Kostin v. Pacific Indemnity is a recent federal decision from Connecticut denying insurance coverage that should be of particular interest to those impacted by a Ponzi scheme. In a coverage dispute arising out of the Madoff scandal, the court rejected the policyholder’s argument that Madoff’s misuse of funds constituted “wrongful entry” into her bank account and denied coverage for her clawback liability to the bankruptcy trustee.
The case is particularly interesting because it involves homeowners’ insurance, not the commercial crime or liability (D&O and E&O) policies often considered in coverage cases relating to Ponzi schemes. The insured, Susan Kostin, sought recovery under her family’s “Masterpiece” homeowner’s primary and excess liability policies. Kostin and her family lost millions from an account established to manage family assets, including principal and expected profits. The coverage dispute related specifically to a $3.75 million withdrawal clawed back by the bankruptcy trustee, plus $799,000 in attorneys’ fees and litigation costs spent on fighting to keep that money.
The court invoked several standard rules of policy construction, ultimately leading to its decision against coverage. The central question was whether the claims against Kostin included claims for “personal injury,” defined by the policies to include a legal obligation resulting from “wrongful entry or eviction.” This is a standard definition of “personal injury” seen in many different types of liability coverage. Here, Kostin saw a window of opportunity and made a creative argument: Madoff’s Ponzi entries into the account ledger were wrongful, so there should be “wrongful entry” coverage for Kostin’s liability to the trustee.
In the end, the court based its coverage denial on its distinction between two types of “wrongful entry”: unauthorized intrusions versus fraudulent accounting ledger entries. While “unauthorized intrusions” into accounts might be covered, the court held “fraudulent accounting” entries would not be covered. In creating that distinction, the court focused on the fact that “wrongful entry” is coupled with the term “eviction” in the policy’s definition of “personal injury.” Kostin never alleged that Madoff was operating the account without authorization, so the court found no “wrongful entry.”
The decision was appealed to the Second Circuit. That result on appeal could be important and significant to other Ponzi victims seeking coverage under the personal liability provisions offered by some homeowners’ insurance policies.
Two takeaways here: First, do not assume that coverage is unavailable for clawback liability for Ponzi schemes, even if homeowners’ coverage is the only available policy. Second, keep in mind that the underlying allegations almost always drive the threshold liability coverage decision, particularly as to the duty to defend. For Kostin, the result might have been different if the alleged basis for her liability had instead been Madoff’s use of personal financial information to gain unauthorized access to her bank account. That type of allegation might qualify as “wrongful entry” under the trial court’s analysis.