The insured vs. insured exclusion is a standard exclusion in most management liability insurance policies. The exclusion precludes coverage for claims brought by one insured against another. The IvI exclusions in most management liability insurance policies typically include a number of exceptions to the exclusion preserving coverage for claims that otherwise would be excluded. In a recent decision, a Texas intermediate appellate court found that the IvI exclusion in an investment management firm’s policy did not preclude coverage for an arbitration award because the underlying dispute arose out of an employment practices claim and therefore the dispute – including even the derivative claims the claimant asserted in the arbitration – came within the exclusion’s coverage carve-back for wrongful employment practices claims. As discussed below, the court’s opinion has a number of interesting features.
The Underlying Dispute
In 2008, Russ Gatlin and George Stelling formed an investment management firm and several related entities, Prophet Management. Stelling and Gatlin were the firm’s only two members. As partners, they each had rights to year-end profit distributions and to the firm’s carried interests.
In October 2011, Gatlin removed Stelling as Prophet’s COO and as president of a Prophet portfolio company. Stelling sent Gatlin a demand letter alleging wrongful termination and that Prophet and Gatlin were spreading rumors to harm his reputation and damage his career. Stelling’s claims were initially the subject of mediation, which was unsuccessful. Stelling then submitted his claims to arbitration.
In the arbitration, Stelling contended that his termination was wrongful. He also asserted derivative claims on behalf of the various Prophet entities. As the appellate court later said in its opinion in the subsequent coverage lawsuit, each count in Stelling’s statement of claim in the arbitration “is rooted in Stelling’s termination or its consequences.” The arbitration resulted in a substantial award in favor of Stelling.
The Insurance Coverage
At the relevant times, Prophet maintained a program of management liability insurance that consisted to a primary $5 million layer and two $5 million excess layers. When Stelling first sent his demand letter, Prophet submitted the letter to its management liability insurance carriers. All three carriers initially denied coverage. However, the primary and first level excess carriers ultimately paid their limits of liability in payment of various defense expenses and indemnity amounts. The second level excess carrier (hereafter, the Insurer) declined to pay Prophet’s remaining defense expenses and indemnity amounts.
Among other things, the insurer argued that coverage for Stelling’s claims under the management liability insurance policy’s EPL coverage part was precluded by the policy’s insured vs. insured exclusion. The insurer also argued that even if coverage was not entirely precluded by the IvI exclusion, coverage was at least precluded under the exclusion for the derivative claims Stelling had asserted in the arbitration, and therefore that the various defense fees and indemnity amounts had to be allocated between covered and non-covered amounts. The insurer also argued that if the various amounts were properly allocated, it would be apparent that the underlying policies had not been exhausted by payment of covered loss, and therefore that it excess coverage had not been triggered.
Prophet filed a coverage lawsuit against the insurer in Texas state court. The parties filed cross-motions for summary judgment. The trial court entered summary judgment in favor of the insurer. Prophet appealed the trial court’s ruling.
The August 19, 2019 Opinion
In a detailed opinion written by Justice Bill Whitehill for a unanimous three judge panel, the Texas intermediate appellate court reversed the trial court’s ruling with respect to the IvI exclusion and allocation issues.
In addressing the appeal, the appellate court presented the issues involving in a neat and smart flow chart:
The court found that because the underlying dispute involved a claim by one insured person against another insured person, the IvI exclusion was triggered. However, the parties disagreed about whether the wrongful employment practices claim coverage carve-back in the exclusion preserved coverage for the claim. The court described the parties’ positions as “ships passing in the night.”
Among other things, the insurer argued that the carve-back could not apply to preserve coverage for the entire underlying dispute because in the arbitration Stelling had presented derivative claims on behalf of Prophet itself that were not wrongful employment practices claims.
In rejecting the insurer’s position, the appellate court found that all of the substantive counts in Stelling’s arbitration statement of claim involved Interrelated Wrongful Acts within meaning of the policy. The court also noted that the policy provides that more than one claim involving Interrelated Wrongful Acts constitute a single Claim — which Claim, the court further found, began when Stelling first sent his October 2011 demand letter to Prophet.
The court further noted that the exclusion’s carve-back preserved coverage for “Claims for Wrongful Acts in connection with Wrongful Employment Practices,” observing that the Claim for which the carve-back preserves coverage is not limited only to those acts specifically identified as Wrongful Employment Practices , it also includes Interrelated Wrongful Acts “in connection with” such practices.
The court concluded that the Stelling Claim “arose out of” Prophet’s termination of Stelling’s employment. That the claim initially labeled as wrongful termination was subsequently expanded or refined “is of no consequence” because “the substance of all of Stelling’s assertions “was interrelated and made in connection with his Wrongful Employment Practices Assertions.”
The court found that “all requisites” of the Wrongful Employment Practices exception to the exclusion had been met, and therefore concluded that Prophet has “satisfied its burden that this exception negates the IvI exclusion.”
Finally, with respect to the insurer’s argument based on the need for an allocation between covered and noncovered amounts, the court held that the insurer had failed to carry its burden to distinguish between covered and noncovered amounts.
It is important to note with respect to the court’s conclusions that the court was applying Texas law, including Texas legal principles governing the interpretation of insurance contracts. These rules of construction were a key part of the court’s analysis. In connection with several policy interpretation issues, the Court, applying Texas rules of construction, held that the policyholder was entitled to prevail because the policyholder had offered “at least one reasonable interpretation” of the relevant terms. The importance of these Texas rules of construction to the court’s analysis may limit the extent to which the Texas court’s interpretations may be persuasive to courts in other jurisdictions that have different rules of construction.
There is another aspect of this insurance dispute’s context that arguably is also relevant — that is that the insurer in this dispute was the second level excess insurer that was contesting its obligation to pay even though the two underlying insurers had fully paid out their limits. An excess insurer in this position is never going to be perceived as occupying the high ground and in fact will likely be portrayed as trying to dodge the coverage obligations that the other insurer had fulfilled. And whether or not these kinds of considerations had any effect on the appellate court’s views of this dispute, they certainly are relevant for those of us in advisory positions when counseling insurance buyers about the various insurer’s claims paying reputations.
The court’s conclusion that the coverage carve-back preserved coverage for all of Stelling’s claims, including even the derivative claims he asserted in the arbitration proceeding, is interesting for a number of reasons, most importantly because of the way the appellate court read the policy as a whole in order to determine the meaning and scope of the coverage carve-back. The relevance of the policy’s various Interrelated Wrongful Act provisions were instrumental in the court’s conclusion that the coverage carve-back preserved coverage for Stelling’s entire claim. The court’s analysis provides an interesting illustration of the often-stated principle that insurance contracts are to be read as a whole.
The court’s conclusion with respect to the coverage carve-back is interesting in another, more general way – that is, that while the IvI exclusion often comes into play, the exclusion has a number of exceptions in the form of the coverage carve-backs that may operate to preserve coverage notwithstanding the exclusion. The carve-backs are not always relevant and therefore may not always apply to preserve coverage. But as this case shows, the exclusion’s coverage carve-backs can be critical in preserving coverage in certain instances. In addition, the court’s analysis shows how important the wording of these exceptions to the exclusions can be.
There is an interesting post on the Sua Sponte Dallas Appellate Blog about the Texas appellate court’s opinion, here.
For a prior post discussing another one of the standard IvI exclusion coverage carve-backs, please refer here.