In a recent post in which I discussed the “basic value proposition” of D&O insurance, I noted that among the five indispensable elements required in order for coverage under a D&O insurance policy to exist is the requirement that a Claim for an alleged Wrongful Act against an Insured Person acting in an Insured Capacity. The prerequisite that the Insured Person must have been acting in an Insured Capacity at the time of the alleged Wrongful Act arises from the fact that individuals act in a number of different capacities; it is only conduct undertaken in their capacity as an officer or director of the insured company for which the insurance policy provides coverage.
A June 22, 2015 decision by the Eleventh Circuit, applying Georgia law, provides a good illustration of how an individual might be acting in multiple capacities, and underscores the fact that the insurance under a D&O policy is only available when the insured was acting in his or her capacity as a director or officer of the insured company. The case presents some interesting policy wording lessons. A copy of the Eleventh Circuit’s opinion can be found here.
The Virginia Miller Langdale Family Trust owned 24.8 percent of The Langdale Company (TLC). Johnny Langdale, a grandson of TLC’s founder, is TLC’s CEO. Johnny Langdale and his uncle Harley Langdale were the trustees of the Trust. The two were also officers and directors of TLC. The Trust beneficiaries later alleged that the two trustees “engaged in a scheme” to “consolidate their control” over TLC by having TLC redeem the Trust’s stock at “an absurdly low price.”
The Trust beneficiaries filed a Georgia state court action against the two trustees, alleging breach of trust and breach of their fiduciary duties to the Trust beneficiaries. The beneficiaries’ complaint included a Count III which alleged that Johnny and Harley Langdale had breached their fiduciary duty as directors of TLC to the company’s minority shareholders.
TLC filed a separate Georgia state court action against the Trust beneficiaries, seeking a judicial declaration that TLC held clear title to certain company stock. The Trust beneficiaries filed a counterclaim against TLC for fraud and conspiracy. The counterclaim alleged that TLC had aided and abetted Johnny and Harley Langdale’s misconduct. Among other things, the counterclaim sought in Count V relief from TLC on a respondeat superior basis for its officers’ misconduct. The two Georgia state court actions were later consolidated.
TLC demanded that its D&O insurer fund its defense of Count III of the beneficiaries’ lawsuit and Count V of the counterclaim. The insurer denied coverage for the defense expenses, in reliance of exclusion 4(g) to the policy, which provides in pertinent part that the insurer is not liable to may payment for “any Loss in connection with any Claim made against an Insured alleging, arising out of, based upon, or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity, other than as Executive or Employee of a Company.”
Johnny Langdale and TLC filed a federal district court action against the insurer seeking damages for breach of contract; a declaratory judgment that the insurer had a duty to advance defense costs; and damages for bad faith. The parties filed cross motions for summary judgment. The district court granted the insurer’s summary judgment motion. TLC appealed.
The June 22 Decision
In an unpublished June 22, 2015 opinion, a three-judge panel of the Eleventh Circuit affirmed the district court’s grant of summary judgment, holding that Exclusion 4(g) bars coverage.
TLC had argued that Count III of the beneficiaries’ state court complaint and Count V of the counterclaim alleged that Johnny and Harley Langdale had breached fiduciary duties they owed as TLC directors, with respect to which, the company argued, both TLC and the individuals were entitled to have their defenses paid under TLC’s D&O insurance policy. These counts in the state court complaint and counterclaim alleged that the two individuals breached their duties as TLC directors by engaging in self-dealing; failing to disclose and concealing from the beneficiaries critical information about TLC; and in designing and executing the redemption from the Trust of the TLC shares.
Based on its review of the underlying allegations, the appellate court concluded that “the pleadings make it clear that Johnny and Harley Langdale’s alleged misconduct as officers and directors [of TLC] necessarily arose out of their alleged breaches of the fiduciary duties they owed as trustees to the Trust beneficiaries.” The claims against TLC and the claims against Johnny and Harley Langdale for the two individuals’ alleged misconduct as TLC directors and officers “could not have existed independent from their alleged misconduct as trustees.” Because the allegations of wrongdoing in the state court complaint and the counterclaim “arose out of” Johnny and Harley Langdale’s “wrongful acts in their capacities as trustees,” the allegations are subject to Exclusion 4(g). Accordingly, the appellate court affirmed the district court’s grant of summary judgment in favor of the insurer.
The ruling in this case is very fact-specific and highly dependent on the Trust beneficiaries’ allegations against Johnny and Harley Langdale. But while the outcome of the coverage dispute is very much a reflection of the specific allegations involved, the case does provide a good illustration of the nature and significance for D&O insurance coverage determination purposes of “insured capacity.”
An unusual feature of the policy language involved here is that the policy addressed the insured capacity issue in an exclusion. This is a relatively unusual way for a policy to address the issue of insured capacity. More typically, the insured capacity issue is addressed in the D&O insurance policy’s definition of the term “Wrongful Act.” The significance of the definition is that D&O insurance provides coverage for Claims against Insured Persons alleging a Wrongful Act. The typical definition will specify that the term Wrongful Act refers to any breach of duty, neglect, omission or act by an officer or director “in their respective capacities as such” or any matter claimed against an officer or director “solely by reason of his or her status as an Executive or Employee of a Company.” In fact, the policy at issue in this case had this language in its definitions section, and the language I just cited was a direct quote of the policy’s definitional language. Interestingly, this language did not enter into the court’s analysis.
While the facts of this case were unique, it is not unusual for a director or officer to be acting in multiple capacities. Company executives may act in a personal capacity as well as a corporate capacity. A representative of a private equity firm who sits on a portfolio company’s board may be acting both in his capacity as representative of the PE firm and of the portfolio company. Because of the frequency with which corporate officials may act in dual or multiple capacities, it is important that the D&O insurance policy does not require in order for coverage to apply that the insured person was acting “solely” in an insured capacity.
In this case, the court did not find that coverage was precluded because the two individuals were acting in a dual capacity; rather, the court’s ruling turned on its conclusion that all of the misconduct alleged “arose out of” the two individuals’ uninsured capacity as trustees of the Trust, and not out of their insured capacity as directors and officers of TLC. The “arising out of” language appeared in the policy exclusion at issue, which, as I noted is an unusual D&O insurance policy feature. A different policy that did not have the “insured capacity” exclusion – and in particular that did not have the “arising out of” exclusionary language – might possibly have produced a different outcome.
Nevertheless, the important thing to note about this case is the critical significance of insured capacity and its role as a prerequisite to coverage under a D&O insurance policy.
The blog post that I mentioned at the outset of this article discussing the “basic value proposition of D&O insurance” is a part of my continuing series on the Nuts and Bolts of D&O insurance. The entire series can be found here.