caused by the willful act of the insured; but he is not exonerated by the negligence of the insured, or of the insured's agents or others" (emphasis added). Willful, for purposes of section 533, has a unique meaning: even an act which is "intentional" or "willful" within the meaning of traditional tort principles generally will not exonerate the insurer from liability under section 533, unless it is done with a "preconceived design to inflict injury." Clemmer v. Hartford Ins. Co., 22 Cal. 3d 865, 887, 151 Cal. Rptr. 285, 297, 587 P.2d 1098 (1978). Section 533 does not preclude coverage for acts that are negligent or reckless. J.C. Penney, 278 Cal. Rptr. 64, 70, 804 P.2d 689.
Thus, Section 533 would not per se bar insurance coverage for alleged violations of § 10(b) and Rule 10b-5, which require only a showing of recklessness to fulfill the scienter requirement. If Federal could show that the individual officers and directors made knowing misrepresentations, they might be able to prove that the actions were willful, and hence, invoke the prohibitions of Section 533. Federal, who bears the burden of proof on this issue, has presented no evidence raising a genuine issue of material fact with respect to a possible higher level of scienter. Thus, summary judgment is appropriate, unless Federal can put forth facts which show that the acts of the officers and directors were willful.
E. Were the actions taken by "insured persons", and are defendants entitled to an allocation?
Federal next contends that allocation of settlement payments and defense costs is necessary because the Policy does not cover conduct committed by the corporation or by other uninsured parties, namely other employees of Raychem or outside accountants.
1. The law governing allocation
The Ninth Circuit has held that an insurer providing directors' and officers' liability insurance ("D & O insurance") may allocate defense costs between covered and uncovered claims in the underlying litigation. See Gon v. First State Ins. Co., 871 F.2d 863, 868-69 (9th Cir. 1989) (requiring insurer to pay all legal expenses as they were incurred, subject to apportionment and reimbursement for defense of uncovered claims after settlement or judgment in the underlying action); Okada v. MGIC Indem. Corp., 823 F.2d 276, 282 (9th Cir. 1986) (requiring insurer to advance defense costs for all covered and potentially covered claims, but allowing insurer to reserve rights with respect to those claims which might fall within the policy's exclusions).
The Ninth Circuit has not, however, addressed the situation in the instant case: allocation of settlement payments and defense costs between directors and officers and the corporation itself or other uninsured parties when they are joined as defendants in litigation under one covered claim.
Other circuits addressing the issue of settlement payments have largely adopted "relative exposure" approaches to allocation: allocating according to the relative risk of exposure of the various parties involved. The best reasoned of those cases, however, hold that allocation is appropriate only if, and only to the extent that, the defense or settlement costs of the litigation were, by virtue of the wrongful acts of uninsured parties, higher than they would have been had only the insured parties been defended or settled. This has been referred to as the "larger settlement rule."
For example, in Nodaway Valley Bank v. Continental Cas. Co., 916 F.2d 1362, 1367 (8th Cir. 1990), the court upheld a district court's allocation of the liability exposure in a suit, which had settled, against the insured officers and directors, other uninsured employees, and an uninsured corporate holding company. The lower court had reasoned that the directors and officers bore the greatest risk of exposure, and so it allocated 90% of the liability for the settlement payments to the directors and officers, and 10% to the uninsured defendants.
The Nodaway case is distinguishable from Raychem's situation, however, because the plaintiff in the underlying case in Nodaway actually made claims against the uninsured employees. In Raychem's case, uninsured employees were not named as defendants.
Moreover, the district court in Nodaway rejected the insurer's argument that it was liable for the conduct of insured directors and officers but not for the corporate liability created by their acts. The court reasoned that where the uninsured corporate employer is joined in litigation with insured officers and directors, the D & O insurance should provide full coverage. Nodaway Valley Bank v. Continental Cas. Co., 715 F. Supp. 1458, 1466 (W.D. Mo. 1989). The court stated that the insurer's argument:
comes dangerously close to saying that D & O insurance is never adequate insurance, making whole the insureds, when the uninsured corporate employer is joined in litigation with insured officers and directors. This would defeat the reasonable expectations of insureds who have purchased insurance that supposedly gives full coverage for director and officer liability. It seems clear that merely derivative corporate liability should not cause an apportionment between the primary wrongdoer and a vicarious wrongdoer, where both are joined in litigation. My conclusion would not expand the insurance policy to unfairly create corporate coverage; it simply gives full effect to the D & O coverage. Defendant would of course not be exposed to responsibility for corporate coverage where an uninsured employee creates corporate liability or even, apparently, where the corporation alone is sued.
715 F. Supp. at 1466. The court also noted that it was not required to resolve all fact and legal issues in the underlying case, but simply to determine what reasonable allocations should have been made, considering uncertainties in both fact and law known at the time of the settlement. 715 F. Supp. at 1465.
The Seventh Circuit has also adopted the "larger settlement rule." See Harbor Ins. Co. v. Continental Bank Corp., 922 F.2d 357, 368 (7th Cir. 1990). The underlying securities fraud suits were one class action against directors, officers and employees of the corporate employer identified only as "John Does," and a second suit which named the corporate employer and five of its directors, identified by their proper names. The corporation settled the two suits and then sued the insurer for reimbursement.
With respect to allocation between the corporation and its insured directors and officers, the Seventh Circuit found that the district court should allocate all liability for settlement payments to the directors and officers: "To allow the insurance companies an allocation between the directors' liability and the corporation's derivative liability for the directors' acts would rob [the corporation] of the insurance protection that it sought and bought." 922 F.2d at 368. To the extent that the amount for which Continental settled was larger than it would have been but for the misfeasance of uninsured persons or persons against whom no claim was made, however, the court found that the corporation's reimbursement should be reduced. The court remanded to the district court for a determination of how much larger the settlement was by virtue of the activities of uninsured individuals. 922 F.2d at 368.
In an earlier case, however, one district court, using the relative exposure rule, required the parties to allocate the settlement costs between those amounts attributable to the insured directors and officers and those attributable to the corporation and its accountants. See Pepsico Inc. v. Continental Cas. Co., 640 F. Supp. 656 (S.D.N.Y. 1986). Rule 10b-5 suits were filed against the corporation, the corporation's directors and officers, a former corporate officer, and the corporation's accounting firm. The corporation and its directors and officers settled the case, with the insurer retaining its right to object to the reasonableness of the settlement. The insurer then objected to the settlement as unreasonable because it reflected the liability of the corporation and the accounting firm. The court agreed, reasoning that the corporation and the accounting firm benefitted from the settlement. 640 F. Supp. at 662. The court noted, however, that evidence of a good faith settlement of the underlying litigation creates a presumption that the costs are covered by the policy. Id.
In evaluating whether defense costs should be allocated between the corporation and the insured directors and officers, courts have adopted the "reasonably related" test. As stated by one court:
We do not believe that [insurer] is entitled to an apportionment between tort and contract counts based simply on the fact that an item of legal service or expense would be of use to counsel in defending a claim asserted under a contract count . . . in addition to its use in defending a tort count. Having purchased this form of . . . insurance, the [insured] is entitled to the full benefit of its bargain. So long as an item of service or expense is reasonably related to the defense of a covered claim, it may be apportioned wholly to the covered claim.
Continental Cas. Co. v. Bd. of Education of Charles County, 302 Md. 516, 489 A.2d 536, 545 (1985). See also Harristown Development Corp. v. International Ins. Co., 1988 U.S. Dist. LEXIS 12791, 1988 WL 123149 (M.D. Pa. 1988) (following the Charles County case and concluding that "costs and expenses for items that were of use in defense of [an insured director] are recoverable from [the insurer] even though they may also have been useful in defense of [an uninsured corporation].") Other courts have adopted variations of the "reasonably related" test.
2. Federal is not entitled to allocation
This court adopts, as most appropriate to this case, the rule in Harbor, 922 F.2d at 368, concerning settlement payments and the rule in Charles County, 489 A.2d at 545, concerning defense costs.
Under Insuring Clause 2 of the Policy, Federal is obligated to:
pay on behalf of the insured organization all loss which the insured person has become legally obligated to pay. . . . (emphasis added).