It is not uncommon for companies to add third parties as additional named insureds to their D&O insurance policies. Most of the time that doesn’t cause any problems. However, serious problems can arise in a subsequent claim if a company’s interests and the interests of the additional named insured conflict. At a minimum, in the event of a serious claim, the company and the third party can clash as they compete for the finite proceeds of the insurance policy. In a recent coverage decision, the Delaware Superior Court, applying Delaware law, held that AR Capital, an additional named insured under the D&O insurance program of VEREIT, was entitled to have its costs of defending the underlying claims advanced under the program. The Court’s December 12, 2018 ruling, which can be found here, provides an interesting perspective on additional named insured issues.

 

Background

American Realty Capital Properties was a publicly traded real estate investment trust. In July 2015, it changed its name to VEREIT (for clarity and consistency’s stake, I refer to the company below as VEREIT). During the period 2011-2014, AR Capital provided management and advisory services related to VEREIT’s investments and operations. In 2014, VEREIT’s audit committee began investigating accounting and reporting irregularities at the company. In 2014 and 2015, VEREIT released several restatements of financial statements the company had issued during the period AR Capital was providing the management services.

 

Following the restatements, the SEC began an investigation of VEREIT and issued a subpoena to AR Capital. In addition, VEREIT shareholders filed a number of securities class action lawsuits against VEREIT, AR Capital, and directors and officers at both companies. The securities lawsuits were consolidated in the Southern District of New York. In addition, VEREIT shareholders have filed at least eight opt-out actions against VEREIT and AR Capital.

 

During the relevant period, VEREIT maintained an $80 million D&O insurance program, consisting of a $10 million primary layer and seven $10 million layers of follow-form excess insurance. By endorsement, AR Capital was added as an additional named insured to the primary policy (and therefore to the entire program). To add AR Capital to the policy, the definition of the term “Company” was amended by endorsement to include AR Capital. When the investigation and lawsuits arose following the restatements, AR Capital and VEREIT submitted the matters to the D&O insurers as claims under the program. The primary insurer and eventually the first layer excess insurer funded the companies’ defenses to the matters. (I am simplifying here for brevity’s sake.)

 

Because the policy was VEREIT’s, AR Capital submitted its defense cost invoices to VEREIT, for VEREIT to submit to the insurers. AR Capital contends that at some point VEREIT stopped forwarding the invoices, while continuing to forward its own, so that the VEREIT’s invoices were being paid while AR Capital’s were not, meaning that the programs policy proceeds were being depleted in payment of VEREIT’s expenses, arguably to the detriment of AR Capital.

 

AR Capital filed a lawsuit in Delaware Superior Court against the insurers in VEREIT’s D&O insurance program seeking a judicial declaration that it was covered under the insurance program and entitled to have its defense costs advanced. VEREIT intervened in the declaratory judgment action; as the court subsequently put it, VEREIT “intervened in this lawsuit to protect its interests in the finite amount of available insurance proceeds.” AR Capital filed a counterclaim against VEREIT based on the company’s actions that AR Capital alleged had prevented its invoices from being paid. The parties filed cross-motions for summary judgment and VEREIT filed a motion to dismiss AR Capital’s counterclaims.

 

The Court’s Ruling

On December 12, 2018, Delaware Superior Court Judge William C. Carpenter, Jr. granted in part and denied in part the various parties’ motions, among other things ruling that AR Capital, as an additional named insured under the primary policy, was entitled to have its costs of defense for most of the underlying matters advanced, subject to later repayment if is determined that AR Capital is not entitled to coverage.

 

In reaching this ruling, Judge Carpenter rejected a number of arguments VEREIT had raised disputing AR Capital’s rights to have its defense costs advanced. For example, VEREIT had tried to argue that the endorsement adding AR Capital as an additional named insured to the program was intended only to protect AR Capital’s individual directors and officers under Coverage Part B (the reimbursement coverage) but not for the company itself under Coverage Part C (providing entity coverage for securities claims). Judge Carpenter rejected this argument, noting that the endorsement added AR Capital as an additional named insured by including it within the policy’s definition of the term “Company.”

 

If the parties to the policy had wanted to exclude AR Capital from the Side C coverage, “they could have simply stated so in the Endorsement.”  He added that “even a non-lawyer with elementary comprehension of the English language could have created such an exception,” noting further that “to suggest that the language in [the endorsement] does so now is nothing more than a lawyer-created assertion that the Court rejects.”

 

Judge Carpenter also rejected VEREIT’s argument that because the underlying claims did not involve AR Capital’s securities, the claims did not meet the definition of Securities Claim triggering Side C coverage as to AR Capital. He noted that to trigger a Securities Claim, the matter must simply be “brought by a security holder of a Company with respect to such security holder’s interests in securities of such Company.” He said that the underlying claims “clearly would be encompassed under this definition.”

 

Judge Carpenter ruled that AR Capital was entitled to have its costs of defense advanced “up to the same amount VEREIT has already been paid,” and thereafter AR Capital and VEREIT shall be paid their defense costs as incurred on a first-in, first-out basis.

 

Having determined that AR Capital was entitled to coverage under the policy as an additional named insured, Judge Carpenter then reviewed the various underlying matters to determine whether and to what extent AR Capital was entitled to have its costs of defending the matters advanced under the insurance program. Judge Carpenter determined that AR Capital was entitled to advancement of its costs incurred in defending the consolidation securities class action, the opt-out actions, and the SEC investigation. However, he concluded that AR Capital was not entitled to advancement of its costs incurred in responding to VEREIT’s audit committee investigation.

 

Finally, Judge Carpenter granted VEREIT’s motion to dismiss portions of AR Capital’s counterclaim. In doing so, he noted that the Court “appreciates that AR Capital believes that it has been treated unfairly by VEREIT,” adding that “based upon arguments made before the Court, it cannot say those beliefs are totally unjustified.” But, he added, “the personal animosity between counsel or between the parties and the tit-for-tat litigation asserts a Hunger Games mentality that is clearly unwelcome and undermines counsels’ professional credibility with the Court.” AR Capital and VEREIT “should be partners joined together in an attempt to obtain maximum benefits under the policies that are still in effect and stop their internal battles.”

 

Discussion

Although this case began as a declaratory judgment action against VEREIT’s insurers, by the time it came for the Court to rule on the parties’ motion, it was really a fight between AR Capital and VEREIT over the proceeds of the policies; as Judge Carpenter put it, VEREIT had intervened in the lawsuit “to protect its interest in the finite amount of available insurance proceeds.”

 

It isn’t really apparent from Judge Carpenter’s opinion but it is important to understanding the context of this dispute to appreciate that the underlying claims are very serious. The basic allegation is that American Realty Capital Partners committed a multi-year fraud. Indeed, the company’s former CFO, Brian Block, was criminally convicted of accounting fraud and sentenced to 18 months in prison. The seriousness of the allegations means that the insurance program’s policy proceeds are likely to be put under serious pressure – thus, even though an $80 million program, it can fairly be referred to as “finite.” And hence the competition between AR Capital and VEREIT for the insurance money.

 

The pressure on the insurance program is not limited just to the past and likely future costs of defense. Earlier this year, VEREIT announced that it had entered into a series of separate settlements with several of the opt-out claimants (as discussed in detail here). The total amount of these settlements is $217.5 million. It isn’t clear from the company’s press releases how the company’s D&O insurance may have figured (if at all) in the payment of these settlement amounts. It also isn’t clear given the size of these settlements how there can be any remaining proceeds under the insurance program to fund future defense costs. (If anybody understands this situation, I would be grateful if you could drop me a note, which will of course be kept anonymous.)

 

This situation and the dispute between AR Capital and VEREIT illustrate the problems that can arise when third-parties are added to insurance policies as additional named insureds. It is a fairly frequent occurrence for a policyholder to ask that various parties be added to the policy. Often from the policyholder’s perspective, adding the parties to the policy represents efficiency or even cost savings. But sometimes the requests make no sense. For example, from time to time I get requests to add, for example, a shareholder to the policy; the request is made without recognition that the shareholder is a potential claimant, and adding the shareholder to the policy would be a really bad idea. To be sure, adding a party as an additional named insured isn’t always a problem; in fact most of the time it is no big deal. But just the same, on numerous occasions over the years I have found myself trying to persuade a policyholder that adding a particular party as a named insured is a really bad idea.

 

However, I can see that in this situation, having AR Capital added as an additional named insured only seems like a bad idea with the benefit of hindsight. From reviewing the amended complaint in the underlying securities class action lawsuit, it is clear that there was at the time a very high degree of overlap between the executives of American Realty Capital Properties and at AR Capital. By and large, the same individuals held the same positions in both companies, as well as in a number of other related entities. AR Capital’s offices were in the same building as the other related entities. The securities lawsuit complaint alleges that AR Capital was owned or controlled by a small group of persons who were also senior executives of American Realty Capital Properties. I am sure that the idea of adding AR Capital as an additional named insured did not seem like a big deal at the time. With the benefit of hindsight, it is apparent that AR Capital and American Realty Capital Properties were not only separate, but had separate ownership and interests that, in retrospect, make the idea of having them together on the same insurance program a bad idea.

 

But whatever else might be said about this particular situation, it does highlight the fact that adding a party as an additional named insured – something often viewed as routine and not a big deal at all—can turn out to be a very big deal indeed. At a minimum, the dispute here, and the fight over finite and dwindling insurance proceeds, provides a good illustration of why the question of adding an additional named insured to a policy is one that should be considered carefully. Sometimes the right answer may not be to add the party to the policy; sometimes the answer will be that the party should get its own insurance.