Among the terms and conditions typically found in a D&O insurance policy is the so-called “Insured vs. Insured” exclusion, which precludes coverage for claims brought by one insured against another insured. The exclusion often figures in D&O insurance coverage disputes, as I have frequently noted on this blog. While the exclusion broadly precludes coverage for an entire category of claims, the exclusion often also has exceptions that preserve coverage for certain types of claims that would otherwise be excluded.
In a recent case in the Northern District of California, a D&O insurance policyholder tried to argue that the underlying claim came within one of the standard coverage carve-backs typically found in this type of exclusion, a provision preserving coverage for derivative claims. In a September 26, 2016 order (here), Northern District of California Judge Haywood S. Gilliam, Jr., applying California law, held that the Insured vs. Insured Exclusion applied to preclude coverage and that the underlying lawsuit did not come within the coverage carve-back. The parties’ dispute and the court’s ruling provide a useful backdrop to think about the exclusion and alternative wordings that are sometimes available in the marketplace.
Background
Sunrise Specialty Co. makes antique-style plumbing fixtures. Robert Weinstein is the company’s CEO and majority shareholder. In October 2014, three of the company’s minority shareholders sued Weinstein and Sunrise, alleging Weinstein had mismanaged the company. The individuals’ complaint alleged that Weinstein had breached his fiduciary duty to the company. They sought Weinstein’s removal as a company director; inspection of the company’s books and records; and dissolution of Sunrise. All three of the plaintiffs had been directors of Sunrise until November 18, 2013.
Sunrise submitted the complaint to its D&O insurer. The insurer denied coverage based on the Insured vs. Insured exclusion in Sunrise’s policy, on the ground that the plaintiffs in the underlying action, as former directors, were Insureds under the policy. Sunrise argued that the underlying complaint came within the carve-back in the Insured vs. Insured exclusion for derivative claims. The insurer contended that the individuals’ lawsuit was not a derivative action. Sunrise filed a lawsuit against its D&O insurer, alleging that the insurer had breached its duty to defend and the covenant of good faith and fair dealing. The parties filed cross-motions for summary judgment.
The policy’s Insured vs. Insured Exclusion precludes from coverage a claim “brought or maintained by, on behalf of, in the right of, or at the direction of any Insured in any capacity.” The exclusion also included six exceptions preserving coverage for certain types of claims. Among the six coverage exceptions is a provision specifying that coverage would apply to a claim of it is “brought derivatively by a securities holder of the Parent Company and is instigated and continued totally independent of, and totally without the solicitation, assistance, active participation of, or intervention of any Insured.”
The September 26 Order
In a September 26, 2016 order, Judge Gilliam denied Sunrise’s motion for summary judgment and granted the insurer’s motion, holding that the Insured vs. Insured Exclusion applied and that the underlying action did not fall within the Derivative Claim exception to the exclusion.
In attempting to argue that the derivative claim carve-back applied to preserve coverage for this claim, Sunrise argued first, that the underlying claim was a derivative claim, and second, that at the time the claim was tendered to the insurer, it was not clear that the claim was being continued with the “solicitation, assistance, active participation or, or intervention of any Insured.” In support of this argument, Sunrise attempted to rely on cases involving supposed “nominal” parties and that drew a distinction between “active” and “nominal” participation in a lawsuit.
Judge Gilliam found that because each of the named plaintiffs in the underlying lawsuit was an Insured under the policy, it “would be nonsensical” to conclude that the action was being continued “totally without the solicitation, assistance, active participation of, or intervention of, any Insured.” Judge Gilliam found the cases on which the plaintiffs sought to rely for the distinction between “active” and “nominal” participation “unpersuasive” and “involving an entirely distinct and unrelated context.” The cases, which related to parties’ attorneys’ participation in settlement negotiation, do not, Judge Gilliam said, “in any way bolster Plaintiffs’ argument that a lawsuit can be brought without the ‘active participation’ of each of its individual named Plaintiffs.”
Judge Gilliam concluded that because the underlying action did not even potentially fall within the derivative claim exception to the exclusion, he did not need to reach the question of whether or not the underlying action was derivative claim.
Discussion
The company here was always going to have a problem arguing that the Insured vs. Insured exclusion did not preclude coverage for a claim in which the three named plaintiffs were named Insureds under the policy. And while there may have been interesting arguments that the individual claimants’ complaint was in the nature of a derivative action, the fact that the three insured persons filed the lawsuit pretty much eliminated the possibility that the underlying action was brought without the “active participation” of an Insured. Their names were on the front page of the complaint, for crying out loud.
One of the considerations that insurers frequently cite to justify the presence of the exclusion in the policy is their assertion that they do not want to cover in-fighting; fights between top executives, the insurers contend, often are emotional, can be costly to defend, and can be difficult to settle. All of these considerations may be true at least some of the time. The problem for individuals seeking coverage under the insurance policy is that as a result of exclusion there is no coverage under the policy for an entire category of claims that in fact arise frequently.
The fact that the insured vs. insured exclusion can cut off coverage for a type of claim that actually arises fairly frequently has led insurance buyers and their advisors to seek ways to restrict the exclusion’s preclusive effect and to preserve coverage at least in certain circumstances. Indeed, that is the reason that the typical Insured vs. Insured exclusion has numerous carve-backs; for example, the exclusion at issue in this dispute included a provision preserving coverage for derivative claims, as long as the derivative claim was brought without the involvement of an insured person. (The explanation for both the carve-back and the independence requirement is that a derivative claim is nominally brought on behalf of the corporate entity, which is insured under the policy; without the carve-back, the derivative claim might be said to be brought by or on behalf of an insured – the corporate entity – against other insureds. The requirement in the carve-back for independence preserves the overall policy intent to preclude coverage for claims brought by one insured against another insured.)
More recently, insurance buyers and their advisors have been able to secure even more significant alterations to the exclusion, in order to even further restrict the scope of the exclusion’s preclusive effect. The most significant of these alternations involves the change in the exclusion from an “Insured vs. Insured” exclusion to an “Entity vs. Insured” exclusion. Under this version of the exclusion, the exclusion only applies if the corporate entity itself is the party bringing the claim. If, as was the case here, the underlying claim is brought by individual insureds without the involvement of the entity itself, the exclusion simply would not apply. This alteration obviously substantially narrows the preclusive effect of the exclusion. However, this alteration frequently has to be negotiated and is not always available. It is more common in public company D&O policies but still relatively unusual for private company D&O policies.
In addition to the Entity vs. Insured formulation, another alteration to the traditional Insured vs. Insured exclusion that insurance buyers and their advisors are sometimes able to negotiate is an additional provision carving back coverage for defense expenses. With this type of provision in the exclusion, insured persons who find themselves the target of a lawsuit brought by another insured person at least have the benefit of the insurance in order to defend themselves. Given how frequently these type of disputes arise, the inclusion of defense cost coverage is a substantial benefit; the absence of defense cost coverage in the typical Insured vs. Insured exclusion means that individuals that get hit with these types of lawsuit either have to depend on the entity for indemnification (which may or may not be forthcoming) or reach into their own pockets to defend themselves.
The coverage carve- backs included with most Insured vs. Insured exclusion these days have become fairly standard, but at one time, they had to be negotiated. It was only with the passage of time that these kinds of provisions became standard. The additional kinds of alterations of the exclusion I noted above – that is, the alteration of the exclusion to an Entity vs. Insured exclusion, and the provision for defense cost coverage – now usually have to be negotiated, and are still not always available. However, it may be with the passage of time that these features will also become standard. Which would be a good thing, because disputes between insured persons are frequently occurring events.