William Saoud sells insurance-related products. Starting in 2017, he offered some of his clients a new financial instrument: a promissory note issued by 1 Global Capital, LLC. The investment opportunity was too good to be true.
William Saoud, Patricia Boland-Saoud and Bill Saoud Financial, LLC v. Everest Indemnity Insurance Company, No. 21-1621, United States Court of Appeals, Sixth Circuit (July 14, 2022)
Global Capital declared bankruptcy and the SEC sued the company for alleged violations of the Securities and Exchange Act. Saoud’s clients also sued him. Saoud sought indemnification from his insurer, Everest Indemnity Insurance Company, and ultimately sued seeking a declaratory judgment and breach of contract. The trial court granted summary judgment in favor of Everest, concluding that the claims related to 1 Global Capital were not covered by the policy.
Several customers sued Saoud and his wife, Patricia, who was also an employee of the company. Their complaint generally alleged that the Saouds had misrepresented that 1 Global Memorandum of Indebtedness was a safe investment and had sold an unregistered security in violation of Michigan securities laws.
On February 19, 2019, Saoud Financial notified Lancer of two additional lawsuits filed by clients and of investigations by the Michigan Department of Licensing and Regulatory Affairs and the SEC. Saoud Financial claimed costs in excess of $100,000. Lancer and Everest never responded to this message.
Because Saoud Financial was in “limbo” regarding Everest’s coverage position, Saoud Financial again reached out to Lancer and notified it of an upcoming mediation, so Everest could participate. But Saouds never heard from Lancer or Everest. The Saudis eventually settled the lawsuits.
On July 10, 2019, the Saouds and Saoud Financial sued Everest in Michigan state court, alleging breach of contract and seeking a declaratory judgment. Everest removed the suit to federal court and ultimately notified the Saouds that it would not defend or indemnify them for the suits because, in its view, the claims did not fall within the scope of the policy. The district court ultimately granted summary judgment to Everest, concluding that an exception to coverage applied. The Saouds are appealing.
The Everest policy included an “unregistered security exclusion.” This provision excludes coverage for any claim”[b]based on, attributable to or arising out of the use of or investment in any security not registered with the Securities and Exchange Commission.”
The parties disputed whether the 1 Global Memorandum of Indebtedness was a “security” within the meaning of the exemption. The district court explained that a “note” is presumed to be a “security” under the Securities Acts and concluded that 1 Global Memorandum of Indebtedness was a “note.”
The court also confirmed, after ordering additional information, that 1 Global Memorandum of Indebtedness was a “collateral” because it was not a note due in nine months or less and, even if it were, 1 Global Memorandum of Indebtedness was not “advertising paper.”
Saouds argued that the “unregistered security exclusion” applies only if the complaints alleged that Saouds sold “securities” that were required to be registered with the SEC and concluded that the security exclusion does not apply.
The Saouds argued that the waiver or estoppel should preclude Everest’s reliance on the “Unregistered Securities Exclusion” because Everest did not timely waive coverage. In limited circumstances, Michigan courts prohibit insurers from raising defenses to coverage that they could have previously raised. But this doctrine cannot widen the coverage of an insurance policy to protect the insured against risks which were not included in the policy or which were expressly excluded from the policy.
Everest never represented the Saouds in the underlying litigation and therefore never controlled the Saouds’ litigation strategy to their detriment. Nor have the Saouds presented any evidence of actual prejudice from Everest’s delay in informing the Saouds that it would neither defend nor indemnify them. Instead, they argue that prejudice should be presumed. No presumptive prejudice applies and Everest did not waive the right to address the exclusion.
Finally, the Saouds appear to argue that even if Everest had no duty to indemnify, it still had a duty to defend. The duty to defend is, of course, not “restricted by the precise language of the pleadings” or “confined to meritorious suits and may even extend to acts that are baseless, false or fraudulent, so long as the allegations against the insured can even be alleged to be covered by the insurance cover.
Contrary to Saoud’s argument, the duty to defend is not unlimited. The insurer is not obliged to defend itself against damage claims that are expressly excluded from the insurance cover. In other words, there is no duty to defend if there is no duty to indemnify by law. Here, all claims against the Saouds were based on the same unregistered securities.
Both the duty to defend and the obligation to indemnify are dependent on whether “Unregistered Security Exclusions” apply. Because the Sixth Circuit concluded that the exclusion applies, Everest had no duty to defend.
Everest had an effective exclusion. It refused to defend or indemnify. Although the duty to defend is broad, it is not unlimited. Since there was no duty to indemnify, there was no duty to defend, especially when it was determined that they were defrauding their customers by selling the unregistered securities and that fraud should never be an action where insurance protects the fraudsters.