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Kerr v. Gotham Insurance Co.

United States District Court, E.D. Arkansas, Western Division

October 17, 2019




         The Arkansas Insurance Commissioner (the “Receiver”) serves as the official receiver for Cosmopolitan Life Insurance Company (“Cosmo”), and in that capacity, he commenced this action in state court pursuant to Ark. Code Ann. § 23-89-101[1] against Gotham Insurance Company (“Gotham”). Gotham removed the case pursuant to the Court's diversity jurisdiction. Before the Court are (1) the Receiver's motion for summary judgment [ECF Nos. 15, 16, 17], Gotham's response in opposition [ECF Nos. 23, 24], and the Receiver's reply [ECF No. 30] and (2) Gotham's cross-motion for summary judgment [ECF No. 25, 26, 27], the Receiver's response in opposition [ECF Nos. 31, 32], and Gotham's reply [ECF No. 37]. After careful consideration, Gotham's motion is granted.

         I. Background

         From 2005 through March 2009, John Mathis Lile, III (“Lile”) served as the president of Cosmo, and he owned a minority share of the company. Lile also had majority or sole ownership of a separate company, Advanced Brokerage of America, Inc. (“AIBA”), and he served as the company's CEO.[2] AIBA and Cosmo provided services to small businesses with self-funded health plans, and Gotham issued an errors and omissions policy (“the Policy”) to AIBA.

         A. The Underlying Lawsuit

         In 2009, Cosmo was insolvent, and the Arkansas Insurance Department took the company into receivership. The Receiver filed suit against Lile and AIBA, charging that Lile had misappropriated Cosmo's funds. The Receiver sought relief\ under two causes of action: breach of fiduciary duties and conversion.[3] The Receiver voluntarily dismissed the original complaint but refiled it in 2012. The Receiver's renewed complaint framed the action as one for “breach of fiduciary duties and conversion, ”[4] but the pleading included a third cause of action titled: “Alternatively, Negligence.”[5]

         The facts alleged in the renewed complaint are these.[6] AIBA sold and administered a health benefit product called Employers Choice Health Plan (“ECHP”) by which small business owners would provide health benefits to employees by self-funding employee health care claims up to a “retention limit.” Cosmo offered excess loss coverage (“ELC”), also known as “stop-loss” insurance, that reimbursed employers for payments over the retention limit. Cosmo entered a separate “treaty” with participating employers for ELC or stop-loss coverage.[7]

         To fund the ECHP, participating employers paid monthly fees to AIBA. Pursuant to an unwritten business plan (the “Business Plan”), [8] AIBA took 16% of the gross monthly fees to pay claims up to the employer retention limit. The Business Plan directed that AIBA would then segregate the remaining gross monthly fees as follows: 20% for AIBA's administrative costs and 64% for Cosmo's ELC or stop-loss coverage. The Business Plan called for AIBA to retain the portion of gross monthly fees designated for retention limit coverage and administrative costs and distribute the remaining 64% to Cosmo. Once an employer exhausted its retention limit, the Business Plan anticipated that Cosmo, having received its share of monthly fees, would pay valid claims that exceeded the retention limit.

         Prior to 2006, Cosmo and AIBA operated independently. Each company maintained separate financial records and followed the Business Plan.[9] In 2003 or 2004, Lile acquired a minority share in Cosmo and began running the company.[10]In 2004, Cosmo's ELC claims exceeded capital, and Lile asked AIBA's chief financial officer to delete claims from records to make it appear that Cosmo was solvent.[11] When the financial officer refused, Lile told her that he “did not pay her to think, ” and she resigned.[12]

         Subsequently, Lile hired one person to handle the finances of both AIBA and Cosmo, which enabled Lile to misuse funds earmarked for Cosmo under Business Plan. By April 2007, Cosmo was 75 days behind on paying claims, and some health care providers refused to honor ECHP insurance.[13] Lile instructed his financial officer to allocate 50% of each week's employer fee deposits toward retention limit payments, [14] money was not allocated to Cosmo according to the Business Plan, and Cosmos's financial condition worsened.

         Lile misapplied or misappropriated Cosmo's funds by (1) failing to distribute fee payments to Cosmo, in the total amount of $1, 405, 749.50;[15] (2) using Cosmo's funds to pay for AIBA employee health care expenses, in the total amount of $193, 167.78;[16] (3) using Cosmo's funds to pay for his own health care expenses, in the total amount of $2, 845;[17] (4) using Cosmo's funds to pay for his personal credit card expenditures, in the total amount of $289, 000, [18] and (5) using Cosmo's funds to make overpayments to one of Lile's companies, in the total amount of $480, 596.36. The grand total of these separate categories of misappropriated funds equaled $2, 371, 358.50.[19]

         With the renewed complaint, the Receiver sought a $2, 371, 358.50 judgment under three theories of relief: breach of fiduciary duties, conversion, and negligence. In support of each claim, the Receiver realleged and incorporated the factual allegations set forth above and additional allegations:

• In support of the claim for breach of fiduciary duties, the Receiver alleged that as President of Cosmo, Lile breached his fiduciary duties to Cosmo and its shareholders “to [ensure] Cosmo's compliance with the terms of the business model, the ELC treaty, or both, and not to use Cosmo's funds to pay for obligations for which Cosmo was not liable.”[20] The Receiver alleged that as a proximate cause of Lile's breach, Cosmo suffered damages in the amount of at least $2, 371, 358.50.
• Under the conversion claim, the Receiver alleged that “Lile made improper and unauthorized disbursements from Cosmo to or on behalf of himself, [AIBA], and ECHA in the amount of at least $2, 371, 358.50.”[21]
• Under the heading “alternatively, negligence, ” the renewed complaint stated: “In the event the jury determines that the Receiver failed to carry the burden to show that Defendants acted intentionally, the Receiver asks for an alternative finding . . . that Defendants acted negligently.”[22] The Receiver repeated that “Lile had a duty to Cosmo and its policy holders to [ensure] Cosmo's compliance with the terms of the business model, the ELC treaty, or both, and not to use Cosmo's funds to pay for obligations for which Cosmo was not liable.”[23] The Receiver charged that Lile “acted unreasonably and failed to exercise proper care in the performance of his legal duties by failing to ensure Cosmo's compliance with the terms of the business model, the ELC treaty, or both, and by using Cosmo's funds to pay for obligations for which Cosmo was not liable.” The Receiver alleged that Lile's negligence proximately caused damages of at least $2, 371, 358.50, and he sought to hold AIBA vicariously liable for the damages.[24]

         B. The Coverage Lawsuit

         In 2013, with the Underlying Lawsuit still pending, Lile and AIBA filed suit (“the Coverage Lawsuit”) against Gotham, the defendant in this case, charging that the insurer breached a duty under errors-and-omissions policies to defend AIBA in the Underlying Lawsuit and three additional suits brought by small businesses that had self-funded insurance plans administered by AIBA.[25] Gotham counterclaimed, and the parties entered a settlement agreement that released Gotham from claims for coverage under certain errors-and-omissions policies, including the Policy at issue in this case.[26]

         C. Lile's Criminal Conviction

         In 2014, Lile pleaded guilty in this Court to theft or embezzlement in connection with health care, in violation of 18 U.S.C. § 669. The elements of the federal crime included that Lile converted to his own personal use, without lawful authority, assets belonging to Cosmo, and that he acted knowingly and willfully. In pleading guilty, Lile acknowledged that from 2005 through March 2009, he used a credit card issued to him as president of Cosmo for thousands of dollars of nonbusiness-related expenses, all of which were paid by Cosmo or AIBA. On July 23, 2015, Lile was sentenced to serve twelve months and one day in prison, three years of supervised release, and he was ordered to pay $118, 500 in restitution to Cosmo.[27]

         D. Settlement of Underlying Lawsuit and Consent Judgment

         In 2017, the Receiver, Lile, and AIBA entered a settlement agreement in the Underlying Lawsuit, which called for a $2 million Consent Judgment in favor of the Receiver. The Receiver agreed that he would never collect or attempt to collect the Consent Judgment from Lile or AIBA.[28] The Underlying Lawsuit concluded with the entry of a Consent Judgment (the “Consent Judgment ”) that memorialized the terms of the settlement agreement and provided that the judgment was “based solely on the claim of negligence set forth in the Receiver's Renewed Complaint.”[29] The Consent Judgment provided:

Further, pursuant to the terms of the Agreement, the Receiver will pursue [AIBA's] errors and omissions insurance carrier for collection of this judgment but forbear any and all execution of this judgment against Lile and [AIBA]. Moreover, the Receiver's claims of breach of fiduciary duties and conversion, and for punitive damages, shall be, and are hereby, dismissed with prejudice.[30]

         E. The Present Lawsuit

         In 2018, the Receiver filed this action against Gotham pursuant to Ark. Code Ann. § 23-89-101, seeking to collect the $2 million Consent Judgment from Gotham, pursuant to the Policy. Section 23-89-101 allows a party injured by an insured to maintain a direct action against the insurer and collect, by way of subrogation, an unsatisfied judgment against the insured. “The statute . . . is contractual in nature . . . and places [the injured party] in the shoes of the insured suing the insurer alleging coverage under the insurance agreement.” Equity Fire & Cas. Ins. Co. v. Coleman, 326 Ark. 100, 102, 928 S.W.2d 796, 797 (1996).

         II. Discussion

         The Receiver seeks judgment in its favor, asserting that the Policy covers the amount owing under the Consent Judgment. Gotham also seeks judgment in its favor, asserting that (1) the Consent Judgment is not covered under the Policy's insuring agreement, (2) the Receiver's claim for satisfaction of the Consent Judgment is excluded under several Policy provisions, and (3) the Collection Lawsuit settlement released Gotham from all obligations under the Policy before entry of the Consent Judgment.

         Summary judgment is proper if the evidence, when viewed in the light most favorable to the non-moving party, shows that there is no genuine issue of material fact and that the defendant is entitled to entry of judgment as a matter of law. Fed.R.Civ.P. 56; Celotex Corp. v. Catrett, 477 U.S. 371, 322 (1986). When a nonmoving party cannot make an adequate showing on a necessary element of the case on which that party bears the burden of proof, the moving party is entitled to judgment as a matter of law. Celotex, 477 at 322-23. A factual dispute is genuine if the evidence could cause a reasonable jury to enter a verdict for either party. Miner v. Local 373, 513 F.3d 854, 860 (8th Cir. 2008).

         Here, the Receiver, who stands in the shoes of the insured, has the burden to make a prima facie case of coverage by showing that the Consent Judgment is covered under the Policy's Insuring Agreement. Reynolds v. Shelter Mut. Ins. Co., 313 Ark. 145, 852 S.W.2d 799 (1993)(citing Southern Farm Bureau Casualty Ins. Co. v. Reed, 231 Ark. 759, 332 S.W.2d 615 (1960)). If the Receiver makes that showing and Gotham relies on an exclusionary provision to deny coverage, Gotham has the burden to show that the Receiver's claim is excluded under the Policy.

         A. Coverage Under the Insuring Agreement

         Arkansas law governs the substantive issues in this case and holds that “an insurance policy, having been drafted by the insurer without consultation with the insured, is to be interpreted and construed liberally in favor of the insured and strictly against the insurer.” Noland v. Farmers Ins. Co., 319 Ark. 449, 892 S.W.2d 271, 272 (1995). However, “[t]he terms of an insurance contract are not to be rewritten under the rule of strict construction against the company issuing it so as to bind the insurer to a risk which is plainly excluded and for which it was not paid.” Smith v. Shelter Mut. Ins. Co., 327 Ark. 208, 937 S.W.2d 180, 182 (1997) (quotations and citations omitted).

         The Policy's Insuring Agreement provides coverage for “Damages . . . arising out of a negligent act, error, or omission resulting in a claim for financial loss” provided, among other things, that the “negligent act, error, or omission took place in the rendering of or failure to render Professional Services.”[31] The Policy defines “Damages” as follows:

Damages means monetary judgment, award or settlement, except for those for which insurance is prohibited by law. Damages does not include punitive or exemplary Damages, fines, penalties, sanctions, taxes, awards or Damages that are multiples of any covered fees, deposits, commissions or charges for goods or services. Damages does not include any amounts that represent, or are substantially equivalent to, the return, restitution, disgorgement, forfeiture or rescission of any personal profit, remuneration or financial advantage, or monies to which an insured was not entitled.[32]

         The “Named Insured” is AIBA, and “Covered Persons and Entities” include “any present or former principal, partner, officer, director, or employee of the Named Insured . . ., but only as it respects Professional Services rendered on behalf of the Named Insured.”[33] The Policy Declarations specify “Professional Services” as “Third Party Administrator of employee benefits, placement, administration of stop loss.”[34]

         Gotham argues that the Consent Judgment is not covered under the Policy because (1) Lile is not an insured or “Covered Person” with respect to the Consent Judgment, (2) the Consent Judgment does not meet the Policy's definition of “Damages, ” and (3) coverage is excluded under several provisions.

         i. ...

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