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March 30, 1998


The opinion of the court was delivered by: LINDBERG

 I. Statement of Facts

 Defendant Federal Insurance Co. issued the executive protection insurance policy at issue to Peter Kiewit Sons' Inc. (Kiewit's parent company). It took effect January 12, 1994, and covered Peter Kiewit, its subsidiaries and their duly elected or appointed directors and officers. The policy limit was $ 10 million, which applied after a $ 2.5 million deductible was met. The policy stated that Federal would:

pay on behalf of the insured organization all loss for which the insured organization grants indemnification to each insured person, as permitted or required by law, which the insured person has become legally obligated to pay on account of any claim first made against him, individually or otherwise, 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.

 The term "insured organization" as defined in the policy included Peter Kiewit and its direct and indirect subsidiaries, and "insured person" included "any person who has been, now is, or shall become a duly elected director or a duly elected or appointed officer of the Insured Organization." The term "insured" included "the insured organization and any insured person." A "claim" was defined as: a "civil proceeding commenced by the service of a complaint or similar pleading . . . against any insured person" and "loss" as "the total amount which any insured person becomes legally obligated to pay on account of each claim . . . for which coverage applies, including but not limited to, damages, judgments, settlements, costs and defense costs." "Wrongful act" was "any error, misstatement, misleading statement, act, omission, neglect, or breach of duty committed, attempted, or allegedly committed or attempted, by an Insured Person."

 The policy included an allocation provision that stated: "if both loss covered by this coverage section and loss not covered by this coverage section are incurred, either because a claim against the insured person included both covered and uncovered matters or because a claim is made against both an insured person and others . . . the insured and the company shall use their best efforts to agree upon a fair and proper allocation of such amount between covered loss and uncovered loss."

 Certain instances of loss were not covered under the policy. For instance, the "insured v. insured" exclusion stated:

[Federal] shall not be liable for Loss on account of any claim made against any insured person:
. . .
(c) brought or maintained by or on behalf of any insured except:
(i) a claim that is a derivative action brought or maintained on behalf of an insured organization by one or more persons who are not insured persons and who bring and maintain the claim without the solicitation, assistance or participation of any insured,
(ii) a claim brought or maintained by an insured person for the actual or alleged wrongful termination of the insured person, or
(iii) a claim brought or maintained by an insured person for contribution or indemnity, if the claim directly results from another claim covered under this coverage section.

 In 1988, Kiewit formed a subsidiary, Kiewit Communications Co., which eventually became MFS Communications Corp. (MFSCC), to pursue business opportunities in the telecommunications industry and to provide businesses with an alternative source of local telecommunications services. In June 1989, MFSCC increased to 80% its ownership interest in Metropolitan Fiber Systems, Inc. (MFS Telecom), a company that managed an alternate local communications network in Chicago. James Crowe, CEO of MFSCC; Royce Holland, president and chief operating officer; and Terrence Ferguson, general counsel; were the MFSCC executives primarily involved in these negotiations, with Crowe acting as the lead negotiator. The original owners of the company--Arthur Brantman, Anthony Pompliano, Howard Gimbel and David Husman--retained the remaining 20% of the shares in MFS Telecom. In August 1990, the 20% interest was further divided so that 10 individuals held the shares.

 Several of the minority shareholders approached Crowe in late 1991 regarding the sale of their shares to MFSCC. Only Anthony Pompliano completed the deal at this time, selling for $ 85,000 per share in June 1992. In July 1992, negotiations renewed with the remaining minority shareholders, leading to MFSCC's purchase of the remainder of the minority shares for $ 135,000 per share. MFSCC paid Pompliano an additional $ 50,000 per share to equalize his sale price with that of the other minority shareholders.

 In May 1993, MFSCC sold 20% of its stock through an initial public offering. As a result, six of the minority shareholders brought an action in March 1994 in the Northern District of Illinois against Crowe, MFSCC and Kiewit. The four-count complaint contained allegations of violations of federal securities laws, fraud, breach of fiduciary duty, and breach of contract and the duty of good faith and fair dealing. MFS was named in all four counts, while Crowe and Kiewit were named in Count I for violation of federal securities laws. Peter Kiewit notified Federal of the lawsuit in June 1994. In August 1994, Pompliano and his wife joined the suit as plaintiffs. Pompliano had served as president and CEO of MFS Telecom from January 1988 until April 1990. He was also a director and vice chairman of Telecom's board from April 1990 until June 1991. Federal learned of Pompliano's joining the lawsuit sometime between August and October 1994.

 The complaint alleged that MFS had concealed material information from the plaintiffs prior to the sale of their shares of Telecom stock to MFS in September 1992. More specifically, the plaintiffs alleged that MFS had failed to inform them of its plan to implement an initial public offering of stock (IPO) in Telecom's parent company, MFS, and its retention of Salomon Brothers, an investment banking firm, to implement the sale. In light of the planned IPO, the plaintiffs alleged that stock was much more valuable at the time of sale than the price they received and that they would not have sold their shares had the defendants disclosed the material information. Plaintiffs also alleged that MFS engaged Salomon Brothers for advice concerning how to buy the minority shareholders' MFS Telecom stock prior to, and as part of the plan for, a public offering involving MFS Telecom.

 Also allegedly unknown to the minority shareholders was the fact that during the negotiations to acquire their MFS Telecom stock, MFS was also secretly negotiating with British Telecommunications PLC regarding a potential substantial investment by British Telecom in MFS Telecom. The plaintiffs alleged that by failing to disclose this material information, MFS breached the shareholder agreement and the duty of good faith and fair dealing arising thereunder by inducing the minority shareholders to enter into the 1992 stock purchase agreements and thereby sell their MFS Telecom stock at an unfair price.

 Crowe had been CEO of MFSCC since its inception and was the highest ranking employee at the company. He had primary responsibility for establishing the strategic plans and objectives of MFSCC, including all aspects of capital acquisition such as public offerings, stock purchases, and mergers and acquisitions. For initiatives in these areas that required board approval, Crowe was responsible for making recommendations and presenting them to the board for approval.

 The insurance policy did not require Federal to assume the defense of the lawsuit, and all three defendants retained the law firm Bartlit, Beck, Herman, Palenchar & Scot. In July 1994, Federal sent Kiewit a five-page letter summarizing its view of the allegations in the complaint and the terms of the policy. *fn2" Federal set forth specific policy provisions under which coverage might be denied, including the finding of fraud, intentional misconduct or personal profit, or the award of penalties or punitive damages. Federal concluded the letter with a reservation of rights under the policy to deny coverage or rescind the policy, stating that:

it reserved all rights under the policy and available at law to deny coverage . . . on additional and alternative bases as other terms, conditions, exclusions, endorsements, and provisions of the policy, including representations, statements, declarations and omissions in connection with the application therefor, are found to be applicable.

 The letter also stated that Federal's "position as to the coverage for this matter [is] premised upon . . . presently known facts and are by necessity subject to change as additional . . . facts are developed through the course of discovery and further pleadings."

 Although not responsible for control of the defense, Federal agreed to pay--after the $ 2.5 million deductible--80% of the defense costs based on a Federal ...

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