chevron-down Created with Sketch Beta.
January 30, 2019 Practice Points

Second Circuit Rules in Insurance Warranty Case

Coverage determination relies on the terms of an insurance warranty, rather than the policy, to find no excess coverage for an investment firm’s SEC investigation.

By Jennifer Loyd

Caution should be exercised by insurers and insureds when entering into an insurance warranty, as the terms of such a warranty may impact a court’s coverage determination. The U.S. Court of Appeals for the Second Circuit recently held that the terms of a warranty, which included a representation that a corporation’s directors and officers were “unaware of facts and circumstances that would reasonably be expected to result in a claim,” precluded coverage for the cost of defending a Securities and Exchange Commission (SEC) investigation under an excess policy. Patriarch Partners, LLC v. Axis Ins. Co., No. 17-3022, 2018 WL 6431024 (2d Cir. Dec. 6, 2018). This was the case even though the Second Circuit did not examine whether the policy expressly incorporated the warranty’s terms. Id. In making its finding, the court applied New York law, pursuant to the agreement of the parties. Id., at *5.

The Defense Costs at Issue

Patriarch Partners, LLC, is a private equity investment firm, which bundles distressed loans to sell to investors as collateralized loan obligations (CLOs). Id., at *1. After commencing an initial inquiry and investigation, the SEC issued an order, dated June 3, 2011, that indicated that it had “‘information that tends to show’ that Patriarch had acted in ‘possible violation’ of the Securities Act of 1933 and the Securities and Exchange Act of 1934 in the ‘structuring and marketing’ of certain Patriarch CLOs.” Id., at *3.

On July 5, 2011, Patriarch’s outside counsel met with SEC officials. On August 11, 2011, Patriarch’s outside counsel received and forwarded correspondence from the SEC to Lynn Tilton, Patriarch’s founder, sole director and sole officer. Id., at *2. The Court noted that Ms. Tilton immediately responded. Id. In March 2015, the SEC filed an administrative enforcement action against Patriarch and in the intervening years, the costs of defending the SEC proceeding had exceeded the combined underlying policy limits of $20 million. Id., at *4.

The Warranty to Third Tier Excess D&O Insurer

According to the court, prior to August 12, 2011, Patriarch’s “tower” of D&O coverage insurance composed of several policies totaling $20 million in policy limits, as follows: (1) D&O policy with Continental Casualty Co. with policy limits of $10 million; (2) first layer excess policy issued by Great American Insurance Company with policy limits of $5 million; and (3) second layer excess policy issued by Illinois National Insurance Company with policy limits of $5 million. Id., at *3.

The court indicated that on August 12, 2011, Patriarch accepted a quote from Axis Insurance Company for a $5 million third layer of excess coverage, creating a claims-made, follow-form policy that was effective as of July 31, 2011. Id., at *4. On the same day, at the request of Axis, Patriarch’s founder, sole director and sole officer, Lynn Tilton, executed the following warranty:

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 [the Axis 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). . .By executing this letter, I confirm that I understand that the Insurer is relying upon this warranty in order to incept the proposed coverage.

Id., at *4.

The warranty was further noted to be “material to the underwriting and acceptance of risk for the Captioned Policy.” Id.

The Second Circuit’s Decision and Reliance on the Warranty

While the Second Circuit affirmed the Southern District of New York’s holding on appeal, it did so on altogether different grounds. The trial court did not mention the warranty, upon which the Second Circuit relied as the primary basis for its decision.

The Second Circuit concluded that, “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.” Id., at *6.

In contrast, the trial court had determined that “the SEC investigation was a ‘Claim’, under the underlying CNA policy, which was pending prior to the inception of the AXIS policy, and was therefore excluded from coverage.” Patriarch Partners, LLC v. Axis Ins. Co., 16-CV-2277 (VEC), 2017 WL 4233078 (S.D.N.Y. September 22, 2017), aff’d on other grounds, Patriarch Partners, LLC, supra.


The Second Circuit’s reliance upon the terms of a warranty to make a coverage determination teaches us that when entering into a warranty, caution should be exercised by insurers and insureds. Based on the Second Circuit’s decision, it would appear that warranties, as well as applicable policies, should be reviewed thoroughly to ensure that the parties’ expectations are carried out.

Jennifer Loyd is a partner in Litchfield Cavo’s New York City, New York, office.

Copyright © 2019, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).