The New York Supreme Court, Appellate Division, First Department’s June 23 decision in Dupree v. Scottsdale Ins. Co., Case No. 653412-11, highlights the importance of negotiating favorable language in a fraud exclusion, a standard feature in D&O liability insurance policies that precludes coverage for claims arising out of fraudulent or criminal acts committed by the insured, typically as determined by a final adjudication in the underlying action.

In Dupree, the insured, Rodney Watts, sought coverage for defense of a criminal action alleging (i) conspiracy to commit bank fraud, (ii) bank fraud, and (iii) making false statements. Scottsdale paid for Watts’ defense through his conviction and sentencing pursuant to a preliminary injunction. Scottsdale, however, sought to be relieved of its obligation to pay for Watts’ subsequent appeal – and to recoup defense costs it had already paid – based on the operation of the policy’s fraud exclusion, which became operable only upon a “final judgment” against the insured. The question before the court was simple enough: when is a judgment final for purposes of triggering the fraud exclusion? In particular, is a judgment final during the pendency of an appeal?

The court’s answer provides more confusion than clarity. Looking to criminal law, rather than insurance or indemnification decisions, as the policyholder would have expected, the court held that “it is well settled that the imposition of the sentence constitutes the final judgment against the accused (see, e.g. Criminal Procedure Law §  1.20[15]).” The court ruled that notwithstanding that “the appeal may, at some point, relieve Watts of that judgment, the finality of it is not changed by the pendency of the appeal.” The court, thus, ruled that Scottsdale was no longer obligated to pay for Watts’ defense and further ruled that Watts must reimburse Scottsdale for defense costs the insurer previously paid.

The Dupree decision demonstrates the importance of negotiating clear policy terms on the front end, before a dispute arises. Many D&O policies contain fraud exclusions that apply only upon a “final adjudication in the underlying action” – not a “final judgment.” Such language may have made a difference in Dupree for the simple reason that the term “judgment” may be more narrowly construed than “adjudication.” Rule 54 of the Federal Rules of Civil Procedure, for example, defines a judgment to include a “decree and any order from which an appeal lies.” An “adjudication”, in contrast, is often used to refer to the entire process of resolving a dispute and may be broadly construed to encompass an appeal as well. Moreover, in light of Dupree, policyholders may consider negotiating for language that provides additional clarity as to whether the fraud exclusion can be triggered before all appeals are concluded. Dupree stands as a stark reminder of how an insured may benefit from a review of its insurance program by experienced coverage counsel who can assist in determining whether an existing insurance program provides adequate protection and can recommend changes to help insure that the policyholder gets the full benefit of the bargain should a claim arise.