declining to extend ILA’s holding to establish a cause of action for negligent mismanagement of an insurance company
How later courts described this case
- declining to extend ILA’s holding to establish a cause of action for negligent mismanagement of an insurance company
Written by the judges who cited it.
The opinion
State ex rel. Comm’r Ins. v. Custard, 2010 NCBC 6.
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
WAKE COUNTY 06 CVS 4622
STATE OF NORTH CAROLINA, on
Relation of its Commissioner of Insurance,
AS LIQUIDATOR OF COMMERCIAL
CASUALTY INSURANCE COMPANY
OF NORTH CAROLINA,
Plaintiff,
v. ORDER & OPINION
A. RICHARD CUSTARD, by and through
his Guardian ad Litem; WENDY J.
CUSTARD; E. NIMOCKS HAIGH; and
DELTA INSURANCE SERVICES, INC.,
Defendants.
{1} This matter comes before the Court on Defendants’ Motion for Summary
Judgment pursuant to Rule 56 of the North Carolina Rules of Civil Procedure. After
considering submissions by counsel and hearing oral arguments, the Court hereby
GRANTS Defendants’ Motion for Summary Judgment.
Nelson Mullins Riley & Scarborough, LLP by Joseph W. Eason, Christopher
J. Blake, and Leslie Lane Mize for Plaintiff.
Hunton & Williams LLP by Steven B. Epstein and Bryan A. Powell for
Defendants.
Tennille, Judge.
INTRODUCTION
{2} The pending Motion requires an exploration of the contours and role of
“good faith” in North Carolina corporate governance law at a time when the
mismanagement of risk at financial institutions by some corporate officers has
almost destroyed our economy. The case arises in the context of a financial
institution—an insurance company—where (1) risk management is an essential,
fundamental element of the business and (2) mismanagement of risk can impact not
only shareholders and other corporate constituents but also innocent policyholders.
{3} The current Motion poses significant questions concerning the duties of
officers and directors and to whom those duties are owed and the standards of
review applied by the courts. It is the first case to interpret North Carolina’s Risk-
Based Capital Requirements and their interrelationship with corporate law. N.C.
Gen. Stat. §§ 58-12-2 to -70 (2009). It echoes familiar refrains in these economic
times: reliance on outside financial experts—actuaries—whose choice of risk
assessment methods proved inadequate to protect against the financial loss which
occurred and a regulatory agency whose oversight did not prevent the failure.
{4} This case requires the Court to explore (in the context of an insolvent
insurance company) the defining principles that fairly distinguish between director
and officer conduct that involves (1) a breach of the duty of loyalty that should be
remediable by an award of monetary damages and (2) an exculpable or
indemnifiable breach of the duty of care.
{5} For the reasons set forth below, the Court GRANTS Defendants’ Motion
for Summary Judgment with respect to the breach of fiduciary duty claims asserted
in the Amended Complaint. The Court will address the severance payment claim
asserted against Defendant E. Nimocks Haigh (“Haigh”) separately in Part IX.
I.
{6} This action was filed in Wake County Superior Court on March 31, 2006.
Defendants A. Richard Custard (“Mr. Custard”), Wendy J. Custard (“Mrs. Custard”),
and Delta Insurance Services, Inc. (“Delta”) filed the Notice of Designation on May
2, 2006. This action was designated a mandatory complex business case by Order of
the Chief Justice of the Supreme Court of North Carolina dated May 3, 2006, and
was assigned to the undersigned Chief Special Superior Court Judge for Complex
Business Cases by Order dated May 8, 2006.
{7} On January 2, 2007, the Court granted Plaintiff leave to file an Amended
Complaint. Shortly thereafter, Plaintiff filed a Motion for Appointment of Guardian
Ad Litem for Mr. Custard. The Court entered an Order under seal on June 18,
2007, which appointed Robert E. Soby to serve as Mr. Custard’s guardian ad litem.
{8} Defendants filed a Motion for Summary Judgment on July 15, 2009. On
September 1, 2009, Plaintiff filed a Memorandum in Response and Opposition to
Defendants’ Motion. Defendants filed their reply brief on September 21, 2009, and
the Court heard oral arguments on October 22, 2009. Many facts are undisputed.
Where facts are disputed the Court will so indicate and determine their materiality.
{9} The Amended Complaint is based upon the premise that Mr. Custard, Mrs.
Custard, and Haigh (collectively, the “individual Defendants”) directed the business
of Commercial Casualty Insurance Company of North Carolina (“CCIC”) in such a
way as to promote the best interests of Custard Insurance Adjusters (“CIA”) and in
disregard of the interests of CCIC shareholders and policyholders. Plaintiff
emphasized the fact that Mr. and Mrs. Custard (the “Custards”) owned a majority
interest in both companies. In essence, the North Carolina Department of Insurance
(“NCDOI” or the “Department”) asserted that the individual Defendants breached
their fiduciary duty by selling insurance through CCIC to provide a source of claims
(losses) for CIA to adjust without regard to the solvency of CCIC. Not surprisingly,
there does not appear to be any evidence to support what is, on its face, an
irrational theory.
{10} The NCDOI did not pursue this conflict of interest theory on summary
judgment. Rather, for the first time, the NCDOI based its theory of liability on
allegations that the individual Defendants showed a lack of good faith in (1) filing
CCIC’s monthly reports with the NCDOI and (2) continuing to sell a high volume of
artisan insurance policies in California after seeing that losses on those policies
were coming in at higher than expected rates. Because the Court grants summary
judgment on other grounds, it need not address the fairness issues raised by this
shift in theory. 1 Defendants have made and preserved their argument that
1 Plaintiff never sought to amend its Complaint or discovery responses to assert this new theory of
liability.
fundamental fairness should prohibit a plaintiff from asserting a totally new theory
of liability after discovery has closed in response to a motion for summary judgment.
II.
A.
{11} It is helpful to put the present controversy in the context of overall
insurance regulation and understand the competing forces that exist within that
regulatory scheme. The current regulatory scheme that exists in North Carolina
and most other states revolves around risk-based capital requirements. Risk-based
capital regulatory practices grew out of insurance company insolvency concerns in
the late 1980s and early 1990s. Scott E. Harrington & Gregory R. Niehaus, Risk
Management and Insurance 116 (2d ed. 2004). 2 During that time about one percent
of insurance companies failed each year. Id.
{12} Insurance company insolvency can result from a number of factors.
Management can make errors in judgment about the risks associated with the
policies being written or the adequacy of the premiums being charged to cover the
risks. 3 Management also can make bad investment decisions with the insurance
company’s capital. 4 Insolvency also can result from management fraud, which
usually involves either deliberately underreporting claims liabilities or deliberately
overstating asset values.
{13} Protecting against insurer insolvency is costly. The costs can arise from
insurers taking less risk by writing fewer policies or refusing to cover certain types
of liability. Solvency regulation also adds to costs. For example, increasing the
amount of capital required increases “the amount of premiums needed to provide a
2 This work is particularly helpful in understanding the economics of insurance and the basis for
insurance regulation by state agencies.
3 The major determinants of insurance premiums charged by an insurance company are: (1) expected
claim costs, (2) investment income, (3) administrative costs, and (4) fair profit loading. Id. at 135
fig.8.1. The most significant determinant by far is expected claim costs. Id. at 135. Rational
companies will not knowingly charge premium rates which are less than their expected claim costs.
Investment income can sometimes cover a shortfall, but accurate setting of premium rates is critical
to a successful insurance company.
4 For example, an insurance company that invested heavily in real estate thinking it was a safe long-
term investment might find its capital severely impaired when a real estate bubble bursts. Other
large and unexpected reductions in capital also can cause insolvency.
given amount of coverage.” 5 Id. In light of these costs, an insolvency-proof
insurance system probably is not economically feasible.
{14} There were some lessons to draw from the failures of property and liability
companies in the late 1980s. Harrington and Niehaus summarize them as follows:
Many property-liability insurers that failed during the 1980s
wrote large amounts of business liability insurance, including products
liability, environmental liability, and professional liability insurance
(e.g., for physicians, architects, and engineers). These insolvencies
were associated with much higher claim costs than the insurers
originally reported on their financial statements. Evidence suggests
that a large component of the increase in claim costs was probably
unexpected in many cases; in other words, the actual costs were
significantly higher than could reasonably have been expected when
the insurers wrote the business and initially reported estimates of
claim costs.
Conversely, it has been argued that some of these insurers
deliberately wrote large amounts of business at prices that they knew
to be too low in comparison to expected claim costs, either because they
had inadequate incentives to be safe or in an attempt to generate cash
and buy time after they began to experience difficulty. These insurers
also are alleged to have hidden their inadequate prices and capital by
deliberately understating their estimated liabilities and using
questionable (if not completely phony) reinsurance arrangements. . . .
Some property-liability insurer insolvencies during the mid- to
late 1980s probably were influenced by low prices during the “soft
market” for business liability insurance during the early 1980s. A
large increase in market interest rates in the late 1970s and early
1980s also may have contributed to some of those insolvencies. Higher
interest rates substantially reduced the market value of bonds held by
many insurers. Some companies might have been weakened to the
point that they engaged in excessively risky behavior in the hope of
getting lucky and avoiding insolvency. (This behavior sometimes is
known as “going-for-broke” or “gambling for resurrection.”)
Id. at 118. Those opposing contentions are echoed in this case.
B.
{15} In the absence of an insolvency-proof system, consumers must look to other
protections. One protection is the use of solvency ratings. The leading financial
5 The phenomenon results from the higher taxes paid on income from increased capital. See id.
ratings companies who rate insurance companies are Moody’s Investors Service,
A.M. Best Company (“AM Best”), Duff & Phelps Corporation, and Standard & Poor’s
Financial Services.
{16} In this case, AM Best provided solvency ratings for CCIC. Although the
quality of agency ratings has been questioned following the subprime meltdown,
solvency ratings still enjoy widespread use and are considered when selecting an
insurance company. See Harrington & Niehaus, supra, at 119. Therefore, an
insurance company “could experience a significant reduction in sales to business
policyholders if it were to lose a high rating.” Id. CCIC had an A- rating but was in
danger of losing that rating, as will be more fully discussed in Part III.C. The
significance of such a downgrade is shown by the fact that eighty-five to ninety
percent of property-liability companies maintain an AM Best rating of A- or better.
Id. at 121. Because insolvencies can be caused by unpredictable adverse events and
because rating companies sometimes err in their assessments, solvency ratings
provide little protection to policyholders. They can, however, affect the market for
an insurance company’s product.
C.
{17} Another outgrowth of the solvency problems of insurance companies in the
late 1980s was the creation of risk-based capital (“RBC”) requirements for adoption
by states. 6 These model requirements were conceived by the National Association
of Insurance Commissioners (“NAIC”) and adopted by North Carolina in Article 12,
Chapter 58 of our General Statutes. RBC requirements are a form of legislated
solvency monitoring that provide for specific steps to be taken by the Commissioner
of Insurance (“Commissioner”) when significant target capital events occur.
The NAIC’s property-liability RBC formula encompasses four
major risk categories: (1) asset risk (the risk of issuer default and
market value declines); (2) credit risk (e.g., the risk that reinsurance
6 Many states, including North Carolina, also created state guaranty systems that provided funds for
policyholders and claimants whose claims could not be paid by insolvent insurance companies. See,
e.g., Insurance Guaranty Association Act, N.C. Gen. Stat. § 58-48-1 to -130 (2009). At this point,
there is no evidence before the Court with respect to the amount, if any, that North Carolina’s state
guaranty system may be required to pay as a result of the liquidation of CCIC.
and other receivables will prove to be uncollectible); (3) underwriting
risk (the risk that prices and reported claim liabilities will be
inadequate compared to realized claim costs); and (4) miscellaneous
“off-balance sheet” risks, such as the risk associated with rapid
premium growth. . . .
. . . The important point is that in states that have adopted the
NAIC’s model RBC law, each insurer must calculate a dollar figure
called its RBC. This figure is higher for insurers that take on more
risk. An insurer’s actual capital is then compared to its RBC.
Harrington & Niehaus, supra, at 125. This type of insurance solvency regulation
places a premium on accurate information. If an insurer’s actual capital falls below
specified percentages of its RBC, regulators can take the actions shown below in
Table 1:
Table 1: Risk-Based Capital Thresholds for Insurance Companies
RBC Level Insurer Event Regulatory Action
Company must file plan with insurance
Between 150 and 200%
Company Action commissioner explaining the cause of
of formula RBC
deficiency and how it will be corrected
Between 100 and 150% Commissioner must examine insurer and
Regulatory Action
of formula RBC take corrective action as necessary
Between 70 and 100% Commissioner has legal grounds to
Authorized Control
of formula RBC rehabilitate or liquidate the company
Less than 70% of Commissioner must take over the
Mandatory Control
formula RBC company
SOURCE: Harrington & Niehaus, supra, at 126 tbl.7.3.
{18} Under RBC requirements, an insurer’s actual capital or its “surplus” is
compared to its RBC. Surplus equals assets minus liabilities for unearned
premiums and unpaid claims. 7 In order to improve its ratio of surplus to RBC, an
insurance company can take one or more of the following steps: (1) raise more
7 This case is focused on the liability side of the equation.
In other words, the allegations center on
understating liabilities, rather than overstating asset values.
capital, (2) write less coverage, or (3) reinsure more of its business. We will see the
implications of all three options in the factual scenario set out in Part III.C.
{19} RBC requirements play an important role in balancing solvency risks and
keeping insurance costs at acceptable levels. By creating a stepped approach, the
RBC thresholds attempt to reduce costs by letting management rather than state
regulators run insurance companies until liquidation becomes necessary.
{20} RBC law frames two issues before the Court: Plaintiff’s breach of fiduciary
duty claims and Plaintiff’s severance payment claim. The Court will address these
two issues later in Parts VII and IX.
III.
{21} The Court now turns from the general industry and regulatory control to
the specific facts in this case. Part A will identify the parties; Part B will provide a
historical overview of the Company; and Part C will delve deep into the Company’s
corporate management and financial reporting. 8 In Part D, the Court will consider
whether there are material facts in dispute.
A.
{22} The State of North Carolina on relation of its Commissioner of Insurance,
as Liquidator (“Plaintiff” or “Commissioner”), brought this action on behalf of CCIC
and its creditors and policyholders under sections 58-30-120(a)(12) and (a)(13) of the
North Carolina General Statutes.
{23} Delta was a corporation organized under the laws of the State of Georgia
in 1988. Prior to the entry of the 2006 Order of Rehabilitation, Delta owned all
outstanding shares of CCIC stock. Mr. Custard owned a controlling interest in
Delta. He owned 80% of Delta’s stock. (Allen Dep. Ex. 6 at 13.) As for the
remainder of Delta’s stock, Haigh owned 5%, Mrs. Custard owned 5%, and two of
the Custards’ relatives owned 10%. (Allen Dep. Ex. 6 at 13.)
{24} The Custards also owned and controlled CIA, a company that adjusted
property and casualty insurance claims for companies nationwide. (Am. Compl. ¶
8 Throughout this opinion, “CCIC” and “the Company” will be used interchangeably.
10.) They owned 100% of CIA’s stock. (W. Custard Dep. Ex. 20.) CIA performed
claims handling services for the majority of CCIC’s claims. (Soby Aff. ¶ 4.) The
California artisan claims were handled by CIA’s Las Vegas office. (Reed Aff. ¶ 15.)
{25} Mr. Custard is a resident of the State of Georgia. He served as chief
executive officer of CCIC and president of both CIA and Delta.
{26} Mrs. Custard, wife of Mr. Custard, is also a resident of the State of
Georgia. She served as secretary of CCIC and Delta.
{27} Haigh is a resident of Iredell County, North Carolina. From 1992 until
March 2003, he served as CCIC’s president and chief operating officer. During that
time, he also served as executive vice president and treasurer of Delta.
{28} The individual Defendants served as members of the board of directors at
both CCIC and Delta.
B.
{29} CCIC was organized under the laws of the State of Georgia in 1988. (Am.
Compl. ¶ 9.) At that time, the name of the Company was Commercial Casualty
Company of North Georgia. (Hoerl Dep. 344:2–6.) Delta was the sole shareholder.
(Am. Compl. ¶ 9.)
{30} At first, CCIC primarily wrote professional liability insurance policies for
environmental consultants in Florida. (Am. Compl. ¶ 13.) When the profitability of
its environmental business declined in 1998, CCIC decided to expand into California
and switch its policy focus to liability insurance for small contractors and tradesmen
(“artisans”). 9 (Am. Compl. ¶¶ 15, 18.) For its California artisan business, CCIC
adopted another insurance company’s underwriting guidelines, rates, and forms as
its own. (Am. Compl. ¶¶ 20–21.) The Court takes judicial notice of the fact that
California experienced a construction boom in the years at issue (1998–2002), thus
expanding the potential to sell artisan insurance in that state. The California
9 Artisan insurance is a form of general liability insurance that provides coverage to small businesses
“that contract skilled services to the public or other business.” (Allen Dep. Ex. 6 at 17.) This class
would include carpenters, electricians, masons, painters, plumbers, and other similar trades. (Allen
Dep. Ex. 6 at 17.) Artisan contractors usually are “subcontractors on larger jobs” who work under a
general contractor. (Allen Dep. Ex. 6 at 17.) They rarely perform “subcontract work themselves.”
(Allen Dep. Ex. 6 at 17.)
Department of Insurance (“CADOI”) controlled the rates CCIC could charge for
insurance issued in California. See Cal. Ins. Code § 11737 (West 2009).
{31} In 2000, CCIC acquired an automobile liability insurance business based
in Charlotte, North Carolina. (Am. Compl. ¶ 34.) The Company planned on
growing its non-standard automobile line and wanted a larger presence in North
Carolina. (Jackson Dep. Ex. 19.) These plans changed in 2002 when the Company
decided to significantly reduce its writings in non-standard auto and focus on its
California artisan business instead. (Jackson Dep. 241:6–16.)
{32} CCIC redomesticated in the State of North Carolina in 2001 and became
subject to NCDOI regulations. (Am. Compl. ¶¶ 2, 39.) Financial considerations
drove this decision. (Allen Dep. 685:13–15.) North Carolina offered a lower
premium tax rate than Georgia. (Haigh Aff. ¶ 25.) This decision saved the
Company $1.5 million in out-of-state premium taxes in 2002. (Haigh Aff. ¶ 25.)
{33} During 2001 and 2002, CCIC’s growth outperformed the Company’s ability
to generate policyholder surplus. (Giesecke Dep. Ex. 60 at 2.) In addition,
management’s efforts to secure outside capital investments were not successful.
(Giesecke Dep. Ex. 60 at 2.) During this time, management took a number of steps
to improve overall capitalization: they sought rate increases, eliminated
unprofitable writings, and obtained more reinsurance. (Haigh Aff. ¶¶ 48, 52, 68.)
Nonetheless, profitability continued to decline and in early 2003 CCIC ceased
operations nationwide. (Am. Compl. ¶¶ 72, 74.)
{34} On April 2, 2004, CCIC was declared insolvent. (Am. Compl. ¶ 76.) The
Wake County Superior Court entered an Order of Liquidation against CCIC and
appointed Plaintiff as liquidator. (Trendel Aff. ¶ 2.) The parties dispute the
amount by which CCIC’s liabilities will exceed its assets. Results from discovery,
particularly detailed actuarial studies, have not yet been submitted to the Court. 10
10 Despite the fact that six years have now passed since CCIC wrote any policies, the actuaries hired
by both sides appear to be millions of dollars apart in their assessment of CCIC’s future liabilities.
Only time will resolve the conflicting opinions of the actuaries. It has been argued to the Court that
this wide divergence results from vagaries in California law that make it difficult to know when a
statute of limitations has run.
C.
{35} Haigh managed CCIC’s daily operations. (Haigh Aff. ¶ 9.) In addition to
Haigh, CCIC’s core management team consisted of the following individuals: Bill
Allen (“Allen”), Buck Giesecke (“Giesecke”), and Mike Reed (“Reed”). (Haigh Aff. ¶
10.) As chief financial officer, Allen prepared financial statements, maintained the
books, and oversaw the accounting department. (Haigh Aff. ¶ 11.) Giesecke, vice
president of marketing, oversaw CCIC’s underwriting department as well as the
preparation of form and rate filings with state insurance departments. (Giesecke
Aff. ¶ 4.) Reed oversaw claims management. (Reed Aff. ¶ 3.)
{36} Haigh consulted with his management team regularly about important
decisions. (Haigh Aff. ¶ 10.) Haigh is the only member of the management team
whom Plaintiff names as a defendant.
{37} Haigh kept Mr. Custard abreast of CCIC’s day-to-day operations. (Haigh
Dep. 327:1–16.) However, he did not need Mr. Custard’s approval when making
everyday management decisions. (Haigh Dep. 327:6–16.) Mr. Custard did not
prepare CCIC’s financial statements. (Allen Dep. 465:15–19.) He relied on
management to determine the numbers, including the Company’s loss estimates.
(Allen Dep. 504:14–25, 505:1.)
{38} Mrs. Custard “let the people who had the expertise run” the day-to-day
operations. (W. Custard Dep. 113:12–13.) She kept herself “aware of what was
going on through [her] husband.” (W. Custard Dep. 51:21–24, 52:7–9.) Like her
husband, she did not participate in the preparation of the financial statements and
when she signed them, she relied on “the people that prepared them” with regard to
the truth and accuracy of the statements. (W. Custard Dep. 102:5–7, 112:15–21.)
{39} Fred Hoerl (“Hoerl”) worked as CCIC’s internal actuary from 2000 until
2003. (Hoerl Aff. ¶ 2.) He prepared rate filings and quarterly internal loss reserve
analyses for various CCIC insurance products, including the California artisan
policies. (Hoerl Aff. ¶¶ 4, 6, 11.)
{40} CCIC’s annual financial statements were reviewed by Ernst & Young
(“E&Y”), a large, outside accounting firm that provides auditing and actuarial
services. (Allen Aff. ¶ 3.)
{41} The following timeline sets forth and describes the corporate management
and financial reporting in the years leading up to CCIC’s collapse. For a detailed
account of the actuarial evidence in support, refer to Appendices A through D. 11
May 16, 2001: CCIC increased its reinsurance for the California artisan
business from a $50,000 to a $100,000 retention level. (Haigh Dep. Ex. 16.)
This move increased its exposure to the California market.
June 12, 2001: CCIC filed a Petition for Redomestication with the NCDOI to
become a North Carolina domiciled insurance carrier. (Haigh Aff. ¶ 22.) This
regulatory move increased policyholder surplus by saving CCIC $1.5 million
in out-of-state premium taxes in 2002. (Haigh Aff. ¶ 25.)
June 13, 2001: Hoerl prepared a quarterly loss reserve analysis which
estimated that the 2001 losses at three months were “exceptionally large in
comparison to previous years.” (Haigh Dep. Ex. 29 at 1.) He concluded that
reliance on non-California data to select loss development factors for the
California artisan business “could be understating” the development in
California. (Haigh Dep. Ex. 29 at 2.) He also suggested that such reliance
“be watched closely as accident year 2001 develops.” (Haigh Dep. Ex. 29 at 2.)
June 14, 2001: AM Best, a financial strength rating agency that measures an
insurance company’s ability to pay claims, sent Haigh a formal notice of
CCIC’s financial-strength rating. (Haigh Dep. Ex. 9.) Although CCIC
received an A- (Excellent) rating, the notice stated that the Company’s
“significant premium growth ha[d] resulted in high gross underwriting
leverage and significant reinsurance dependence given capital limitations.”
11 The timeline in this case is significant.
For that reason, the Court has used abbreviated
descriptions supported by detailed Appendices in hopes that the reader does not get lost in actuarial
complexity and jargon. It is important to note that the timeline begins within the applicable statute
of limitations. The Court has heretofore dismissed claims of breach of fiduciary duty arising prior to
March 1, 2001 based on the statute of limitations. See State ex rel. Long v. Custard, No. 06-CVS-
4622 (N.C. Super. Ct. Aug. 8, 2007).
(Haigh Dep. Ex. 9 at 6608.) The notice also stated that AM Best would
“closely monitor future capitalization to ensure that business growth [was]
adequately supported.” (Haigh Dep. Ex. 9 at 6608.) Loss of its A- rating
would adversely impact CCIC’s business.
July 18, 2001: Mr. Custard stated in a letter to Haigh that “low profitability”
was “a sign of positive transition” and that CCIC was “giving 110% to move
beyond it to growing profitability” in California. (Haigh Dep. Ex. 20.)
August 7, 2001: In a letter to Haigh, Mr. Custard stated that even though
“bottom line profits” were down, “the position of the company and the top line
momentum [we]re better than they ha[d] ever been.” (Haigh Dep. Ex. 22.)
October 1, 2001: Haigh recognized that CCIC needed more capital to support
its growth and began capital raising efforts. (Allen Dep. Ex. 5.) Part of his
efforts included obtaining a company valuation (the “Geneva Report”). The
Geneva Report valued the Company at between $17 and $20 million. (W.
Custard Dep. Ex. 28 at 1.) The Geneva Report also stated that “[w]ithout an
increase in profitability or an injection of capital by the primary shareholder,
the Company may have to curtail its aggressive expansion plans or risk being
downgraded by AM Best.” (W. Custard Dep. Ex. 28 at 3.)
October 22, 2001: Hoerl prepared a reserve analysis comparing CCIC’s 2001
losses (through September) to its 2000 year-end losses. (Allen Dep. Ex. 11.)
In his executive summary, Hoerl stated that the changes in the loss ratios for
the California artisan business were substantial and that it “may have
additional adverse development each quarter as the numbers develop.”
(Allen Dep. Ex. 11 at 1; see also infra App. A.)
December 5, 2001: CCIC submitted a California rate filing with the CADOI
seeking a 20% rate increase for its remodeling class. (Giesecke Aff. ¶ 8; Haigh
Aff. ¶ 28.) This increase was sought to increase premium volume, to decrease
the number of policyholders, and to decrease CCIC’s exposure to losses.
(Haigh Aff. ¶ 28.)
December 19, 2001: The NCDOI granted CCIC’s Petition for Redomestication
and became the Company’s primary source of regulation. (Haigh Aff. ¶ 24.)
December 20, 2001: Giesecke decided to apply a 15% “bad risk” surcharge on
all new business and renewals written until the CADOI approved the CCIC
rate filing. (Giesecke Aff. ¶¶ 14–15.) This decision was intended to increase
CCIC’s profitability and policyholder surplus. (Haigh Aff. ¶¶ 26, 31.)
January 1, 2002: At the beginning of 2001, CCIC’s policyholder surplus stood
at $15.213 million. (W. Custard Dep. Ex. 12 at 1.) However, over the course
of the year, this surplus dwindled to $4.969 million. (W. Custard Dep. Ex. 12
at 1.) When Haigh and Giesecke met with CCIC brokers in California, Haigh
agreed that the surplus ratio was too high but “was confident that [CCIC]
would have sufficient capital and surplus” to offset that ratio by mid-year.
(Maucere Dep. 27:6–22, 30:5–11.)
January 22, 2002: Giesecke instructed CCIC’s California agents to stop using
schedule rating credits. (Giesecke Aff. ¶ 18.) This decision was intended to
increase CCIC’s profitability and policyholder surplus. (Giesecke Aff. ¶ 17.)
February 7, 2002: Hoerl completed his initial reserve analysis for CCIC’s
2001 annual statement based on CCIC’s 2001 year-end loss data. (Hoerl Aff.
¶ 16.) He based his analysis on CCIC’s California and non-California loss
experience—applying a 50% weight to each. 12 (Hoerl Aff. ¶ 23.) He found
that the Company’s loss experience in California had a “unique development
pattern” that was “steeper and more rapid than the development pattern” for
non-California losses. (Hoerl Aff. ¶ 17; see also infra App. B.) For example,
the Company’s year-end loss estimates for California increased from 46% in
2000 to 90.7% in 2001. (Giesecke Dep. 149:11–16.) Hoerl concluded that the
California losses had “deteriorated significantly” in 2001. (Hoerl Aff. ¶ 22.)
12 Hoerl assumed that the CCIC’s California experience and non-California experience “each
represented about a 50% influence on the [Company’s] combined LDFs.” (Hoerl Dep. Ex. 8 at 1.)
February 20, 2002: The CADOI approved a 16.2% rate increase in response
to CCIC’s December rate filing application, which requested a 20% increase.
(Giesecke Aff. ¶ 21.)
February 28, 2002: CCIC filed its 2001 annual statement with the NCDOI.
Management selected and booked lower loss ratios than Hoerl’s analysis
would suggest “based upon their belief that California losses would develop
more similarly to CCIC’s non-California artisan losses.” (Hoerl Aff. ¶ 20.)
Table 2: Loss Ratio Estimates – Management
Accident Hoerl’s Estimates for Management’s Selections
Year 2001 Reserve Analysis for 2001 Annual Statement
2000 82.1% 56.7%
2001 69.9% 55.8%
SOURCE: Hoerl Dep. Ex. 58 at 1856; Allen Dep. Ex. 12.
Management decided to base its loss ratio estimates for the California artisan
business on the Company’s historic “rest of country” loss experience because
CCIC’s loss experience in California was immature. (Allen Aff. ¶¶ 10–11.)
Management also relied on E&Y’s preliminary actuarial analysis, which
discounted Hoerl’s use of California loss data. (Allen Aff. ¶ 14; Haigh Dep.
454:18–22; see also infra April 30, 2002 timeline entry.)
March 22, 2002: CCIC imposed a new underwriting restriction that reduced
the maximum allowable work for the remodeling class from 40% to 25% for
new and renewal business. (Giesecke Dep. Ex. 31 at 1.) This restriction was
intended to increase CCIC’s profitability and policyholder surplus. (Haigh
Aff. ¶ 40.) CCIC also decided to stop writing coverage for physical automobile
damage and limit its automobile market to North Carolina. (Haigh Aff. ¶ 41.)
This decision was based on CCIC’s high loss experience with this line outside
of North Carolina. (Haigh Aff. ¶ 41.)
March 31, 2002: CCIC entered a quota share reinsurance agreement. (Allen
Dep. Ex. 77.) This agreement “reduce[d] CCIC’s net leverage” by transferring
25% of all future writings from Company books to the books of a reinsurer.
(Allen Aff. ¶ 47.) CCIC entered this agreement to address its “higher-than-
anticipated production” and to control its net leverage. (Allen Aff. ¶ 48.)
April 30, 2002: E&Y delivered a Reserve Study to CCIC. (Hoerl Aff. ¶ 21.)
Although E&Y based its Reserve Study on the same 2001 year-end loss data
that Hoerl used in his analysis, E&Y reached a different conclusion. (Hoerl
Aff. ¶ 22.) E&Y concluded that the Company’s California artisan business
losses remained “largely unchanged” in 2001. (Hoerl Aff. ¶ 22.)
Table 3: Loss Ratio Estimates for 2001 – E&Y
Accident Year Hoerl’s Estimates E&Y’s Estimates
1999 108.6% 98.0%
2000 82.1% 56.7%
2001 69.9% 55.8%
All Years 79.7% 62.5%
SOURCE: Hoerl Dep. Ex. 58 at 1856; Hoerl Aff. ¶¶ 16, 18.
E&Y based its loss ratio estimates for the California artisan business on
CCIC’s loss experience in other states. (Evans Dep. Ex. 5.) As a result, the
Reserve Study showed lower loss ratios estimates than Hoerl’s analysis had
shown. (Hoerl Aff. ¶ 18–19; Hoerl Dep. Ex. 58 at 1856; see also infra App. C.)
May 13, 2002: CCIC filed its first quarter financial statement with the
NCDOI. (Allen Aff. ¶ 22.) This quarterly statement revealed no material
change in the Company’s loss experience in California. (Allen Aff. ¶ 23.)
May 17, 2002: Haigh sent Giesecke an email about seeking a California rate
increase. (Haigh Dep. Ex. 43.) He stated that CCIC’s production was “far
beyond expectations” and “running ahead of surplus.” (Haigh Dep. Ex. 43.)
May 23, 2002: Dale Evans (“Evans”), an actuary for the NCDOI, reviewed
the E&Y Reserve Study. (Evans Dep. Ex. 2 at 27239.) He “concur[red] in all
respects with the findings and conclusions” and agreed that E&Y’s methods
were “appropriate and proper.” (Evans Dep. Ex. 2 at 27241.) Evans also
reviewed E&Y’s decision to apply CCIC’s non-California loss experience to its
California artisan business. (Evans Dep. 135:21–25, 136:1–4.) He concluded
that “the selections made by the opining actuary appeared to evidence good
judgment and to be free from bias.” (Evans Dep. Ex. 2 at 27240.)
June 11, 2002: Giesecke prepared a memorandum that compared expiring
premium rates to renewal premium rates in light of management’s rate and
underwriting changes. (Giesecke Aff. ¶ 28.) He determined that the changes
would result in a 53.4% increase in the amount of premium CCIC received
from its California artisan business. (Giesecke Aff. ¶ 28.) Giesecke believed
this increase would improve CCIC’s profitability. (Giesecke Dep. 173:10–25.)
June 14, 2002: AM Best downgraded CCIC’s A- (Excellent) financial-strength
rating to a B++ (Very Good). (Haigh Dep. Ex. 143.) AM Best’s initial A-
report stated that although overall capitalization was “not as strong” as it
had been in years past, it did “support the current premium volume.” (Haigh
Dep. Ex. 51 at 25979.) However, the A- report also stated that the “aggressive
premium growth in recent years and projected growth presents long-term
uncertainty related to the profitability of [CCIC’s new California artisan
business].” (Haigh Dep. Ex. 51 at 25978.) AM Best decided to lower the
rating because it predicted that “[t]he growth in net premiums, net loss LAE
reserves and reinsurance recoverables in conjunction with modest projected
surplus growth” would “strain the capital base.” (Haigh Dep. Ex. 143.)
June 21, 2002: CCIC submitted a rate filing to the CADOI seeking a 43.4%
rate increase for its California artisan business. (Hoerl Aff. ¶ 30.) Hoerl
prepared this California rate filing based on the Company’s 2001 year-end
loss data. (Hoerl Aff. ¶¶ 30, 33.)
June/July 2002: CCIC retained investment brokers to help secure capital
investments. (Wilson Aff. ¶¶ 3, 5.) The investment brokers recommended
that CCIC acquire Kaw Acquisition Corporation (“Kaw”) to facilitate a reverse
merger and attract the capital the Company needed. (Wilson Aff. ¶¶ 8–9.)
July 8, 2002: CCIC requested that a $1 million dividend be paid to Delta.
(Jackson Dep. Ex. 16.) In response to this dividend request, Betty Jackson
(“Jackson”) at the NCDOI reviewed CCIC’s first quarter financial statement
and supplemental filings. (Jackson Dep. Ex. 17.) Based on her review, she
recommended that the NCDOI approve the request. (Jackson Dep. Ex. 17.)
July 16, 2002: Dash Propes at the NCDOI expressed concerns about CCIC’s
surplus being “skinny for their writings and line of business.” (Jackson Dep.
Ex. 18.) However, Jackson’s review and recommendation “did not suggest a
skinny surplus,” and she did think that the financial information indicated
that the Company was near insolvency. (Jackson Dep. 167:1–6, 170:4–21.)
August 2, 2002: CCIC filed its second quarter financial statement with the
NCDOI. (Allen Aff. ¶ 22.) This quarterly statement revealed no material
change in the Company’s loss experience in California. (Allen Aff. ¶ 23.)
September 20, 2002: A Stock Purchase Agreement memorialized an $8.5
million capital investment into Kaw. (Wilson Aff. ¶ 16.) Approximately $6
million of this investment would be injected into CCIC. (Wilson Aff. ¶ 11.)
However, this investment transaction never transpired. (Haigh Aff. ¶ 60.)
October 8, 2002: The NCDOI reviewed the premium rate adequacy of the
California writings. (Evans Dep. Ex. 30.) Its review stated that “[i]t was
abundantly clear . . . that the appropriate parties at CCIC are well aware of
the risks inherent in their rapid growth” in California and that they have
“been taking strong measures to deal with that risk.” (Evans Dep. Ex. 30.)
October 9, 2002: The CADOI approved an 8.45% rate increase in response to
CCIC’s June 2002 rate filing. (Giesecke Dep. Ex. 47.) However, in its rate
filing application, CCIC had requested a 43.4% increase. (Hoerl Dep. Ex. 72.)
The CADOI rejected the 90% loss ratio contained in the rate filing—a rate
filing that Hoerl had prepared—and applied a 69% loss ratio instead. 13
(Hoerl Aff. ¶ 40.)
13 The CADOI’s loss ratio was similar to the loss ratios that CCIC’s management had applied to the
Company’s 6/30/02 and 9/30/02 financial statements.
October 16, 2002: Haigh and Giesecke met with potential investors in Los
Angeles, California. (Haigh Aff. ¶ 60.) Their efforts to secure a capital
investment were unsuccessful, and they left the meeting realizing that a
capital investment would not occur by year end. (Haigh Aff. ¶ 60.)
November 1, 2002: CCIC filed its third quarter financial statement with the
NCDOI. (Allen Aff. ¶ 22.) This quarterly statement revealed no material
change in CCIC’s California loss experience. (Allen Aff. ¶ 23.)
November 18, 2002: CCIC issued a formal underwriting bulletin announcing
its decision to eliminate the carpentry construction class in California. (Haigh
Aff. ¶ 68.) At that time, the carpentry construction class accounted for 35% of
its California artisan business. (Haigh Aff. ¶ 70.) However, the overall loss
ratios for the class had risen to approximately 103%, and CCIC drastically
needed to restore its overall loss ratio to a more acceptable level. (Haigh Aff.
¶¶ 69–70.) CCIC eliminated the carpentry construction class in an effort to
generate more policyholder surplus. (Haigh Aff. ¶¶ 69–70.) Ultimately, CCIC
achieved a reduction in its California artisan premium volume—a reduction
Haigh hoped would improve profitability. (Haigh Aff. ¶ 72.)
Table 4: California Artisan Premium Volume
California Artisan
Month Year
Premium Volume
October 2002 $7.5 million
November 2002 $4.5 million
December 2002 $4.4 million
January 2003 $3.0 million
February 2003 $2.3 million
March 2003 $1.9 million
SOURCE: Giesecke Dep. Ex. 77, 78.
November 19, 2002: Haigh notified his management team that CCIC had
stopped writing new business in the Hudson artisan program in New York.
(Haigh Aff. ¶ 137.) This underwriting cutback was intended to slow the
Company’s growth and to improve its profitability. (Haigh Aff. ¶ 137.)
December 16, 2002: CCIC’s management team prepared a revised Operating
Plan for 2002 and 2003 to outline the actions CCIC was taking to address the
high written premium-to-surplus ratio. (Haigh Aff. ¶ 70.) CCIC had reduced
writings and had “eliminated portions of the business where profitability was
questionable.” (Giesecke Dep. Ex. 60 at 2.) Management expected these
changes to “make the remaining book of Artisan business significantly more
profitable going forward.” (Giesecke Dep. Ex. 60 at 2.)
December 31, 2002: CCIC’s policyholder surplus stood at $4.69 million. (W.
Custard Dep. Ex. 12.) However, $475,358 was later added to the surplus due
to net income after tax. (W. Custard Dep. Ex. 12.)
January 16, 2003: Haigh continued discussions with potential investors but
secured no real commitments. (Haigh Aff. ¶ 139.) The Company completed a
preliminary year-end analysis for 2002 which showed a net statutory loss of
approximately $1.4 million and a profit of $1 million. (Haigh Aff. ¶ 139.)
February 1, 2003: CCIC’s management eliminated all renewal business in
the carpentry construction class of its California artisan business. (Allen Aff.
¶ 57.) This decision was intended to increase the Company’s profitability and
policyholder surplus. (Allen Aff. ¶ 57.)
February 28, 2003: E&Y reviewed CCIC’s loss and loss adjustment expense
reserves and issued a statement of actuarial opinion (“February Opinion”).
(W. Custard Dep. Ex. 11 at 1274.) The February Opinion stated that the
Company had not made a “reasonable provision in the aggregate for all
unpaid losses and loss adjustment expenses.” (Ciardiello Dep. Ex. 8 at 4.)
The February Opinion was based upon a significant change in the factors
E&Y used to determine unpaid losses. (Evans Dep. 141:2–16 & Ex. 6 at
2856–70.)
March 1, 2003: CCIC filed its 2002 Annual Statement with the NCDOI. (W.
Custard Dep. Ex. 1.) At the time of filing, management and E&Y did not
agree on the reserve levels for 2002. (Allen Dep. 229:4–10.) E&Y believed
management’s reserve estimates were “several million dollars lower” than
what was appropriate. (Haigh Aff. ¶ 144.) The reserve estimates that E&Y
suggested were at a level that would trigger regulatory action under North
Carolina’s RBC requirements. (Haigh Aff. ¶ 144; see generally supra Part
II.C.) E&Y relied on CCIC’s California loss experience in calculating their
reserve estimates for 2002—a fundamental change in their approach. (Haigh
Dep. 1916:10–17.)
March 5, 2003: CCIC terminated Haigh for cause from his officer and
director positions with CCIC and Delta. (Haigh Aff. ¶ 160.) Mr. Custard
blamed Haigh for the Company’s losses. (Haigh Dep. 23:7–15.) According to
Mrs. Custard, Haigh “made some bad business decisions” in 2001 and 2002.
(W. Custard Dep. 50:16–17.) Specifically, she thought that “he grew the
company too quickly.” (W. Custard Dep. 52:14–17.) Upon termination, the
Board of Directors appointed Mr. Custard to take Haigh’s place as president
and chief executive officer of the Company. (W. Custard Dep. Ex. 3.)
March 7, 2003: The NCDOI placed CCIC under administrative supervision.
(Wilson Aff. ¶ 26.) The Commissioner believed that CCIC was “in such
condition as to render continuance of its business hazardous to the public or
to the holders of its policies.” (Blades Dep. Ex. 39 at 87.) Management
maintained control of day-to-day operations, but certain transactions and
expenses were subject to a supervision agreement. (Holloway Dep. 18:14–23,
22:13–16.) Burton Holloway, a NCDOI employee, served as CCIC’s on-site
supervisor. (Holloway Dep. 18:10–13.)
March 14, 2003: Mr. Custard invested an additional $1 million of surplus
into the Company and was “actively pursuing other surplus-enhancement
steps.” (Blades Dep. Ex. 39 at 86.)
March 24, 2003: Mr. Custard sent Haigh a letter which stated Mr. Custard
would lose $7.6 million if CCIC went broke. (W. Custard Dep. Ex. 7.)
April 14, 2003: CCIC filed an Amended 2002 Annual Statement with the
NCDOI. (W. Custard Dep. Ex. 11.) The Amended Statement included a
reissued actuarial opinion by E&Y. (W. Custard Dep. Ex. 11 at 1.) E&Y now
opined that CCIC had made a “reasonable provision in the aggregate for all
unpaid losses and loss adjustment expenses.” (W. Custard Dep. Ex. 11 at 4.)
April 15, 2003: CCIC submitted a RBC Plan to the NCDOI. (W. Custard
Dep. Ex. 12.) The RBC Plan set out the steps management intended to take
to overcome the financial difficulties the Company faced. Due to the
Company’s diminished surplus, CCIC ceased writing new business. (W.
Custard Dep. Ex. 12 at 9.)
April 30, 2003: E&Y reissued its Reserve Study for CCIC’s management and
directors. (Evans Dep. Ex. 6 at 2652.) Although E&Y based its 2001 Reserve
Study on the Company’s non-California loss experience, E&Y based its 2002
Reserve Study entirely on the Company’s loss experience in California.
(Evans Dep. 141:2–10.) As a result, the 2002 Reserve Study presented
substantially higher loss ratios estimates than the 2001 Reserve Study.
(Evans Dep. 139:5–11; see also infra App. D.)
June 30, 2003: CCIC stopped writing renewal business in accordance with its
RBC Plan. (W. Custard Dep. Ex. 12 at 7.)
November 17, 2003: CCIC was placed into rehabilitation. From that point
forward, the Commissioner of the Department of Insurance held title to all of
the Company’s assets and was responsible for running the day-to-day
operations. (Holloway Dep. 24:5–9.)
D.
{42} Plaintiff identifies the commencement date of Defendants’ capital-raising
efforts as a material factual dispute. Defendants stated in their Memorandum of
Law in Support of their Motion that Haigh’s efforts to secure outside capital began
in June 2002. (Defs.’ Mem. Supp. Mot. Summ. J. at 18, 21.) In contrast, Plaintiff
contends that Defendants’ recapitalization efforts began in 2001. (Pl.’s Mem. Resp.
Opp’n at 14, 21.) At the hearing, Defendants conceded this fact. As such, there is
no need for a jury to resolve this discrepancy in the parties’ submissions.
{43} Plaintiff also identifies the variance in the loss ratios used to prepare the
Company’s financial statements as a genuine factual dispute. However, according
to the NCDOI’s actuary, the Defendants’ continued reliance on the non-California
loss experience to prepare the Company’s 2002 annual statement was reasonable.
(Evans Dep. 35:19, 150:10–21.) The Court likewise finds the variance in the loss
ratios to be a matter of methodology rather than a material factual dispute. See
infra Part VII.F.
IV.
{44} Summary judgment is proper “if the pleadings, depositions, answers to
interrogatories, and admissions on file, together with the affidavits, if any, show
that there is no genuine issue as to any material fact and that any party is entitled
to judgment as a matter of law.” N.C. R. Civ. P. 56(c). “An issue is ‘genuine’ if it
can be proven by substantial evidence and a fact is ‘material’ if it would constitute
or irrevocably establish any material element of a claim or a defense.” Lowe v.
Bradford, 305 N.C. 366, 369, 289 S.E.2d 363, 366 (1982) (citation omitted). “It is not
the purpose of the rule to resolve disputed material issues of fact but rather to
determine if such issues exist.” N.C. R. Civ. P. 56 cmt.
{45} The burden of showing a lack of triable issues of fact falls upon the moving
party. See, e.g., Pembee Mfg. Corp. v. Cape Fear Constr. Co., 313 N.C. 488, 491,
329 S.E.2d 350, 353 (1985). Once this burden has been met, the nonmoving party
must “produce a forecast of evidence demonstrating that [it] will be able to make
out at least a prima facie case at trial.” Collingwood v. Gen. Elec. Real Estate
Equities, Inc., 324 N.C. 63, 66, 376 S.E.2d 425, 427 (1989). Courts must exercise
caution in granting a motion for summary judgment. N.C. Nat’l Bank v. Gillespie,
291 N.C. 303, 310, 230 S.E.2d 375, 379 (1976). The court should resolve any doubt
as to the merits of the motion by denying it. See Volkman v. DP Assocs., 48 N.C.
App. 155, 157, 268 S.E.2d 265, 267 (1980).
V.
{46} At the outset it is important to remember that although the development
of the law of corporate governance has involved setting fundamental and clearly
understandable standards of review for conduct of corporate officers and directors,
each of those reviews is contextual. Different standards of review are used in
different contexts, particularly where the function being exercised by the board is
significant. This Court’s explanation of the function of standards of review in First
Union Corp. v. SunTrust Banks, Inc. bears repeating here:
Professor Eisenberg has succinctly described the difference
between standards of conduct and standards of review and their
divergence in corporate governance:
A standard of conduct states how an actor should conduct
a given activity or play a given role. A standard of review
states the test a court should apply when it reviews an
actor’s conduct to determine whether to impose liability or
grant injunctive relief.
In many or most areas of the law, these two kinds of
standards tend to be conflated.
The conflation of standards of conduct and standards of
review is so common that it is easy to overlook the fact
that whether the two kinds of standards are or should be
identical in any given area is a matter of prudential
judgment. Perhaps standards of conduct and standards of
review in corporate law would always be identical in a
world in which information was perfect, the risk of
liability for assuming a given corporate role was always
commensurate with the incentives for assuming the role,
and institutional considerations never required deference
to a corporate organ. In the real world, however, these
conditions seldom hold, and the standards of review in
corporate law pervasively diverge from the standards of
conduct. A byproduct of this divergence has been the
development of a great number of standards of review in
this area. In the past, the major standards of review have
included good faith, business judgment, prudence,
negligence, gross negligence, waste, and fairness. An
important new development has been the emergence of
intermediate standards of review.
There are two main reasons why standards of review and
standards of conduct have diverged in corporate law: fairness and
efficiency. Both are related to needs of the corporate structure. The
corporate structure requires competent directors willing to serve. In
order to attract competent directors it is only fair that we judge their
conduct according to the circumstances in which they must make
decisions. Those circumstances include the fact that they often have to
act without full information. They do not have control over the
business environment that can affect the decisions they make. The
business environment is constantly changing and courts, not as
knowledgeable as businesswomen when it comes to operational
business decisions, thus should defer to their business judgment.
While we want to set high aspirational goals (standards of conduct) for
directors, it is fundamentally fair to review their conduct on a less
demanding level because of the circumstances in which they are called
upon to act.
The efficiency argument relates to creation of corporate value or
wealth. In order for the corporation to increase in value and thereby
increase the wealth of its owners, it must take risks. If we discourage
the directors who must make those risk decisions from being bold and
creative by imposing a standard of review that is too onerous and
creates too great a possibility of unacceptable liability, we defeat one of
the very purposes for which corporations exist. Just as we limit the
liability of those who contribute their financial capital to the
enterprise, we must limit the liability of those who contribute their
human capital (knowledge and judgment) in order to promote creation
of value or wealth. Accordingly, where fairness and structural
requirements dictate, standards of review have diverged from
standards of conduct in corporate law. Significantly, when that
divergence is permitted, the law recognizes that some legal duties may
go unenforced.
Former Chancellor Allen has described the business judgment
rule this way: “Closer to a description of the ‘rule’ that courts enforce,
in the absence of a director conflict of interest, would be as follows: in
the absence of a conflicting financial interest, a director will be liable
for corporate losses caused by board action he authorizes, only if he has
authorized such action without at that time having a good faith belief
that, in the circumstances present, he has satisfied his obligation to be
reasonably informed.”
Where fairness and structural requirements have not supported
the need for standards of review to diverge from standards of conduct
in corporate law, the two have tended to conflate. For example, where
courts have applied a duty of loyalty as opposed to a duty of care, the
standard of review has been more closely aligned with the duty
standard. Directors in self-interested transactions are required to
establish that the transaction was entirely fair to the corporation. The
reasons are clear. In cases in which a director engages in a transaction
with the corporation in which she has a personal interest, it is fair to
apply a stricter standard of review. The director has more complete
information since she is a party to the transaction and she has some
control over it. It is fair to ask the director to simply prove that the
manner in which the transaction in question is conducted is no
different from the manner in which the same transaction would be
conducted between the corporation and a third party on the open
market. The question is not whether the decision was good or bad,
only if it was the same as an open market transaction. That does not
require the same kind of judicial expertise and does not call for the
institutional deference that duty of care questions require. There is no
structural incentive to reduce the director’s potential liability, and
there exists an incentive to require directors to be particularly careful
when they engage in self-interested transactions with the corporation.
In a self-interested transaction, the director is acting both on her own
behalf and as the economic agent of the owner/shareholder.
In summary then, standards of review in corporate law diverge
from standards of conduct when fairness and structural requirements
dictate that such a divergence will promote corporate value or wealth
creation. Where fairness and structural requirements do not support a
divergence between the standard of review and the standard of conduct
and thus do not promote corporate value, the two standards are more
closely aligned or conflated. When conflation is present, legal duties
are less likely to go unenforced.
Prior to the 1980s, when courts decided whether to apply a duty
of loyalty to a particular fiduciary action, they were actually selecting a
situation-specific process for reviewing that fiduciary action. If the
duty of loyalty was applied, the review process included placing the
burden on the fiduciary to justify the action on a market-specific basis.
The fiduciary had to prove her action did not diminish corporate value.
Application of the loyalty standard of conduct with its entire fairness
standard of review protected corporate value by prohibiting fiduciaries
from taking unfair advantage of their position to transact business
with the corporation at less than fair market value.
If the duty of loyalty standard of conduct was not applied or a
duty of care standard of conduct was applied, the review process placed
the burden of proof on the party challenging the fiduciary action. The
fiduciary received the benefit of the business judgment rule with its
divergent and less demanding standard of review. The less demanding
standard of review process was selected because under the
circumstances it best promoted corporate value by preventing judicial
review under circumstances where that judicial review would deter
director risk-taking. It reduced director risk of liability. A
combination of the standard of review and placement of burden of proof
can have a significant impact on final determination of an issue.
Standards of review serve other functions. They can serve as
guideposts to alert businessmen to conduct that would trigger judicial
intervention. They also serve as self-imposed restraints, limiting
judicial intervention in the corporate process to those situations in
which intervention can promote corporate value.
First Union Corp. v. SunTrust Banks, Inc., 2001 NCBC 9A ¶¶ 22–30 (N.C. Super.
Ct. Aug. 10, 2001), http://www.ncbusinesscourt.net/opinions/2001%20NCBC%2009A
.pdf (citations and footnotes omitted).
{47} In the First Union case, this Court was called upon to apply a standard of
review in the context of deal protection devices in a stock-for-stock merger subject to
shareholder approval. A transaction was at the heart of the conduct being reviewed
in that case. This case, however, involves the determination of the proper standard
of review in two contexts: (1) the operation of the business and the application of the
corporate charter’s exculpatory provisions and (2) the director’s duty to monitor. For
purposes of this analysis, the determination of whether there was an absence of
good faith or the existence of bad faith is virtually the same.
VI.
{48} North Carolina courts have frequently looked to the well-developed case
law of corporate governance in Delaware for guidance. First Union Corp. v.
SunTrust Banks, Inc., 2001 NCBC 9A ¶ 32 (N.C. Super. Ct. Aug. 10, 2001),
http://www.ncbusinesscourt.net/opinions/2001%20NCBC%2009A.pdf. Given the
number of issues raised in this case which have not been addressed by the North
Carolina appellate courts, it is useful to look at the fiduciary duty cases in Delaware
which deal with “good faith” and “bad faith.” Fortunately, these cases have been
collected and addressed in an article written by some of the leading experts and
authors on Delaware corporate law. See Leo E. Strine, Jr. et al., Loyalty’s Core
Demand: The Defining Role of Good Faith in Corporation Law, 98 Geo. L.J. 629
(2010). The article provides an in-depth analysis of the treatment of good faith
under Delaware case law and focuses on the key analysis:
The important work of substance, rather than rhetoric, is in defining
principles that allow courts to fairly distinguish between two forms of
director conduct: (1) conduct that involves a breach of the duty of
loyalty and that should be remediable by an award of monetary
damages, and (2) conduct that involves an exculpable or indemnifiable
breach of the duty of care.
Id. at 634.
{49} That key analysis is central to this case because the corporate charter of
CCIC contains an indemnity clause which exculpates director and officer action
taken in good faith. (Haigh Aff. Ex. A at 7.) The indemnity clause provided:
A director of the corporation shall not be personally liable to the
corporation or its shareholders for monetary damages for breach of the
duty of care or other duty as a director, except for liability (i) for any
appropriation, in violation of the director’s duties, of any business
opportunity of the corporation, (ii) for acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of
the law, (iii) for the types of liability set forth in Section 14-2-154 of the
Georgia Business Corporation Code, 14 or (iv) for any transaction from
which the director derived an improper personal benefit.
(Haigh Aff. Ex. A at 7.)
{50} Actions not taken in good faith or taken in bad faith are not subject to
exculpation. It is thus critical in this case to differentiate between the two forms of
conduct and to determine the category into which Defendants’ actions fall. Before
14 Section 14-2-832 of the Georgia Business Corporation Code takes up liability for unlawful
distributions and was formerly found in section 14-2-154. Ga. Code § 14-2-832 cmt. (2009).
getting started with that task, though, it is useful to look at several core principles
underlying the analysis.
{51} First, there is no duty of good faith separate and apart from the duties of
care and loyalty under either Delaware or North Carolina law. The article Loyalty’s
Core Demand makes it clear that the Delaware Supreme Court has backed away
from the creation of a third fiduciary duty based solely on good faith. In Stone v.
Ritter, 911 A.2d 362, 370 (Del. 2006), the Delaware Supreme Court clarified the
waters previously muddied in Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361
(Del. 1993), and held that the requirement that directors act in good faith was the
core component of the duty of loyalty and not a separate fiduciary duty. The North
Carolina courts have not created a separate fiduciary duty of good faith because it is
not necessary and would create significant uncertainty under our law.
{52} Second, every analysis of fiduciary conduct is contextual in nature, and the
contexts in which fiduciary duties are applied are constantly changing. This second
principle is clearly supported by the case law cited in Robinson on North Carolina
Corporation Law directed to the question of whether different judgments might be
made about director conduct in different industries or businesses. Robinson cites to
cases from the late 1800s which indicate that under North Carolina law a director
of a bank might be held to a higher standard of care than a director of another
business. Russell M. Robinson, II, Robinson on North Carolina Corporation Law
§ 14.03[1] (7th ed. 2009).
{53} What is clear today is that the duties of a director of a behemoth bank such
as Bank of America or Wells Fargo are vastly different from those of a local bank
director in the late 1800s. The context has changed, but the principle remains just
as applicable. Director obligations will be judged in the context in which they occur,
and thus conduct by directors of an insurance company may be judged differently
from conduct by directors of a textile company depending on the actions in question.
The guiding principle was succinctly stated by the Delaware Court of Chancery:
“[N]o matter what our model [of corporate law], it must be flexible enough to
recognize that the contours of a duty of loyalty will be affected by the specific factual
context in which it is claimed to arise . . . .” TW Servs., Inc. v. SWT Acquisition
Corp., Nos. 10427, 10298, 1989 Del. Ch. LEXIS 19, *28 n.14 (Del. Ch. Mar. 2, 1989).
{54} Third, in some context-specific applications of the duty of loyalty and care,
both standards may be implicated. See Strine, Jr. et al., supra, at 638–39). One of
these areas is the director’s duties when disclosure is required.
{55} Fourth, the duty of loyalty is not limited to instances involving conflicts of
interest. It also contains a component of affirmative action. Stated differently,
there may be circumstances devoid of a conflict of interest in which the duty of
loyalty requires a director to act. Under a duty of loyalty, a director is not only
required to avoid conflicts of interest but also to (1) act in the best interests of those
to whom a fiduciary duty is owed and (2) try in good faith to perform her duties with
care.
{56} Fifth, the duty of loyalty is most difficult to apply in circumstances in
which the director acts without an apparent selfish interest for injuring the
corporation, most notably in circumstances alleging failure to properly monitor
corporate activities. See In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959,
967 (Del. Ch. 1996).
{57} Finally, although questions of motive and a director’s state of mind may
arise, the existence of those issues does not automatically preclude summary
judgment. Concomitantly, there may be instances in which a director’s or officer’s
motive or state of mind is a question for the jury. 15 This case, though, is not one of
those instances. The Court has a significant gatekeeper role in determining which
factual circumstances warrant submission of bad faith issues to a jury.
VII.
A.
{58} This case requires not only an understanding of basic concepts of
insurance regulation but also a clear understanding of the role of “good faith” and
15 Were the Court to hold that motive or state of mind are always jury questions, the litigation costs
and burdens would deter rational business people from serving on boards and would add enormous
unnecessary overhead to corporate budgets.
“bad faith” under the North Carolina law governing the fiduciary duties of corporate
officers and directors. Little has been written about the role of good faith in
fiduciary duty under North Carolina law. In fact, Robinson on North Carolina
Corporation Law poses at least four unanswered questions about fiduciary duties of
officers and directors which will be addressed in this opinion. 16 Fortunately, or
unfortunately, much has been written about the role of good faith in the fiduciary
law of Delaware. 17 For the reasons set forth below, the definitions of good faith and
bad faith under Delaware law and their application by Delaware courts are useful
tools for interpreting North Carolina law.
{59} The standard of care applicable to business decisions and business risks in
North Carolina is set forth in section 55-8-30(a) of our General Statutes:
A director shall discharge his duties as a director, including his duties
as a member of a committee: (1) In good faith; (2) With the care an
ordinarily prudent person in a like position would exercise under
similar circumstances; and (3) In a manner he reasonably believes to
be in the best interests of the corporation.
N.C. Gen. Stat. § 55-8-30(a)(1)–(3). That language requires the Court to look at the
care (1) an ordinarily prudent person, (2) in a like position, (3) would exercise under
similar circumstances, and (4) whether the officer or director acted in a manner he
reasonably believed to be in the best interests of the corporation. That standard of
conduct is subject to review under the business judgment rule.
{60} Although there is not an abundance of appellate guidance on application of
the business judgment rule in North Carolina, it is clear that our courts do apply
the rule. See, e.g., Sec. Nat’l Bank v. Bridgers, 207 N.C. 91, 176 S.E. 295 (1934);
Gordon v. Pendleton, 202 N.C. 241, 162 S.E. 546 (1932); State v. Harnett County
16 Is there a separate duty of good faith under North Carolina law? May different directors be held to
different standards of care? May directors in different kinds of companies be held to different
standards of care? Is the standard of review under the duty of care “negligence” or “gross
negligence”? Robinson, II, supra, 14.03[1].
17 Chancellor Chandler recently described the concept of good faith in Delaware as “[s]hrouded in the
fog of . . . hazy jurisprudence.” In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 754 (Del. Ch.
2005). Another author asserts that Delaware courts have used “good faith” as a rhetorical cure to
balance authority and accountability. See Sean J. Griffith, Good Faith Business Judgment: A
Theory of Rhetoric in Corporate Law Jurisprudence, 55 Duke L.J. 1 (2005).
Trust Co., 192 N.C. 246, 134 S.E. 656 (1926); Besseliew v. Brown, 177 N.C. 65, 97
S.E. 743 (1919); Anthony v. Jeffress, 172 N.C. 378, 90 S.E. 414 (1916); Braswell v.
Pamlico Ins. & Banking Co., 159 N.C. 628, 75 S.E. 813 (1912). Robinson has
described application of the rule as follows:
The business judgment rule has been the subject of as much discussion
and writing as any other single topic of state corporation law. Its
terms and applicability have been defined by countless court decisions
rather than by statute. It operates primarily as a rule of evidence or
judicial review and creates, first, an initial evidentiary presumption
that in making a decision the directors acted with due care (i.e., on an
informed basis) and in good faith in the honest belief that their action
was in the best interest of the corporation, and second, absent rebuttal
of the initial presumption, a powerful substantive presumption that a
decision by a loyal and informed board will not be overturned by a
court unless it cannot be attributed to any rational business purpose.
Robinson, II, supra, §14.06 (footnotes omitted).
{61} Former Chancellor Allen of the Delaware Chancery Court has explained
application of the business judgment rule in this way:
What should be understood, but may not widely be understood by
courts or commentators who are not often required to face such
questions, is that compliance with a director’s duty of care can never
appropriately be judicially determined by reference to the content of
the board decision that leads to a corporate loss, apart from
consideration of the good faith or rationality of the process employed.
That is, whether a judge or jury considering the matter after the fact,
believes a decision substantively wrong, or degrees of wrong extending
through “stupid” to “egregious” or “irrational”, provides no ground for
director liability, so long as the court determines that the process
employed was either rational or employed in a good faith effort to
advance corporate interests. To employ a different rule—one that
permitted an “objective” evaluation of the decision—would expose
directors to substantive second guessing by ill-equipped judges or
juries, which would, in the long-run, be injurious to investor interests.
Thus, the business judgment rule is process oriented and informed by a
deep respect for all good faith board decisions.
In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, 967–68 (Del. Ch. 1996)
(second emphasis added) (footnotes omitted).
{62} Absent proof of bad faith, conflict of interest, or disloyalty, the business
decisions of officers and directors will not be second-guessed if they are “the product
of a rational process,” and the officers and directors “availed themselves of all
material and reasonably available information” and honestly believed they were
acting in the best interest of the corporation. In re Citigroup Inc. S’holder
Derivative Litig., 964 A.2d 106, 124 (Del. Ch. 2009) (citation and footnote omitted).
The standard of review “is predicated on concepts of gross negligence.” Id.
{63} The CCIC corporate charter contains the following exculpatory provision:
A director of the corporation shall not be personally liable to the
corporation or its shareholders for monetary damages for breach of the
duty of care or other duty as a director, except for liability (i) for any
appropriation, in violation of the director’s duties, of any business
opportunity of the corporation, (ii) for acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of
the law, (iii) for the types of liability set forth in Section 14-2-154 of the
Georgia Business Corporation Code, 18 or (iv) for any transaction from
which the director derived an improper personal benefit.
(Haigh Aff. Ex. A at 7.) To avoid the application of this exculpatory clause, Plaintiff
must prove that the Company’s officers and directors have not acted in good faith
and that the same standard of review applies. The directors are entitled to the
same presumption of good faith. To hold otherwise would require the Court to
exercise the twenty-twenty hindsight forbidden by the business judgment rule.
{64} Plaintiff’s first prong of attack on its breach of fiduciary duty claim is
based upon the business decisions made by Haigh during the period 2000 to 2003.
Clearly, the decisions about what policies to write, what premiums to charge, and
how much insurance to write without reinsurance are quintessential business
judgments which determine the profitability and viability of an insurance company.
Plaintiff may not overcome the exculpatory provisions by simply showing that the
decisions were wrong, stupid, or egregiously dumb. Proof that it would have been
“more prudent” to write less coverage is insufficient to establish lack of good faith.
18 Section 14-2-832 of the Georgia Business Corporation Code addresses liability for unlawful
distributions and was formerly found in section 14-2-154. Ga. Code § 14-2-832 cmt. (2009).
B.
{65} Having abandoned his conflict of interest theory with respect to CIA, the
Commissioner first asserts that Defendants should be subject to liability for breach
of fiduciary duty based on business decisions made in connection with the volume of
California artisan business.
{66} With respect to Haigh, the Commissioner asks the Court to hold him
directly liable for the poor business decisions he made. The burden here is on the
Commissioner to show that Haigh violated his duty of care when making the
decisions he made as to the amount of artisan business CCIC wrote in California.
The Commissioner must make some showing in that regard to overcome the
presumption of the business judgment rule. Presumably, Mr. Custard would be
vicariously liable for those business decisions as CEO (even though it is clear that
Haigh conducted CCIC’s day-to-day operations). Mr. Custard could also be held
liable through his duty to monitor the business risks as a director. Mrs. Custard’s
liability for the business decisions would presumably be based on her duty to
monitor since it is clear that she had no role in day-to-day management.
{67} Liquidation resulted from the business risks undertaken by CCIC in
writing artisan insurance policies in California. There is little doubt on this record
that the premiums were set too low and too much business was written. As the old
adage says: “It is hard to make up for losses on volume.” CCIC either misjudged or
mistimed the market. Every individual Defendant concedes that the business
decisions made were wrong.
{68} In order to establish a lack of good faith in business decisions in the
context of an insurance company, a plaintiff such as the Commissioner must show
that the officers and/or directors displayed a conscious indifference to risks in the
face of clear signals of the existence of problems likely to lead to insolvency. 19 The
review of the conduct is context-specific. The insurance business is based on risks.
As long as the process employed by the officers and directors was rational and they
19 The Court deals with bad faith in connection with filing financial statements in Part VII.F.
believed they were advancing the corporation’s business, the Court will not second-
guess their business decisions—with a clear exception.
{69} Officers and directors of insurance companies have a duty to policyholders
to act in such a manner as to avoid insolvency that would render the policies
written worthless or substantially diminished in value. Where officers or directors
of an insurance company intentionally fail to act in the face of a known duty to act
to avoid insolvency, they have demonstrated a conscious disregard for their duties.
Such conduct would amount to bad faith and would take the officers and directors
outside the protection of the exculpatory provisions of a corporate charter. 20
{70} For example, if officers and directors of an insurance company knew that
the company was on the brink of insolvency or liquidation under RBC regulations
and nonetheless adopted a go-for-broke strategy of writing excessive premiums in
hopes of riding out the insolvency threat, such conduct would be a violation of their
fiduciary duties. Such conduct would be imprudent given their position in the
insurance company and their obligations to policyholders.
{71} In this case, there is no evidence of any irrational process. In addition to
its in-house actuary, the Company also used outside actuarial experts. There is no
evidence the business was run in any abnormal fashion. Efforts were made to
increase rates, cut back on unprofitable lines, and raise capital. Management did
write the wrong policies for the wrong premiums. Nonetheless, those decisions,
whether right or wrong, were not made in any conscious effort to disregard their
impact on the business.
{72} All the evidence supports a finding that Defendants were trying to run and
build up a successful insurance company. The Custards stood to lose millions of
dollars of their own money if the Company failed. Haigh stood to lose the value of
his investment in Delta as well as his source of income. There were no excessive
salaries or irrational bonus plans. Haigh’s bonus was tied to income, not sales
20 So, to answer one of Robinson’s questions: Yes, directors in different kinds of companies can have
different duties.
volume. Moreover, all of Mr. Custard’s correspondence was based on growing the
Company.
{73} The business was properly staffed with competent people. The actors were
not indifferent; they made judgments. These judgments ultimately turned out to be
wrong from a business standpoint, but no evidence suggests that the actors did not
honestly believe that their decisions were in the Company’s best interest. There is
no evidence that Defendants had any allegiance to any other goal, duty, or purpose.
There were no internal conflicts of interest, and the Court finds no evidence of bad
motive.
{74} The requirement of good faith on the part of officers and directors is a
simple, straightforward requirement—an honest belief that (1) their actions are in
the best interest of and not harmful to the corporation and (2) they have adequate
information upon which to base their decisions. The Commissioner has failed to
produce evidence of a lack of good faith sufficient to overcome the presumption of
good faith under the business judgment rule with respect to the business decisions
made by Defendants.
C.
{75} To the extent the Commissioner is relying upon a theory that the directors,
particularly the Custards, breached their fiduciary duties by failing to oversee the
market risk being taken by Haigh in writing CCIC’s California artisan business,
that theory also fails.
{76} The standard of review for directors’ duty to monitor was initially set forth
in Caremark by Chancellor Allen:
Generally where a claim of directorial liability for corporate loss is
predicated upon ignorance of liability creating activities within the
corporation . . . only a sustained or systematic failure of the board to
exercise oversight—such as an utter failure to attempt to assure a
reasonable information and reporting system exists—will establish the
lack of good faith that is a necessary condition to liability.
In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, 971 (Del. Ch. 1996).
{77} The Caremark standard has been reemphasized recently by both the
Delaware Supreme Court in Stone v. Ritter, 911 A.2d 362, 364–65 (Del. 2006), and
the Delaware Chancery Court in In re Citigroup Inc. Shareholder Derivative
Litigation, 964 A.2d 106, 122 (Del. Ch. 2009). In Stone v. Ritter, the Delaware
Supreme Court reiterated Caremark’s holding that a showing of bad faith conduct is
essential to establish director oversight liability. Stone, 911 A.2d at 370. The
Delaware Supreme Court said:
Caremark articulates the necessary conditions predicate for director
oversight liability: (a) the directors utterly failed to implement any
reporting or information system or controls; or (b) having implemented
such a system or controls, consciously failed to monitor or oversee its
operations thus disabling themselves from being informed of risks or
problems requiring their attention. In either case, imposition of
liability requires a showing that the directors knew that they were not
discharging their fiduciary obligations. Where directors fail to act in
the face of a known duty to act, thereby demonstrating a conscious
disregard for their responsibilities, they breach their duty of loyalty by
failing to discharge that fiduciary obligation in good faith.
Id.
{78} In Citigroup, Chancellor Chandler summarized the required proof of
failure to monitor as follows:
Thus, to establish oversight liability a plaintiff must show that the
directors knew they were not discharging their fiduciary obligations or
that the directors demonstrated a conscious disregard for their
responsibilities such as by failing to act in the face of a known duty to
act. The test is rooted in concepts of bad faith; indeed, a showing of
bad faith is a necessary condition to director oversight liability.
Citigroup, 964 A.2d at 123. This Court believes that North Carolina courts will
follow similar standards of review with respect to the monitoring duties of directors.
{79} The recent holding of the Delaware Court of Chancery in Citigroup is
particularly instructive in that it deals with the directors’ duties to oversee market
risks. In that stockholder derivative action, plaintiffs alleged that the officers and
directors of Citigroup breached their fiduciary duties by failing to oversee and
manage the corporation’s subprime lending market risks. 21 Id. at 111. Although
the decision turned on a demand futility pleading analysis, it articulated the
standard of conduct to be applied when the directors are alleged to have failed to
monitor business risk:
[P]laintiffs’ theory essentially amounts to a claim that the director
defendants should be personally liable to the Company because they
failed to fully recognize the risk posed by subprime securities. . . .
[W]hat is left appears to be plaintiff shareholders attempting to hold
the director defendants personally liable for making (or allowing to be
made) business decisions that, in hindsight, turned out poorly for the
Company.
Id. at 124.
{80} The Court concluded that the claims implicated not only a Caremark
standard of review of directors’ duty of oversight, 22 but also the interrelationship
between the presumption of the business judgment rule and the exculpatory
provision in the Citigroup charter. Id. at 125. The Court, in essence, applied
virtually the same standard of review for the Caremark claims and the claims
purportedly falling into a non-exculpatory category. The Court held that the
plaintiffs were required to plead bad faith conduct by “alleging with particularity
that a director knowingly violated a fiduciary duty or failed to act in violation of a
known duty to act, demonstrating a conscious disregard for her duties.” Id.
{81} This action rests at the summary judgment stage. We have more than
pleadings to rely upon in judging the directors’ conduct. The claims in this case and
the claims pled in Citigroup summon the same appropriate standards of review.
The Commissioner must meet either the Caremark standard to establish a failure
to monitor or the bad faith standard to overcome the exculpatory provision in
CCIC’s corporate charter addressing violations of the duty of care. The bar for both
rests at a high level. See id.
{82} There is no evidence that the directors of CCIC acted in bad faith in
monitoring business risks. Haigh was experienced and had an experienced staff.
21 Numerous other claims were alleged but not relevant here.
22 See supra ¶ 76.
He used outside actuaries to assess CCIC’s risks, and the NCDOI accepted their
methodology. The business was showing a profit, albeit a small one.
{83} There were only two red flags that might have caused the directors to
question what was happening. First, there was Hoerl’s assessment that the
California losses might be bigger than expected. However, no evidence indicates
that the Custards were aware of Hoerl’s assessment, and even if they had known,
they were entitled to rely on E&Y’s analysis. Second, there was some evidence that
the volume of business being written was at some point running ahead of surplus.
However, Haigh was working to find new capital and the Company was exiting non-
profitable business, reinsuring portions of its business, and seeking rate increases—
all steps designed to address the shortfall. Plus, in the fall of 2002, the Company
made significant additions to its loss reserves.
{84} In this context, the Commissioner has failed to establish that any director
had the illicit state of mind sufficient to support a finding of bad faith in the
monitoring context. There is no showing of a conscious disregard of red flags.
There is no showing of actual knowledge that the business was failing. There is no
showing of reckless indifference, improper motive, personal advantage, or deliberate
disregard of corporate interests. The Custards stood to lose millions of dollars from
such conduct. The Company was complying with all its filing requirements. It did
not fall into any violation of the RBC requirements until 2003, and that event was
triggered by the increase in losses resulting from reevaluation of the claims in the
Las Vegas office of CIA and the change in loss analysis methodology by E&Y. The
Court, therefore, concludes that there is no evidence to support submitting an issue
of bad faith failure to monitor to a jury.
D.
{85} The Commissioner has urged the Court to read State ex rel. Long v. ILA
Corp., 132 N.C. App. 587, 513 S.E.2d 812 (1999), as establishing a cause of action
for negligent mismanagement of an insurance company. The Court declines to give
that decision such a broad interpretation for a number of reasons. For one, in ILA
the Court specifically declined to address the issue of a duty of an insurance
company officer or director to a policyholder because, as in this case, the
Commissioner brought suit on behalf of the company. Id. at 592, 513 S.E.2d at 816.
For another, the defendant in ILA was liable because he had a conflict of interest,
breached his fiduciary duty, and caused damage to the company. 23 Id. at 602–03,
513 S.E.2d at 822. The court in ILA made no holding that the defendant would be
liable for negligent mismanagement if he had not breached his fiduciary duty and
was not, therefore, entitled to protection of the business judgment rule. The court
did not treat the negligence claim as an independent cause of action.
{86} The problem arises from the language of one sentence in the opinion which
reads: “plaintiff has standing to bring suit against defendant for breach of fiduciary
duty and negligent mismanagement.” Id. at 593, 513 S.E.2d at 817 (emphasis
added). However, the decision is clearly based on a determination that defendant
breached his fiduciary duties as a corporate officer and director and that his breach
caused the damages found by the trial court. The court said: “The evidence in the
record reveals that defendant’s actions were more than mere errors in judgment.
Instead, he was a leading participant in a plan to benefit himself and his interests
at the expense of ILA.” Id. at 602, 513 S.E.2d at 822. The court held that such
conduct abrogated the application of the business judgment rule because he acted in
his own self interest, not in the best interest of the corporation and, thus, in bad
faith. Id. Accordingly, he was held responsible for his actions which caused damage
to the corporation, and the corporation was entitled to recover those damages which
inured to the benefit of the policyholders. Id. at 604, 513 S.E.2d at 823. Not having
the benefit of the gross negligence standard of review, the director’s conduct was
subject to a negligence standard of review under the statute.
{87} In the case before this court, there has been no showing of a conflict of
interest or breach of fiduciary duty of loyalty. The ILA decision should not be read
to create a stand-alone cause of action for negligent mismanagement. To do so
would void the statutory scheme for fiduciary liability set forth in section 55-8-30 of
23 When determining liability, the court inILA also considered the fact that the director defendant
“did not reasonably rely on advice from professionals.” Id. at 604, 513 S.E.2d at 823.
the North Carolina General Statutes and the common law application of the
business judgment rule, and there is no language in the ILA opinion to support such
a sweeping interpretation. Judge Edmunds correctly applied the statute and the
business judgment rule. He did not create a new, freestanding cause of action for
negligent mismanagement. The decision simply held that a director who is not
entitled to the protection of the business judgment rule can be liable for negligent
conduct which harms the corporation.
E.
{88} In responding to duty of care claims, it is not uncommon for directors to
assert their reliance on outside advisors as a defense. See N.C. Gen. Stat. § 55-8-
30(b). The rationale for this statutory safe harbor is “the growing complexity of
business affairs” which makes it “necessary for directors to rely on other corporate
personnel” and “outside experts in discharging their responsibilities.” See Robinson,
II, supra, § 14.05.
{89} This safe harbor is disquieting at a time when the reliance on computer
models of risk by financial institutions proved so disastrous for the economy. What
we considered to be quantitative information turned out to have a significant and
ignored qualitative aspect. Perhaps we need more qualts and fewer quants.
Computer models may contain mathematical wizardry but be devoid of common
sense. See Number-Crunchers Crunched: The Uses and Abuses of Mathematical
Models, Economist, Feb. 13, 2010 (Special Report), at 5, 8. In one sense, the safe
harbor here is disquieting because, had E&Y used a different judgment in 2002 in
assessing CCIC’s risk from its California artisan business, CCIC might never have
gotten into trouble. It would have been slowed down by a higher claim rate. In this
case, the statute provides protection to the directors because they relied on E&Y’s
judgment and expertise in assessing CCIC’s potential liabilities.
{90} With respect to reliance on E&Y’s analysis, it is important to look at the
statutory language of section 55-8-30(b)(2). It requires the director to reasonably
believe the work being done by the outside advisor is “within their professional or
expert competence.” § 55-8-30(b)(2). In this case, there is no evidence that any
director had any reason to believe that E&Y did not possess the technical expertise
to do the work. E&Y’s 2002 report is thorough, comprehensive, and performed by
fully qualified professionals. Its decision to use non-California data was based upon
a facially logical determination that it was better practice to use more mature data
than immature California data alone. The NCDOI knew about the decision and did
not disagree with the methodology. There is no evidence in this record that E&Y
was not competent to perform the actuarial work relied upon. In fact, all evidence
is to the contrary.
{91} The Custards not only relied on E&Y, they also relied on Haigh. Haigh,
who was the principal manager of CCIC at the time, agreed with E&Y that use of
non-California data was more appropriate. Allen, the CFO, also supported E&Y’s
analysis. 24 Under the statute, the Custards are entitled to rely on the judgment of
both Haigh and Allen. Section 55-8-30(b) provides that a director “is entitled to rely
on information, opinions, reports, or statements, including financial statements and
other financial data, if prepared or presented by one or more officers or employees of
the corporation whom the director reasonably believes to be reliable and competent
in the matters presented.” § 55-8-30(b)(1). There is no evidence before the Court to
suggest that the Custards’ belief that Haigh and Allen were reliable and competent
in these matters was unreasonable.
{92} Although subparts (b)(1) and (b)(2) of section 55-8-30 protect directors who
reasonably rely on officers, employees, and outside experts, a director will not be
relieved of responsibility if she does not follow or ignores the advice provided. See
State ex rel. Long v. ILA, 132 N.C. App. 587, 603, 513 S.E.2d 812, 822 (1999). It is
not enough to get advice; it must be followed. In addition, a director cannot rely on
a report if she has actual knowledge that it is inaccurate. In this case, the only
evidence tending to show lack of reasonable reliance was Hoerl’s differing view of
how the California losses would develop. But he was not a certified actuary, and his
opinion was considered and rejected by E&Y. His views were not hidden or ignored.
E&Y simply came to a different judgment—a judgment upon which the individual
24 Plaintiff never accused Allen of any wrongful conduct.
Defendants relied. While Haigh’s conduct is subject to a closer review because he
had Hoerl’s views to consider, he was still entitled to rely on E&Y’s judgment in the
risk analysis. 25
{93} In conclusion, the safe harbor provided by section 55-8-30(b) of the North
Carolina General Statutes remains applicable. The Commissioner has not produced
sufficient evidence to overcome its presumptions. The statutory language provides
strong support for Defendants’ position that they exercised their duty of care in
good faith. There is no evidence that Defendants are not entitled to its protections.
F.
{94} Finally, the Court addresses the Commissioner’s arguments that the
individual Defendants breached their fiduciary duties by filing misleading financial
reports with the NCDOI sometime in the last half of 2002.
{95} If the Company’s directors had adopted a go-for-broke or gambling-for-
resurrection strategy, they would have violated their fiduciary duties. However, the
Commissioner does not argue or offer proof that they adopted such a strategy. If
the officers and directors had knowingly filed false or misleading reports with the
NCDOI, they would have violated their fiduciary duties. However, there is no
evidence that they knowingly took such action. If the directors had consciously
disregarded their duty to oversee the companies’ filing requirements, they would
have violated their fiduciary duties. However, there is no evidence of a conscious
disregard of those duties.
{96} In carrying out their fiduciary duties to ensure that their company’s
submissions to the regulatory authorities are correct, corporate officers and
directors must have a good faith belief that the submissions are correct. A good
faith belief must be an informed belief.
{97} In addition, corporate directors have a duty to conduct lawful activities.
As the Loyalty’s Core Demand article points out, corporations are chartered to only
perform legal acts. Strine, Jr. et al., supra, at 652 & n.69. An illegal act would be
25 To answer another of Robinson’s questions: Yes, different directors may be subject to differing
duties, at least based on their knowledge.
outside the scope of activities authorized by a corporate charter. To knowingly
cause a “corporation to engage in unlawful acts” or unlawful business practices is
disloyalty “in the most fundamental of senses.” Id. at 650. When directors of an
insurance company knowingly acquiesce in the filing of false financial reports with a
regulatory agency, they are being disloyal to the company’s essential purpose and
have breached their fiduciary duty. See id. Complying with the law (e.g. honest
regulatory filings) “comes ahead of profit-seeking” in the insurance industry, “and
directors owe a duty of loyalty to that hierarchy” of corporate obligations in their
supervision of corporate affairs. Id. at 651.
{98} The RBC regulatory structure is based upon a public policy to control risks
associated with insurance. Officers and directors of insurance companies know the
importance of the need for strict compliance with the regulatory scheme to protect
policyholders in the event of insolvency by the insurer. The obligation to comply
with the regulatory requirements lies at the core of the business. Directors of
insurance companies have a fiduciary duty—under both a duty of care and a duty of
loyalty—to exercise good faith in the supervision of the regulatory filings which
protect policyholders as well as the owners of the company. Officers responsible for
the regulatory filings have a fiduciary duty to see that the filings are accurate, in
compliance with regulations, and not misleading. The duties of directors are
monitoring duties, whereas the duties of officers are duties of care.
{99} At the center of this motion for summary judgment is the question of
whether Plaintiff has produced sufficient evidence to get to the jury on the issue of
whether the officers and directors violated their fiduciary duties with respect to the
regulatory filings. The Court concludes that the evidence is insufficient under the
applicable standards of review.
{100} The only evidence in this record that CCIC was “going for broke” or
“gambling for resurrection” is the large increase in premiums written in 2002 after
the brokers expressed reservations at the end of 2001. After 2001, CCIC took steps
to reduce the amount of premiums written. There is no evidence that it adapted a
go-for-broke strategy or that it had a belief that its methodology for setting reserves
would be reversed by E&Y in 2003. Deliberately adopting a gambling-for-
resurrection strategy in the context of an insurance company would be a breach of
fiduciary duty. However, that was not the case here.
{101} The Commissioner may argue that the existence of the spike in business
written in 2002 is sufficient to infer a go-for-broke strategy. However, there is no
evidence that the increase in premiums was affirmatively generated for purposes of
gambling on an outcome. Here, the Custards had a $6 million investment at CCIC
which would have been put at significant risk by a go-for-broke strategy. Mr.
Custard’s admonitions to Haigh were to make the business more profitable, not to
go for broke. Moreover, Mr. Custard’s investment of $1 million in the Company in
2003 is entirely inconsistent with a go-for-broke strategy. CCIC also had taken
steps to reduce the premiums being written. It had expanded reinsurance, raised
rates, reduced its exposure in certain markets, and attempted to raise capital. All
those actions contradict a go-for-broke strategy.
{102} With respect to financial reporting, officers and directors owe a fiduciary
duty to exercise good faith in submitting financial information to the NCDOI. It
matters little whether that good faith obligation is contained in a duty of care or a
duty of loyalty. Nor is it significant for this decision whether that duty was owed to
policyholders or the corporation. The “good faith” determination would be the same.
{103} Similar to Delaware law, North Carolina law does not contain a third
separate duty of good faith. Rather, the requirement of good faith is found in the
statute 26 and is the core concept embodied in the requirement of loyalty.
{104} What then is “good faith” as embodied in these fiduciary duties? Good
faith requires that officers and directors have a loyal state of mind: that is, a
justifiable, honestly held belief that they are acting in the best interests of the
corporation, whether they are making operating decisions or monitoring certain
aspects of corporate functions. In that sense, motive becomes a significant factor,
and one never far from the minds of those charged with reviewing corporate
conduct. Neither errors in judgments nor negligence establish bad motive.
26 N.C. Gen. Stat. § 55-8-30.
{105} The issues surrounding the filing of monthly reports with the NCDOI raise
different questions than those related to the decisions regarding what volume of
business the Company would write. At the risk of repetition, the Court finds the
following facts to be undisputed and controlling with respect to the determination of
Defendants’ alleged bad faith in connection with the filing of monthly financial
reports with the NCDOI.
{106} CCIC did not misstate and has not been accused of misstating any
material information on its financial statement other than its loss reserves. It is
not accused of overstating assets or understating any other liability. All of the
other information it provided in its financial statements to the NCDOI remain
unchallenged.
{107} When it received a claim, CCIC would set up a case reserve consisting of
both an indemnity portion (what will be owed to the claimant) and allocated loss
adjustment expenses (“ALAE”) (the cost to administratively handle the claim).
Every claim was assigned to the year in which the loss occurred, without regard to
when it was actually paid. Loss reserves are set by accident year.
{108} CCIC’s historical or incurred losses consisted of the indemnity and ALAE
payments previously made, plus case reserves for future indemnity and ALAE
payments to be made in the future. The latter reserves changed as new payments
were made, whereas the former remained constant.
{109} During the period at issue, CIA’s Las Vegas office set the loss reserves for
open California artisan insurance claims. For some period of time, CIA used a “step
reserve” approach which undervalued CCIC’s California artisan claims. 27 In the
fourth quarter of 2002, management realized the extent to which the claims had
been under-reserved and that case reserves had to be increased substantially.
{110} In addition to past or historical claims, CCIC was required by the NCDOI
to periodically estimate its additional future losses for each accident year. These
27 Under the “step reserve” approach, CIA adjusters “would increasingly add to the expense reserves
over the life of the claim rather than trying to predict at claim inception the total expenses which
would be incurred over the life of the claim.” (Reed Aff. ¶ 27.)
future losses are incurred but not reported reserves (“IBNRs”). IBNRs consist of
two components. The first is an estimate of increases to the reserves that exist for
claims already received, and the second is a reserve for future claims that have not
been reported but will be assigned to that accident year.
{111} Because IBNRs are an unknown, they must be estimated in some manner.
The estimates are prepared by actuaries. They look at past data to try to predict
the future. In addition to the Company’s in-house actuary, CCIC also retained an
outside firm to provide actuarial services.
{112} Actuaries take the historical data and purely mathematical calculations
based on known growth in losses and then select appropriate cumulative loss
development facts (“CDFs”) to project what they believe will be the ultimate losses
for an accident year. (See, e.g., Hoerl Dep. Ex. 58 at 1813.) The actuaries then use
other methods in combination with the method just described to come up with a
selected ultimate loss and ultimate loss ratio for each accident year. (See, e.g.,
Hoerl Dep. Ex. 58 at 1841, cols. 8–9.) It is important to note here that the selected
loss ratio is not a purely mathematical calculation or extension of numbers in the
sense of multiplication or division. The actuary applies judgment. That judgment
depends in large part on the amount and quality of historical data.
{113} The loss ratio is then combined with CCIC’s expense ratio to determine if
the business written in a particular year on a particular line of business is
profitable. While an insurance company may compensate for small underwriting
losses by making a profit on its investments, it is the management’s ability to
determine the right premium to generate underwriting gains that is critical to
success. See supra ¶ 12 n.3.
{114} Returning to the ultimate loss selection, it becomes clear that the more
data the actuary possesses, the more refined and, hopefully, more accurate her
calculations. For simplicity’s sake, take an example of accident years in 2000 and
1996. An actuary evaluating losses in 2001 would have far more data to use in
evaluating 1996 losses than 2000 losses. It is from historical data that the actuary
makes her judgments on how losses will grow for a particular accident year.
{115} How the ultimate losses are determined impacts the reserves required by
the NCDOI under its RBC formulas. The higher the projected ultimate loss, the
greater the reserve required. CCIC’s failure to meet its reserve requirements
triggered the Commissioner’s actions. The failure to meet the requirements
resulted in part from a change in 2003 by E&Y in its methodology for calculating
CCIC’s losses in its California artisan business.
{116} It is that change which is at the heart of the Commissioner’s bad faith
breach of fiduciary claim based upon CCIC’s regulatory filings. To some extent it
also impacts the good faith issues associated with the amount of premiums written.
{117} It is undisputed that in April 2002, when its loss reserves for 2001 and
prior years were set, Haigh, Allen, and Hoerl believed that CCIC’s historical data
for its California artisan business was not reliable from both a quantity and quality
standpoint. Hoerl believed the data showed losses of greater magnitude in
California than non-California artisan policies but agreed that E&Y’s use of non-
California data with more and better historical data was actuarially sound. E&Y
was an outside firm and made its judgment to use non-California data independent
of CCIC’s management. E&Y had Hoerl’s information available when it did so.
{118} At that time the NCDOI found nothing wrong with E&Y’s judgment in
using non-California data to set the loss selection amount for California artisan
losses because of the immaturity of the California data. The Court finds that
decision to be rational and understandable, but with twenty-twenty hindsight,
probably an error. It certainly was not a red flag which raised or should have raised
concern on the part of CCIC management.
{119} The Court digresses here to address Plaintiff’s argument that CCIC used
different loss calculations when seeking a rate increase for its artisan policies in
California in the summer of 2002. 28 First, it is clear that E&Y had the same
information. Second, CCIC was trying to get a rate increase in California in 2002;
using more California data, even though immature, to get that rate increase was
28 Hoerl used an estimated loss ratio of 93.8% for the California artisan line for all years compared to
the 76.4% he had developed internally using different CDFs.
not a sign of bad faith. The application was a public document, and no deception
was being practiced. Hoerl used different CDFs for the rate increase than were
used to calculate reserves for RBC purposes. The CADOI did not accept his CDFs.
{120} Hoerl did an internal actuarial analysis of ultimate losses on February 7,
2002. 29 He concluded from his analysis that the California data showed a steeper
and more rapid development pattern than the non-California artisan book, and he
brought that conclusion to the attention of management. On February 28, 2002,
CCIC filed its annual statement with the NCDOI which showed a loss ratio of
67.2% for 2000 and 56.3% for 2001. (Hoerl Dep. Ex. 54 at 2.)
{121} Returning to the E&Y April 30, 2002 report, it is clear that E&Y supported
Haigh and Allen’s view that it was more reliable to use non-California historical
data to determine projected ultimate losses than the short history in California.
The E&Y report contained the following provisions in its “Reliance & Limitations”
section:
The projection of ultimate loss and LAE reserves are estimates of
future events, the outcomes of which are unknown at this time.
Considerable uncertainty and variability are inherent in the
estimation of loss reserves. As a result, it is possible that actual
experience may be different than the estimates promulgated in this
report, and such difference may be material. As such, we cannot
guarantee that future experience will be as expected in this report or
recorded by the Companies.
....
Our estimates of ultimate losses are based on historical loss
development experience of the Companies, supplemented with an
Ernst & Young study of industry development patterns based on U.S.
Annual Statement Schedule P data as published in Best’s Aggregates
and Averages (1999). In using this historical information we assumed
that past loss development is predictive of future development.
(Haigh Dep. Ex. 38 at 3.)
{122} The same section points out that E&Y relied on the financial information
given to it by Allen, the CFO. There is no allegation that the information was
29 Hoerl used a loss ratio of 79.7% in this analysis. (Hoerl Dep. Ex. 8 at 1.)
inaccurate, and no claims have been made against Allen. It is clear that E&Y made
a judgment to use selected LDFs from non-California data which were lower than
the data for California would indicate based upon the limited information available.
It also appears that the use of the lower numbers can compound the error in
ultimate loss reserves because of their use in a cumulative development pattern.
Furthermore, it appears that the decision to use non-California numbers applied to
all the other methodologies used by E&Y to test the ultimate loss determination. In
the end, E&Y used an average ultimate loss ratio of 62.5%. That number was lower
than any number Hoerl had used because E&Y gave less or little weight to the
actual California numbers. It was a judgment call, and it supported Haigh and
Allen’s views on how the losses would develop.
{123} There is nothing in this record to indicate that E&Y did not act totally
independent of CCIC management or exercise its best judgment. In fact, the E&Y
analysis was reviewed by an actuary in the NCDOI. The NCDOI actuary reported
to his supervisor: “I concur in all respects with the findings and conclusions of
[E&Y’s] opining actuary and his associate with respect to the loss and LAE reserves
of CCIC at 12/31/01. The methods they employed were appropriate and properly
used. The assumptions and judgments made were reasonable and the conclusions
sound.” (Evans Dep. Ex. 2 at 27241.)
{124} The Commissioner points to the rate filing dated June 21, 2002, as some
evidence of either CCIC’s fraud in filing its reports with the NCDOI or its obligation
to amend or change E&Y’s selection of LDFs in determining its ultimate losses. In
that rate filing based on the same December 31, 2001 numbers used by E&Y, Hoerl
exercised his judgment to use different data than E&Y. Instead of using only
historical non-California data, Hoerl used a database including the California data
that resulted in significantly higher LDFs. The only evidence of record as to why he
chose the LDFs he used is that (1) he was being as aggressive as possible to get the
highest rate increase which would lower CCIC’s ultimate loss ratio and (2) he
believed the California losses would develop differently.
{125} Hoerl deserves credit for his assessment of how the California losses would
develop. History has confirmed his views. However, the now-proven fact that he
was right does not establish bad faith on the part of Haigh or CCIC’s management
or directors. Several points are worth noting. First, E&Y’s opining actuary, Gary T.
Ciardiello, was an accredited actuary; Hoerl was not. Our statutes protect
management from error based on reliance upon experts.30 CCIC management had
a strong incentive to follow the expert guidance, in addition to the fact it believed
the guidance was correct. 31 Second, Hoerl had a business motive—obtaining a rate
increase—to use the different LDFs. E&Y’s task in its study was to see that
reserves were set by a reasonable method. Most significantly, the CADOI rejected
Hoerl’s numbers, reducing his loss ratio from 88.7% to 69.6%.
{126} To summarize, there is nothing in this record to indicate that CCIC’s use of
the loss ratios recommended by E&Y based on the 2001 numbers was an act of bad
faith, or even negligent. The rate increase filing in June 2002 does not change that
conclusion in any way for the reasons set forth above.
{127} The issue then moves to what, if anything, triggered an obligation on the
part of CCIC management to change the loss ratio on an interim basis before the
next annual E&Y analysis. The Commissioner contends that the June 30, 2002 and
September 20, 2002 quarterly reports were false and misleading because the loss
ratios were not changed in light of the 2002 developments.32
{128} During 2002, CCIC made changes to its underwriting policies which
management believed would improve performance. CCIC received a rate increase
in 2001. Then, in 2002, CCIC received another rate increase, although not as much
as requested. CCIC also added reserve strength to its loss reserves for accident
years prior to 2002. Those additions were apparent in the financial statements filed
with the NCDOI. By September 30, 2002, CCIC had added over $5.5 million to the
reserves for years prior to 2002.
30 It is not difficult to imagine a different scenario in which management would have been held liable
for ignoring an expert report and relying on a non-accredited employee actuary.
31 The NCDOI also relied on the expert.
32 CCIC filed monthly reports, but both parties have focused on the June and September reports.
{129} Management’s belief that the underwriting changes were having a positive
effect on 2002 losses is reflected in the direct ultimate loss ratio reported to the
NCDOI in the June 30 quarterly statement that was filed in August. CCIC used a
loss ratio of 53% for its California artisan losses. Hoerl’s internal projection was
actually lower. He used a loss ratio of 51.5%. The June 30 filing did not differ
substantially from the E&Y Reserve Study. It reflected management’s belief and
Hoerl’s belief that loss ratios were better for the 2002 book of business.
{130} Following that filing, CCIC heard back from the CADOI on its June rate
increase request. That response came in late September 2002. The CADOI used a
loss ratio of 69.6%. So at the end of September 2002, management’s judgment, the
E&Y’s analysis, and the CADOI’s judgment all were reasonably aligned. The loss
ratio CCIC used in its June rate increase request is an outlier. As noted above,
CCIC made significant increases to its loss reserves for years prior to 2002 and
increased its loss ratio on California artisan business to 70.5%, virtually the same
as the 69.6% used by the CADOI on September 25, 2002.
{131} The Court will not go into great detail regarding the 2001 California rate
increase request and the E&Y 2001 analysis. Suffice it to say that there was an
even greater disparity between the loss ratio used in the 2001 rate request and the
loss ratio used in the E&Y analysis. Despite that difference, the Commissioner has
not challenged the E&Y loss ratio for 2001. Such an omission again demonstrates
that the 2002 California rate filing request is not evidence of bad faith or fraud on
the part of CCIC’s management.
{132} It is critical to look at the elements that caused CCIC’s financial status to
change so drastically. Three factors in particular caused CCIC’s loss reserves to
skyrocket, placing the Company in the risk category for NCDOI action in 2003.
First, the actual reported losses on California artisan insurance increased over
historical loss projections. Second, CCIC made massive additions to its reserves in
the fourth quarter of 2002 as the result of a previous underestimation of claims by
the Las Vegas office of CIA which handled the California artisan claims. Third,
E&Y changed its methodology for calculating loss reserves to focus solely on the
California numbers and no longer used nationwide historical numbers. The
combination of all three factors resulted in an average 100% increase in loss
reserves for all years.
{133} The fact that actual losses were higher than previously projected does not
establish bad faith. Setting premiums to cover losses is what insurance companies
do every day. If the premiums are too high, the company loses business. If the
premiums are too low, the company incurs losses on the premiums written.
{134} The substantial increase in reserves for open claims resulting from the
mistakes in the Las Vegas adjustment office had a compounding impact. It
increased the actual reserve for open claims by almost $9 million. That larger
number was then used to determine the known growth in losses, causing a higher
loss ratio. It clearly impacted the CDFs and E&Y’s decision to use actual California
data instead of nationwide historical data when setting reserves in 2003. The
numbers were too dramatic to ignore.
{135} The Commissioner has provided no evidence that CCIC management
either orchestrated or was aware of the problems in CIA’s Las Vegas office. To the
contrary, the record establishes that management increased the reserves in the last
quarter of 2002 to reflect the new information it received when management of the
Las Vegas office changed. Again, no indicia of bad faith or improper motive are
attributable to CCIC management.
{136} The change which had the most dramatic impact was unmistakably E&Y’s
decision to forgo use of nationwide historical data (which it had used in 2002) and
use solely California data to determine ultimate losses on the California artisan
policies. Table 5 below shows the magnitude of change between E&Y’s 2002
Reserve Study and its 2003 Reserve Study. 33 See also infra App. D.
33 The percentages are derived from a chart used by Defendants’ counsel at oral argument. The
numbers were not challenged by the Commissioner.
Table 5: E&Y Reserve Study Comparison
Accident E&Y 2001 E&Y 2002 Percent
Year Reserve Study Reserve Study Increase
1999 98.0% 136.4% 39.2%
2000 56.7% 117.1% 106.5%
2001 55.8% 122.7% 119.9%
All-Year Total
62.0% 122.8% 98.1%
(1999–2001)
SOURCE: Hoerl Dep. Ex. 58 at 1856; Evans Dep. Ex. 6 at 2856.
{137} The explanation for the change is apparent from the uncontradicted facts.
The decision on what data to use was a judgment call. No one has second-guessed
the 2002 judgment of E&Y. Then, in 2003, E&Y changed its judgment because the
historical data on California was more mature. It was certainly more robust in that
actual losses had far exceeded projections, thus impacting the judgment on growth
patterns. CCIC had already added $12.5 million to the reserves for 2000 and 2001
before E&Y began its 2003 work.
{138} As a result of the significant reserve strengthening that took place in the
latter part of 2002, E&Y chose to change the CDFs it used. This change increased
the required reserves for ultimate losses, and CCIC failed to meet the applicable
risk-based standards. The Court will not delve deeply into the numbers because it
is abundantly clear that the change in judgment by E&Y caused a significant
enough change in the required reserves to lead the Commissioner to the action he
ultimately and rightly took. Defendants did not act in bad faith in failing to change
the loss reserves prior to E&Y’s change in its method of calculation.
{139} History teaches us at least three things. First, our knowledge is
vulnerable. What we think we know with certainty can and probably will be proven
wrong. Second, things will change. Third, bad things will happen, randomly.34
34See generally Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life
and in the Markets (2004).
{140} E&Y acknowledged the vulnerability of its “knowledge” and that things
could change. Its report stated:
The projection of ultimate loss and LAE reserves are estimates of
future events, the outcomes of which are unknown at this time.
Considerable uncertainty and variability are inherent in the
estimation of loss reserves. As a result, it is possible that actual
experience may be different than the estimates promulgated in this
report, and such difference may be material. As such, we cannot
guarantee that future experience will be as expected in this report or
recorded by the Companies.
(Haigh Dep. Ex. 38 at 3.) Things did change, and they changed for the worst.
{141} The judgment made by E&Y, Haigh, and Allen was not an absolute worst
case scenario calculation. California losses turned out to be much worse than
projected and much worse than losses on comparable policies in other states. It
highlights the dilemma faced by many financial planners. Planning and estimating
for the worst case scenario is conservative, avoids all risk, limits business
opportunity, and is costly. 35 See supra ¶¶ 12–13.
{142} In the insurance industry, RBC plans are designed to invoke intervention
before the worst case scenario arises, but they are no guarantee against it. Instead,
they are a compromise dictated by economic reality. That is why many states, like
North Carolina, have guaranty funds paid for by insurance companies. See supra
¶ 17 n.6.
VIII.
{143} The Commissioner’s Memorandum raises three specific areas in which the
Commissioner asserts there are disputed facts preventing summary judgment. The
Court will address each separately. However, the disputes either do not exist or are
immaterial to the outcome of this decision. In particular, the California rate actions
and the Kaw transaction would not appear to be the cause of any damage the
35 It is worth noting that it was not until after the banking crisis hit that the U.S. Treasury actually
did a worst case scenario analysis and changed the capital requirements of the country’s financial
institutions.
Commissioner seeks to recover. Even if the funds were in dispute, they would not
be material to the outcome.
A.
{144} The Court finds that there is not a material credibility issue with respect
to Haigh’s testimony about his reservation over the adequacy of CCIC’s reserves.
Those statements related to his belief after February 2003 when E&Y took the
position that the reserves were not adequately stated. They did not relate to his
beliefs about the adequacy of the reserves in 2002 when both he and E&Y used a
different methodology to calculate the reserves for losses. In any event, if Haigh
had reservations in 2002, these reservations were unknown to the Custards.
{145} Despite the corrections Haigh made to his 2006 testimony, 36 Plaintiff still
maintains that Haigh harbored doubts about the reserve liabilities which kept him
from moving forward with a capital transaction. (Pl.’s Mem. Resp. & Opp’n at 24.)
The evidence before the Court, however, suggests otherwise.
{146} In June 2002, CCIC received notice that AM Best would downgrade its
solvency rating if the Company did not secure an outside capital investment. For
several months thereafter, Haigh worked with a team of investment and legal
professionals to raise capital through a reverse merger transaction. (Haigh Aff. ¶
110.) On September 30, 2002, Haigh and Wilson executed a Letter of Commitment
which indicated that a capital infusion would be forthcoming. (Haigh Dep. Ex. 270.)
During the negotiations that followed, Haigh reassured the investor that CCIC was
“ready to commit the necessary time, capital and other required resources to close a
mutually beneficial transaction.” (Haigh Dep. Ex. 69.) Although the negotiations
ultimately reached an impasse (see Haigh Aff. ¶ 141), the Court views Haigh’s
efforts during this time as steps towards a capital transaction.
B.
{147} To the extent Plaintiff raises an issue regarding the lawfulness of CCIC’s
rate actions in California, the Court declines to deny Defendants’ Motion on this
36 At his March 2006 deposition, Haigh had not yet been served with the lawsuit. Therefore, he did
not retain counsel and did not spend significant time in preparation. (Haigh Aff. ¶¶ 150–52.)
ground. The CADOI examined the Company’s rating and underwriting practices
and decided not to cite CCIC for any violations of section 790.03 of the California
Insurance Code. (O’Connell Dep. Ex. 9.) The decision as to liability and whether to
impose penalties under section 790.03 rests with the Insurance Commissioner of
California. Cal. Ins. Code § 790.035 (West 2009).
{148} Furthermore, the California rate actions do not create a genuine issue of
material fact with respect to Defendants’ knowledge of the Company’s profitability
in California. CCIC’s management realized that its California artisan business was
less profitable than its non-California artisan business. (Hoerl Dep. Ex. 54.) The
question of whether Defendants appropriately responded to this realization has
already been addressed.
C.
{149} Plaintiff further contends that Defendants’ attempts to structure a capital
investment into Kaw constitute self-dealing and a violation of section 58-7-200 of
the North Carolina General Statutes. According to Plaintiff, in July and August of
2002, CCIC disbursed company funds to purchase shares of Kaw for the personal
benefit of Haigh and Mr. Custard. (Pl.’s Mem. Resp. & Opp’n at 20, 42.) Plaintiff
claims that this transaction violated North Carolina insurance laws because CCIC
“invested in” its directors, officers, and controlling shareholders. The evidence
before the Court, however, does not support a claim brought under a theory of self-
dealing or under section 58-7-200 of the North Carolina General Statutes.
{150} Defendants were trying to secure an outside capital investment into Kaw
so that CCIC could maintain its A- rating. (Wilson Aff. ¶¶ 3, 5.) A reverse merger
transaction through a public shell company, like Kaw, provided a realistic avenue
for raising capital. (Wilson Aff. ¶¶ 7–8.) Any increases in shareholder value that
Haigh or Mr. Custard could have personally realized as a result would have been
predicated on a growth in the Company’s profitability. Although a self-dealing
theory may be appropriate in certain situations where a director derives a personal
benefit from a transaction at the expense of the corporation, we are faced with no
such situation in the present case.
{151} Plaintiff also argues that CCIC’s disbursements to Delta support a claim
for self-dealing and violate section 58-7-200. (Pl.’s Mem. Resp. & Opp’n at 43.)
However, the Court views these disbursements as one of the steps the Company
took to raise outside capital, not as evidence of self-dealing.
IX.
A.
{152} On August 13, 2003, Haigh entered into a Settlement Agreement with
CCIC. (Holloway Dep. Ex. 19.) The Settlement Agreement provided that CCIC
would make certain payments to Haigh: $50,000 at the time of execution, ten
monthly payments of $10,000 each thereafter, and a $7,874.63 reimbursement for
the business expenses he incurred as President. (Holloway Dep. Ex. 19.) CCIC also
agreed to release Haigh from any and all liabilities arising out of his Employment
Agreement. (Holloway Dep. Ex. 19.) In return for the release and payments, Haigh
agreed to waive any and all claims he may have had against the Company under
the terms of his Employment Agreement, including his claims to a thirty-day notice
of termination and a three-year severance payout. (Holloway Dep. Ex. 12, 19.)
{153} When the parties executed the Settlement Agreement, CCIC was under
administrative supervision. (Patterson Aff. ¶ 3.) During a period of administrative
supervision, North Carolina insurance laws require the insurer to “comply with the
lawful requirements of the Commissioner.” N.C. Gen. Stat. § 58-30-60(d). In this
case, the Commissioner issued a Summary Order that required CCIC to obtain
written approval from the Commissioner prior to engaging in certain transactions.
(Blades Dep. Ex. 39.) The Commissioner’s list of regulated transactions included,
but was not limited to, the following: conveying or disposing of assets, transferring
property, withdrawing from bank accounts, making payments to company officers or
directors, and incurring any debt, obligation, or liability. (Blades Dep. Ex. 39.)
{154} The Commissioner appointed one of his deputy commissioners (“Oglesby”)
to carry out the provisions of the Summary Order. (Blades Dep. Ex. 39.) Oglesby
then designated the Department’s Chief Forensic Accountant (“Holloway”) as the
Company’s on-site supervisor and primary contact. (Holloway Dep. 18:12–13 & Ex.
7.) As on-site supervisor, Holloway was responsible for reviewing transactions and
approving expenses that were subject to the Commissioner’s supervision. (Holloway
Dep. 18:16–23.) Therefore, CCIC consulted with Holloway on numerous occasions
when negotiating the payments at issue. (Holloway Dep. Ex. 8–11, 13–14, 16–18.)
{155} On May 6, 2003, the NCDOI pre-approved CCIC’s Settlement Agreement
with Haigh. (Holloway Dep. Ex. 15.) The Department conditioned its approval on
the understanding that there would be no guarantee of continued payments if the
Company moved into rehabilitation or liquidation. (Holloway Dep. 95:1–2 & Ex. 15;
Holloway Aff. ¶ 9.) Further negotiations took place during the drafting process, but
eventually the parties executed the Settlement Agreement—an agreement whose
terms and contents received NCDOI approval. (Patterson Aff. ¶ 9; Holloway Dep.
121:1–4.)
{156} From August 13, 2003 until November 4, 2003, Haigh received payments
under the terms of the Settlement Agreement. (Haigh Aff. ¶ 170.) However, those
payments stopped when CCIC was placed into rehabilitation on November 17, 2003.
(Haigh Aff. ¶ 170; Trendel Aff. ¶¶ 4–5.) At that point, the Commissioner, in his
capacity as rehabilitator, disavowed the Settlement Agreement under section 58-30-
120(a)(11) of the North Carolina General Statutes. (Oglesby Aff. ¶ 12.) The
Commissioner now seeks to recover the payments Haigh received while CCIC was
under administrative supervision.
B.
{157} Prior to discovery, Haigh moved for summary judgment on all claims
asserted against him in the Amended Complaint. In support of his motion, he
relied on the Commissioner’s Verified Petition for an Order of Rehabilitation and
the Affidavit of William S. Patterson, a financial examiner at the NCDOI. This
Court denied the motion at that time based on the limited factual record.
{158} Shortly thereafter, discovery commenced. After approximately twenty-one
months of discovery, Defendants jointly filed a motion for summary judgment on all
claims. Their motion included the claims on which Haigh had moved for summary
judgment in his previous motion. Plaintiff contends that Defendants’ Motion is
improper given the Court’s 2007 Order denying Haigh’s earlier motion. The Court
disagrees.
{159} It is well-established in our jurisprudence that “where one judge denies a
motion for summary judgment, another judge may not reconsider . . . summary
judgment on the same issue.” Cail v. Cerwin, 185 N.C. App. 176, 182, 648 S.E.2d
510, 515 (2007) (citation omitted). However, as our case law illustrates, this rule
only applies in the two-judge context. See, e.g., id.; Hastings v. Seegars Fence Co.,
128 N.C. App. 166, 493 S.E.2d 782 (1997); Huffaker v. Holley, 111 N.C. App. 914,
433 S.E.2d 474 (1993); Whitley’s Elec. Serv., Inc. v. Walston, 105 N.C. App. 609, 414
S.E.2d 47 (1992); Smithwick v. Crutchfield, 87 N.C. App. 374, 361 S.E.2d 111
(1987). A judge is “clearly within his rights in vacating” his own summary
judgment order, for “[s]uch procedure does not involve one judge overruling
another.” See Carr v. Great Lakes Carbon Corp., 49 N.C. App. 631, 635, 272 S.E.2d
374, 377 (1980), rev. denied, 302 N.C. 217, 276 S.E.2d 914 (1981); Miller v. Miller,
34 N.C. App. 209, 212, 237 S.E.2d 552, 555 (1977).
{160} The Court rejects Plaintiff’s suggestion that “the first judge himself may
not change his mind and overrule his own order.” See Dictograph Prods. Co. v.
Sonotone Corp., 230 F.2d 131 (2d Cir. 1956) (Hand, J.). In the subpart below, the
Court will consider whether the record now before it warrants summary judgment
on Plaintiff’s third claim for relief, which seeks to recover the settlement payments
CCIC made to Haigh in the months prior to rehabilitation.
C.
{161} Once a rehabilitation order has been entered, the receiver appointed
under such order may recover (on the insurer’s behalf) certain pre-rehabilitation
payments. Specifically, section 58-19-60(a) of the North Carolina General Statutes
allows the receiver to recover payments made to a director or officer as part of a
termination settlement. N.C. Gen. Stat. § 58-19-60(a)(i). However, this recovery
provision is not without limitation. For one, it only applies to payments made in the
year preceding the petition for rehabilitation. § 58-19-60(a). For another, it
excludes payments that were lawful and reasonable when paid if “the insurer did
not know and could not reasonably have known that such [payments] might
adversely affect [its] ability . . . to fulfill its contractual obligations.” § 58-19-60(b).
{162} Plaintiff, in his capacity as receiver, now seeks to recover the settlement
payments Haigh already received. (Am. Compl. ¶¶ 85–88.) Neither side disputes
that CCIC made the termination payments within one year of rehabilitation. (Pl.’s
Mem. Resp. & Opp’n at 48.) The evidence before the Court, though, establishes that
(1) the payments were lawful and reasonable when paid and (2) the Company did
not and could not have known that such payments might hinder their ability to
fulfill their contractual obligations. Therefore, the limitation of subpart (b) of
section 58-19-60 bars Plaintiff’s recovery.
{163} CCIC and Haigh negotiated at arm’s length. The Company terminated
Haigh for cause. (W. Custard Dep. Ex. 7.) Mr. Custard blamed Haigh for CCIC’s
financial downfall and stood to lose millions of dollars on account of Haigh’s alleged
mismanagement. (W. Custard Dep. Ex. 7.) Haigh had fallen into disfavor and was
not in a position to receive a sweetheart deal.
{164} When settlements talks began, CCIC refused to accept Haigh’s initial
proposal for a $300,000 lump sum payment. (Holloway Dep. Ex. 10.) Instead, it
countered and eventually worked its way down to $150,000 to be paid out over the
course of ten months with no guarantee of continued payments in the event of
rehabilitation or liquidation. (Holloway Dep. Ex. 11, 15, 17.) Given the liabilities
that loomed on both sides had the parties not reached a settlement, the Court
believes the parties reached a fair compromise.
{165} In addition, the Department approved the settlement payments during a
time of active supervision. (Holloway Dep. 128:7–17.) Administrative supervision
is a regulatory tool designed “to protect the interests of policyholders, claimants,
creditors, and the public generally” through “early detection of any potentially
dangerous condition in an insurer.” § 58-30-1(c)(1). When the parties executed the
Settlement Agreement, the Department viewed the payments as lawful, fair, and
reasonable. (Holloway Dep. 111:5–12, 129:25, 130:1–20.) When its view changed,
the Department stopped making payments. (Holloway Dep. 134:11–25, 135:1–2.)
Therefore, in effect, the negotiated right to terminate payments in the event of
rehabilitation or liquidation safeguarded CCIC from any future payments that may
have hindered its ability to fulfill its contractual obligations.
{166} For these reasons, the Court GRANTS Defendants’ motion with respect to
Plaintiff’s third claim for relief. The Commissioner may not recover the termination
payments Haigh received while the Company was under the Department’s watch.
D.
{167} In its Memorandum in Response and Opposition to Defendants’ Motion for
Summary Judgment, Plaintiff argues that the settlement payments were a voidable
preference under section 58-30-150 of the North Carolina General Statutes. 37
Section 58-30-150(a) defines a “preference” as:
a transfer of any of the property of an insurer to or for the benefit of a
creditor, for or on account of an antecedent debt, made or suffered by
the insurer within one year before the filing of a successful petition for
liquidation under this Article, the effect of which transfer may be to
enable the creditor to obtain a greater percentage of this debt than
another creditor of the same class would receive.
Despite its newfound reliance on North Carolina’s voidable preference provision,
Plaintiff never questions the continued applicability of section 58-19-60. Instead,
Plaintiff merely impugns the strength of Defendants’ factual support. (Pl.’s Mem.
Resp. & Opp’n at 48.) For the reasons stated in subpart (c), the Court already
determined that the evidence before it supports summary judgment on Plaintiff’s
recovery claim under section 58-19-60(b). Nonetheless, the Court will consider what
effect, if any, section 58-30-150 may have on its prior determination.
{168} Where “two statutory provisions conflict, one of which is specific or
‘particular’ and the other ‘general,’ the more specific statute controls in resolving
any apparent conflict.” Furr v. Noland, 103 N.C. App. 279, 281, 404 S.E.2d 885, 886
37 Plaintiff first raised its voidable preference argument in response to Defendants’ Motion for
Summary Judgment. Plaintiff’s third claim for relief, however, only sought recovery based on
violations of section 58-19-60. Given this shift in theory, the Court will address the interplay
between sections 58-19-60 and 58-30-150 of the North Carolina General Statutes.
(1991) (internal quotations and citation omitted). Plaintiff brings the interplay of
two North Carolina insurance laws to the Court’s attention: the voidable preference
provision 38 and the recovery provision. 39 These two provisions present a potential
for ambiguity in that a liquidator could interpret certain transfers as avoidable
under the former while at the same time interpret those same transfers as
nonrecoverable under the latter.
{169} The Court resolves any ambiguity between these two provisions in favor of
the specific and particular language set forth in section 58-19-60. Although under
section 58-30-150 a liquidator may avoid “a transfer of any of the property,” section
58-19-60 specifically identifies payments “in the form of a termination settlement”
as being within its scope. Compare § 58-30-150(a) with § 58-19-60. The “transfers”
at issue in this case were in the form of a termination settlement. Section 58-19-60,
therefore, controls, and the determination set forth in subpart (c) remains in effect.
CONCLUSION
{170} In April 2002, E&Y selected the LDFs used to set CCIC’s reserve levels. It
used historical “rest of country” data rather than actual California data to do so.
This selection was a judgment call, and one with which Haigh and Allen agreed.
Evans, an actuary with the NCDOI, reviewed the E&Y Reserve Study in May 2002,
and advised his supervisor that the selections made by the opining actuary at E&Y
evidenced good judgment and were free from bias. He had no recommendations for
approaching loss development selections differently.
{171} In the third and fourth quarters of 2002, the Company’s California losses
for the previous years accelerated, and errors in CIA’s Las Vegas office resulted in
large increases to the reserves for actual claims made. With that new knowledge,
E&Y changed its methodology for calculating the LDFs and CDFs used to project
ultimate losses. The new projections placed CCIC at risk from a capital standpoint
and resulted in the NCDOI liquidating the Company.
38 N.C. Gen. Stat. § 58-30-150.
39 N.C. Gen. Stat. § 58-19-60.
{172} The NCDOI does not fault E&Y for its methodology in 2002 or 2003. Yet it
asks the Court to impose liability for breach of fiduciary duty on CCIC’s officers and
directors for employing the same methodologies. Plaintiff faults Defendants for not
realizing that the California losses would develop more aggressively and for failing
to change their loss development approach sooner. Based on the record before the
Court, however, it is clear that the information that drove E&Y’s change in methods
did not surface until the third and fourth quarter of 2002, and by then the damage
was already done. E&Y’s subjective judgment on what factors to use was driven by
the new information, and application of the math dictated the ultimate loss reserve
number which triggered liquidation.
{173} It is readily apparently that from 1999 to sometime in 2002, CCIC’s
management failed in its primary business task: the premiums selected were too
low to cover the losses on the policies written, and too many policies were written on
the mistaken assumption of what the losses would be. Those decisions were
quintessential business decisions that are made everyday by insurance industry
managers. They are subject to the business judgment rule, and Plaintiff has failed
to adduce evidence of bad faith on the part of the officers or directors of CCIC which
would void the indemnification provision in CCIC’s corporate charter.
{174} Filing false or misleading financial statements with the NCDOI would
constitute bad faith on the part of officers and directors of an insurance company.
The standard for bad faith in this context requires either scienter or an officer or
director acting with such a conscious disregard of the duty to report accurate
information that it makes such conduct culpable. Here, it is undisputed that the
officers and directors relied on an independent actuarial opinion in setting the
reserve estimates it reported to the NCDOI. This outside expert used his own
professional judgment to apply historical non-California information when selecting
his LDFs and did not change that judgment until the year-end numbers for 2002
came in which demonstrated the error in that judgment. CCIC’s management made
a significant increase in its loss reserves in the second half of 2002 in response to
the changes in the actual claim losses. The outside expert’s failure to convert to use
of all California numbers before the 2003 audit has not been shown to be the
product of fraud or a conscious disregard of a duty to act.
{175} Our recent economic downturn is a stark reminder that computer models
of risk are not always accurate and reliance on them can prove disastrous. The
entire regulatory scheme and our statutes encourage use of and reliance upon
experts and their computer models. Whether that is a good policy is debatable
following our recent economic crisis. Nonetheless, it was the policy in effect during
the period at issue and is still supported by statute. There is no evidence that
CCIC’s officers and directors knew, should have known, or consciously disregarded
information that E&Y’s methodology was wrong, or that E&Y would change its
methodology for determining CCIC’s ultimate losses or what that change would be
if it occurred.
{176} Bad faith giving rise to personal liability may be found, at a minimum,
under the following circumstances, depending on the context:
(a) Taking or approving action which, though legal, the Courts find to be
inequitable; 40
(b) Taking or approving action which is not in the best interest of the
corporation in order to advance a personal interest, either financial or
nonfinancial, in nature; 41
(c) Knowingly taking or approving action which violates the law 42 and
exposes the corporation to liability or other forms of harm;
(d) A sustained or systematic failure of the board to exercise oversight—such
as an utter failure to attempt to assure a reasonable information and
reporting system 43 or deliberate, conscious, or intentional disregard of
duty; or
(e) A failure of the directors of an insurance company to exercise adequate
oversight to ensure that the company’s filings with the appropriate
40 See Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del. 1971).
41 See N.C. Gen. Stat. § 55-8-30.
42 See In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 755 (Del. Ch. 2005).
43 See In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, 970 (Del. Ch. 1996).
regulatory agency charged with overseeing its solvency were in
compliance with regulatory requirements.
{177} In a derivative action, a plaintiff seeking to hold insurance company
directors liable for bad faith and/or a failure to monitor corporate activity must
adduce facts which tend to establish that the directors acted in such a manner that
their conduct falls into one of the categories described above. Only then would the
burden shift to the directors to establish that their conduct was undertaken in good
faith and with proper motives. Such a standard of review implements the goal of
Caremark to relieve directors of having to prove that corporate cataclysms had not
resulted from their negligence without some prima facie evidence of bad faith on the
part of the directors. The Commissioner has failed to establish a breach of fiduciary
duty by Defendants. This case involves only breaches of the duty of care that are
exculpable and/or indemnifiable. The Commissioner has failed to establish evidence
of bad faith that would support an award of monetary damages.
{178} Therefore, based on the foregoing, it is hereby ORDERED, ADJUDGED,
and DECREED that Defendants’ Motion for Summary Judgment is GRANTED.
IT IS SO ORDERED, this the 19th day of March, 2010.
APPENDIX A
On October 22, 2001, Hoerl prepared an internal loss reserve analysis
comparing the Company’s 2001 losses (through September) to the 2000 year-end
losses. (Allen Dep. 145:3–6.) This analysis focused on CCIC’s California artisan
business. (Hoerl Dep. 88:13–16.) In his executive summary, Hoerl observed that
the changes in the non-California book of business had been “small” whereas the
changes in the California artisan business had been “substantial.” (Hoerl Dep. Ex.
7 at 1.) His results for the ultimate loss and ALAE loss ratios illustrate this finding.
Table 6: Estimated Loss Ratios – Hoerl
Non-California Book of Business California Artisan Business
As of December 2000 As of September 2001 As of December 2000 As of September 2001
Direct 47.7% 49.3% 46.3% 76.4%
Net 44.4% 44.3% 35.8% 73.6%
Ceded 53.0% 55.7% 60.7% 79.5%
SOURCE: Hoerl Dep. Ex. 7 at 1.
These results strongly suggested that the Company’s loss development pattern in
California would be different. (Hoerl Dep. 92:16–21.) The direct loss ratios for
CCIC’s California artisan business increased from 46.3% to 76.4% in nine months.
(Hoerl Dep. Ex. 7 at 1.) However, the non-California book of business only increased
from 47.7% to 49.3% during that same time period. (Hoerl Dep. Ex. 7 at 1.)
Hoerl’s analysis also revealed a growth in earned premium. As of September
2001, the direct earned premium of CCIC’s California artisan business ($28 million)
accounted for a large portion of the Company’s total book of business ($49 million).
(Hoerl Dep. Ex. 7 at 1.) This growth in premium, like the loss estimates, “suggested
the possibility of a more aggressive development pattern” in California losses.
(Hoerl Dep. Ex. 7 at 1.)
APPENDIX B
Hoerl prepared an initial loss reserve analysis based on the Company’s 2001
year-end loss data. (Hoerl Aff. ¶ 16.) This analysis was reviewed by management
when making selections for the 2001 annual statement. (Hoerl Dep. 108:12–16.)
Hoerl found that CCIC’s California loss experience had “deteriorated significantly.”
(Hoerl Aff. ¶ 22.) A comparison of the year-end results illustrates this finding.
Table 7: Loss Ratios for Artisan Direct – Hoerl
California Artisan Business
Final Reserve Analysis for 2000 Initial Reserve Analysis for 2001
Accident Year Annual Statement Annual Statement
1999 60.7% 108.6%
2000 40.0% 82.1%
2001 Not Revealed
All-Year Total 46.2% 79.7%
SOURCE: Hoerl Aff. ¶ 16; Hoerl Dep. Ex. 8 at 1434.
The ultimate loss and ALAE ratio estimates for CCIC’s California artisan business
increased from 46.2% in 2000 to 79.7% in 2001. (Hoerl Dep. Ex. 8 at 1.) This
increase suggested that the Company’s California artisan business would not be as
profitable as Hoerl initially had predicted in his 2000 Reserve Analysis. (Hoerl Dep.
112:1–17.)
Hoerl based his 2001 analysis on the assumption that the California artisan
business and the non-California book of business “each represented about a 50%
influence on the Company’s combined loss development factors.” (Hoerl Dep. Ex. 8
at 1.) However, as the loss pattern in California developed, Hoerl began to have
concerns that this “credibility-weighted approach . . . might be understating the
actual losses in CCIC’s California artisan program.” (Hoerl Aff. ¶ 9.)
APPENDIX C
E&Y prepared an independent actuarial analysis of CCIC’s 2001 year-end
losses. (Hoerl Aff. ¶ 21.) The E&Y Reserve Study was based upon the same data
that Hoerl analyzed in his internal review; nevertheless, E&Y reached a different
conclusion. (Hoerl Dep. 407:11–17.) E&Y reported that CCIC’s loss experience in
California was “largely unchanged.” (Hoerl Dep. Ex. 58 at 20.) In contrast, Hoerl
had reported that the California losses were deteriorating. (Hoerl Dep. 416:9–25.)
According to Hoerl, neither analysis was right or wrong, just a difference of opinion.
(Hoerl Dep. 413:19–22.) The E&Y Reserve Study also recognized this variability
when addressing the limitations of its analysis: “[c]onsiderable uncertainty and
variability are inherent in the estimation of loss reserves.” (Hoerl Dep. Ex. 58 at 3.)
Unlike Hoerl, E&Y gave no weight to CCIC’s loss experience in California.
(Allen Aff. ¶ 20.) Instead, E&Y based its loss estimates entirely on the Company’s
non-California loss experience. (Allen Aff. ¶ 20.) Ultimately, the senior consulting
actuary at E&Y concluded that the losses management booked to the 2001 annual
statement were “reasonable” and met applicable requirements of North Carolina
insurance laws. (Hoerl Dep. Ex. 57 at 3.) Although Hoerl disagreed with E&Y’s loss
estimates, he recognized the reasonableness of management giving more weight to
E&Y’s estimates because their actuary held more accreditations. (Hoerl Aff. ¶ 21.)
Table 8: Comparison of 2001 Loss Ratio Estimates for Artisan Direct
California Artisan Business
Accident Year 2001 Reserve Analysis 2001 Reserve Analysis 2001 Annual Statement
(Hoerl) (E&Y) (Management)
1999 108.6% 98.0% Not Revealed
2000 82.1% 56.7% 63.2%
2001 Not Revealed 55.8% 56.3%
All Years 79.7% 62.5% Not Revealed
SOURCE: Hoerl Aff. ¶ 22.
APPENDIX D
Although E&Y based its 2001 Reserve Study on CCIC’s non-California loss
experience, it based its 2002 Reserve Study entirely on CCIC’s California loss
experience. (Evans Dep. 141:2–10.) As a result, the 2002 Reserve Study presented
substantially higher loss ratios estimates than the 2001 Reserve Study. (Evans
Dep. 139:5–11.) A comparison of the year-end results illustrates this finding.
Table 9: Loss Ratio Estimates for California Artisan Business
Accident E&Y 2001 E&Y 2002
Year Reserve Study Reserve Study
1999 98.0% 136.4%
2000 56.7% 117.1%
2001 55.8% 122.7%
2002 79.2%
All-Year Total
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