Free Reply to Response to Motion - District Court of Arizona - Arizona

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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

James K. Thurston, ARDC No. 6202021 Patrick K. Cary, ARDC No. 6227274 Daniel E. Tranen, ARDC No. 6244878 WILSON, ELSER, MOSKOWITZ, EDELMAN & DICKER LLP 120 North LaSalle Street Chicago, IL 60602 Telephone: (312) 704-0550 Facsimile: (312) 704-1522 Admitted Pro Hac Vice Mark G. Worischeck, No. 011147 J. Steven Sparks, No. 015561 SANDERS & PARKS, P.C. 3030 North Third Street, Suite 1300 Phoenix, AZ 85012-3099 Telephone: (602) 532-5795 Facsimile: (602) 230-5054 Attorneys for Defendant Carolina Casualty Insurance Company UNITED STATES DISTRICT COURT DISTRICT OF ARIZONA Alanco Technologies, Inc., et al. Plaintiffs, v. Carolina Casualty Insurance Company, Defendant. Case No.: CV-04-0789-PHX-DGC DEFENDANT'S MEMORANDUM OF LAW IN REPLY TO ITS MOTION FOR SUMMARY JUDGMENT

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Defendant Carolina Casualty Insurance Company ("Carolina") for its Memorandum of Law in Response to Plaintiffs' Motion for Summary Judgment, states as follows: I. INTRODUCTION Plaintiffs' (collectively, "Alanco") Response Brief has made two critical concessions. First, with respect to the "no Loss" argument, Alanco "acknowledge[s] that the amended complaint...sought rescission." Alanco then argues that on December 1, 2004, TSI Nevada "waive[d] rescission." Alanco, however, concedes Carolina's extensive legal authority holding that a lawsuit seeking rescissionary damages is not covered under a D&O insurance policy. At best, Alanco is only entitled to coverage
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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

from the date this Order was entered (i.e., December 1, 2004 forward), eliminating $373,698.20 incurred prior to this date. As discussed herein, however, the entire Amended Lawsuit is still barred from coverage based on the "no Loss" argument. Alanco's second critical concession relates to the two other lawsuits ­ the TSI Bankruptcy and the Nevada Lawsuit ­ for which Alanco seeks coverage. Carolina's unchallenged Affidavits have attributed $195,133.40 to the TSI Bankruptcy, and $32,858.80 to the Nevada Lawsuit. Alanco concedes these figures are accurate.

Accordingly, if this Court finds the TSI Bankruptcy and/or the Nevada Lawsuit are not covered, these precise amounts should be subtracted from Alanco's legal invoices. II. ARGUMENT A. The "No Loss" Argument

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Carolina's Motion argues that there is no coverage for the Amended Lawsuit because the plaintiffs in that claim seek "rescission or rescissionary damages which constitute an `ill-gotten' gain and are not insurable." Alanco's Response Brief does not challenge any of Carolina's authority, but simply argues that as reflected in a December 1, 2004 Bankruptcy Court Order, the plaintiffs to the Amended Lawsuit "voluntarily waive[d] rescission as a potential remedy." (Alanco Response Brief, p.12.) As a result: (1) Alanco concedes that the allegations of the Amended Lawsuit prior to the December 31, 2004 Order allegedly dismissing the rescission claim ­ are not covered; and (2) Carolina's authority is unchallenged that a claim seeking increased corporate consideration ­ such as the Amended Lawsuit ­ is not insurable under law. Furthermore, the "evidence" Alanco presents to indicate that the plaintiffs to the Amended Lawsuit waived rescission as a remedy is not admissible, and in any event does not prove what Alanco argues it proves. Moreover, whether the plaintiffs to the Amended Lawsuit waived the rescission remedy or not is completely immaterial, because even without such remedy, the Amended Lawsuit still seeks the dollar-value equivalent of amounts they are allegedly owed ­ and that is not insurable.

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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

1.

The Legal Fees and Costs Incurred Prior to December 1, 2004 Are Not Covered

Preliminarily, Exhibit B to Alanco's Response is not admissible evidence,1 as it was never identified or produced in discovery in this case. Connolly v. Allstate Ins. Co., 1997 U.S. App. LEXIS 9369 (9th Cir. 1997); Pac Fab, Inc. v. Sunline Int'l USA, 2002 U.S. Dist. LEXIS 26479 (D.Ariz. 2002).2 Alanco concedes that "Plaintiffs are certainly willing to acknowledge that the amended complaint...sought rescission...". (Response Brief, p.12) Alanco then argues that by (an inadmissible) Court Order dated December 1, 2004, TSI Nevada "waive[d] rescission." Id. Alanco, however, concedes Carolina's extensive legal authority

holding that a lawsuit based on rescission or rescissionary damages is not covered under an insurance policy. At best, Alanco is only entitled to coverage for fees and costs incurred after the date of this Order. This Court has already ruled that portions of the underlying lawsuit against Alanco are not covered based on the I v. I exclusion. Similarly, given: (i) Alanco concedes (as it must) the Amended Lawsuit involved a claim for rescissionary damages; and (ii) Alanco has not challenged any of Carolina's extensive legal authority that lawsuits based on rescissionary damages are not covered under D&O policies ­ Carolina respectfully submits that this Court should bar Alanco from recovering

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See, Carolina's separately filed Motion to Strike Plaintiffs' Response SOF, which Carolina expressly adopts and incorporates herein. Exhibit B also cannot be used as impeachment evidence on this issue, since the existence of "Loss" is an element of insured's case, and not a "defense." The insured must first prove the claim implicates coverage under the Policy, and it cannot do that without proving it was subject to a Loss ­ and Carolina does not have the burden of proving the absence of Loss. Since the existence of a Loss is Alanco's burden, it cannot use documents to address that burden which have not been identified or exchanged in discovery. See, e.g., Connolly and Pac Fab, supra.
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Second, Exhibit B to Alanco's Response does not indicate that the rescission remedy in the Amended Lawsuit was indeed waived. While the order does reference the "Alanco Litigation," at that time, two Alanco Litigations were pending: (i) the Amended Lawsuit; and (ii) the Nevada Lawsuit, against Alanco and its directors and officers. Alanco has presented no evidence that the "Alanco Litigation" was a reference to the Amended Lawsuit.
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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

$373,698.20, the total amount of legal fees and costs incurred prior to December 1, 2004, the date TSI Nevada purportedly waived its rights to rescission.3 2. Post-December 1, 2004, the Amended Lawsuit Still Seeks Rescission-Like Damages

The Amended Lawsuit concerns Alanco's purchase of TSI Nevada's assets in exchange for Alanco's stock. Specifically, as set forth in the Amended Lawsuit: "6 million shares of Alanco common stock would be exchanged for TSI Nevada's assets." (Carolina's SOF, Ex.1, ¶36.) As Alanco explained in its filings with the Bankruptcy Court, TSI Nevada sought to "`undue the transaction,' with each party returning to the other what it parted with in the original transaction" whereby TSI Nevada's would be "obligat[ed]...to return the six million shares of Alanco stock." (Carolina's SOF, ¶3.) The only thing the December 1, 2004 Order eliminates is TSI Nevada's ability to actually rescind the transaction ­ i.e., for TSI Nevada to actually get back its assets from Alanco, and for Alanco to actually get back its 6 million shares of stock from TSI Nevada. The December 1, 2004 Order, however, does not eliminate TSI Nevada's

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right to recover damages for Alanco's alleged misrepresentations as to the value of the Alanco stock TSI Nevada was to receive (in exchange for TSI Nevada's assets). Alanco's Response Brief also implies that if the remedy sought in the Amended

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Lawsuit constitutes "damages" as opposed to the equitable remedy of actual rescission, then the claim is a covered Loss under the Policy. Alanco, though, cites no authority for this position. Indeed, it fails to do so because the position is incorrect: whether an insured is liable to return (a) the property itself, or (b) the monetary equivalent of such property ­ does not change the fact that the insured does not suffer a Loss by returning

3

This total is reached by adding together all of Stinson's and Oman's invoices prior to December 1, 2004 (Carolina's SOF, Ex.4.A and B.), which for Oman include $972.80, $4,344.50, $8,194.40, $4,387.00, $2,840.41, $712.80, $1,313.00, $978.00, $1,133.50, $234.10, $681.50, $5,446.30, $4,717.70, $4,933.50, $2,252.50, $1,911.00, $2,207.50, $2,744.00, $1,841.00, $1,176.00, $5,709.10, all totaling $58,750.61; and Stinson's invoices for $858.50, $5,111.10, $9,462.20, $20,414.45, $36,607.17, $23,979.51, $26,794.60, $35,566.48, $32,671.24, $14,074.21, $45,321.28, $64,086.85, all totaling $314,947.59.
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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

either. The case law on this issue is clear ­ none of which Alanco disputes ­ an insured does not suffer a "Loss" by returning the property it wrongfully obtained through its conduct, or the monetary equivalent of such property. See, Pan Pacific Retail Properties, Inc. v. Gulf Ins. Co., 2004 U.S. Dist. LEXIS 28534 (S.D.Cal. 2004); Conseco, Inc. v. National Union Fire Ins. Co., 2002 WL 3196447 (Ind. Cir. 2002); Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001). Here, the Amended Lawsuit seeks the monetary equivalent of what Alanco should have paid (but failed to) when it purchased TSI Nevada's assets: "TSI Nevada has been stripped of all of its assets, ... and has been left with a block of Alanco stock with materially and substantially less value...than that which was promised to the TSI Nevada shareholders." (Carolina SOF, Ex.1, ¶62.) The Amended Lawsuit therefore alleges that Alanco obtained TSI Nevada's assets without paying the proper price for them. When the Amended Lawsuit seeks to force Alanco to pay the proper price, Alanco does not suffer a "Loss" though its underpayment of those assets. Restoring the underpayment does not result in a "Loss" to Alanco ­ it merely represents payment for value previously received. Indeed, the Amended Lawsuit is very similar factually with Conseco, Inc. v. National Union Fire Ins. Co., 2002 WL 3196447 (Ind. Cir. 2002). In Conseco, plaintiff alleged misrepresentations related to an IPO offering. Specifically, plaintiffs alleged they purchased a stock that defendants represented had a "$5" value when in reality it was only worth "$3" ­ and they sued for the "$2" price differential. Similarly here, the core damage allegation of the Amended Lawsuit is that TSI Nevada received: "a block of Alanco stock with materially and substantially less value...than that which

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was promised to the TSI Nevada shareholders."

Like Conseco, the TSI Nevada

shareholders were promised a "$5" stock from Alanco, but received a stock worth only "$3." As set forth in Conseco and the other unchallenged "no Loss" cases cited, Alanco was never entitled to this "$2" underpayment ­ it represents an ill-gotten gain

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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

to Alanco ­ and Carolina cannot be held liable for Alanco's corporate obligation to return this "$2" differential to TSI Nevada. B. The Fee Statements 1. Daggett Overstatement: $4,555

Alanco argues that the hourly rate of attorney Daggett is not overstated because it reflects a rate increase "made in the ordinary course of [his firm's] business." This simply is wrong. From November 19, 2003 (Daggett's very first entry) until October 31, 2004, Daggett's rate was $285 per hour. From November 1, 2004 through

November 30, 2004, his rate was $325. From December 1, 2004 through August 31, 2005 (his last entry), his rate is $285.4 (See, Carolina's SOF, Ex.4.A (Invoice No. 9634529 for November 2004 time)). Accordingly, for 19 months his hourly rate was $285, and one month "sandwiched" in between, his rate was $325 ­ obviously a mistake, and not a rate increase made in the "ordinary course of business." This mistake totals to $4,184.50. Alanco concedes $370.50 was improper. 2. Greenberg Fees: Only $2,534.31 Potentially Covered

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Alanco argues it is entitled to $20,265 of the Greenberg fees ­ again, Alanco is wrong. The very first page of Alanco's exhibit reflecting the Greenberg invoices is the "Bill Payment Report" by Greenberg. (Carolina's SOF, Ex.4.C.) It lists all "payment[s]" made by Alanco.5 After July 31, 2003, there are only four payments made by Alanco of the Greenberg fees: $982.43, $180.68, $986.70 and $384.50, all totaling $2,534.31. Id. Accordingly, to the extent Alanco is entitled to any portion of the Greenberg fees, it is only entitled to $2,534.31, and not $20,000. ///

Mr. Daggett's hourly rate is not listed on the billing invoices. However, by simply dividing his time spent by the total expense yields his billing rate. Incredibly, in its initial letter (Carolina's SOF, Ex.4), Alanco demanded "$120,287.43" for the Greenberg invoices. Alanco did not realize it had inadvertently included the "Bill Payment Report" that reflected another insurer, Philadelphia Insurance Company, had paid over $80,000 of these invoices.
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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

3.

TSI Bankruptcy

Section VII.B. of the Policy provides "All Claims based upon or arising out of the same Wrongful Act or any Related Wrongful Acts...shall be considered one Claim." (Carolina's SOF, Ex.3.) Although never stated in its Brief, Alanco impliedly argues that the TSI Bankruptcy is "related" to the Amended Lawsuit (otherwise, as noted by Carolina's Response Brief, the TSI Bankruptcy was a "Claim" first made after all Carolina policies expired). Alanco has presented this Court with absolutely no evidence whatsoever of a single "Wrongful Act" that is alleged in the TSI Bankruptcy against Alanco. In fact, the only "evidence" (which Carolina has sought to strike) in the record is TSI Nevada's notice of filing for bankruptcy. (Alanco's Response SOF, Ex.D.) No "Wrongful Act" is contained in this filing. As a matter of law, this Court cannot find any evidence of related "Wrongful Acts" such that the TSI Bankruptcy and the Amended Lawsuit constitute "one Claim." Second, the Policy's Insuring Clauses provide coverage for any "Claim first made against the Directors and Officers", or, in the case of a "Securities Claim", also a "Securities Claim first made against the Company." Alanco concedes that TSI never made any "Claim" against Alanco or its directors and officers. Rather, it was Alanco that was making a claim against TSI Nevada's estate as a "creditor", so that "Alanco could garner significant concessions in the underlying litigation." (Alanco's Response, p.6.) Alanco's Response Brief concedes that "matters initiated by the insured are not recoverable." (Alanco's Response, p.8.) Here, the claims in the TSI Nevada

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Bankruptcy were clearly initiated by Alanco against TSI Nevada's estate so that the Policy's Insuring Clauses are not triggered. Third, the directors and officers were not involved in the TSI Bankruptcy. Alanco, as "creditor", pursued claims against TSI's estate. As noted above, the Policy only affords coverage to Alanco itself for a "Securities Claim." Not only are no claims being made against Alanco (nor its directors and officers), but they certainly do not
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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

involve "Securities."

Indeed, the only evidence contained in the record is TSI

Nevada's initial filing of bankruptcy ­ which does not contain any allegations against Alanco, "Securities Claims" or otherwise. Fourth, it is undisputed that Alanco never provided Carolina with notice of the TSI Bankruptcy. Without any citation to authority or the Policy, Alanco argues it had no "duty to make a separate claim." In fact, Section VII.A. of the Policy expressly states that "[a]s a condition precedent to their rights under this Policy, the Insureds shall give the Insurer written notice of any Claim made against the Insured as soon as practicable, but in no event later than 90 days after such Claim is first made." (Carolina's Motion, Ex.3.) Alanco has presented this Court with absolutely no

evidence that provided to Carolina written notice within 90 days. 4. The Nevada Lawsuit

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It is undisputed that Alanco has presented this Court with absolutely no evidence that it provided Carolina with written notice of the Nevada Lawsuit within 90 days (see, argument related to TSI Bankruptcy). Alanco argues "no reasonable

interpretation of the Policy...would require Plaintiffs to submit a separate claim for costs incurred in the Nevada lawsuit." As set forth above, the Policy mandates it. Further, the Policy requires Carolina's consent as to the law firm selected to defend the litigation. (Carolina Motion, Ex.3.) The Policy also mandates that Alanco "cooperate" with Carolina and further mandates that Carolina "shall be entitled to effectively associate in the defense and the negotiation" of Claim. Id., Section VI.A. Rhetorically, how is Carolina to consent to counsel, seek Alanco's cooperation or be "associate[d] in the defense and the negotiation" of a Claim for which it has never been advised. Moreover, it is obvious that Alanco never expected coverage for the Nevada Lawsuit as Alanco never submitted the legal invoices of the Nevada law firm that actually defended the Nevada Lawsuit. Instead, without any warning to Carolina ­ either by written notice, the Second Amended Complaint or through discovery ­ Alanco now attempts to "bootstrap" these fees and costs.
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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

5.

Oman Invoices

Alanco concedes only $84,587.89 of Oman's invoices totaling $107,390.14 are potentially covered under the Policy. The vast majority of Oman's invoices are not covered because they are related to the TSI Bankruptcy ($58,105.36) and the Nevada Lawsuit ($12,974.40). Moreover, despite its statements without foundation or basis in evidence in the Response Brief, Alanco has presented this Court with absolutely no evidence that Oman performed services otherwise that would have been performed as outside counsel. For example, in the Nevada Lawsuit, Alanco had its Nevada counsel of record, apparently the Stinson firm too (or so Alanco would like this Court to believe), as well as Oman. Three counsel on one case, without evidence that Oman performed outside counsel services, is simply neither "reasonable" nor "necessary" as mandated under the Policy. Oman, a director of Alanco, simply served as the corporate representative for Alanco to liaise with outside counsel in the Amended Lawsuit ­ the fact that he is also an attorney does not give rise to his services being recoverable under the Policy. 6. Retention

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Alanco argues a $100,000 retention is applicable rather than a $200,000 retention.6 For "Securities Claims" a retention of $200,000 applies; for all "Other Claims" a $100,000 retention applies. (Carolina's Motion, Ex. 3, Declaration Page.) Alanco concedes the Amended Lawsuit involves a "Securities Claim", but argues because the Amended Lawsuit also contains other causes of action that are not "Securities Claims", the lower retention applies. The Policy provides "one Retention amount shall apply to each and every Claim."
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In relevant part, the Policy defines "Claim" as "a civil...proceeding

Alanco argues that Carolina is using the "previous year's" Policy, and referring to the wrong retention (Alanco's Response, p.10.) Alanco provided notice of a potential Claim during the 2001-02 Policy and the subsequent Amended Lawsuit is deemed related back thereto. However, Carolina has no problem using the subsequent year's $100,000 and $200,000 retentions.

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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

...commenced by: service of a complaint." A proceeding encompasses the entire "lawsuit", not each separate cause of action. Indeed, if "proceeding" meant each cause of action, rather then the entire lawsuit, then eleven retentions should be applicable to the Amended Lawsuit. Carolina also notes Alanco's arguments are inconsistent. In one breath, Alanco concedes the Amended Lawsuit is a "Securities Claim", but nevertheless argues the lower retention should apply because the Amended Lawsuit also contains non"Securities Claim" causes of action. In the very next breath, Alanco argues that the retention may be waived if the Amended Lawsuit is dismissed. However, the retention is waived "[s]olely with respect to a Securities Claim." (Carolina Motion, Ex. 3, Section V.E.) retention.7 C. The Ninth Circuit's Strict Ripeness Requirements Have Not Been Met In This Case The Amended Lawsuit cannot be a non-"Securities Claim" for the

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purposes of the retention, but a "Securities Claim" for the purposes of waiving the

The Ninth Circuit is clear that when coverage under an insurance policy depends upon what is determined in the underlying claim for which coverage is sought, the coverage dispute is not ripe for adjudication. See, e.g., American National Fire Ins. Co. v. Hungerford, 53 F.3d 1012, 1027 (9th Cir. 1995). Here, it is undisputed that the Amended Lawsuit is not concluded ­ and a verdict could trigger the Fraud Exclusion. Contrary to Alanco's argument that the Policy requires Carolina to advance Costs of Defense, only covered Costs of Defense need to be advanced. Moreover, while Alanco argues in Hungerford "the facts were not yet fully developed," yet in the

Even if the Amended Lawsuit was dismissed, it would not meet the definition of "No Liability" necessary for the retention to be waived insofar as the dismissal is apparently based on TSI Nevada's new board not wanting to pursue the lawsuit any further, rather than a "final judgment of no liability obtained prior to trial...by reason of a motion to dismiss or a motion for summary judgment...". (Carolina SOF, Ex. 3, Section III.J.)

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Amended Lawsuit the facts "are as developed as they can ever be." Until the Amended Lawsuit is resolved, the facts are not fully developed, as there has been no trial or final determination yet in the Amended Lawsuit. Because the factual determinations in the Amended Lawsuit have not yet been made, no final judgment can be entered in this case at this time. III. CONCLUSION For the reasons set forth in Carolina's Motion and as set forth herein, Carolina respectfully requests this Court to enter Summary Judgment in its favor. DATED this 21st day of February, 2006. SANDERS & PARKS, P.C.

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By: s/ Mark G. Worischeck____________

Mark G. Worischeck J. Steven Sparks 3030 N. Third Street, Suite 1300 Phoenix, AZ 85012-3099 and James K. Thurston Patrick K. Cary Daniel E. Tranen WILSON, ELSER, MOSKOWITZ, EDELMAN & DICKER LLP 120 North LaSalle Street Chicago, IL 60602 Attorneys for Defendant Carolina Casualty Insurance Company

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LAW OFFICES SANDERS & PARKS, P.C. 1300 ABACUS TOWERS 3030 NORTH THIRD STREET PHOENIX, ARIZONA 85012-3099 TELEPHONE (602) 532-5600 FACSIMILE (602) 532-5700

I hereby certify that on February 21, 2006, I electronically transmitted the foregoing document to the Clerk's Office using the CM/ECF System for filing and transmittal of a Notice of Electronic Filing to the following EM/ECF Registrants: mdaggett @stinsonmoheck.com cbeams @stinsonmoheck.com Attorneys for Plaintiffs To be hand-delivered as a courtesy hard copy on February 21, 2006, to The Honorable David G. Campbell s/ Mark G. Worischeck

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