A litigious state of mind: wasting away again in Insuranceville: corporate misconduct leads to a new era in insurance claims.

Since the 2001 Enron collapse, corporate misconduct has been a leading story on the business pages. We have seen indictments, trials and convictions. From an insurance perspective, we now are seeing the ultimate result: insurance coverage claims for corporate misconduct. A recent, interesting example involves Tyco International.

Tyco is known for having been led by Dennis Kozlowski. There had been reports of extraordinary excesses: a $6,000 shower curtain, a 40th birthday party on the Island of Sardinia, and even a private performance by singer-songwriter Jimmy Buffet, whose lyric "Wasting away again in Margaritaville" is ironically appropriate here. It's appropiate because "wasting away again" went corporate funds, while shareholders sought their money back, prosecutors sought criminal convictions, and Kozlowski sought insurance.

In June, a jury convicted Kozlowski of stealing millions of dollars from Tyco. He was found guilty of grand larceny, conspiracy, securities fraud and eight of nine counts of falsifying business records.

Before this criminal trial was held, Kozlowski had asked insurers to pay for the cost of defending against the criminal trial, and two civil cases (an ERISA action and a securities suit). The trial court in the insurance litigation had concluded that the defense costs were covered (duty to defend or reimburse).The insurer appealed and obtained a decision providing an insurance perspective on corporate misconduct, Federal Insurance Co. vs. Kozlowski.

Most interestingly, the insurance case addressed the "personal profit" exclusion. This excludes claims "based upon, arising from, or in consequence of such Insured Person having gained in fact any personal profit, remuneration or advantage to which such Insured Person was not entitled...."

Since everything arose from the allegation that Kozlowski "stole" from Tyco (the court used the word "stole"), it would seem to be a clear case for the "personal profit" exclusion. Stealing is certainly a personal profit to which a person is not entitled. Simple.

Complexity, however, is what the court saw. The securities suit and the criminal action were found to be partly covered and partly excluded because the allegations in these two suits did not "solely and entirely" fall within the "personal profit exclusion" (the court found that the insurer must defend the whole ERISA action). The court then concluded that "to the extent such liabilities are excluded from coverage by the personal profit exclusion, Federal is not required to pay for defense costs."

There are three fundamental problems with this decision. First, the court's decision seems to go around the basic coverage question. The court seemingly said that coverage is excluded to the extent that coverage is excluded. Both sides here will be claiming support from this decision, and that is a problem. The Insurance issues presented required more direct guidance.

Second, the limited guidance provided seemed to start from the wrong point. The court held that the claim was partially covered and partially excluded because it found that covered and non-covered allegations were "intertwined." The court explained the problem of covered claims by noting that the cases against Kozlowski involved overstating assets, failing to reveal illegal profits, and concealing facts regarding accounting practices. The court was concerned that book doctoring, in itself, did not create a "personal profit" But, book doctoring cannot be viewed by itself. Book doctoring was a vehicle used in the stealing.

Finally, even if you accept the adequacy of the court's guidance and you accept that the court pointed in the right direction, will it be possible to get to the court's destination? Here, separating covered defense costs from non-covered defense costs will be another case in itself. Kozlowski will present carefully crafted fee invoices and insurers will carefully audit. But inevitably, segregating the fees will be difficult, if not impossible.

For example, Kozlowski testified at his criminal trial. Teams of lawyers undoubtedly spent many hours preparing him to testify. It will be very difficult to reasonably distinguish the covered preparation time from the non-covered preparation time.

As investigators and prosecutors continue to devote more resources to corporate misconduct, we can expect more suits and consequently, more insurance issues. The Federal Insurance decision will surely not be the last word on these issues. In fact, this decision will probably , not be the last word on Kozlowski's insurance claim.

Alan S. Rutkin, a Best's Review columnist, is a partner in Rivkin Radler LLP, Uniondale, N.Y. He may be reached at [e-mail].