One of the basic requirements in order for coverage to be triggered under a directors’ and officers’ liability insurance policy is that the misconduct alleged must have been undertaken by insured individuals in an “insured capacity” – that is, in their capacities as directors or officers of the insured entity. In a recent insurance coverage ruling, the Delaware Superior Court held that because the allegations against the insured individuals “arose out of” their involvement with entities other than the insured entity, there was no coverage for the individuals under their bankrupt company’s D&O insurance policy. The ruling underscores the importance of capacity issues in determining D&O insurance coverage and highlights the ways in which allegations of misconduct undertaken in multiple capacities can lead to complicated coverage questions. The Delaware Superior Court’s November 30, 2018 decision can be found here.
Keith Goggins and Michael Goodwin became directors of U.S. Coal in October 2009. During the time of their involvement with U.S. Coal, Goggins and Goodwin attempted to “reinvigorate” U.S. Coal through debt purchase and other capital restructuring. Goggins and Goodwin undertook these restructuring actions through two investment vehicles they formed, East Coast Miner LLC (“ECM”) and East Coast Mine II LLC (“ECM II”). Goggin was an investor and manager of the two investment entities, Goodwin was just an investor in the two investment entities.
In 2014, U.S. Coal’s creditors filed a petition for a Chapter 7 bankruptcy. A trustee was appointed. In 2015, U.S. Coal’s unsecured creditors committee filed a lawsuit against Goggin, Goodwin, ECM, and ECM II, alleging that Googin and Goodwin breached their fiduciary duties and committed other actions in favor of their own personal interest.
In an amended complaint, the Trustee substituted for the creditors as the named plaintiff. The amended complaint alleged that Googin and Goodwin “schemed to form and use the ECM entities to control U.S. Coal and defraud its creditors” by entering into various agreements that provided the entities with a higher return on investment and a preferred recovery in the event of U.S. Coal’s liquidation. The Trustee’s suit alleged twenty-one counts against Goggin, Goodwin and the ECM Entities. The court later said in the insurance coverage action that the counts brought against Googin and Goodwin were “largely based on their self-interested dealing that benefited ECM entities and themselves and undermined the interest of U.S. Coal and its debtors and creditors.”
Goggin and Goodwin submitted the claim to U.S. Coal’s D&O insurer, which defended the claim under a reservation of right. The insurer took the position that the claims against the two individuals were not covered under policy Exclusion 4(g), the “capacity” exclusion. The various parties sought to mediate the underlying claim. When the parties were unable to resolve the claim through mediation, Goggin and Goodwin filed an action in Delaware Superior Court seeking a judicial declaration that Exclusion 4(g) does not apply to the claims against them and that the insurer is obligated to pay all of their defense and indemnity expenses. Goggin and Goodwin filed a motion in the coverage lawsuit for judgment on the pleadings.
Exclusion 4(g) provides that:
The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured:
(g) alleging, arising out of, based upon, or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity, other than as an Executive or Employee of a Company….
The November 30, 2018 Decision
In a November 30, 2018 Memorandum Opinion and Order, Delaware Superior Court Judge Paul R. Wallace, applying Delaware law, denied Goggin and Goodwin’s motion for judgment on the pleading, ruling that exclusionary clause applied to preclude coverage.
In reaching his decision, Judge Wallace said the “capacity” exclusion’s language “is clear and unambiguous.” He specifically noted the exclusion’s use of the “arising out of “ language, a term he noted that Delaware’s court have construed “broadly.” He also noted that court’s interpreting “arising out of” language have applied a “but-for” test to construe the meaning of insurance policy exclusions. Under this analysis, the question is “where the underlying claim would have failed ‘but for’ the excluded conduct.”
Applying the “but for” test in this case, Judge Wallace found that the alleged conduct “falls under the exclusionary clause.” He said that the Trustee Claims “would not have been established ‘but-for’ Goggin and Goodwin’s alleged ECM-related misconduct.” He added that “but for” the individuals’ roles as members and managers of the ECM entities, the claims in the amended complaint would have failed.
Judge Wallace added the observation that the Trustee’s claims are “most reasonably viewed as having arisen from Goggin and Goodwin’s misconduct as members/managers of the ECM Entities (although certainly related too to their co-existence as U.S. Coal’s directors).”
Accordingly, Judge Wallace said, “the exclusionary clause applies and eliminates [the insurer’s] coverage obligation under the D&O Policy.” Because the exclusion applies, the individuals “would not be due coverage for the ECM-related activity claims under the D&O policy.”
Judge Wallace’s ruling in this case is very fact-specific. However, the coverage dispute and the circumstances alleged in the underlying claim do highlight the importance of capacity issues for D&O insurance coverage determination.
An unusual feature of the policy language involved here is that the policy addressed the insured capacity issue in an exclusion. This is a relatively unusual way for a policy to address the issue of insured capacity. More typically, the insured capacity issue is addressed in the D&O insurance policy’s definition of the term “Wrongful Act.” The significance of the definition is that D&O insurance provides coverage for Claims against Insured Persons alleging a Wrongful Act. The typical definition will specify that the term Wrongful Act refers to any breach of duty, neglect, omission or act by an officer or director “in their respective capacities as such” or any matter claimed against an officer or director “by reason of his or her status as an Executive or Employee of a Company.”
Disputes involving capacity issues are not uncommon, for the simple reason that 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 the two individuals were acting in a dual capacity; rather, the court’s ruling turned on its conclusion that the misconduct alleged “arose out of” the two individuals’ uninsured capacity as manager members of the ECM Entities, and not out of their insured capacity as directors and officers of U.S. Coal. The “arising out of” language appeared in the policy exclusion at issue, which, as I noted is an unusual D&O insurance policy feature.
The interpretation and application of a different policy that did not have the “insured capacity” exclusion – and in particular that did not have the “arising out of” exclusionary language – might possibly have produced a different outcome. In that regard, I think it is important to note that Judge Wallace expressly acknowledged (albeit parenthetically) that while the Trustee’s claims “arose out of” their capacities as members/managers of the ECM Entities, the claims were “certainly related too to their co-existence as U.S. Coal’s directors.”
The two individuals wouldn’t have been sued in the Trustee’s complaint if they weren’t directors of U.S. Coal. Indeed, the gravamen of the Trustee’s complaint is that, due to conflicts of interest, the two individuals’ breached their duties as directors of U.S. Coal. The fact that they allegedly were acting in a dual capacity, in my view, ought not be sufficient to preclude coverage entirely; at most, the fact that the claims allege misconduct allegedly undertaken in a dual capacity ought to result in an allocation between covered and non-covered claims. A policy without the exclusionary language – language which, as noted above, is unusual – might have provided at least allocated coverage to the extent the individuals were sued (as Judge Wallace acknowledged) in their capacities as U.S. Coal directors.
All of that said, the important thing to note about this case is the critical significance of capacity questions and the role of capacity as a prerequisite to coverage under a D&O insurance policy.
In an earlier post (here), I discussed a June 2015 opinion of the Eleventh Circuit in which the appellate court affirmed a district court ruling interpreting the same exclusionary provision as was at issue here, and applying the exclusion to preclude coverage for an underlying claim in which individual insureds were alleged to be acting in a dual capacity.
A December 4, 2018 memo from the White & Williams firm discussing the Delaware Superior Court’s decision can be found here.