D&O Insurance: Applying the Insured vs. Insured Exclusion When Plaintiffs Include Both Insured Persons and Non-Insureds
In a June 29, 2012 opinion (here), the Seventh Circuit, applying Illinois law, held that when the defendants in a lawsuit include both persons who are insureds under the defendant company’s D&O policy and persons are not insureds, the policy’s Insured vs. Insured exclusion does not preclude coverage for the entire lawsuit, but only the portion attributable to the claims brought by the non-insured person defendants. The extent of coverage available when the defendants include both insured persons and non-insureds is to be determined by the policy’s allocation provisions.
The underlying claim (referred to as the “Miller action”) involves a lawsuit brought by five individuals against Strategic Capital Bancorp, Inc. (SCBI) and two of its officers. In their suit, the plaintiffs asserted claims for fraud, civil conspiracy for alleged violations of the Illinois Consumer Fraud and Deceptive Business Practices Act. Three of the plaintiffs in the Miller action are former SCBI directors and therefore qualify as “Insureds” under the SCBI D&O policy. The other two Miller action plaintiffs are not Insureds under the policy.
The SCBI D&O policy includes an exclusion (of a type found in most D&O policies, and usually referred to as an “Insured vs. Insured” exclusion) precluding coverage for “Loss on account of any Claim made against any Insured: …brought or maintained by or on behalf of any Insured or Company in any capacity.” The Policy also contained an allocation provision, specifying that when loss from a Claim incudes both “covered and uncovered matters” the amount “shall be allocated” between covered Loss and uncovered loss based upon the relative legal exposures of the parties to the covered and uncovered matters.”
SCBI submitted the Miller action as a claim under its D&O policy. The carrier denied coverage for the claim in reliance on the Insured vs. Insured exclusion. Coverage litigation ensued. The District Court ruled in favor of the carrier, holding that the “plain language” of the exclusion precludes coverage for civil proceedings “brought or maintained by any Insured.” SCBI appealed.
The June 29 Opinion
In an opinion written by Judge David Hamilton for a three judge panel, the Seventh Circuit affirmed in part and reversed in part the holding of the district court. The appellate court affirmed the district court to the extent the lower court had held that coverage under the policy for the claims brought by the three former directors was precluded by the Insured vs. Insured exclusion, but reversed the district court to the extent that the lower court had held that the exclusion also precluded coverage for the claims brought by the plaintiffs who were not Insureds. The Seventh Circuit, In reliance on its 1999 decision in the Level 3 Communications, Inc. v. Federal Insurance Co. case (here)– which the Court said was “practically indistinguishable“ from this case -- held that there was coverage under the policy for the claims brought by the non-insureds, and that defense costs and any indemnity amounts would have to be allocated between covered Loss and uncovered loss using the policy’s allocation provisions.
In the Level 3 case, the Seventh Circuit had also addressed the question of the application of an Insured vs. Insured exclusion in a D&O policy to a claim that ultimately included both insured and noninsured claimants. Initially, the claimants in the underlying case had only consisted of non-insureds. However, six months after the underlying lawsuit had been commenced, an insured person joined as a plaintiff. The Seventh Circuit held in the Level 3 case that in that situation “the insurance contract requires allocation of covered and noncovered losses rather than barring all recovery because of the presence of an insured on the plaintiff’s side of the case.”
The D&O insurer in this case attempted to distinguish the Level 3 case based on two factual differences: timing and “majority rule.” The carrier first argued that in the Level 3 case, the insured plaintiff did not join the underlying suit until six months after it was filed. The Seventh Circuit said that its ruling in Level 3 had not depended on the timing, and so rejected this attempt to distinguish the earlier case.
Second, the carrier argued, in reliance on what the appellate court described as a “counting noses” approach that coverage in a mixed claimant case like this should be based o n the number of insured plaintiffs or proportion of damages claimed by insured plaintiffs. The court said that this “proposed additional requirement for a majority of non-insureds claimants or dollars has no basis in the …policy language.”
The appellate court also noted that the carrier attempted to rely on the Eleventh Circuit’s 2005 opinion in the Sphinx International v. National Union Fire Insurance Co. case (here), which also involved a claim brought both by insured persons and noninsureds. In that case, a former director initiated a securities suit and then published a nationwide notice soliciting other shareholders to join the suit. The former director then amended his complaint to add the additional plaintiffs. The Eleventh Circuit held that coverage was precluded for the entire suit based upon the company’s D&O policy’s Insured vs. Insured exclusion., which precluded coverage for loss arising from a Claim brought “By or at the behest of … any DIRECTOR or OFFICER … unless such claim is instigated and continued totally independent of, and totally without the solicitation of, or assistance of, or active participation of, or intervention of any DIRECTOR OR OFFICER of the company.” The Eleventh Circuit had held that the director plaintiff had actively solicited the other plaintiffs, and therefore the exclusion precluded coverage for the entire claim.
The Seventh Circuit found the Sphinx decision to be distinguishable by its fact, including in particular with regard to the policy language involved in that case. The Seventh Circuit also noted that Sphinx itself had distinguished the Level 3 case because the policy language in the earlier case was “too dissimilar” to the language at issue in Sphinx “to be decisive.”
One of the reasons carriers include Insured vs. Insured exclusions in their policies is that, in addition to avoiding collusive suits, the carriers don’t want to pick up coverage for corporate infighting. Internecine battles can be vexatious and often are not susceptible to resolution on a rational business basis. Given this justification for the inclusion of an Insured vs. Insured exclusion in the policy, I can see how the carriers would take the position that if any one of the plaintiffs is an insured person, the entire claim should be excluded. The argument would be the involvement of even one insured presents too great a risk that the carrier might be dragged into corporate infighting or persona score settling.
There may be something to this argument; the carrier did succeed in convincing the district court that the involvement of even one insured as a plaintiff – or more specifically, the involvement here of three insured persons among the five claimants – is sufficient to preclude coverage for the whole claim.
The problem with this argument – that one insured person plaintiff “taints the entire suit,” as the appellate court put it-- is that it can lead to some hard questions. As the appellate court noted, the carrier here took this “proposed rule” to “its logical limit,” arguing that it should apply and control even if there were 99 plaintiffs who were not insureds and only one insured person plaintiff. The appellate court also noted that the carrier had argued that the rule should apply even if separate complaints by an insured person plaintiff and non-insured were consolidated, even if only for pretrial proceedings. These examples from the logical limits of the insurer’s argument proved to be more than the court could accept, leading the appellate court to follow a solution based on allocation of between covered Loss and uncovered loss.
For carriers that nonetheless believe that Insured vs. Insured exclusion should apply even if only one of many plaintiffs is an insured person will want to consider the Seventh Circuit’s analysis of the Sphinx International opinion. The more encompassing exclusionary language at issue in that case seems likelier to preclude coverage when claimants include both insured person plaintiffs and non-insureds, particularly where the insured person plaintiff is actively involved in t he litigation.
For all D&O insurance practitioners the potentially different claims outcome based on the differences between the exclusionary language at issue in the Sphinx International case and the language involved here underscores the critical importance of these differences in policy wordings. In particular, those of us who are involved in representing policyholders in the insurance purchasing process will want to play close attention to the language used in the Insured vs. Insured exclusion in prospective policies, in order to determine whether it more closely resembles the language at issue in the Sphinx International case or the language involved here.
It is probably worth noting one particular challenge the carrier faced on appeal in the Seventh Circuit. The three judge panel that heard this case included Judge Richard Posner. Judge Posner wrote the opinion in the Level 3 case. Given that fact, it was always going to be the case that the Level 3 decision was toing to loom large here.