Between April 2, 2007 and October 1, 2008, Susan Kostin, Mr. Kostin's widow, withdrew a total of $3.75 million from the Kostin Company's Madoff account.

Adversary proceeding in bankruptcy court against insured

Ms. Kostin claimed that, during this time period, Madoff “made wrongful entries” into her personal account “to disburse to her money belonging to other [Madoff] customers in order to further the goals of the Ponzi scheme[.]” The wrongful account entries made by Madoff, Ms. Kostin claimed, consisted of fictitious profits and the funds transferred by Madoff into her personal account consisted of other people's money.

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In the aftermath of the revelation of the massive fraud, a bankruptcy proceeding focused on the liquidation of Madoff's company and Madoff's personal assets was commenced in the U.S. Bankruptcy Court for the Southern District of New York, and Irving H. Picard was appointed bankruptcy trustee.

In November 2010, the trustee filed an adversary proceeding in the bankruptcy court against Ms. Kostin, the Kostin Company, and other Kostin family members, denominated as Picard v. Kostin Company, Adversary Proceeding No. 10-04950 (BRL).

Notification to homeowner's & excess insurance carriers

Ms. Kostin asserted that she timely notified her homeowner's and excess insurance carriers, Pacific Indemnity Company and Federal Insurance Company, of the claims being made against her and sought coverage.

The insurers denied her claim and she secured counsel at her own expense, who contested the trustee's claim over the course of four years. Following a mediation, Ms. Kostin settled the trustee's claim, agreeing to return $3.375 million. Her attorney's fees and litigation costs exceeded $799,000.

Refusal to reimburse legal defense costs

Pacific and Federal refused to reimburse Ms. Kostin for the costs of her legal defense or for the settlement amount, and she filed suit for breach of the homeowner's and excess insurance policies. She argued that she was entitled to coverage under her policies' “wrongful entry” provision.

The insurers moved to dismiss.

The Homeowner's Insurance Policy

The homeowner's insurance policy covered:

damages a covered person is legally obligated to pay for personal injury or property damage which take place anytime during the policy period and are caused by an occurrence.

It defined “personal injury” to include:

wrongful entry or eviction

District court dismissed complaint

The district court dismissed Ms. Kostin's complaint, holding that, as a matter of law, the “wrongful entry” coverage provided by Ms. Kostin's insurance policies did not extend to the liability that she faced as a result of Madoff's false accounting practices and fraud.

In its decision, the district court explained that, although the phrase “wrongful entry” might be interpreted in the context of the homeowner's insurance policy to include a variety of unauthorized or otherwise tortious intrusions into real property, personal property, or electronic accounts, it could “not reasonably be interpreted to include the making of fraudulent ledger book 'entries.'”

Rather, the district court ruled, the phrase “wrongful entry” only could reasonably be read in context to refer to “an unauthorized or otherwise tortious 'act of entering' — i.e. an intrusion — and not as the act of wrongfully 'making or entering a record.'”

Fraudulent accounting practices not covered

The district court reasoned that the term “wrongful entry” did not appear alone in the insurance policy but was part of the phrase “wrongful entry or eviction.” Thus, it ruled, in the context in which it appeared, “wrongful entry” could not be reasonably read to encompass any imaginable type of entry that was somehow wrongful but as “something akin to an unauthorized or tortious intrusion.”

Related: Madoff claims impact homeowner policies

The district court pointed out that Ms. Kostin's complaint made it clear that the “wrongful entry” at issue was not a tortious act of entering or intrusion but instead was a fraudulent act of making or entering a record. Moreover, the district court noted, Ms. Kostin alleged that Madoff had engaged in unauthorized transactions once within her account and not that Madoff had lacked authorization to access her account.

Accordingly, the district court concluded, the “wrongful entries” at issue consisted of fraudulent accounting practices, rather than unauthorized intrusions, and were not covered by Ms. Kostin's insurance policies.

The case is Kostin v. Pacific Indemnity Co., No. 3:17-cv-1320 (JBA) (D. Conn. April 10, 2018).

Steven A. Meyerowitz, Esq., is the director of FC&S Legal, the editor-in-chief of the Insurance Coverage Law Report, and the founder and president of Meyerowitz Communications Inc. Email him at [email protected].