The drama surrounding former crypto mogul Samuel Bankman-Fried’s criminal prosecution and conviction has dominated the business pages for weeks. In addition, and as the news reports noted at the time, just before the criminal trial began, SBF sued one of FTX’s excess D&O insurers, alleging the insurer was refusing to pay his legal bills. Earlier this week, it emerged that SBF has withdrawn his insurance coverage lawsuit. But while the coverage lawsuit apparently now will not go forward, the interesting questions the situation presented are still worth asking. And the short-lived coverage litigation also unearthed some interesting stuff, as discussed below. Daphne Zhang’s November 7, 2023, Bloomberg article about the coverage litigation, which contains a comprehensive overview of the coverage dispute, can be found here.
On August 4, 2022, a $20 million renewal tower of D&O insurance went into effect for Paper Bird, Inc. (effectively, the corporate parent of FTX Ventures, FTX Trading, and Almeda Research). The tower consisted of four layers of $5 million each. FTX filed for bankruptcy in November 2022. A host of civil and criminal actions against SBF and other FTX executives followed. SBF was indicted on December 13, 2022. SBF’s criminal trial began October 3, 2023.
On October 2, 2023, the day before his criminal trial began, SBF sued the second-level excess insurer (that is, the 5 x 10 insurer) in the FTX insurance tower in the Northern District of California. A copy of the complaint can be found here. Among other things, the complaint recites that the primary and first layer excess insurers had acknowledged coverage and paid out defense expenses as incurred, up to their full limit of liability, but that the second-level excess insurer had failed to pay SBF’s defense expenses as incurred. The complaint alleges that the second-level excess insurer had breached its contract and had also breached the implied covenant of good and fair dealing.
On October 10, 2023, Daniel Friedberg, the former general counsel of FTX Trading, filed a motion to intervene in SBF’s lawsuit against the second-level excess insurer. Friedberg has been sued by FTX’s new management alleging that he helped SBF loot the cryptocurrency company, as well as in a liability action by the trustee in bankruptcy, among other legal proceedings. In his motion to intervene, Friedberg alleged, among other things, that it was unfair he had received nothing under the insurance program, while SBF and others had managed to exhaust the first two $5 million layers in insurance.
Friedberg’s motion is interesting. He alleges that the “first come, first served” way that the insurers had been paying defense expenses favored others, including SBF, to Friedman’s detriment. Friedberg contends that the first two layers of insurance had been exhausted by payments of defense expense of others pursuant to the first in, first out principle. He also contended that the second layer excess insurer – the defendant in the coverage action – proposed to make payments according to the same principle. In his motion to intervene, Friedberg argues that under California law the second-level excess insurer must distribute the limits of liability under principles of “equitable allocation,” rather than under the first come-first served basis.
Friedberg’s motion includes a number of tidbits. First, he alleges in his motion papers that the second-level excess insurer (the defendant in the coverage action) had in fact already advanced on behalf of SBF defense costs of over $870,000. Second, the Friedberg motion recites that in August 2023, the third-level excess insurer (that is, the 5 x 15 insurer) initiated an interpleader action to enlist the assistance of the court in the distribution of the limits of liability under its policy.
Third, Friedberg’s motion lays out the way that, as of September 2023, the insurance proceeds that had been disbursed to that point had been divided amongst the various former executives of FTX and related entities. (The Bloomberg article to which I linked at the top of the post captures this payment information in a slick bar chart.) The payment information shows that of the approximately $10.9 million of insurance that had been paid out to date, $5.7 million had been paid on behalf of SBF, with lesser amounts paid out on behalf of other executives.
While the various papers filed with the court clearly show a desperate fight for the insurance money, there are other things the papers do not reveal. For example, the papers do not explain why the second-level insurer (the coverage litigation defendants) paid out nearly $900,000 on behalf of SBF, and then after that refused to pay anything further. It does not seem that the insurer was withholding payment because it contended there was no coverage; why would it pay out nearly $900,000 if that were the case? And if the second-level insurer thought it had defenses to coverage, why would the third-level excess insurer interplead its policy proceeds with the court?
We may never know (at least not officially) why the second-level excess insurer withheld payment, because on November 6, 2023, SBF’s lawyer filed a notice dismissing his lawsuit with prejudice. A copy of the notice can be found here. The notice itself is silent about the reasons for which the lawsuit was withdrawn; presumably, some accommodation was reached to work out the payment and allocation disputes.
Since the coverage lawsuit is now withdrawn, one might say that the whole kerfuffle was just a tempest in the teapot. Or perhaps that SBF’s filing of the coverage lawsuit complaint was just a form of negotiation by other means, as, it could also be argued, was Friedberg’s motion to intervene.
But while the lawsuit has been withdrawn, the questions that the suit raised, and that Friedberg’s motion to intervene underscored, is how should an insurer administer the proceeds of an insurance policy when there clearly were going to be demands for the insurance from multiple insureds that will far exceed the amount of insurance available? This is a problem that is often summarized, “too many insureds, not enough insurance.”
Harking back to my days on the claim side, I can say that the rule-of-thumb and the default administrative principle for paying claims is that the insurer pays the bills in the order in which they come in. That is, the presumption was that the bills get paid on a first come, first served basis, until the limits are gone. It is worth noting in the context of this coverage dispute that the insurers contended that the first come-first served payment method was actually required by the wording of the primary policy, which provides that the insurer “shall advance or pay Policy Costs on a current basis but no less than once every sixty (60) days.”
There are of course other ways to address the question of how insurance proceeds are to be divided. One of these other ways is the mechanism that the third level excess carriers (that is, the 5 x 15 insurer) apparently has employed here is to initiate an interpleader action. An interpleader action is a process by which the rights of competing claimants to an asset can have their rights determined. In an interpleader action, a party who knows that two or more other parties are claiming an asset that they control can ask the court to decide who has rights to the asset. The party can then deposit the asset into the custody of the court or a third party and remove themselves from the litigation.
Between these two alternatives is a lot of ground for dispute, as, in fact, the coverage action and the motion to intervene show here. Insurers may and often do face competing demands. In fact, I have long suspected that is why insurers so often try to take refuge in the rule-of-thumb first come-first served model, because it is neutral and takes any discretion out of the process.
The possibility of a cry of foul from one of insureds who feels shortchanged is one reason why the interpleader option may be an attractive option for the insurers. Some insurers may sometimes hesitate to pull the trigger on an interpleader though, if they retain hope that they can dispute coverage (obviously, the filing of an interpleader action completely eliminates any potential coverage defenses).
We don’t know why the second-level excess insurer here didn’t initiate an interpleader action, even after the third-level excess insurer filed for interpleader in August 2023. That is of course one more thing we don’t know, including whether the second-level insurer was trying to contest coverage, or whether instead it withheld further payment on its policy (after the initial payment of $870,000) because of concerns about allocation.
I suspect that readers may well have many thoughts about the way to try to address these problems. I will say that this is the kind of example I always want to try to keep at the ready to try to inform an insurance buyer that is trying to make sure they buy only the minimum amount of insurance. There has to be enough insurance to allow the insureds to fight a difficult fight. To be sure, the possibility that this policyholder or any other buyer might buy enough insurance to fund all of the needs this situation requires seems purely speculative. The point is, though, that in a serious fight significant funds are going to be required, even if there is a massive fraudulent scheme involved.
Readers interested in reading about an example of interpleader from the distant past involving a dispute between AIG and Hank Greenberg will want to refer here.