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Fraudster Loses Coverage Battle In 2nd Circuit

March 10, 2016

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The former CEO of a vending machine sales company, Multivend LLC d/b/a Vendstar, lost a coverage battle in the Second Circuit Court Appeals this week. The CEO, Weaver, sought coverage under a claims-made directors and officers’ liability policy provided by Axis. Weaver was indicted in 2012 for conspiracy, mail and wire fraud in connection with a multi-state scheme to defraud customers/clients by providing false statements about the success of his company’s vending machines. Such statements included that customers would earn back their investment in one year, would earn substantial profits, and that customers could earn $800 a day by using Vendstar’s equipment.
Before Weaver was indicted on fraud charges, he advised Axis of the potential charges being brought by the Department of Justice. Axis denied coverage under the D&O policy because it excluded coverage for “any claim made against any insured […] in any way involving […] any demand, suit or other proceeding” prior to the policy period. The basis for Axis’ denial was a 2007 letter sent by the Attorney General of Maryland to Vendstar. The letter advised that Vendstar may be selling business opportunities in violation of Maryland’s disclosure and anti-fraud provisions of its Business Opportunities Sales Act. Maryland requested that Vendstar cease operations in the state until its investigation is complete, requested additional information, and advised that failure to respond may result in a formal legal action.
After the disclaimer, Weaver commenced a declaratory judgment action against Axis challenging its refusal to provide coverage in the criminal prosecution. Weaver conceded that the facts pertaining to the criminal indictment and the 2007 Maryland letter are the same, but he argued that the 2007 letter was merely a request for information and not a “demand.” The Eastern District disagreed, finding in favor of Axis. Weaver appealed, and the Second Circuit reviewed.
<a href="" rel="">The Second Circuit affirmed</a>, and rejected Weaver’s argument that the 2007 Maryland letter did not constitute a demand. The court noted that even if a letter uses polite language or requests information, all that is required for a demand is an assertion of a right and a request for compliance with that right. Since the Maryland letter made its request pursuant to its authority under the Maryland Business Opportunity Sales Act, and sought compliance with the law, the 2007 letter was a “demand.”
This case may provide additional problems for multi-state corporations. Such companies may receive regulatory letters from agencies of different states, and if the letters are based on similar facts, the company or individual may face a loss of coverage. Here, the Second Circuit allowed Axis to disclaim based on a letter sent from an unrelated government entity five years before federal charges were filed. Now, when an insurer receives notice of a suit or demand from a state agency, it should investigate to see whether any similar demands have been made by other states, and if so, it may have a solid basis to deny coverage under a claims-made policy.
Although the decision in this case appears straightforward, it provides a word of caution when dealing with correspondence from governmental agencies. Careful attention must be paid as to whether an agency is simply requesting additional information, notifying an insured about an investigation, or making a demand that must be forwarded to an insurer (all of the above in this case). Regardless, the extent of Weaver’s fraud does not make him a sympathetic insured and – like a bag of Lays potato chips hanging from that spiral ring in one of his vending machines – he was denied coverage.
Thanks to Dan Beatty for his contribution to this post. If you have any questions about this post, please email <a href="">Brian Gibbons</a> for additional information.


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