation conducted on behalf of
United Way. Although that report expressed concern about the
close relationship between Aramony and Paulachak and the
"lucrative consulting arrangements" between United Way
and Paulachak authorized by Aramony, Federal concluded that there
had not yet been a claim alleging a "Wrongful Act" as
defined in the policy, and declined to provide coverage for
Paulachak at that time.[1]

On May 19, 1992, Paulachak was subpoenaed to appear before the
federal grand jury. Federal was advised of this development, but
again stated that it would not provide coverage for Paulachak in
the absence of an allegation that he had committed a
"Wrongful Act."

On July 14, 1992, Aramony and Hamp Coley, Partnership
Umbrella’s only other director, authorized the payment of
"advances for expenses" pursuant to Code
? 13.1-878 to cover Paulachak’s legal expenses arising
from the federal grand jury’s investigation. This action was
undertaken upon the advice of Partnership Umbrella’s special
counsel and with Aramony and Coley acting as a quorum of the
board members eligible to decide such matters. See Code
? 13.1-878(C)(providing that decisions to advance legal
expenses "shall be made in the manner specified in
? 13.1-880" for making indemnification decisions). It
was agreed that if it were subsequently determined that the
advances to Paulachak would violate the relevant Code provisions,
the advances would constitute a loan to Paulachak repayable at 7%
interest.

Paulachak signed a "statement of good faith belief
pursuant to Virginia Code Section 13.1-878" in which he
stated that his conduct as an officer and director of Partnership
Umbrella was both lawful and in the best interests of the
organization. This document is dated July 14, 1992, but a
notary’s attestation form at the foot of the document was
never completed.[2] As a result of the decision to
advance expenses to Paulachak, Partnership Umbrella alleges that
it paid attorney’s fees on Paulachak’s behalf for the
period beginning in February 1992 until May 1994 exceeding
$307,000 and that approximately $69,918 in fees incurred during
that time are still owed.

On May 3, 1994, Paulachak received a letter from the United
States Attorney for the Eastern District of Virginia indicating
that Paulachak was a target of the grand jury’s
investigation. Paulachak advised Federal of this development and
contended that the "target letter" was a "claim
triggering coverage" under the policy. Federal responded
that this letter did not constitute a claim of a "Wrongful
Act" under the policy and declined to provide coverage.

On September 13, 1994, Aramony, Paulachak, and another United
Way employee were named in a multi-count indictment alleging that
they were involved in a conspiracy to use Partnership Umbrella
"for illegitimate objectives . . . including the
spending of funds in the possession of [Partnership Umbrella] for
the personal use, benefit and pleasure of the defendants and
certain of their associates." Among the other crimes charged
in the indictment were wire fraud and filing false tax returns.
Following Paulachak’s indictment, Federal denied liability
under Insuring Clause 1 of the policy on the ground that
Paulachak’s legal expenses were subject to a
"dishonesty exclusion" in the policy.

On April 3, 1995, Paulachak was convicted on eight counts of
the indictment including the conspiracy count, one count of wire
fraud, and six counts related to the filing of false tax returns.[3] On April 7, 1995, Federal
advised Partnership Umbrella that no determination of liability
under Insuring Clause 2 could be made until Partnership Umbrella
decided whether it would indemnify Paulachak.

On April 18, 1995, Coley, acting as de facto chairman
of the board of directors of Partnership Umbrella, convened a
meeting of the board. Paulachak, who was still a director,
attended the meeting with his personal attorney. Coley
"approved" the appointment of Preston Garrison as a new
board member. Coley and Garrison then approved Paulachak’s
request that "in the event of his involuntary termination
due to legal proceedings, that he be granted continued
compensation and benefits for a one year period." Based upon
the representation of Paulachak’s counsel that Federal would
require a formal decision on indemnification, Coley and Garrison
also approved a proposal to indemnify Paulachak, which Coley was
to have reviewed by outside counsel. At the conclusion of the
meeting, Coley was formally elected as chairman of the board of
directors.

On May 25, 1995, Coley and Garrison approved a formal
resolution of indemnification "for attorney’s fees and
expenses which [Paulachak] incurred from May 3, 1994, the date of
the target letter, through the conclusion of any proceeding with
respect to the indictment, including any appeal." The
resolution states that the indemnification was based upon a
determination that Paulachak "was not adjudged guilty on the
basis that any personal benefit was improperly received by him
from [Partnership Umbrella]," but, rather, that "the
monies and other benefits received by Mr. Paulachak which were
the subject of the indictment were intended to be fringe
benefits."

On March 18, 1996, following an extensive investigation by
Federal into the circumstances surrounding the decision to
indemnify Paulachak, Federal formally denied coverage under
Insuring Clause 2. Federal maintained that the indemnification
determination did not comport with the requirements for making
such determinations under Virginia law and that in any case the
determination was "unfounded and invalid." Federal
further asserted that it was not liable under either of the
insuring clauses for any of Paulachak’s legal expenses,
whether indemnified or not, because those expenses arose from a
risk not insurable under Virginia law and were subject to
exclusions within the policy.

Thereafter, on March 18, 1996, Federal filed a declaratory
judgment action seeking a determination that it was not liable
under the policy to Partnership Umbrella or Paulachak.
Partnership Umbrella filed a counterclaim alleging breach of
contract. Partnership Umbrella sought to recover both the monies
it had advanced to Paulachak for legal expenses incurred prior to
May 3, 1994 under Insuring Clause 1 and for legal expenses
subject to the indemnification resolution under Insuring Clause 2
up to the maximum limit of the policy.[4]
Partnership Umbrella further contended that if it could not
recover the monies paid as indemnification under Insuring Clause
2 because its indemnification decision was unlawful, it should
nonetheless be able to recover these monies under Insuring Clause
1.

It is not disputed that Paulachak is an "insured
person" as defined by the policy. Nor is it disputed that
the policy was in force at all times relevant to the claims made
by Paulachak and Partnership Umbrella for reimbursement and
indemnification under the insuring clauses of the policy. Rather,
as stipulated by the parties, the disputed issue of law in the
trial court was whether, under the language of the policy,
Federal would remain liable under Insuring Clause 1 after
Partnership Umbrella made a decision to indemnify Paulachak if
that decision were subsequently determined to have been unlawful.
The parties further disputed the standard of law to be applied in
determining whether the indemnification decision was lawful.

The parties agreed that if these issues were resolved "in
a manner unfavorable to Partnership Umbrella," it would
withdraw its counterclaim. Accordingly, on January 10, 1997, the
two following questions of law were submitted to the trial court.

1. If [Partnership Umbrella] cannot recover under Insuring
Clause 2 because of a determination that its indemnification of
Paulachak was not "as permitted . . . by
law," may [Partnership Umbrella] recover under Insuring
Clause 1 either the amounts it has paid for Paulachak’s
defense, or the amounts Paulachak was "legally obligated to
pay?"

2. Can Federal argue to the jury in this case, based on the
substantive merits of [Partnership Umbrella’s] decision to
indemnify Paulachak, that the indemnification did not meet the
statutory standards governing indemnification (including those
attorney’s fees for counts on which Paulachak was not
convicted)?

The parties filed briefs addressing these two questions. With
respect to the first question, Federal maintained that once a
decision to indemnify an insured person is made by the insured
organization, coverage under Insuring Clause 1 ceases with
respect to all legal expenses incurred by an insured person, even
if the decision to indemnify was unlawful. Because Federal
further maintained that the indemnification decision had been
taken contrary to what was "permitted or required by
law," it asserted it also had no liability under Insuring
Clause 2. Partnership Umbrella contended that the coverage of
Insuring Clause 1 applied to any loss sustained by an insured
person that was not actually indemnified by the insured
organization. Thus, it further contended that if its
indemnification was not lawful, there was no indemnification and
it was entitled to coverage for any funds disbursed by it as
advances or under the indemnification resolution.

In a letter opinion dated March 24, 1997 and subsequently
adopted by reference in the May 13, 1999 final order, the trial
court concluded that Partnership Umbrella, as a party to the
contract, could enforce Paulachak’s rights under Insuring
Clause 1 and, citing Atlantic Permanent Fed. Savings &
Loan Ass’n v. American Casualty Company of Reading,
Pennsylvania
, 839 F.2d 212 (4th Cir. 1988), could also claim
a right of equitable subrogation. Thus, under either theory, and
even if Partnership Umbrella were barred from recovering under
Insuring Clause 2, the trial court concluded that Partnership
Umbrella might still recover under Insuring Clause 1. However,
the trial court further determined that Partnership
Umbrella’s rights under Insuring Clause 1 were limited to
any rights Paulachak would have had under that clause and, thus,
"are limited to the amounts of money for attorney fees which
are due and owing but not yet paid," and for which Paulachak
had not been indemnified. Thus, the trial court ruled in its
final order that Partnership Umbrella could not "recover
under Insuring Clause 1 for any of the amounts it has paid on
Paulachak’s behalf." In effect, the trial court
determined that any monies advanced to Paulachak constituted
"indemnification" regardless of whether these payments
were made under the July 14, 1992 decision to advance legal
expenses or under the May 25, 1995 indemnification resolution,
which applied only to those expenses incurred following
Paulachak’s receipt of the target letter.

With respect to the second question presented to the trial
court, Partnership Umbrella contended that the action of the
individual directors to indemnify Paulachak was subject to the
"business judgment rule" as codified in Code
? 13.1-870 and, thus, was not subject to review by a trial
court or a jury for compliance with requirements of Code
? 13.1-876 which authorizes indemnification under certain
circumstances. Federal contended that it should be entitled to
argue that the decision of Partnership Umbrella to indemnify
Paulachak did not comport with the provisions of Code
? 13.1–876, even if the actions of the individual
directors were not violative of that statute.

The trial court agreed with Federal. The trial court noted
that the position taken by Partnership Umbrella would render
meaningless the provisions of Code ? 13.1–876(D),
which prohibits indemnification in certain cases, if a decision
in violation of that prohibition were not subject to judicial
review. Accordingly, the trial court ruled that Federal could
"argue to the jury in this case, based on the substantive
merits of [Partnership Umbrella’s] decision to indemnify
Paulachak, that the statutory standards governing indemnification
were not met."

Following receipt of the trial court’s letter opinion,
Partnership Umbrella, by motion, requested a clarification of
that opinion. In that motion, Partnership Umbrella inquired
whether the trial court’s opinion prohibited it from
recovering the monies paid as advances for legal expenses
incurred by Paulachak prior to his receiving the May 3, 1994
target letter. In its final order, the trial court denied the
motion for clarification without comment. Determining that its
resolution of the two questions of law was "in a manner
unfavorable to" Partnership Umbrella, the trial court
dismissed Partnership Umbrella’s counterclaim with prejudice
and entered judgment for Federal. We awarded Partnership Umbrella
this appeal.

DISCUSSION

Partnership Umbrella contends that the trial court erred in
ruling that Partnership Umbrella could not seek to recover under
Insuring Clause 1 of the policy all of the legal expenses which
it paid on behalf of Paulachak.[5]
We will first consider whether Partnership Umbrella is entitled
to seek repayment from Federal for the payments it made to
Paulachak and his attorneys as advances pursuant to Code
? 13.1-878 which were not subsequently confirmed under the
indemnification resolution. We will then consider whether
Partnership Umbrella can seek to recover from Federal those
monies paid after May 3, 1994 and ultimately confirmed under the
indemnification resolution if that resolution is determined to be
unlawful. In this context, we are not concerned with the
viability of a claim under Insuring Clause 2 of the policy.

In considering these issues, we apply the well established
rule that when the language in an insurance policy is clear and
unambiguous, courts do not employ rules of construction; rather,
they give the language its plain and ordinary meaning and enforce
the policy as written. Osborne v. National Union Fire Ins. Co.,
251 Va. 53, 56, 465 S.E.2d 835, 837 (1996); see also Virginia
Farm Bureau Mut. Ins. Co. v. Hodges
, 238 Va. 692, 696, 385
S.E.2d 612, 614 (1989); United Services Auto. Assoc. v. Webb,
235 Va. 655, 657, 369 S.E.2d 196, 198 (1988); Atlas
Underwriters, Ltd. v. Meredith-Burda, Inc.
, 231 Va. 255, 259,
343 S.E.2d 65, 68 (1986). We are of opinion that the language in
Insuring Clause 1 of the policy is clear and unambiguous.

Under Insuring Clause 1, unless an exclusion in the policy is
found to apply, Federal would be obligated "to pay on behalf
of each of the Insured Persons all Loss for which the Insured
Person is not indemnified by the Insured Organization." The
July 14, 1992 action by Partnership Umbrella’s board of
directors only authorized the payment of advances pursuant to
Code ? 13.1-878 for Paulachak’s legal expenses
incurred to that date and in the future. It is self-evident that
such advances were not made as indemnification, since the
decision to indemnify requires a separate determination under
Code ? 13.1-880. Moreover, unlike indemnification, advances
must be subject to a written undertaking by the director that
they will be repaid if it is ultimately determined that the
director did not meet the standard of conduct required under Code
? 13.1-876 for an indemnification decision.

By contrast, the May 25, 1995 indemnification resolution was
made pursuant to Code ? 13.1-880. By its express terms,
that resolution applied only to "attorney’s fees and
expenses which [Paulachak] incurred from May 3, 1994." Thus,
while some of the monies advanced to Paulachak or paid on his
behalf to his attorneys after May 3, 1994 subsequently were
approved as "indemnification," the payments for
expenses incurred prior to May 3, 1994 were never so approved and
indemnified and Paulachak remained "legally obligated to
pay" those expenses.

Accordingly, Paulachak, as an "Insured Person" is
entitled to seek recovery under Insuring Clause 1 for all
of the expenses he incurred that were not subject to
indemnification by Partnership Umbrella. Similarly, under the law
of this case, see note 5, supra, Partnership
Umbrella may seek to recover under that clause those funds which
it paid on Paulachak’s behalf as advances pursuant to Code
? 13.1-878 and may seek to enforce the policy on his behalf
with respect to monies still "due and owing."

We now consider Partnership Umbrella’s further contention
that it should also be able to seek recovery of those funds it
paid as indemnification if it is determined that the May 25, 1995
indemnification resolution was unlawful. Partnership Umbrella
argues that the modifying language of Insuring Clause 2, "as
permitted or required by law," creates a condition precedent
that the decision to indemnify must be valid before the coverage
under Insuring Clause 1 will be terminated. Federal responds that
once the insured organization makes a decision to indemnify an
officer or director, coverage for the expenses incurred by that
officer or director under Insuring Clause 1 terminates and any
coverage that is available under the policy must come under
Insuring Clause 2.

Applying the same standard for interpreting an insurance
policy cited above, we are of opinion that when read together the
insuring clauses are clear and unambiguous as to the effect of a
decision by "the Insured Organization . . . [to] grant[] indemnification to [an] Insured Person." Once that
decision has been made, the coverage of Insuring Clause 2 becomes
effective and the "Insured Person," by the express
terms of Insuring Clause 1, is no longer entitled to recover his
indemnified expenses.

The modifying language in Insuring Clause 2, "as
permitted or required by law," does create a condition
precedent; however, it would be counterintuitive to hold that
this condition applies to coverage under Insuring Clause 1 where
no such language is found. Rather, when read in the context of
both insuring clauses, the validity of the indemnification
decision is a condition precedent only to recovery under Insuring
Clause 2 where the limiting language occurs. It should be
self-evident that if a decision to indemnify is not
"permitted . . . by law" and, thus, payments
made pursuant to it would not be subject to reimbursement under
Insuring Clause 2, neither would the loss incurred by the insured
person be subject to direct reimbursement under Insuring Clause
1. Therefore, Partnership Umbrella’s contention that what it
may not be able to recover as a result of an invalid or unlawful
decision to indemnify Paulachak, it should nonetheless be able to
recover by subrogation under Insuring Clause 1 is without merit.

Partnership Umbrella’s remaining assignment of error
states that "[t]he Trial Court erred by ruling, as a matter
of law, that Partnership Umbrella was prohibited from recovering
anything from [Federal] under either Clause 1 or Clause 2 of the
insurance policy if its indemnification decision is not
valid." Partnership Umbrella does not relate this assignment
of error to either of its questions presented and offers no
substantive argument on the issue it presents. Moreover, the
error assigned does not correctly state the substance of the
trial court’s ruling. Rather, as expressly stated in the
final order, the trial court merely held, with regard to the
second question submitted to the court by the parties, that
Federal "can argue to the jury in this case, based on
the substantive merits of [Partnership Umbrella’s] decision
to indemnify Paulachak, that the statutory standards governing
indemnification were not met." (Emphasis added.) In short,
while it may be that the trial court would ultimately rule as
Partnership Umbrella implies in its assignment of error, the
trial court did not rule on the effect of the failure to meet the
statutory standard, but only on whether that issue could be
raised. Assuming that Partnership Umbrella intended to challenge
that ruling, we hold that the trial court did not err in its
ruling.

The question whether Partnership Umbrella met the required
statutory standard governing indemnification has yet to be
decided. The effect of the failure to meet that standard is one
of law, upon which the trial court has not yet ruled. As we have
stressed throughout this opinion, neither the determinations of
law made by the trial court nor our review of that judgment in
this opinion deals with the merits of Partnership Umbrella’s
claims, the potential defenses available to Federal under the
exclusions of the policy, or the application of the
indemnification statutes to any determination of fact made as to
Partnership Umbrella’s compliance with the standard therein.
Rather, those claims and defenses are yet to be resolved in the
trial court proceedings.

CONCLUSION

For these reasons, we will reverse that portion of the trial
court’s judgment that prohibits Partnership Umbrella from
seeking recovery under Insuring Clause 1 for those payments made
on behalf of Paulachak for legal expenses incurred by him prior
to May 3, 1994. We will affirm the trial court’s judgment in
all other respects, and the case will be remanded to the trial
court for further proceedings consistent with the views expressed
in this opinion.

Affirmed in part, reversed in part, and remanded.

FOOTNOTES:

[1] It is undisputed that the
policy provides only reimbursement and indemnification coverage.
Federal had no duty to provide Paulachak with a defense.

[2] Federal maintains that the
required "Undertaking To Repay Advances" obligating
Paulachak to repay the advances if he was not subsequently
indemnified by Partnership Umbrella, which was also prepared at
this time, was not signed until several years later and
back-dated by Paulachak to reflect the July 14, 1992 decision
date. As we have noted above, we are not here concerned with
whether Federal can successfully defend against the claims made
by Partnership Umbrella and Paulachak. Accordingly, we will
express no opinion on this issue.

[3] Paulachak was sentenced to 30
months imprisonment for these crimes. His conviction and sentence
were subsequently upheld on appeal. See Aramony v.
United States
, 88 F.3d 1369, 1392 (4th Cir. 1996).

[4] There is some disagreement in
the record over the amounts of the legal expenses actually
incurred by Paulachak and advanced or indemnified by Partnership
Umbrella; however, it is not disputed that in total these
expenses exceed Federal’s maximum possible liability under
the policy.

[5] Partnership Umbrella notes on
brief that Federal failed to assign cross-error to the trial
court’s determination that Partnership Umbrella could seek
to recover those amounts which had not been indemnified and which
are still "due and owing." We agree that this portion
of the trial court’s ruling is not subject to review because
it is not the subject of an assignment of cross-error. Rule
5:18(b). Similarly, although Federal asserts on brief that
"the doctrine of subrogation does not support [Partnership
Umbrella’s] argument," it did not assign cross-error to
the trial court’s determination that Partnership Umbrella
could enforce the policy on behalf of Paulachak and recover
directly those monies to which it was entitled under the
equitable doctrine of subrogation. Accordingly, we will affirm
the trial court’s ruling with respect to these issues. In
doing so, however, we express no opinion on the validity of the
arguments directed to these issues by the parties in the trial
court or on appeal. Rather, we simply recognize that
Federal’s failure to assign cross-error prevents
relitigation of these issues on remand as they are now "the
law of the case." Lockheed Info. Mgmt. Systems v.
Maximus, Inc.
, 259 Va. 92, 108, 524 S.E.2d 420, 429 (2000).

 

 

 

 

 

 

 

 

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