One of the key elements to establish coverage under a directors and officers insurance policy is the existence of claim is for actions undertaken by an insured individual in an insured capacity – that is, in his or her capacity as a director or officer of the company. Things in life are never simple, and lawsuits often allege that corporate director or officer defendants were acting in multiple capacities – that is, both in their capacity as a director or officer and in other capacities as well. These multiple capacity claims often present policy interpretation and coverage issues under D&O insurance policies.
In a recent case, the District Court of North Dakota (applying North Dakota law) held that coverage under a D&O insurance policy does not apply to a claim alleging that the insured defendant was acting in multiple capacities. The court also held that the Insured vs. Insured exclusion precluded coverage where the claimants included both insured persons and individuals that were not insured persons. The decision raises some interesting policy language and policy interpretation issues. A copy of May 18, 2018 decision by District of Massachusetts Judge William G. Young, sitting by designation in the District of Nevada, can be found here.
Robert Molbert founded H.O.M.E., a financial services holding company. During the 1990s, Robert Molbert began to transfer ownership of H.O.M.E to his four children through a stock purchase agreement: Lauris Molbert; Kristi Benz; Karna Kornkven; and Eric Molbert. For the past 20 years, Lauris, a practicing attorney, has served as President and director of H.O.M.E. Beginning in 2005, Kristi Benz also served as a director of H.O.M.E.
In 2015, Lauris sued his three siblings, seeking to enforce a provision of the stock purchase agreement that would allow him to exercise call options to buy his siblings’ shares. The three siblings answered Lauris’s complaint and filed a counterclaim against Lauris. The counterclaim contains nine counts, alleging fraud; breach of fiduciary duty against Lauris as a shareholder, director, officer, controller and attorney; two counts of breach of fiduciary duty against Lauris as trustee of a family trust; breach of fiduciary duty against Lauris as an attorney providing legal advice to the siblings; two counts of violation of statutory duties; declaratory judgment that the stock purchase agreement is unenforceable; and unjust enrichment.
According to the subsequent opinion in the separate insurance coverage lawsuit, all of the claims in the counterclaim relate to an event in 1993 when the siblings allege Lauris had presented the stock purchase agreement for them to sign and misrepresented the terms.
Lauris submitted the siblings’ counterclaim to H.O.M.E.’s D&O insurance carrier. The carrier denied coverage for the counterclaim based on the Insured vs. Insured exclusion, relying on the fact that one of the three counterclaim plaintiffs, Kristi Benz, is a director of H.O.M.E. In subsequent correspondence, the insurer continued to deny coverage, but subject to a reservation of rights, agreed to advance some defense costs under an agreement. The carrier filed a declaratory judgment action against Lauris and H.O.M.E. The insurer filed a motion for summary judgment.
The Relevant Policy Terms
The policy defines the term “management practices wrongful act” to mean:
Any actual or alleged, misstatement, misleading statement, error or omission, or neglect or breach of duty by an insured person acting solely in their capacity as … director, officer, trustee, member of an advisory board, or committee, volunteer, organizer or employee of the company.
The policy’s insured vs. insured exclusion provides in relevant part that:
The insurer shall not be liable to make any payment for loss in connection with any claim based upon, arising out of, relating to, in consequence of, or in any way involving: … any claim by, or on behalf of, or at the behest of the company, any successor or trustee of the company, affiliate of the company or any insured person in any capacity.
The May 18, 2018 Decision
In his May 18, 2018 Memorandum and Order, Judge Young granted the insurer’s motion for summary judgement, ruling that because the counterclaim alleged wrongful acts by Lauris undertaken by him in multiple capacities, Lauris was not acting in an insured capacity within the meaning of the policy; and because one of the counterclaim plaintiffs is an insured person, coverage for the entire claim is precluded by the Insured vs. Insured exclusion.
In ruling on the capacity issue, Judge Young first surveyed the case law interpreting policies containing the “solely” verbiage in the capacity provision. He then turned to the allegations in the counterclaim and concluded that “it is impossible to extrapolate a claim against Lauris in which he acted ‘solely’ as a director or officer for H.O.M.E.” After noting the counterclaim plaintiffs allegations against Lauris relating to his actions undertaken as an attorney, Judge Young noted that the allegations “inextricably intertwine his role in providing legal advice with his role as a director or officer.”
Interestingly, Judge Young then went on to say that it is irrelevant if it ultimately is determined that Lauris violated only his duties as a director or officer. Judge Young said “even assuming that Lauris were ultimately found to have breached only his fiduciary duties as a director or officer, H.O.M.E. woudol still not have a case for coverage.” This, Judge Young said is “because the underlying complaint not only alleges that he simultaneously acted in noncovered capacities during all relevant times but also that these capacities aided the breach of his fiduciary duties as direct or officer.” It “irrelevant” whether Lauris breached his duty as a lawyer, “the inquiry is whether the counterclaims allege he was acting as a personal lawyer or another capacity when he breached his duties as a personal lawyer in another capacity.”
In concluding in the alternative that coverage is also preclude by the Insured vs. Insured exclusion, Judge Young relied heavily on the Eighth Circuit’s 2017 decision in Jerry’s Enterprise, Inc. v. U.S. Specialty Insurance Company (applying Minnesota law, discussed at length here). In the Jerry’s case, the underlying claims had been filed by a shareholder and former director, and by her two children, who were shareholders but not directors or officers. The Eighth Circuit concluded that the Insured vs. Insured exclusion operated to preclude coverage for the entire underlying claim, including even claims asserted by the two children, who were not Insured Persons under the applicable policy. In reliance on Jerry’s, Judge Young concluded that the Insured vs. Insured exclusion precluded coverage for the entire counterclaim, and not just the claims asserted in the counterclaim by the one sibling that was a director of H.O.M.E. and therefore was an insured person under the policy.
As a preliminary matter, it is important to note at the outset that given the applicable policy’s definition of the term “management practices wrongful act,” requiring as it does that the wrongful acts be undertaken “solely” in a director or officer capacity, it was always going to be an uphill battle for Lauris to establish that the claims against him fell within the policy’s coverage, given the allegations against him.
The real problem here is the wording of the policy. I want to emphasize at the outset that I am not finding fault with anyone in connection with the placement of H.O.M.E.’s policy. I have no idea what alternative were available to H.O.M.E. when it placed its policy, nor do I know what considerations or tradeoffs may have come into play in connection with binding the coverage on the terms and conditions reflected in the policy.
That said, the problem here is that the capacity provision of the definition of wrongful act contained the word “solely.” The simple fact is that, particularly in the private company context, individuals named as defendants in D&O lawsuit rarely are alleged to have been acting in a single or sole capacity, as this case illustrates.
Another example of a situation in which an individual named as a defendant will be alleged to have been acting in multiple capacities is when a representative of a private equity firm is serving on the board of one of the PE firm’s portfolio companies.
Simply put, many if not most D&O claims involve allegations against individual directors and officers in which the individuals are alleged to have been acting in multiple capacities. For that reason, care should be taken when a policy is put in place that the capacity provision in the definition of wrongful act should not contain the word “solely.”
Indeed, I would argue that the inclusion of the term “solely” in the policy’s capacity provision is so likely to result in preclusion of coverage for claims that should be covered — and indeed that represent the very kind of claims for which policyholders purchase the coverage in the first place — that a carrier’s inclusion of the word “solely” in the capacity provision in and of itself makes the policy unsuitable for its intended use and ought not to be offered for sale in the first place.
As for Judge Young’s alternative conclusion that the policy’s Insured vs. Insured exclusion also precludes coverage, I have to say that given his willingness just to follow the Jerry’s decision in the Eighth Circuit, it was again going to be tough for Lauris to establish coverage. I am not sure that this result is the right outcome.
The fact is that two of the three counterclaim plaintiffs were not insured persons under the policy. The three siblings did file a single counterclaim together, but they could just have easily filed their claims separately. Had the two siblings that are not insured persons asserted their claims in complaints separate from that of the insured person plaintiff, it certainly would be easier to see that their claims were not brought by or on behalf of an insured person. But to say the two noninsured person siblings’ claims were not covered simply because instead of being filed separately the claims were filed in a single complaint together with the complaint of the insured person sibling arguably elevates form over substance.
Judge Young touched briefly on the possibility of allocation – that is, rather than to treat the insured vs. insured exclusions preclusive effect as eliminating coverage for the entire counterclaim rather to treat the preclusive effect as a circumstance requiring allocation between covered and noncovered claims. Judge Young noted in this opinion that the relevant policy does not contain an allocation provision, a statement which if true is frankly astonishing in this day and age. However, even if the policy does not contain an allocation provision, that does not mean that the policyholder is not entitled to an allocation between covered and noncovered matters.
There was a time (several decades ago) when D&O policies did not contain allocation provisions, but even then courts regularly held that policyholders were entitled to an allocation between covered and noncovered matters. It could well be argued that Judge Young’s application of the exclusion to preclude coverage for the entire claim, rather than applying an allocation between covered and noncovered matters, is inconsistent with the requirements of the coverage that the insurer provided.
Special thanks to the loyal reader who supplied me with a copy of Judge Young’s opinion