Free Motion for Summary Judgment - 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 MOTION FOR SUMMARY JUDGMENT AND MEMORANDUM OF LAW IN SUPPORT THEREOF

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Defendant Carolina Casualty Insurance Company ("Carolina") for its Motion for Summary Judgment, states as follows: I. INTRODUCTION This Coverage Lawsuit involves an insurance coverage dispute between Carolina, and Alanco Technologies, Inc. ("Alanco") and its directors and officers (collectively, "the Alanco Defendants"). Carolina issued two Directors' and Officers'

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and Corporate Liability Insurance Policies to Alanco (collectively, the "Policy").
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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

In this Coverage Lawsuit, the Alanco Defendants have sought coverage for only three matters: (i) an October 17, 2002 letter sent to Alanco's board (the "October 2002 Letter"); (ii) the original complaint filed by Richard Jones against the Alanco Defendants on January 30, 2003 (the "Original Lawsuit"); and (iii) the Second Amended Complaint filed on July 31, 2003 (the "Amended Lawsuit"). Previously, this Court has already ruled that there is no coverage for the October 2002 Letter or the Original Lawsuit. The Amended Lawsuit is presently pending and has not been resolved by trial or settlement. As such, Plaintiffs are presently seeking approximately $746,455 in legal fees and costs purportedly related to the defense of the Amended Lawsuit. Carolina's Motion for Summary Judgment seeks a ruling that there is no coverage under the Policy because the Amended Lawsuit seeks rescission or rescissionary-damages which constitute an "ill-gotten gain" and are not insurable. In addition, there is no coverage for certain portions of the $746,455 of legal expenses sought by Plaintiffs because they have wrongfully intermingled at least $299,009.67 in other legal expenses: (1) relating to the October 2002 Letter and the Original Lawsuit (which this Court previously held are not covered under the Policy); (2) involving other legal matters for which Plaintiffs have not sought coverage for in this Coverage Lawsuit; (3) involving other legal matters for which Plaintiffs never notified Carolina; (4) involving other legal matters in which Alanco is the claimant; and (5) involving legal invoices of an Alanco Director, who also happens to be an attorney (in addition to the other two law firms retained to defend the Amended Lawsuit). The Policy also contains a $150,000 retention.

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Finally, as the Amended Lawsuit has not been fully and finally resolved, this Court cannot, respectfully, enter any Order against Carolina on coverage as the Policy contains certain exclusions that may be triggered only upon final resolution of 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

II.

ARGUMENT In Arizona, the interpretation of an insurance contract is a question of law to be

determined by the court. Univ. Mechanical Contractors of Ariz., Inc. v. Puritan Ins. Co., 723 P.2d 648, 650 (Ariz. 1986). Insurance contracts that are unambiguous are interpreted according to their plain and ordinary meanings. Estrada v. Planet Ins. Co., 546 P.2d 372 (Ariz. 1976). The mere fact that the parties disagree as to the meaning of insurance policy terms does not in and of itself establish ambiguity. Grossman v. Hatley, 522 P.2d 46, 50 (Ariz. 1974). A. The Amended Lawsuit Does Not Seek Covered "Loss", Since Rescissionary Damages are Not Insurable.

In the Amended Lawsuit, TSI Nevada alleges that the Alanco Defendants made misrepresentations in connection with Alanco's acquisition of TSI Nevada assets. (Facts, ¶1.)1 TSI Nevada's Prayer for Relief seeks that the "transaction between TSI Nevada and Alanco be rescinded." (Facts, ¶2.) Indeed, in legal pleadings, Alanco itself has characterized the Amended Lawsuit by TSI Nevada as follows: "[TSI Nevada] is the Plaintiff in a state court action which seeks to rescind a transaction whereby Alanco obtained [TSI Nevada's] primary assets...[i]n order to be entitled to rescission, [TSI Nevada] must `undue the transaction,' with each party returning to the other what it parted with in the original transaction." (Facts, ¶3.) An insured cannot seek insurance coverage for rescissionary damages because they constitute an "ill-gotten gain." One court has specifically held under a D&O policy, where "damages...are rescissionary, the damages must be for an ill-gotten gain" to the insured and are not insurable. Conseco, Inc. v. National Union Fire Ins.

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Co., 2002 WL 3196447, *9 (Ind. Cir. 2002). In Conseco, like here, the insureds
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sought coverage for a securities lawsuit based on allegations that the insureds made misrepresentations related to the sale of the insured company's stock. Id. *1-2. The
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"Facts" shall refer to Carolina's separately filed Statement of Undisputed Facts In Support Of Its Motion For Summary Judgment.
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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

Conseco court found no coverage under the D&O policy because rescissionary damages did not constitute "Loss" under the Policy. The Conseco court noted: "It is axiomatic that insurance cannot be used to pay an insured for amounts an insured wrongfully acquires and is forced to return, or to pay the corporate obligations of an insured." Id. *6. As emphasized in Conseco, an "ill-gotten" gain does not require allegations of intentional or otherwise nefarious conduct. Rather, an "ill-gotten" gain is simply something to which the insured is not entitled -- and must give back: For example, if bank makes an innocent calculation error and wrongfully acquires funds from a customer, upon realization of the error the bank has to return the funds to the customer; and the bank cannot then claim reimbursement of the funds through insurance. Otherwise the bank would be unjustly enriched with a windfall and profit from its own--albeit innocent--wrong. ...Courts have generally found that if an insured wrongfully acquires funds and then is forced to return the funds, or if an insured is held liable to pay its corporate obligations incurred in the ordinary course of business, it has not suffered a loss, regardless of whether the wrongful conduct was intentional. Conseco, 2002 WL 3196447, *10. In Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001), the Seventh Circuit considered insurance coverage under a D&O policy relating to a securities lawsuit alleging that the insureds made misrepresentations so that they could purchase plaintiffs' shares for an unfairly low price. In an opinion by Chief Judge Posner, the Seventh Circuit determined that the "Loss" incurred in connection with the lawsuit was not insurable under the D&O policy, finding: [the plaintiffs in the underlying suit] were seeking the difference between the value of the stock at the time of trial and the price they had received for the stock from Level 3. That is standard damages relief in a securitiesCase 2:04-cv-00789-DGC Document 78

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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

fraud case. But it is restitutionary in character. It seeks to divest the defendant of the present value of the property obtained by fraud, minus the cost to the defendant of obtaining the property. In other words, it seeks to deprive the defendant of the net benefit of the unlawful act, the value of the unlawfully obtained stock minus the cost to the defendant of obtaining the stock. It is equivalent to seeking to impress a constructive trust on the property in favor of the rightful owner. How the claim or judgment order or settlement is worded is irrelevant. An insured incurs no loss within the meaning of the insurance contract by being compelled to return property that it had stolen, even if a more polite word than `stolen' is used to characterize the claim for the property's return. Level 3, 272 F.3d at 910-11. (Emphasis added.) Similarly, in Pan Pacific Retail Properties, Inc. v. Gulf Ins. Co., 2004 U.S. Dist. LEXIS 28534 (S.D.Cal. 2004), the court examined issues very similar to the present case. In that case, "Pan Pacific [the Insured] and Western entered into an ... Agreement of Merger ... pursuant to which Pan Pacific was to acquire Western in a stock for stock exchange." Id. at *6. Thereafter, the shareholders of Western filed a class action alleging that the consideration paid by [the Insured] for Western was inadequate. Id. at *8. Pan Pacific's insurer asserted that the class action was not covered by the directors and officers insurance policy. Id. at *3. The Pan Pacific court noted: "the law is clear that insurance is not available for the return of an `ill-gotten' gain" (id. at *5), and then ruled that the class action did not implicate coverage under the directors and officers policy, since the class action could not result in a "Loss" to the Insured:

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[T]he core of the complaint filed in the [class] action was that Pan Pacific had not paid a sufficient amount for the shares of Western. ... The [class] action sought increased merger consideration on the theory that the price paid by Pan Pacific was unfairly low and did not reflect the true value of the Western shares. In the end, the plaintiffs [in the lawsuit for which coverage was
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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

sought, Western shareholders] received exactly what they sought ­ more money for their shares of Western in line with their view of the true value of their Western shares. Id., at *9. See also Safeway Stores, Inc. v. Nat'l Union Fire Ins. Co. of Pittsburgh, Pa., 64 F.3d 1282, 1286-87 (9th Cir. 1995) (company's dividend payment was not "loss" under insurance policy since there was no financial detriment to the insured); Republic Western Ins. Co. v. Spierer, Woodward, Willins, Denis and Furstman, 68 F.3d 347, 351-52 (9th Cir. 1995) (restitution not covered by insurance policy); Amer. Cas. Co. of Reading, Pa. v. Hotel and Restaurant Employees and Bartenders Int'l Union Welfare Fund, 942 P.2d 172, 769-71 (Nev. 1997) (amounts owed under contract not insurable, and insured cannot pass its legal obligations on to its insurance carrier).2 Like the D&O policies at issue in Conseco, Level 3, and Pan Pacific,

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Carolina's Policy only provides coverage for Claims made against the Insured whereby the Insured could suffer a "Loss." (Facts, ¶4.) The Amended Lawsuit seeks rescission or rescissionary-damages as a result of the Alanco Defendants alleged misrepresentations.

See also Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 782 N.Y.S.2d 19, 20 (App.Div. 2004) ("defense costs are only recoverable for covered claims"); Stonewall Ins. Co. v. Asbestos Claims Management Corp., 73 F.3d 1178, 1219 (2d Cir. 1995) ("The policies do not contemplate unconditional payment of defense costs for potentially covered claims, but only payment of costs if indemnification is required."); Hurley v. Columbia Cas. Co., 976 F.Supp. 268, 275 (D.Del. 1997) (rejecting insured's argument that directors' and officers' liability insurer must advance defense costs until future determination as to policy coverage: "Neither the duty to defend nor the undertaking to advance defense costs compels Columbia to pay defense costs on a claim that is not covered by the Policy."); In re Kenai Corp., 136 B.R. 59, 64 (S.D.N.Y. 1992) (where policy's definition of "loss" includes defense expenses, and underlying claim is not covered, the insurer should not be required to reimburse defense expenses).
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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

Like Level 3 (plaintiffs "were seeking the difference between the value of the stock at the time of trial and the price they had received for the stock from Level 3"), Pan Pacific (plaintiffs "sought increased merger consideration on the theory that the price paid by Pan Pacific was unfairly low and did not reflect the true value of the Western shares"), the plaintiff in the Amended Lawsuit alleges it: "has been left with a block of Alanco stock with materially and substantially less value and voting power than that which was promised to the TSI Nevada shareholders." (Facts, ¶5.) The Amended Lawsuit seeks rescission or rescissionary-damages ­ i.e., merger consideration that the Alanco Defendants should have paid (but failed to) when it purchased TSI Nevada. Since such damages are not "Loss" to the Alanco Defendants, the Policy is not implicated and there is no coverage for the Amended Lawsuit. B. Even if the Amended Lawsuit is a covered Claim, there is no Coverage for Certain Defense Fees and Expenses Submitted for Coverage by Plaintiffs.

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Plaintiffs have submitted invoices for legal fees, costs and expenses totaling approximately $746,390.14 that are purportedly related to the Amended Lawsuit (the "Legal Invoices"): Stinson Invoices: Greenberg Invoices: $619,064.59 "$20,000" (approximately) $107,390.14 $746,454.73

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Oman Invoices: TOTAL

(Facts, ¶6.) However, the Legal Invoices have improperly included $4,555 in redacted entries, duplicative entries and over-stated attorney rates. (Facts, ¶8.) Stinson's

Invoices also contained six redactions for which Carolina has not been credited. (Facts, ¶8.) Such fees, costs and expenses are not properly reimbursable under the Policy.

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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.

Defense Fees and Expenses Prior to the Amended Lawsuit are Not Subject to Coverage

By Orders dated May 18, 2005 and September 16, 2004, this Court found that the I v. I exclusion applied to bar coverage for: (i) the October 2002 Letter; and (ii) the Original Lawsuit. (Facts, ¶¶9.) However, this Court also concluded that the I v. I exclusion did not apply to the Amended Lawsuit. Id. The Amended Lawsuit was filed on July 31, 2003. (Facts, ¶10.) Consequently, the Policy does not cover any Costs of Defense incurred prior to July 31, 2003. Plaintiffs have submitted legal expenses totaling $42,706.66 incurred prior to July 31, 2003. (Facts, ¶11.) Accordingly, Plaintiffs are not entitled to coverage for these legal expenses as a matter of law. 2. Fees and Expenses Related to the Slander Lawsuit, the TSI Bankruptcy, and the Nevada Lawsuit are Not Covered.

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The Legal Invoices include legal fees, costs and expenses that include at least $238,239.883 (Facts, ¶15) that are related to three other legal matters: (i) a slander lawsuit filed by Alanco against Richard Jones (the "Slander Lawsuit")(Facts, ¶14); (ii) Alanco's participation as a creditor in TSI Nevada's bankruptcy proceeding ("TSI Bankruptcy")(Facts, ¶12); and (iii) a lawsuit against Alanco and its directors and officers filed in Nevada ("Nevada Lawsuit"). (Facts, ¶13.) a. Plaintiffs Coverage Lawsuit does not Seek Coverage for these Three Other Matters.

Plaintiff's Coverage Lawsuit does not seek coverage for the Slander Lawsuit, the TSI Bankruptcy or the Nevada Lawsuit. (Facts, ¶16.) Indeed, Plaintiff's Coverage Lawsuit does not contain a single allegation or reference to these three matters. (Facts,

The Stinson Invoices includes uncovered fees and costs of $166,964.12, representing $10,051.68 (Slander Lawsuit), $19,884.40 (Nevada lawsuit) and $137,028.04 (TSI Bankruptcy) (Facts, ¶16). The Oman Invoices includes uncovered fees and costs of $71,275.76, representing $196 (Slander Lawsuit), $12,974.40 (Nevada lawsuit) and $58,105.36 (TSI Bankruptcy). (Facts, ¶25.)
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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

¶16.) Because Plaintiffs have not pleaded any facts related to these matters or sought coverage for these matters in the Coverage Lawsuit, these matters are not covered under the Policy. Accordingly, $238,239.88 is not covered under the Policy. b. Plaintiffs Never Provided Notice To Carolina Of These Other Three Matters.

Plaintiffs have never provided Carolina with notice of the Slander Lawsuit, the TSI Bankruptcy nor the Nevada Lawsuit. (Facts, ¶17.) Section VII.A. of the Policy provides 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 an Insured as soon as practicable, but in no event later than 90 days after such Claim is first made." (Facts, ¶18.) As Plaintiffs never provided notice to Carolina of these matters, Carolina's "claims-made" policy does not afford coverage for the same. See, Thoracic

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Cardiovascular Associates, Ltd. v. St. Paul Fire and Marine Ins. Co., 181 Ariz. 449, 891 P.2d 916 (App. 1994)(claims-made policy does not afford coverage when insured violates policy's notice provision); Sletten v. St. Paul Fire and Marine Ins. Co.,161 Ariz. 595, 780 P.2d 428 (App. 1989)(same). In addition, the Policy's plain language provides: "The Insureds shall not...incur Costs of Defense without the prior written consent of the Insurer. Only those...Costs of Defense which have been consented to by the Insurer shall be recoverable as Loss under the terms of this Policy." (Facts, ¶18.) Alanco and its Directors and Officers have never sought Carolina's consent to incur Costs of Defense related to the Slander Lawsuit, the TSI Bankruptcy or the Nevada Lawsuit. (Facts, ¶19.) Correspondingly, Carolina has never provided its written consent for the

incurrence of the legal expenses related to the Slander Lawsuit, the TSI Bankruptcy or the Nevada Lawsuit. (Facts, ¶20.) In addition, a claims-made policy insurer like Carolina has no obligation to reimburse pre-notice defense expenses. See, e.g., Xebec Development v. National Union Fire Ins. Co., 15 Cal.Rptr.2d 726 (1983)(under D&O policy: "the existence or
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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

absence of prejudice to National Union is simply irrelevant to National Union's duty to indemnify costs incurred before notice. The policy plainly provides that notice is a condition precedent to the insured's right to be indemnified; a fortiori the right to be indemnified cannot relate back to payments made or obligations incurred before notice.") See also, Borenstein v. National Union Fire Ins. Co., 828 F.2d 242 (4th Cir. 1987)(no reimbursement of defense expenses until after written notice is provided of claim).4 c. The Policy Covers Only The "Defense" Of Lawsuits Against The Insureds, And Not Affirmative Claims Made By The Insureds Against Others.

The Policy's Insuring Clause only provides coverage for "Loss" as a result of a "Claim first made against the Directors or Officers" or a "Securities Claim first against the Company." (Facts, ¶21.) "Loss" includes "Costs of Defense" which is defined as "reasonable and necessary fees, costs and expenses...resulting solely from the...defense and appeal of a Claim against the Insureds." (Facts, ¶21.) The legal fees and costs incurred in conjunction with the Slander Lawsuit is not "against" Alanco; rather, Alanco is the plaintiff prosecuting the Slander Lawsuit against Richard Jones. (Facts, ¶22.)

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Similarly, in the TSI Bankruptcy, the TSI Bankruptcy entity has made no
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4

Even in the duty to defend context, the majority rule is that pre-notice defense expenses are not recoverable -- irrespective of prejudice. See, e.g., American Mutual Liberty Ins. Co. v. Beatrice, 924 F.Supp. 861 (N.D. Ill. 1996)("Because the policies justifying the prejudice requirement do not apply to the tender requirement, courts have concluded that (at least between sophisticated parties) the `no pre-tender defense costs' rule remains viable even in jurisdictions that have adopted the `notice-prejudice' rule.")(cases cited therein). See also, Safeguard Scientifics, Inc. v. Liberty Mutual Insurance Co., 766 F.Supp. 324 (E.D. Pa. 1991), aff'd in part rev'd in part without op., 961 F.2d 209 (3d Cir. 1992)(insured was not permitted to recover $376,000 in prenotice defense expenses); Clemente v. Home Insurance Co., 791 F.Supp. 118 (E.D. Pa. 1992)($318,000 in pre-notice defense expenses incurred without the consent of the insurer were not covered).
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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

"Claim" against Alanco or its Directors and Officers as that term is defined by the Policy. In fact, Alanco has described itself in legal pleadings as a "creditor" in that bankruptcy proceeding. (Facts, ¶23.) Sections 101(10)(A) and (B) of the U.S.

Bankruptcy Code define "creditor" to mean an "entity that has a claim against the debtor" or a "claim against the estate." Like the Slander Lawsuit, in the TSI

Bankruptcy, it is Alanco that is making the claim against the TSI Bankruptcy Estate. An insurance policy does not cover the legal expenses of affirmative claims by the Insured. See, e.g., 3250 Wilshire Boulevard Building, v. Employers Insurance of Wausau, et al., 39 Cal.App. 4th 1277 (1995)("Insurer not obligated to pay legal expenses incurred in Insureds' initiation of collateral action even if collateral action characterized by Insured as a proactive form of defending herself in separate proceedings against her").5 Moreover, as noted above, the plain language of the

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Policy only affords coverage for Claims "against the Company [or the Directors and Officers]", and not "by the Company." The legal fees, costs and expenses incurred related to the Slander Lawsuit, the TSI Bankruptcy and the Nevada Lawsuit total at least $238,239.88. Such fees, costs and expenses are not covered and summary judgment is warranted.

See also, James 3 Corporation et al., v. Truck Insurance Exchange, 91 Cal.App. 4th 1093 (2001)("Liability insurer not obligated to fund counter-claims despite Insureds' argument that such counter-claims are `factually intertwined' with action against Insured"); Patricia Gray v. Underwriters at Lloyd's, London, 2002 Cal.App. LEXIS 6621, 2002 (1995)("Liability Policy does not obligate Insurer to prosecute Insureds' claims"); Mustang Tractor & Equipment Co. v. Liberty Mutual Insurance Co., 1993 WL 566032 (S.D.Tex. 1993)(rejecting insured's "best defense" is a "good offense" argument holding insured not entitled to coverage for its prosecution of an indemnification claim arising out of lawsuit against insured); Towne Realty, Inc. v. Zurich Insurance Co., 548 N.W.2d 64, 69 (Wis. 1996)("insurance contract simply does not establish an obligation on the part of [the insurer] to indemnify the insureds for the pursuit of counterclaims"); Goldberg v. American Home Assurance, 80 A.D.2d 409 (1981)(insured has "no right to reimbursement for the cost of legal fees on his affirmative claims"); Keene v. Insurance Company of North America, 1983 U.S. Dist. LEXIS 16944 (D.D.C. 1983)("the duty to defend cannot be arbitrarily extended to encompass affirmative 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

3.

Fees and Expenses Billed by Steve Oman, an Alanco Officer, are Not Covered.

Plaintiffs also seek coverage for $107,325.55 in invoices generated by Steve Oman (the "Oman Invoices"). (Facts, ¶24.) $22,541.66 of the Oman Invoices relate to legal services related to the October 2002 Letter and the Original Lawsuit for which this Court has held there is no coverage under the Policy. (Facts, ¶25.) Moreover, $71,275.76 of the Oman Invoices are related to the TSI Bankruptcy ($58,105.36), the Nevada Lawsuit ($12,974.40) and the Slander Lawsuit ($196). (Facts, ¶25.) Such fees and expenses are plainly not recoverable. Plaintiffs retained two law firms to defend them in the Amended Lawsuit ­ Greenberg Traurig and Stinson Morrison Hecker. (Facts, ¶26.) In addition to these two law firms, Plaintiffs seek coverage for the Oman Invoices. Oman is an Director of Alanco. (Facts, ¶27.) The record does not contain any evidence that Oman was Plaintiffs' counsel of record with regard to the Amended Lawsuit. He did not enter an appearance in that case, he did not sign or file any of the pleadings in that case, and he is not a member of the law firm that defended the Amended Lawsuit. The Policy defines "Costs of Defense" to include only "reasonable and necessary" defense fees and expenses. (Facts, ¶28.) Given that Plaintiffs already had retained two law firms to act as their counsel of record in the Amended Complaint, the fees, costs and expenses by Oman were clearly not "reasonable and necessary" to defend the Amended Lawsuit. 4. The Policy Contains a $150,000 Retention.

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The Policy contains a $150,000 retention. (Facts, ¶29.) The Policy expressly provides that "one Retention shall apply to each and every Claim." (Facts, ¶29.) Accordingly, Plaintiff's claimed damages must be offset by $150,000, pursuant to the express terms of the Policy.

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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

C.

This Court Cannot Enter A Final Judgment Against Carolina Until The Amended Lawsuit Is Resolved.

Plaintiffs' Coverage Lawsuit seeks a determination that Carolina has a duty to advance Costs of Defense as well as a duty to indemnify Plaintiffs for all loss associated with the Amended Lawsuit. (Facts, ¶30.) This Court, respectfully, cannot enter judgment in Plaintiffs' favor on the indemnity issue until the Amended Lawsuit has been resolved by settlement, judgment or dismissal (after all appeals). Specifically, the Policy contains several exclusions that will (or will not) apply until the Amended Lawsuit is finally and completely concluded, as the applicability of many of the exclusions will depend upon the facts developed and the final findings issued in that case. For example, the Policy contains a Fraud Exclusion and a Personal Profit Exclusion, which both provide that "this exclusion shall not apply unless a judgment or other final adjudication adverse to any of the Insureds in such Claim shall establish that such Insureds" either "committed such criminal or deliberate fraudulent act" or "gained such profit or advantage to which an Insured was not legally entitled." (Facts, ¶31.) In addition, the Policy's definition of "Loss" expressly excludes

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coverage for "punitive...damages." (Facts, ¶32.) The Amended Lawsuit contains express causes of action for "Fraud In The Inducement" (Count I), "Fraud" (Count II), and "Securities Fraud" (Counts III and IV). (Facts, ¶33.) In addition, the Amended Lawsuit alleges: "Kaufmann and Oester have been personally enriched by their schemes." (Facts, ¶33.) The Amended

Lawsuit also seeks punitive damages. (Facts, ¶33.) Consequently, if TSI Nevada demonstrates that Plaintiffs committed fraud or obtained a wrongful personal profit, the exclusion bars coverage for such "Loss." Indeed, the applicable case law even supports a dismissal of this action without prejudice until the Amended Lawsuit is concluded. In American National Fire Ins.

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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

Co. v. Hungerford, 53 F.3d 1012, 1027 (9th Cir. 1995),6 the Ninth Circuit found that because the facts were not yet fully developed in the underlying, non-concluded claim for which coverage was sought, the coverage action was not yet ripe: At the time the district court made its ruling the instant case, the facts necessary to resolve this insurance coverage claim could only have been developed through the [underlying claim]. The district court could do little in this case but assume the facts as alleged to be true, render a decision based entirely upon those facts as provided by [the plaintiff in the coverage case], and hope that the facts developed during the [underlying claim] would be exactly as the federal court assumed them to be in order for the opinion to be of use to the state court.... A declaratory judgment in this case would not terminate the existing controversy, because `the policy exclusions can be applied only in the light of factual determinations that have not been made.'7 Carolina therefore requests that this Court dismiss the Amended Lawsuit without prejudice, or, alternatively, stay the Amended Lawsuit pending the final resolution of the Amended Lawsuit.

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Hungerford and Employers Reinsurance Corp. v. Karussos, 65 F.3d 796, 799 (9 Cir. 1995) have been overruled onthother grounds. In Government Employees Ins. Co. v. Dizol, 133 F.3d 1220, 1224 (9 Cir. 1998), the Ninth Circuit found that a district court may entertain an action under the Declaratory Judgment Act without sua sponte addressing whether jurisdiction should be declined. Such is not an issue in this case. See also Employers Reinsurance Corp. v. Karussos, 65 F.3d 796, 799 (9th Cir. 1995) (in the "general run of insurance coverage cases ... the exercise of a district court's jurisdiction would be unwarranted"); Diamond State Ins. Co. v. Fame Oper. Co., Inc., 917 F.Supp. 736, 739 (D.Nev. 1996) (coverage action dismissed pending conclusion of underlying claim); State Farm Fire & Cas. Co. v. Meridian Indus. Corp., 1995 WL 648423, *3 (N.D. Cal.) (same); Amer. Economy Ins. Co. v. Williams, 805 F.Supp. 859, 863-66 (D. Idaho 1992) (same).
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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

III.

CONCLUSION For the reasons set forth above, Carolina respectfully requests that this Court

enter Judgment in Carolina's favor on one or all of the issues set forth herein, including summary judgment with prejudice on Plaintiffs' Amended Complaint or, alternatively, order that the $746,454.73 in claimed Legal Invoices be reduced by $449,009.67, as follows: $ 4,555.00 (Stinson Invoices: Duplicative/Overstated Rates); $ 42,706.66 (Pre-July 31, 2003 Invoices); $238,239.88 (Invoices related to Slander Lawsuit, TSI Bankruptcy and Nevada Lawsuit); $ 13,508.13 (Unreasonable Oman Invoices) $150,000.00 (Retention) $449,009.67 TOTAL8 Alternatively, Carolina requests that the Coverage Lawsuit be dismissed without prejudice or stayed pending final resolution of the Amended Complaint. DATED this 13th day of January, 2006. SANDERS & PARKS, P.C. By: s/J. Steven Sparks_______________ 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
8

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Carolina notes there is some overlap between the $42,706.66 and the $238,239.88 figures.
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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 January 13, 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 January 13, 2006 to The Honorable David G. Campbell s/ J. Steven Sparks

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Case 2:04-cv-00789-DGC

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