A standard exclusion found in most private company directors and officers insurance policies precludes coverage for claims brought by one insured against another insured – the so-called Insured vs. Insured exclusion. The exclusion typically includes several coverage carve-backs preserving coverage for certain types of claims for which the exclusion would otherwise preclude coverage. One relatively standard coverage carve-back preserves coverage for claims brought by a former director or officer after the individual’s service to the company terminated. While the inclusion of this type of coverage carve-back is fairly standard, the wording of the carve-back can and sometimes does vary in ways that can significantly affect whether or not coverage is available for particular claims.
In a December 13, 2017 decision (here), Central District of California Dean D. Pregerson concluded that an underlying dispute between a former director and his former company did not fall within the coverage carve-back to the Insured vs. Insured exclusion in the company’s D&O insurance policy and therefore that there was no coverage under policy for the underlying claim. The decision highlights the importance of the specific language used in the coverage carve-back.
John Calligeros is a former director and officer of Nationwide Medical, Inc. He left the company and give up his position as director in 2008. In 2007, during the time Calligeros was an officer and director, he received company shares under a Restrictive Stock Agreement (RSA).
Calligeros later sued the company and certain of its directors and officers in a California state court action in which Calligeros alleged that he was induced to sign the RSA based on allegedly fraudulent misrepresentations. Calligeros alleged further that the company improperly failed to pay him dividends owing to him; improperly paid other directors and officers “disguised dividends” in the form of inflated salaries; and improperly failed to pay him his proportionate share of a fee a third-party had paid to acquire an option to purchase the company. Calligeros asserted claims against the company and the individual defendants for breach of contract, breach of fiduciary duty, and fraud and deceit, among other things. The state court lawsuit ultimately went to trial and resulted in a verdict in favor of Calligeros and against the company and the individual defendants of more than $2.7 million in damages.
When the company first received the state court complaint, the company submitted the complaint to its D&O insurer as a claim under its policy. The insurer took the position that coverage for the claim was precluded under the Insured vs. Insured exclusion. However, the insurer provided the company with a defense to the underlying lawsuit, subject to a reservation of rights. During the course of the underlying litigation, the company demanded that the insurer appoint an independent counsel to represent the defendants in the lawsuit. The insurer declined the request for independent counsel on the grounds that there was nothing the appointed counsel could do to affect whether or not there was coverage. The insurer also declined to fund settlements that Calligeros had offered to make.
The insurer filed a separate action in federal court seeking a judicial declaration that there was no coverage under the policy for the claim. The insurer filed a motion for summary judgment.
The Insured vs. Insured exclusion in the company’s policy states that the insurer “shall not be liable for Loss under this Coverage Section on account of any Claim” that is “brought or maintained by … any Insured in any capacity.”
Carve-back iv to this exclusion specified that the exclusion does not apply with a Claim is brought by “a former director or officer of the Company solely in their capacity as a securities holder of the Company and where such Claim is solely based upon and arising out of Wrongful Acts committed subsequent to the date such director or officer ceased to be a director or officer of the Company.”
The December 13, 2017 Decision
In a December 13, 2017 decision, Judge Pregerson granted the insurer’s motion for summary judgment, holding that the insurer did not have a duty to indemnify or defend the company and the individual defendants in the underlying action.
Judge Pregerson concluded that carve-back iv to the Insured vs. Insured exclusion did not apply to preserve coverage in this instance, because “the Underlying Action does not arise out of ‘actual or alleged’ events occurring solely after Calligeros left Nationwide.” Instead, the concluded, “the Wrongful Acts are ‘based upon and arising out of’ alleged statements, representations, or promises made to Calligeros, all of which occurred before Calligeros left Nationwide in 2008.” Because the Wrongful Acts did not arise solely from actions taken after Calligeros’s departure, Judge Pregerson concluded, the Policy’s Insured vs. Insured Exclusion barred coverage.
Judge Pregerson rejected the company’s arguments that the carve-back was susceptible to a different interpretation; the company had argued that the carve-back permits coverage of Loss that arose subsequent to the date Calligeros left the company. Judge Pregerson said that “a plain reading of the Policy reveals that coverage for a Claim is not severable in the matter Defendants describe, i.e., according to whether damages arose before or after Calligeros’s departure.” Rather, he said, the policy focuses on the timing of the alleged Wrongful Acts, all of which must have taken place after Calligeros’s departure in order for there to be coverage.
Judge Pregerson also rejected the company’s argument that the insurer was equitably estopped from relying on the exclusion because of its refusal to provide independent counsel, on the theory that the refusal led to the judgment in the underlying action. In rejecting this argument, Judge Pregerson noted that it was not the presence or absence of independent counsel that barred the application of carve-back iv, it was the allegations in the underlying complaint that determined the inapplicability of the carve-back.
Given the wording of the exclusion and of the coverage carve-back in the policy at issue here, and in light of the allegations in the underlying action, the outcome of this coverage dispute arguably is unremarkable. It seems pretty clear that the actual or alleged Wrongful Acts of which Calligeros complained did not take place solely after his departure from the company, and therefore the requirements for the applicability of the coverage carve-back were not met.
What makes this case interesting to me is not the outcome; it is the wording of the carve-back at issue, which is unusual. The equivalent carve-back in the typical private company D&O insurance policy Insured vs. Insured exclusion does not contain either of the two conditions that the carve-back in the policy at issue included here. The more typical carve-back includes neither the requirement that the claim by the former director must be “solely in their capacity as a securities holder of the Company” nor the requirement that the Claim must be “solely based upon and arising out of Wrongful Acts committed subsequent to the date such director or officer ceased to be a director or officer of the Company” in order for the carve-back to apply.
A much more typical wording of the equivalent coverage carve-back within the Insured vs. Insured Exclusion in most private company D&O insurance policies preserves coverage for claims otherwise precluded from coverage by the exclusion if the Claim is “brought by an Executive who has ceased serving in his or her capacity as an Executive for at least one (1) year.” The term interval specified may vary and often a longer time period is required, sometimes as long as three or four years. However, the only requirements for the carve-back to apply are that it is brought by a former director or officer and that the specified time interval has elapsed. No requirement about the capacity in which the former director or officer is bringing his or her claim, no requirement that the alleged Wrongful Acts that form the basis of his or her claim all must have happened after his or her departure from the company.
As this case well illustrates, the inclusion in the carve-back of these two conditions to the carve-back’s applicability substantially narrows the coverage available for claims brought by former directors and officers; substantially expands the claim preclusive effect of the Insured vs. Insured exclusion; and thus substantially reduces the coverage available under the policy for this category of claims.
It should be noted here that these issues are most likely to be relevant with respect to private companies’ D&O insurance policies. In the current marketplace, most primary public company D&O insurance policies do not contain Insured vs. Insured Exclusions as such; in most instances these days, a public company’s primary D&O insurance policy will contain an Entity vs. Insured exclusion, not an Insured vs. Insured Exclusion. The Entity vs. Insured exclusion precludes coverage only for claims brought by the company itself against an insured individual. An Entity vs. Insured exclusion would not preclude coverage for a claim brought by one insured individual against another individual, so the question of coverage for claims brought against one or more insured individuals by a former director or officer simply wouldn’t come up (at least in terms of the possible preclusive effect of the exclusion).
But while the exclusion found in most public company D&O policy’s would not preclude coverage for claims brought by a former director against other insured persons, the potential impact of the exclusion remains highly relevant for the coverage available under private companies’ D&O insurance policies. It should be emphasized that if the company involved in this dispute had an insurance policy with the more typical carve-back wording, there might well have been coverage under the policy for this claim (subject of course to all of the other policy terms and conditions, which might well affect the availability of coverage in other ways).
I want to emphasize that I am not suggesting here that anybody did anything wrong in connection with the placement of the policy. I have no way of knowing what other insurance alternatives the company might have had, nor any way of knowing what factors might have affected the negotiation of the terms and conditions in this policy. It is frequently the case in policy placements that obtaining preferred terms or preferred pricing involves trade-offs, other less than preferred terms must be accepted.
For me the key point of this case is the critical importance of policy wording. As this case shows, seemingly small wording differences can sometimes have a significant impact on the availability of coverage in the event of a claim. Indeed, the specific wording used can determine whether or not there is any coverage available under the policy.
The critical importance of these kinds of policy wording issues highlights the importance of having a knowledgeable and experienced advisor involved in the insurance placement process – even for private companies. The D&O insurance marketplace is constantly changing and the terms and conditions available are also constantly changing. There are policy wordings available today that were not available only a short time ago. The involvement of an insurance advisor that specializes in these kinds of management liability insurance placements and that is out in the marketplace negotiating terms and conditions every single day provides the best assurance that the insurance put in place is the best available in the marketplace.