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Judge must rule on D&O insurer's claim

The directors and officers of the defunct Reciprocal of America have asked the 4th U.S. Circuit Court of Appeals to grant en banc review of a ruling that requires a district judge to rule on the D&O insurer’s claim that it has no duty to provide representation.

U.S. District Judge James R. Spencer had dismissed without prejudice Great American Insurance Co.’s effort to be absolved of liability after concluding that deciding the issue would result in unnecessary entanglement with complex lawsuits in state and federal courts.

There is no shortage of civil lawsuits in which Spencer could have become entangled, not to mention a long-running criminal investigation.

More than a dozen lawsuits have been consolidated in a multi-district litigation proceeding in Memphis, and two state suits are pending in Alabama.

Great American is seeking rescission because of its reliance on what it contends were fraudulent and material misrepresentations by ROA’s officers when it issued the policy, which has maximum coverage of $20 million.

Although those allegations of fraud might well be part of the Alabama and MDL actions, the 4th Circuit panel said, the general rule is that federal courts must exercise their jurisdiction over proceedings, even when there are parallel actions in state court.

The circumstances in the case before Spencer are not so exceptional as to warrant deviation from that rule, the panel said.

That conclusion puts the directors and officers in an untenable position, McLean attorney J. Jonathan Schraub said in his rehearing petition.

“The panel’s decision, if allowed to stand, allows every insurer to escape its obligations by litigating in advance the underlying claims without the benefit of necessary parties or other means of defense, an inequity fundamentally in contrast to the equitable nature of declaratory relief,” Schraub wrote.

“Such a result is particularly egregious in the D&O context when the overwhelming size and complexity of the underlying litigation alone means that insureds will be unable to litigate such issues in the insurance action. Ultimately, the risk of serving as a corporate officer will be deemed far too great for anyone except the vastly wealthy to undertake,” he argued.

Reinsurance issues

At least one part of the complex web created by the collapse of ROA appears to have been resolved.

Virginia Insurance Commissioner Alfred W. Gross, the deputy receiver for ROA, and First Virginia Reinsurance, ROA’s Bermuda subsidiary, were at odds over who owned a $57 million trust account set up as security for FVR’s reinsurance obligations.

Gross’s attorney, Patrick H. Cantilo, seized the account shortly after ROA was placed in receivership in January 2003.

Under the terms of a settlement that still must be approved by U.S. Bankruptcy Judge Douglas O. Tice Jr. of Richmond and Bermuda bankruptcy authorities, Gross would pay FVR $6 million from the account, and ROA will file a $159 million reinsurance claim in FVR’s liquidation proceeding in Bermuda. However, neither the settlement money nor any liquid assets FVR might have will be used to pay the claim.

FVR will assign any claims it might have against entities related to ROA to ROA.

Still unresolved are claims to the account by three Tennessee-based risk retention groups that ROA created and for which ROA was a reinsurer.

The risk retention groups—American National Lawyers Insurance Reciprocal, Doctors Insurance Reciprocal and The Reciprocal Alliance—contend that their policyholders have dibs on that account because it was set up for their benefit. At the very least, they have a claim to the account equal to that of ROA policyholders because they were so closely related to ROA that it was one insurance entity, the groups contend.

That’s a crucial distinction because policyholders have priority over claims based on reinsurance.

Gross has rejected the arguments of the retention groups, but he and the groups have decided to leave the issue unresolved while they join forces to seek recovery from ROA’s officers, its accountant and others, principally reinsurance giant General Re Corp.

A subsidiary of Warren Buffett’s Berkshire Hathaway, Gen Re has by far the deepest pockets of any of the defendants.

A key allegation is that Gen Re made a series of secret deals with ROA and FVR that concealed the precarious condition of the companies from state insurance regulators. The suits allege Gen Re appeared to be ROA’s reinsurer, when it had secretly transferred the risk to FVR.

A federal criminal investigation of the fraud allegations led to guilty pleas in June 2005 by two former senior executives of Gen Re in a case involving another insurer. They admitted machinations between Gen Re and American International Group to make AIG’s finances appear better than they were.

Just that type of manipulation resulted in the sentencing the same month of Kenneth R. Patterson, the president of ROA at the time of the insolvency, and Carolyn B. Hudgins, executive vice president of the company, on conspiracy and fraud charges.

Court documents alleged that FVR was short of the money it needed to have in a trust account to avoid the scrutiny of state regulators. At the same time, the parent company had barely the amount of surplus it needed to avoid regulators. To get around the problems, ROA reported a $10 million payment to the trust account as the prepayment of a premium, which falsely converted a reduction of surplus to an asset.

The documents also alleged that Patterson created the appearance that the company’s liabilities were smaller than they were by ordering an arbitrary reduction in the amount of reserves allocated to resolve filed cases.

Patterson was sentenced to 12 1/2 years in prison and Hudgins to five years, but Judge Spencer allowed them to remain free while they cooperate in the criminal investigation. Their dates to report to prison have been continued several times, with the latest date set for January.

Gen Re announced last month that the government had told it that it is no longer a target in the criminal investigation.

The civil lawsuits suggest that John William Crews, general counsel to The Reciprocal Group and a founder of ROA, is a target of that investigation. His firm, Crews & Hancock, was paid more than $63 million over the years for legal work done for entities related to ROA.

Much of the multi-district litigation in Memphis has focused on motions to dismiss by the defendants, and U.S. District Judge J. Daniel Breen has dismissed RICO and fraud counts of most of the plaintiffs after concluding that the plaintiffs have not shown that they relied to their detriment on any alleged fraud. Some of the plaintiffs are filing amended complaints, and serious discovery is just beginning after an initial effort at a global mediation was unsuccessful.

The pace has been quicker in Alabama, where a suit brought by the Alabama Hospital Insurance Trust on behalf of its 37 hospital members is set for January. The trust’s attorneys structured their case so that it cannot be removed to federal court.

Formed in 1976 when Virginia hospitals and physicians were having trouble getting medical-malpractice insurance, ROA continued to provide liability and workers’ compensation insurance for health facilities until it failed.

It also created the risk retention groups and provided reinsurance for them. A fifth entity, The Reciprocal Group, administered ROA and the groups.

At the time of the insolvency, ANLIR provided professional liability insurance for 5,000 Virginia lawyers and law firms and DIR provided coverage for 2,000 state physicians and medical groups. ROA and the groups insured more than 40,000 individuals and entities nationwide.

The companies ran into financial difficulty when they attempted to expand into such states as Alabama, Mississippi and Arizona, which had a history of large malpractice awards.

In an order entered last year, the State Corporation Commission said actuaries estimate ROA’s losses at $706.2 million, with only $128.2 million in available assets. About $427 million of the losses are to ROA policyholders, with $279 million in losses to the risk retention group policyholders, the SCC said.

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