False Warranty Eliminates Coverage

It’s Not Nice to Lie to an Insurer – It’s Fatal

Warranties made to insurers and made a part of an insurance policy are special promises the veracity of which are the basis upon which the insurance exists. If the warranty is false the coverage will never apply. For that reason prospective insureds asked to submit a warranty to an insurer should do so carefully, honestly, thoroughly and with absolute good faith and fair dealing.

In Patriarch Partners, LLC v. Axis Insurance Company, No. 17-3022, United States Court of Appeals for the Second Circuit (December 6, 2018) Patriarch Partners, LLC (“Patriarch”) appealed from a judgment entered in the United States District Court granting summary judgment in favor of Axis Insurance Company (“Axis”) on Patriarch’s claims for breach of contract and declaratory relief. The central question presented to the District Court and on appeal is whether a lengthy Securities and Exchange Commission (“SEC”) investigation into Patriarch ripened into a “claim” before the Axis insurance policy inception date, thereby excluding related defense costs from coverage under the terms of the policy and a related warranty provided by Patriarch to Axis.

The District Court ruled that coverage was excluded under the Axis policy’s “prior or pending claims” endorsement.


Patriarch is a private equity investment firm that, among other things, bundles distressed loans to sell to investors as Collateralized Loan Obligations (“CLOs”). Patriarch employs numerous professionals, but Lynn Tilton (“Tilton”) is Patriarch’s founder, sole director, and sole officer.

By letter dated May 27, 2011, and addressed to counsel for Patriarch the SEC contacted Patriarch. In the May 2011 letter, the SEC requested extensive information and documents relating to Patriarch’s organization and business practices. It also requested information about particular “Patriarch Structures,” which the agency defined to include any CLO that Patriarch had provided investment advice on from 2002 until the date of the letter, and certain other funds marketed by Patriarch, including the “Zohar” CLOs.

On June 3, 2011, the SEC internally issued an “Order Directing Private Investigation and Designating Officers to Take Testimony” (the “Order of Investigation” or “Order”) against Patriarch. It bore the same caption as the May 2011 letter. The Order of Investigation authorized certain SEC enforcement officers for the first time to issue subpoenas and take sworn testimony under oath in the Patriarch matter.

In or about June 2011, the SEC requested interviews with two former Patriarch executives, Todd Kaloudis and Meric Topbas. Kaloudis and Topbas each retained counsel for assistance in responding to the SEC requests. In June and July of 2011, they turned to Patriarch for indemnification of their legal expenses, and Patriarch agreed to their requests.

On July 5, 2011, Patriarch’s outside counsel provided information on Patriarch’s structure, operations, and certain of its CLOs.

At that time Patriarch was in the process of renewing its directors and officers (D&O) professional liability insurance portfolio. Patriarch had maintained a “tower” of D&O insurance comprised of several policies totaling $20 million in policy limits. As of June 2011, the existing tower consisted of (1) a primary policy with a $10 million limit issued by Continental Casualty Company (the “CNA Policy”), (2) a $5 million first-level excess policy issued by the Great American Insurance Company, and (3) a $5 million second-level excess policy issued by Illinois National Insurance Company.

On August 9, Patriarch’s insurance broker, Steve Blount, recommended to Patriarch that it purchase a third excess layer of $5 million, extending Patriarch’s policy limit to $25 million.  Axis gave Blount a quote for a third $5 million excess layer. Patriarch accepted the Axis quote on August 12, at which point the Axis Policy became bound. Coverage under the Axis Policy was made effective as of July 31.

The policies defined a “Claim” to include, among other things, “an Investigation of an Insured alleging a Wrongful Act.” An “Investigation” was defined to include “a formal . . . regulatory investigation or inquiry,” including specifically “an order of investigation or other investigation by the [SEC].”

Before Patriarch accepted the Axis quote Blount notified Patriarch’s insurance team that Axis had made its quote contingent upon Patriarch’s execution of a warranty statement (the “Warranty”). Blount wrote in an email dated August 12 that Axis intended the Warranty to “eliminate the potential for Axis to come on the program and be immediately hit with a claim that the client knew was close but hadn’t been filed yet.”  Axis received an executed copy of the Warranty on the latter date.

The Warranty provided:

The undersigned, on behalf of Patriarch and all of its directors and officers, hereby represents that as of the date of this letter neither the undersigned nor any other director or officer of Patriarch is aware of any facts or circumstances that would reasonably be expected to result in a Claim under the Captioned Policy. It is understood that the Captioned Policy and any renewal thereof does not provide coverage for Claims relating to facts or circumstances that, as of the date of this letter, Patriarch was aware of and would reasonably have expected to result in a Claim covered by such Captioned Policy (or future renewal thereof).

On February 27, 2012, just over six months after the Axis Policy became effective, the SEC served the subpoena that it had advised Patriarch in August would be forthcoming (the “Patriarch Subpoena”).

On March 5, 2012, in a letter to all of its D&O insurers, including Axis, Patriarch tendered notice of the Patriarch Subpoena as a “new matter.” CNA responded to Patriarch in a letter dated March 7, 2012, that Patriarch Subpoena “appears to qualify as a ‘Claim’ for a ‘Wrongful Act.'” Axis also acknowledged Patriarch’s notice of the SEC investigation as a Claim but, in a letter dated October 7, 2013, expressly reserved its rights to deny coverage under the Axis Policy.

The costs of defending the SEC proceeding had depleted nearly all of Patriarch’s underlying $20 million in D&O coverage. In August 2015, Patriarch notified Axis that it had exhausted its underlying policy limits, and asked Axis to assume the obligation to cover defense costs. Axis denied coverage on the basis (among others) that the SEC investigation was not a Claim “first made” against Patriarch during the Axis Policy period, because the investigation had begun before the policy inception date of July 31, 2011. Patriarch sued.


By Summary Judgment motion Axis argued that it was excused from coverage on at least two bases: First, that the SEC investigation was a “Claim” first made before the Axis policy incepted and was therefore not covered by the Axis Policy; second, that the Warranty relieved Axis of its obligations because the SEC investigation constituted “facts or circumstances” of which Patriarch was aware that could reasonably have been expected to result in the Claim.

Insurance coverage exclusions must be stated in clear and unmistakable language and are subject to a strict and narrow construction. Any ambiguities are to be construed in favor of the insured.

Patriarch’s position that the Warranty applies only to facts or circumstances subjectively known by Tilton is unsupported by the text of the Warranty, which explicitly refers to facts or circumstances that “Patriarch was aware of.” Moreover, “under traditional principles of agency [an] attorney’s knowledge must be imputed to [her client].” Veal v. Geraci, 23 F.3d 722, 725 (2d Cir. 1994).

Because the Axis Policy is a “follow-form” policy, the same Claims that are “covered by” the CNA Policy are also “covered by” the Axis Policy and other underlying excess policies.  The only reasonable interpretation of the Warranty is that it excludes claims arising from facts or circumstances of which Patriarch was aware as of August 12 and that Patriarch would reasonably have expected to result in a Claim as defined by the CNA Policy.

The Warranty, read as a whole to determine its purpose and intent, contains no ambiguity.

By August 12, 2011, the effective date of the Warranty, Patriarch “was aware” of the SEC Order of Investigation, the escalating severity and focus of the SEC investigation, the subpoena of a former employee, and notice of an impending subpoena to be issued to Patriarch itself. Patriarch had accrued over $390,000 in legal expenses for outside counsel in responding to the SEC’s requests of it by the time the Warranty was executed.

Contrary to the representations made in the Warranty, Patriarch was “aware” that the SEC had become more—not less—insistent in its demands of Patriarch, despite Patriarch’s accrual of hundreds of thousands of dollars in legal costs to prevent such escalation.

These are “facts and circumstances” that could reasonably be expected to give rise to a Claim under the Axis Policy. The Warranty thus excludes Patriarch’s losses arising from its defense of the SEC investigation Claim from coverage under the Axis Policy.


Warranties are special. Patriarch falsely warranted that it was not under investigation although it had already spent more than $300,000 on attorneys fees responding to the investigation of the SEC. It should have advised Axis at the time the warranty was requested that there was a potential for a claim. By presenting a false warranty Patriarch lost the ability to gain defense or indemnity from the Axis policy. A false warranty stops a policy from attaching to the risk.

© 2018 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

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