State v. Custard

• Decision Date: 27 March 2016
• Docket Number: 06 CVS 4622
• Citation: 2010 NCBC 6
• Court: Superior Court of North Carolina
• Parties: STATE OF NORTH CAROLINA, on Relation of its Commissioner of Insurance, AS LIQUIDATOR OF COMMERCIAL CASUALTY INSURANCE COMPANY OF NORTH CAROLINA, Plaintiff, v. A. RICHARD CUSTARD, by and through his Guardian ad Litem; WENDY J. CUSTARD; E. NIMOCKS HAIGH; and DELTA INSURANCE SERVICES, INC., Defendants.

2010 NCBC 6

STATE OF NORTH CAROLINA, on Relation of its Commissioner of Insurance, AS LIQUIDATOR OF COMMERCIAL CASUALTY INSURANCE COMPANY OF NORTH CAROLINA, Plaintiff, v. A. RICHARD CUSTARD, by and through his Guardian ad Litem; WENDY J. CUSTARD; E. NIMOCKS HAIGH; and DELTA INSURANCE SERVICES, INC., Defendants.

No. 06 CVS 4622

Superior Court of North Carolina, Wake

March 27, 2016

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.

ORDER & OPINION

Tennille, Judge.

{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.

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 (l) 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 (l) 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 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 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 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...