And I Thought Government Contracts Were Tough!

And I Thought Government Contracts Were Tough! How Your Insurance Contracts Impact Your Government Contract Work and Vice-Versa June 24, 2014 2014 Kilpatrick Townsend

Panelist Introductions Barry Fleishman and David Cox are partners with Kilpatrick Townsend s nationally and internationally recognized Insurance Recovery team. Their insurance coverage experience includes representation of policyholders before federal and state courts, arbitral tribunals, and judicial and private mediators, focusing on corporate policyholder claims for insurance coverage arising out of liability and loss from catastrophic property damage, bodily injury, personal injury, construction defects, copyright infringement, theft and fraud, defective or misused products, government investigations, errors and omissions, and alleged wrongful acts of directors and officers. They have recovered hundreds of millions of dollars in insurance proceeds for clients, including manufacturers, government contractors, professional services companies, numerous banks and other financial institutions, investment companies and non-profits. They recently resolved an eight-year federal litigation on behalf of a large government contractor for property damage and business interruption arising out of Hurricane Katrina. David Miller is the former General Counsel, Chief Compliance Officer and Corporate Secretary of SkyLink Aviation, a multimillion dollar global logistics company specializing in providing aviation logistics support to governments, NGOs and the private sector. He has expertise in securities law (33 34 Act/Sarbanes/Oxley), compliance (FCPA, OFAC, EAR, ITAR) and government procurement (FAR, DFARS, AIDAR). While at Skylink, Mr. Miller was responsible, among many other thiings, for review and negotiation of all insurance policies including directors and officers, defense based act insurance (DBA), general liability and war risk insurance. He created and implemented monitoring and risk assessment programs to determine types and amounts of insurance required. Bradley Wine is Co-Chair of Morrison & Foerster s Government Contracts Practice. He represents a wide range of government contractors and other businesses in highly regulated industries with a focus on civil litigation, compliance, and counseling. Mr. Wine has a track record of saving and recovering hundreds of millions of dollars for clients by providing strategic business advice, addressing statutory and regulatory compliance issues, and securing complex judgments and settlements. Mr. Wine has represented client interests with respect to municipal, state, federal, and foreign government entities and has appeared before numerous federal and state courts, administrative tribunals, and foreign and domestic arbitration panels. Bill Gladden is a Vice President of TM Financial Forensics, LLC. Mr. Gladden has consulted on matters related to commercial damages, claim preparation, and fraud investigations for more than 17 years. Mr. Gladden has extensive experience addressing economic damages issues including lost profits, purchase price disputes, settlement calculations and distributions, and intellectual property damages. He has also prepared and reviewed numerous claims within the government contracting and construction industries. Mr. Gladden has participated in government contracting investigations (false claim/qui tam lawsuits and self-disclosures) and commercial investigations (Securities and Exchange Commission investigations, accounting reviews, class action and other shareholder lawsuits). Mr. Gladden has testified as an expert on accounting and damagesrelated issues and participated in settlement negotiations. 2

Discussion Overview Government Contractor Risk Environment and Insurance A General Counsel s Perspective Allowability of Insurance Premiums Risk Assessment and Coverage Issues Hot Topics Regulatory Investigations False Claims Act/ Whistleblower Suits FCPA Cyber Property/Business Interruption Handling Insurance Claims and Disputes Accounting for Loss and Proceeds 3

Government Contractor Risk Environment and Insurance A General Counsel s Perspective David Miller, former General Counsel, SkyLink Aviation 4

Allowability of Insurance Premiums Determining Cost Allowability (FAR 31.201-2, 201-3, 201-4) Condition Reasonable Allocable Complies With Standards Terms of Contract General Requirements A generally ordinary and necessary cost that does not deviate significantly from contractor s established practices. A cost that can be assigned to one or more cost objectives on the basis of relative benefits received. A cost meeting CAS Board standards (if applicable); otherwise, U.S. GAAP and practices appropriate to the circumstances. Cost is allowable per the terms of the contract or not expressly unallowable. Limitation Not subject to limitations included elsewhere in FAR 31.2 5

Allowability of Insurance Premiums Selected Limitations to Cost Allowability Selected Limitations FAR Excerpts (emphasis added) Lost Profits Replacement Insurance Coverage Faulty Workmanship Coverage Costs allowed for business interruption or other similar insurance shall be limited to exclude coverage of profit. FAR 31.205-19(e)(2)(ii) The cost of property insurance premiums for insurance coverage in excess of the acquisition cost of the insured assets is allowable only when the contractor has a formal written policy assuring that in the event the insured property is involuntarily converted, the new asset shall be valued at the book value of the replaced asset plus or minus adjustments for differences between insurance proceeds and actual replacement cost. FAR 31.205-19(e)(2)(iii) The cost of insurance to protect the contractor against the costs of correcting its own defects in materials and workmanship is unallowable. FAR 31.205-19(e)(3) 6

Hot Topic Government Contractor Insurable Risks Risk Assessment and Coverage Issues Regulatory Investigations False Claims Act/ Whistleblower Suits FCPA Cyber Property/Business Interruption 7

Risk Environment Regulatory Investigations

Regulatory Investigations Coverage Issue-Spotting D&O, E&O, potentially others Definition of Claim Subpoenas Informal Investigations Voluntary Reporting/Internal Investigations Individuals Only? Or Entity? Cases MBIA, Inc. v. Federal Insurance Co., et al., 652 F. 3d 152 (2d Cir. 2011) Office Depot, Inc. v. Nat l Union Fire Ins. Co. of Pittsburgh, Pa., 734 F. Supp. 2d 1304, 1310 (S.D. Fla. 2010), Definition of Loss Regulatory Exclusions/Sublimits 9

Regulatory Investigations Claim Definition NARROW... 10

Regulatory Investigations Claim Definition BROADER BUT STILL LIMITED... LIMITED TO INSURED PERSON INFORMAL INVESTIGATION 11

Regulatory Investigations Claim Definition BROADER BUT STILL LIMITED... ENTITY INVESTIGATION COVERAGE BUT ONLY FORMAL INVESTIGATION 12

Regulatory Investigations Claim Definition PRETTY DARN BROAD... BUT STILL LIMITED 13

Regulatory Investigations Entity v. Individual Insured ENTITY NAMED 14

Regulatory Investigations Coverage Issue-Spotting D&O, Definition of Claim Subpoenas Informal Investigations Voluntary Reporting/Internal Investigations Individuals Only? Or Entity? Cases MBIA, Inc. v. Federal Insurance Co., et al., 652 F. 3d 152 (2d Cir. 2011) Office Depot, Inc. v. Nat l Union Fire Ins. Co. of Pittsburgh, Pa., 734 F. Supp. 2d 1304, 1310 (S.D. Fla. 2010), Definition of Loss Regulatory Exclusions/Sublimits 15

Risk Environment False Claims Act/Whistleblower Suits

False Claims Act/Whistleblower Suits Coverage Issue-Spotting False Claims Act, Dodd-Frank and SOX Whistleblower Suits D&O, E&O Similar issues as regulatory investigations, also Bad Acts Exclusions usually, upon final adjudication Insured v. Insured exclusion exception for whistleblower? False Claims Act Horizon West, Inc. v. St. Paul Fire & Marine Ins. Co., 45 Fed. Appx. 752 (9th Cir. 2002) Continental Cas. Co. v.s Physicians Weight Loss Ctrs. Of Am., Inc., 61 Fed. Appx. 841 (4th Cir. 2003) EPL coverage for retaliation claims 17

False Claims Act/Whistleblower Suits Insured v. Insured Whistleblower Exception 18

False Claims Act/Whistleblower Suits EPL Coverage for Whistleblower Suits EPL covers liability of employers for claims made by their employees for, among other things, retaliation. Watch out for finger-pointing between D&O and EPL carrier, if different! 20

Risk Environment Foreign Corrupt Practices Act

FCPA Coverage Issue-Spotting Some similar issues as regulatory investigations and whistleblower suits, also Geographic scope of policy operations anywhere in the world? FCPA Exclusions Bad Acts Exclusions - Severability Specialty FCPA Policies Coverage for follow-on shareholder suits Related Claims? 22

FCPA Specialty FCPA Policies Limited, and probably expensive Defense costs, including accountants, auditing, consulting But not fines/penalties Usually extends to entity Claim definition narrow - limited to FCPA or analog investigations, inquiries and proceedings by U.S. and foreign governments Usually written as primary to D&O policy so does not erode limits 23

Risk Environment Cyber

Cyber/Privacy Breach Coverage Issue-Spotting Check E&O, CGL, D&O, Fidelity But cyber-exclusions are entering policies Specialty policies Required by government contract? Non-standard Acts/omissions of third parties? Not all first-party costs covered Cyber Policy Checklist Interaction with FAR/DFARS rules/proposed rules and contractual requirements Coverage for compliance in event of breach 25

Cyber/Privacy Breach Specialty Cyber Policies 3rd Party Coverage Claims by Individuals Injured by Privacy Breach Claims by Third Party Entities Injured by Privacy Breach Regulatory Claims Media Liability 1st Party Coverage Privacy Notification Forensic Investigation Data Restoration/Repair Cyber-extortion Business Interruption Crisis Management (PR) 26

Cyber/Privacy Breach Specialty Cyber Policies Old School Privacy Breaches Ideally, acts of third party vendors 27

Cyber/Privacy Breach Specialty Cyber Policies Third Party Acts Compare With 28

Cyber/Privacy Breach Coverage Issue-Spotting Check E&O, CGL, D&O, Fidelity But cyber-exclusions are entering policies Specialty policies Required by government contract? Non-standard Acts/omissions of third parties? Not all first-party costs covered Interaction with FAR/DFARS rules/proposed rules and contractual requirements Coverage for compliance in event of breach 29

Risk Environment Property Damage/Business Interruption

Property/Business Interruption Coverage Issue-Spotting Business Interruption Business Interruption Contingent Business Interruption Extra Expense Period of Interruption and Expenses to Reduce Loss Issues specific to government contracts Government-owned property Valuation - Government procurement regulations Proving business interruption for companies with single-customer (or near single customer) businesses 31

Property/Business Interruption Government-Owned Property 32

Property/Business Interruption Business Interruption Under Government Contracts Northrop Grumman v. Factory Mutual, 2:05-cv-08444 (C.D. Cal. July 31, 2013) Denied carrier s motion for summary judgment on certain categories of Northrop s business interruption loss, rejecting carrier s argument that since Northrop had not lost any contracts or the specific ships from the storm it couldn t show any lost sales. In the context of this industry and type of contract, requiring a loss of sales as well as lost production would undermine the business interruption insurance that Northrop purchased from Factory Mutual. Northrop s operations were shut down or impaired for a certain period, and Northrop has presented evidence of its calculation of lost gross earnings. It will be up to the factfinder to determine the credibility of the particular method Northrop used and the accuracy of its calculations. 34

Insurance Claims/Disputes First Steps Notice Claims Made Policies (C&O, E&O, etc.) Notice of Circumstances / Prior Notice and Knowledge Exclusions Related Claims Cyber Policies Can be claims-made for third party May need to notice the event Property Policies Notice Timing Notice to the Government v. Notice to the Carrier 35

Insurance Claims/Disputes Privilege Internal Investigations Yes Third Party Assistance with Event/Claim Outside Counsel Yes Brokers Usually No Public Adjustors Usually No Loss Consultants (Accountants, IT, Engineers) Maybe Yes, Maybe No Government requests for insurance status and correspondence 36

Insurance Claims/Disputes Accounting for Insurable Costs and Losses Determining Cost Allowability (FAR 31.201-2, 201-3, 201-4) Condition Reasonable Allocable Complies With Standards Terms of Contract General Requirements A generally ordinary and necessary cost that does not deviate significantly from contractor s established practices. A cost that can be assigned to one or more cost objectives on the basis of relative benefits received. A cost meeting CAS Board standards (if applicable); otherwise, U.S. GAAP and practices appropriate to the circumstances. Cost is allowable per the terms of the contract or not expressly unallowable. Limitation Not subject to limitations included elsewhere in FAR 31.2 37

Insurance Claims/Disputes Accounting for Insurable Costs and Losses First-Party Loss (Your Direct Costs) Accounting for losses based on coverage situation: Policyholder property and assets Employee property Government owned property Policyholder s or Government s proprietary data Calculating Lost Profits: Consideration of Government Contract Terms Lost Opportunity and Mitigation 38

Insurance Claims/Disputes Accounting for Insurable Costs and Losses Claim Pricing (Direct and Indirect Costs) Consider policy language that provides for potential claim to be prepared using direct and indirect costs (or rates) consistent with normal business practice and processes Cybersecurity Special Considerations New for insurance companies and contractors Policy may limit recoverable first-party costs to certain categories; therefore, careful accounting for each type of cost, and any resulting business interruption, is critical Cyber losses should be approached similarly to property losses from loss accounting perspective 39

Insurance Claims/Disputes Accounting for Insurable Costs and Losses Third-Party Loss (Claims Brought Against You) Defense Costs Regulatory Fines/Penalties Settlements/Judgments 40

Insurance Claims/Disputes Accounting for Insurable Costs and Losses Selected Limitations Fines and Penalties Legal Costs FAR Excerpts Costs of fines and penalties resulting from violations of, or failure of the contractor to comply with, Federal, State, local, or foreign laws and regulations, are unallowable except when incurred as a result of compliance with specific terms and conditions of the contract or written instructions from the contracting officer. FAR 31.205-15(a) In accordance with 41 U.S.C. 4310 and 10 U.S.C. 2324(k), costs incurred in connection with any proceeding brought by a Federal, State, local, or foreign government, or by a contractor or subcontractor employee submitting a whistleblower complaint of reprisal in accordance with 41 U.S.C. 4712 or 10 U.S.C. 2409, for violation of, or a failure to comply with, law or regulation by the contractor (including its agents or employees), or costs incurred in connection with any proceeding brought by a third party in the name of the United States under the False Claims Act, 31 U.S.C. 3730, are unallowable if the result is (1) In a criminal proceeding, a conviction; (2) In a civil or administrative proceeding, either a finding of contractor liability where the proceeding involves an allegation of fraud or similar misconduct; or imposition of a monetary penalty, or an order issued by the agency head to the contractor or subcontractor to take corrective action under 41.U.S.C. 4712 or 10 U.S.C. 2409, where the proceeding does not involve an allegation of fraud or similar misconduct; FAR 31.205-47(b)(1), (b)(2) 41

Insurance Claims/Disputes Accounting for Insurable Costs and Losses Selected Limitations FAR Excerpts In the event of a settlement of any proceeding brought by a third party under the False Claims Act in which the United States did not intervene, reasonable costs incurred by the contractor in connection with such a proceeding, that are not otherwise unallowable by regulation or by separate agreement with the United States, may be allowed if the contracting officer, in consultation with his or her legal advisor, determines that there was very little likelihood that the third party would have been successful on the merits. FAR 31.205-47(c)(2) Legal Costs (Cont.) Costs incurred in connection with proceedings described in paragraph (b) of this subsection, but which are not made unallowable by that paragraph, may be allowable to the extent that: (1) The costs are reasonable in relation to the activities required to deal with the proceeding and the underlying cause of action; (2) The costs are not otherwise recovered from the Federal Government or a third party, either directly as a result of the proceeding or otherwise; and (3) The percentage of costs allowed does not exceed the percentage determined to be appropriate considering the complexity of procurement litigation, generally accepted principles governing the award of legal fees in civil actions involving the United States as a party, and such other factors as may be appropriate. Such percentage shall not exceed 80 percent FAR 31.205-47(e) 42

Insurance Claims/Disputes Other Issues Unique to Government Contractors Document preservation and collection Classified/government sensitive documents Export control issues Government involvement in insurance dispute Government witnesses FOIA/Touhy Government assistance with loss Financial (beware the double recovery argument!) Otherwise Use of Historical Government Contracts/Insurance Policies to Prove Case 43

Insurance Claims/Disputes Accounting for Insurance Policy Proceeds Generally Follows the Principles of Cost Allowability: FAR 31.201-5, Credits: The applicable portion of any income, rebate, allowance, or other credit relating to any allowable cost and received by or accruing to the contractor shall be credited to the Government either as a cost reduction or by cash refund. If the government participated in payment of applicable insurance premium, government will expect to receive credit for its share of insurance proceeds. Lump Sum / Settlement Considerations Presents challenges to treatment of proceeds. Lump sum or bottom-line settlements may not differentiate between various claim components (e.g., property damage and lost profits). Possible Advance Agreement. 44

Questions? Bradley D. Wine t +1 703.760.7316 bwine@mofo.com Barry J. Fleishman t +1 202.508.5835 Bfleishman@kilpatricktownsend.com Bill Gladden t +1 312.379.8168 bgladden@tmfin.com David L. Cox t +1 202.508.5830 Dcox@kilpatricktownsend.com www.linkedin.com/in/davidlcox David Miller t +1 703.371.7728 dmiller4551@yahoo.com http://blognetwork.kilpaticktownsend.com/insurancerecovery 45