The insurance available under a D&O insurance policy does not protect insured individuals for all of their activities; rather, the policy protects the individuals only for their actions undertaken in their capacities as officer or directors of the insured organization. The policy does not protect the individuals for actions undertaken in their personal capacity or for actions undertaken as a result of their involvement with entities other than the insured organization.
A recent decision out of the District of North Dakota and applying North Dakota law illustrates the coverage-determinative importance of the question of capacity. In an October 3, 2017 opinion (here), District of North Dakota Judge Daniel Hovland held that because the allegations against the individual who was seeking coverage did not involve alleged actions undertaken in an insured capacity, the individual was not entitled to coverage under the policy. The ruling underscores the importance of capacity issues and also highlights how challenging these issues can sometimes be when individuals are acting in multiple capacities.
This insurance dispute involves a D&O insurance policy issued to Eagle Operating Company. The policy’s coverage extended to “subsidiaries” of Eagle Operating Company. Endorsement No. 2 to the policy defined as “subsidiaries” several entities include Eagle Well Service, Star Well Services and MW Industries. Endorsement No. 9 to the policy deleted Endorsement No. 2, and Endorsement No. 10 named only two entities as “subsidiaries,” Star Well Services and MW Industries. The parties in the subsequent insurance coverage action disputed whether Endorsements Nos. 9 and 10 were properly added to the policy; the court ultimately ruled in the coverage action without deciding whether or not Endorsements Nos. 9 and 10 were properly added to the policy.
In February 2012, Sun Well Services entered an Asset Purchase Agreement to purchase assets owned by Eagle Well Services. The parties to the asset purchase included not only Eagle Well Services but also shareholders of Eagle Well Services. Among the shareholders was Robert Mau. MW Industries was not a party to the asset purchase agreement and Mau did not sign the agreement in his capacity as president of MW Industries. The Asset Purchase Agreement included a covenant not to compete, specifying that for five years neither the seller nor the seller’s shareholders would compete with Sun Well Services.
Two months after the asset purchase agreement was signed, MW Industries sold certain assets to American Well Services, a newly formed company owned by Mau and Gregory Wiedmar. At the time of the sale, Mau was president of MW Industries and Wiedmar was vice president.
In December 2013, Sun Well Services filed a lawsuit against Mau, Eagle Well Service, Widemer and American Well Service, relating to alleged violations of the covenant not to compete. Sun Well Services brought claims of breach of contract against Mau and Eagle Well Services; claims of fraud against Mau, Eagle Well Services, and Wiedmar; claims of civil conspiracy against Mau, Wiedmar and American Well Service; and tortious interference against Widemar.
Eagle Operating Company submitted the Sun Well Services complaint to its D&O insurer as a claim. The insurer denied coverage for the claim on the grounds that Mau had not been sued in an insured capacity, but rather was sued in capacity as either an officer or shareholder of Eagle Well Service. The insurer further contended that coverage for Eagle Well Service was precluded because Eagle Well Service was not an insured entity or subsidiary under the policy, and also precluded by the policy’s breach of contract exclusion. Mau and Eagle Well Service filed a coverage action against the insurer. The parties filed cross-motions for summary judgment.
The October 3, 2017 Order
In an October 3, 2017 order, Judge Hovland granted the insurer’s motion for summary judgment and denied the summary judgment motions of Mau and of Eagle Well Service.
In seeking coverage, Mau had argued that Sun Well Services had sued him in his capacity as a director or officer of MW Industries, and therefore that the insurer had a duty to defend him in the lawsuit. Judge Hovland reviewed the underlying complaint and determined that the lawsuit against Mau related to his participation in the Asset Purchase Agreement. Judge Hovland found “persuasive” the insurer’s arguments that Mau had entered into the agreement in his capacity as an officer or shareholder of Eagle Well Service, not MW Industries, and that Sun did not pursue any claims against MW Industries and did not mention MW Industries in the fraud or civil conspiracy claims. Accordingly, Judge Hovland found that the claims in the underlying lawsuit were not based on any alleged actions, inactions, or misdeeds carried out by Mau in his capacity as a direct and officer of MW Industries, and therefore that the insurer did not owe Mau a duty to defend him in the lawsuit.
Judge Hovland also concluded that the insurer had no duty to defend Eagle Well Service. In reaching this conclusion, he said that he did not need to reach the question of whether or not Endorsements Nos. 9 and 10 applied or were valid. He concluded that even if Eagle Well Service were a “subsidiary” under the policy, that coverage for Eagle Well Services was precluded by the policy’s contractual liability exclusion, which excludes coverage for Loss arising “in connection with any Claim based upon, arising from, or in any way relating to any actual or alleged liability under any contract or agreement.”
In arguing for coverage, Eagle Well Service had tried to argue that fraud claims in the underlying lawsuit created the possibility outside the sphere of the breach of contract claim. Judge Hovland rejected this argument because “any alleged liability was directly related to, based upon, and arose directly from the Asset Purchase Agreement.”
This dispute and Judge Hovland’s analysis of the situation are both a little hard to follow because of the profusion of entities involved. I literally had to draw a diagram to keep all of the various entities straight. It is pretty clear that the profusion of entities also created some policy issuance confusion; the lack of clarity over whether Eagle Well Service was or was not endorsed to the policy as a “subsidiary” is unfortunate and added to the confusion.
The confusing roster of entities notwithstanding, this case does underscore the importance of capacity issues in the determination of coverage for individual insured persons. The kinds of capacity issues involved here often are important to determining whether or not an individual has coverage under a D&O insurance policy.
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 Mau was acting in a dual capacity. Rather, the court concluded that there was no coverage for Mau because the allegations against him in the underlying lawsuit were not based on his alleged actions undertaken an insured capacity. 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.
On a separate issue, Judge Hovland’s ruling with respect to Eagle Well Service that the contractual liability exclusion precluded coverage even for the fraud claim is an illustration of the troublesome problems that arise when the contractual liability exclusion has the broad “based upon, arising out” preamble. As I have argued previously, the problem with the use of the broad preamble in the contractual liability exclusion is that it allows insurers to routinely use the exclusion to preclude coverage for claims that are and ought to be covered under the policy. The fraud claim against Eagle Well Service is the very kind of claim for which companies buy this kind of insurance.
As I have also previously argued, these kinds of outcomes underscore my argument that the contractual liability exclusion should be written with the “for” wording, rather than the broader “based upon, arising out of” wording. All too often, the contractual liability exclusion with the broad preamble becomes a preclusion that swallows up the coverage the policy should be providing. I know that most carriers will not offer a contractual liability exclusion with the “for” wording. As noted in my prior post, I think this is one of the things that the D&O insurance carriers regularly get wrong.
One final note. I have been writing this blog for over eleven years. Throughout that entire time, I have not previously had the occasion to write about a case from North Dakota. I haven’t intentionally been ignoring the Peace Garden State, it just hasn’t come up before. So this blog post represents an odd milestone of sorts. It somehow seemed important for me to acknowledge the milestone.
ACI M&A Liability Conference Discount for D&O Diary Readers: This is just a reminder that D&O Diary readers are eligible for a discount to the upcoming American Conference Institute in December. ACI’s 2nd Annual Summit on M&A Liability will take place in New York on December 5-6, 2017 in New York. The conference features an all-star cast of speakers. Readers of The D&O Diary receive 10% off registration using registration code: P10-873-DD10. Anyone thinking of attending will want to be sure to note that price for the event will increase by $200 on October 20, 2017. Information about the conference including registration details can be found here.