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Herley Industries, Inc. v. Federal Insurance Companies

August 21, 2009

HERLEY INDUSTRIES, INC.
v.
FEDERAL INSURANCE COMPANIES, INC.



The opinion of the court was delivered by: Juan R. Sánchez, J.

MEMORANDUM AND ORDER

This is an insurance coverage dispute arising out of a criminal action brought against Herley Industries, Inc., a designer and manufacturer of microwave systems and electronic components for the defense and aerospace industries, and Lee Blatt, Herley's former CEO and Chairman of the Board;*fn1 a securities action brought against Herley and its officers and directors; and a shareholders' derivative action brought against Herley directors. Herley seeks insurance coverage under a policy issued by Defendant Federal Insurance Companies, Inc. for the costs of defending Blatt's criminal action and the securities and derivative litigation. Federal contends the fraud/willful violation and illegal profits*fn2 exclusions of the policy bar coverage for these claims.

FACTS

The insurance policy at issue is the Executive Protection Portfolio, Policy Number 8156-3872. Herley purchased the policy from Federal to cover executive, entity securities, and fiduciary liability for the period July 31, 2005, to July 31, 2006. Herley, its subsidiaries, and Insured Persons are the insured under the policy. Insured Persons include former, current, and future directors, officers, and managers of Herley. Under the policy, Federal agreed to indemnify Herley up to $10 million for loss "on account of any Claim first made against the Insured Person" during the policy period "for a Wrongful Act committed, attempted, or allegedly committed or attempted by such Insured Person before or during the Policy Period . . .". Policy, Pl. Ex. A, FED 0642. Federal also agreed to cover Herley for loss "on account of any Securities Claim" made against Herley during the policy period "for a Wrongful Act committed, attempted, or allegedly committed or attempted" by Herley or the Insured Persons before or during the policy period.*fn3 Policy, Pl. Ex. A, FED 0642.

The policy provides the following relevant exclusions, as amended by Endorsement No. 6.*fn4

Exclusion 7 of the policy provides Federal shall not be liable for any claim:

(b) based upon, arising from, or in consequence of such Insured Person having gained in fact any profit, remuneration or other advantage to which such Insured Person was not legally entitled; or

(c) based upon, arising from, or in consequence of any deliberately fraudulent act or omission or any willful violation of any statute or regulation by such Insured Person, if a judgment or other final adjudication establishes such a deliberately fraudulent act or omission or willful violation.

Policy, Pl. Ex. A, Exclusion 7, FED 0648; Endorsement No. 6, FED 0669. Exclusion 8 provides Federal shall not be liable for any securities claim:

(a) based upon, arising from, or in consequence of [Herley] having gained in fact any profit, remuneration or other advantage to which [Herley] was not legally entitled; or

(b) based upon, arising from, or in consequence of any deliberately fraudulent act or omission or any willful violation of any statute or regulation by [Herley] or by any past, present or chief financial officer, in-house general counsel, president, chief executive officer or chairperson of [Herley], if a judgment or other final adjudication establishes such a deliberately fraudulent act or omission or willful violation . . . .

Policy, Pl. Ex. A, Exclusion 8, FED 0649; Endorsement No. 6, FED 0669.

On June 6, 2006, the United States Government brought the underlying criminal action against Blatt and Herley with the filing of a thirty-five-count Indictment against both -- twenty-nine counts of wire fraud, two counts of obstructing a federal audit, one count of committing a major fraud against the United States, and three counts of making false statements to the government. On January 30, 2007, the Government filed a Superseding Indictment, which, with the exception of reducing the number of wire fraud counts from twenty-nine to twenty-seven, contained the same allegations as the Indictment. The Government charged that, from about April 2000 through December 2002, Blatt and Herley were involved in a scheme to fraudulently inflate Herley's costs in contracts for voltage controlled oscillators (VCOs) and power heads with the United States Government and Lockheed Martin, the Government's primary contractor.*fn5 As a result of this scheme, Blatt and Herley allegedly obtained money and property in the amount of approximately $3,932,550. On May 5, 2008, Blatt entered into a plea agreement in which he agreed to plead guilty to a single-count Superseding Information the Government agreed to file. The Government also agreed to move to dismiss all counts of the Superseding Indictment against Blatt. During the plea colloquy, Blatt admitted the following facts, as stated by the Government, were true:

[O]n or about March 23rd of 2000, the defendant, Lee Blatt, who was the chief executive officer of defendant Herley Industries at the time willfully failed to keep records that were required to be kept pursuant to Title 26 of the U.S. Code. More specifically, . . .Mr. Blatt's evidence would show fail[ure] to make and keep records with respect to an 18,000 dollar payment made by Herley Industries to Syracuse University. The payment was for work done in the year 2000 on a redesign of a part of an item that's known as a voltage controlled oscillator, or VCO for short. And that work was done for Herley Industries. Because Mr. Blatt did not keep records that would show how the work done by Syracuse should have been allocated, including for what year it should have been allocated, Mr. Blatt violated the recordkeeping requirements of Section 7203 as would be charged in the superseding information.

Mr. Blatt's failure to keep adequate records regarding this 18,000 [dollar] research expense is demonstrated by the fact that Herley Industries later submitted the expense to the defense contract audit agency, also known as the DCAA, as attributable to a 1999 VCO contract when it was not. None of the work that was done by ...


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