Wrongful Conduct Exclusion Only Applies to Cases Where Nassar was Convicted

Seventh Circuit Allows Coverage for USA Gymnastics for Defense & Indemnity of Claims of Abuse by Nassar

Sexual Assault by Insured

It is axiomatic that no one should ever be able to insure against the results of sexual abuse and assault. However, after it became obvious that  Larry Nassar sexually assaulted hundreds of girls and young women over decades during his involvement with USA Gymnastics, Inc. (USAG). As a result of Nassar’s abuse, USAG was sued numerous times and investigated by Congress and federal and state authorities. USAG sought financial help with its defense from various insurers, including Liberty Insurance Underwriters, Inc. (Liberty), with which USAG had a claims-made, directors and officers (D&O) liability insurance policy. In USA Gymnastics v. Liberty Insurance Underwriters, Inc., No. 20-1245, United States Court of Appeals, Seventh Circuit (February 25, 2022) the Seventh Circuit, in a lengthy and reasoned decision, found a way to provide money to the abused women.

The Nassar-related litigation and investigations forced USAG into bankruptcy. In an adversary proceeding, the bankruptcy court issued proposed findings and conclusions, including that the initial Nassar-related claims were timely made and that a wrongful-conduct exclusion applied to only those claims for which Nassar was criminally convicted.

Background

Nassar’s involvement with USAG as a volunteer doctor was actually motivated by his desire to gain access to female athletes whom he victimized.

Nassar was prosecuted for criminal sexual conduct in two counties. He signed written plea agreements and agreed under oath to their terms on the record. He pleaded guilty to seven counts of first degree criminal sexual conduct, and guilty to three counts of first degree criminal sexual conduct. Other charges were dismissed in exchange for compliance with the plea agreements. The state also agreed not to further prosecute Nassar for 115 other criminal sexual conduct charges. Nassar was sentenced to 40-175 years in Ingham County, and to 40-125 years in Eaton County. Both the federal and state convictions resulted in effective life sentences for Nassar. Obviously, although evidence existed to convict him for more than 115 other criminal acts what was already an effective life sentence made further criminal trials surplusage and a waste of judicial effort.

The Insurance

USAG purchased a claims-made D&O policy from Liberty. The policy also contains what has been termed a wrongful conduct exclusion (also called an intentional-acts exclusion) which bars coverage for claims “made against any Insured … based upon, arising from, or in any way related to … any deliberately dishonest, malicious, or fraudulent act, … or any willful violation of law by any Insured provided such conduct was finally adjudicated and in fact occurred.”

The policy included a bodily injury exclusion that barred coverage for physical, emotional, and mental damages, but an exception limits the exclusion to certain types of cases. The policy also had a $250,000 sublimit for “Third-Party EPL” (Employment Practices Liability, although the acronym is not defined in the policy). The bankruptcy court concluded the bodily injury exclusion preserved coverage for the “athlete lawsuits”; that the various investigations were both formal and for wrongful acts, placing them within the scope of coverage; and that the $250,000 sublimit for such claims was ambiguous and unenforceable.

Notice-When Claims Made

Liberty argued that coverage under the claims-made D&O policy is excluded because the initial Nassar-related claims were made before the policy period of May 16, 2016 through May 16, 2017. The FBI’s actions before the policy period did not amount to a claim under the policy. The policy deems a claim made only once “an Insured receives a written demand, complaint, indictment, notice of charges, or order of formal investigation.” Since Liberty failed to show a genuine issue of material fact that USAG had notice before the policy period commenced.

Wrongful Conduct Exclusion

The policy precludes coverage for claims in any way related to certain wrongful conduct by any insured. Liberty argues this exclusion bars coverage for all the Nassar-related claims at issue in this appeal.

The bankruptcy court sided with USAG and concluded that the wrongful conduct exclusion does not apply to most of the Nassar-related claims. Under this reading, Nassar’s illegal actions could affect coverage only for Nassar himself, not for USAG.

D&O policies commonly exclude insurance coverage for claims brought about or contributed to by fraudulent, dishonest, or criminal conduct. The wrongful conduct exclusions in D&O policies differ fundamentally from those in comprehensive general liability (CGL) policies. However, the Seventh Circuit, concluded that the court considered the fortuity principle, which underlies all insurance. That principle addresses those situations where a loss is not accidental, as it is against public policy to allow an insured to collect insurance proceeds for a known or expected loss. It would be a moral hazard to insure against liability arising from intentional and inherently harmful conduct, such as criminal conduct.

The court substituted “Nassar” and “USAG” for the term “Insured” and concluded that it shows how the term “any Insured” should be read here. Nassar is “any Insured’ so the exclusion applies based on his wrongful conduct. The double use of “any Insured”-negotiated by sophisticated parties-is broad language that does not present ambiguity. “Any,” to a reasonable person, does not mean “the” and is not limited to a particular insured’s conduct. Liberty correctly reads the “any Insured” language of the wrongful conduct exclusion. The bankruptcy court’s recommendation incorrectly found ambiguity in this portion of the policy.

Given these specifics of how Nassar’s state criminal sexual abuse cases were resolved, the wrongful conduct that was finally adjudicated encompassed the ten counts on which he pleaded guilty. But Nassar was formally guilty-beyond a reasonable doubt-of only ten of his scores of charged and uncharged acts of sexual abuse. A portion, but not all, of Nassar’s wrongful conduct satisfies this “finally adjudicated … conduct in fact occurred” clause in the wrongful conduct exclusion. The Seventh Circuit ignored the fact that “not prosecuted” is not the same as “not guilty.” Nassar was guilty of all the charges but the prosecutors recognized that he would not live long enough to serve all the sentences he deserved.

Bodily Injury Exclusion

Liberty argued the policy exclude the athlete lawsuits-a subset of the Nassar-related claims-by hundreds of gymnasts seeking to hold USAG responsible for allowing the abuse to take place, causing them to suffer physical, mental, and emotional damage. The policy excludes claims “made against any insured for: (a) bodily injury, sickness, disease, death; or (b) emotional distress, mental anguish …” But an exception provides that part (b) of the exclusion “shall not apply to any claim brought by or on behalf of any Third Person, or any past, present, or prospective Insured Person for an Employment Practices Wrongful Act.”

Because the duty to defend applies even to claims that in part seek excluded relief, Liberty would have a duty to defend the athlete lawsuits seeking relief for emotional distress and/or mental anguish.

Conclusions

  1. None of the activities before the policy period amounted to a claim under the policy, and the district court did not abuse its discretion when it decided not to hear additional evidence in its review of the bankruptcy court’s proposed findings and conclusions. So that portion of the January 13, 2020 order is Affirmed.
  2. The policy’s wrongful conduct exclusion applies to only the ten claims for which Nassar was found guilty, and not to the remaining Nassar-related claims, for which Liberty must provide insurance coverage. The court concluded that the policy provides coverage for expenses and costs related to the various investigations and other matters. The district court’s ruling for USAG that the conduct exclusion does not apply to most of the Nassar-related claims was also affirmed.
  3. Finally, the court concluded that the bankruptcy court should have considered the extrinsic evidence offered as to the use and meaning of the “Third Party EPL” $250,000 sublimit in the policy. Accordingly, that portion of its ruling was reversed, and this case was remanded to the district court and bankruptcy court for those proceedings.

A dissenting justice, an an equally lengthy opinion concluded that the wrongful conduct exclusion in the insurance policy applies to all the Nassar-related conduct, thus requiring judgment to be entered for Liberty.

ZALMA OPINION

USAG either knew, or should have known, of Nassar’s activity, both before and after the policy came into effect, which, had they advised Liberty of the existence of the abuse, the policy would never have been issued. Nassar was a scum who admitted to his ongoing crimes against the women working with USAG, and, for an expression of judicial economy, pleaded guilty to ten crimes that were sufficient to jail him for the rest of his natural life. As a result of the deal made by the criminal court the Seventh Circuit held Liberty to defend and indemnify USAG which would not have happened if he pleaded guilty to all of the charges for which he was truly guilty. The decision was technically correct, as argued and analyzed, but was unfair to Liberty and provided an opportunity for the abused women to recover some money that they cannot recover from Nassar or bankrupt USAG. The court, by this decision, made Liberty an eleemosynary agency.


© 2022 – Barry Zalma

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 practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business.

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