Commercial enterprises sometimes are organized in complex structures consisting of multiple, legally separate legal entities. The legal separation between the various entities can be significant in a variety of ways. One particular context within which these separate legal identities can be very important is in the D&O insurance context, as the insurance may be structured to apply to specified entities (and therefore not to others).


In the D&O insurance context, the availability of coverage for individual directors or officers may depend on the entity within the structure on whose behalf the individuals were acting – that is, the coverage question will depend on the “capacity” in which the individuals were acting. A recent decision by the New York (New York County) Supreme Court Commercial Division highlights the importance of these capacity issues and underscores that the capacity in which an individual was acting can be coverage determinative. The court’s February 2, 2021 opinion can be found here.



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 the company’s prior financial statements.


The Underlying Litigation and SEC Enforcement Action

As discussed here, in October 2014, plaintiff shareholders initiated a series of class action lawsuits in the Southern District of New York against American Realty Capital Properties/VEREIT and four of its directors and officers (Schorsch, Weil, Kahane, and Budko). The plaintiffs alleged that VEREIT had made a series of financial misrepresentations in the later-restated financial statements that ultimately led to the departure of a number of its executives and to the company’s former CFO’s conviction for accounting fraud. The third amended complaint in the securities class action lawsuit can be found here.


Separately, VEREIT shareholders filed a derivative lawsuit against Schorsch, Kahane and Weil for breaching their duties owed to VEREIT as members of VEREIT’s board. In addition, the SEC initiated an enforcement action against AR Capital and Schorsch.


The Settlements and SEC Consent Judgment

In September 2019, the parties to the securities class action reached an agreement to settle the litigation for $1.025 billion. [Although not directly relevant to the subsequent coverage dispute, it is noteworthy that in addition to the ginormous class action settlement, VEREIT also entered a number of very substantial separate opt-out settlements with a number of institutional investors, totaling $217.5 million (as discussed here).]


The parties the Derivative Action reached a settlement in which the individual defendants agreed to contribute consideration worth $225 million to the Class Action settlement. The SEC enforcement action resulted in a consent judgment in which AR Capital and Schorsch were each required to disgorge certain securities and specified cash amounts.


The Insurance Coverage Dispute

At relevant times, AR Capital maintained a $50 million program of D&O insurance consisting of a primary layer of $10 million and four additional follow-form excess layers of $10 million each. An insurance coverage dispute arose in connection with AR Capital’s D&O insurance program. The dispute involves efforts by AR Capital and related entities and the four individuals (Schorsch, Weil, Kahane, and Budko) to obtain coverage for the four individuals’ portion of the lawsuit settlements and the SEC consent judgment described above.


The insurers denied coverage for these amounts and initiated an action seeking a judicial declaration that their policies did not cover the amounts. The defendants in the declaratory judgment consisted of AR Capital and a related entity, and the four individuals. The parties filed cross-motions for summary judgment. In the summary judgment opinion discussed below, the Court referred to the declaratory judgment action defendants collectively as the AR Capital parties.


Although not relevant to this coverage dispute involving AR Capital’s D&O insurance program, it is noteworthy that at relevant times VEREIT maintained its own separate $80 million D&O insurance program; the VEREIT D&O insurance program was itself the subject of separate insurance coverage litigation, as discussed here. (The separate VEREIT coverage litigation involved the question of whether AR Capital was insured under VEREIT’s D&O insurance program.)


The February 2, 2021 Opinion

In a February 2, 2021 opinion, Judge Joel M. Cohen granted the insurers’ motion for summary judgment and denied the AR Capital parties’ cross-motions. In reviewing Judge Cohen’s opinion, it is important to keep in mind that in AR Capital parties were seeking coverage only for the portion of the civil action settlements attributable to the four individuals’ Loss, and not to that of AR Capital’s.


In ruling in the insurers’ favor, Judge Cohen first held that coverage for individuals’ portion of the civil action settlements was precluded because the individuals had been sued in the underlying civil actions in their capacities as directors or officers of VEREIT, not AR Capital. He also ruled that disgorgement amounts paid to resolve the SEC action were uninsurable as a matter of law. Finally, he held that even if the AR parties had suffered an otherwise covered loss, coverage was precluded by the policies’ Insured Capacity Exclusion.


With respect to the initial issue of whether or not the individuals were sued in an Insured Capacity, Judge Cohen noted that the policy provided coverage for Loss arising from a Wrongful Act, defined as “any actual or alleged act, omission, misstatement, misleading statement, neglect, or breach of duty by and Insured Person while acting in his capacity as … and Insured Person of the Company” and “any matter asserted against an Insured Person solely by reason of his or her status as a director or officer of the Company.”


The settlements of the underlying civil actions, Judge Cohen said, “did not result from Claims for their Wrongful Acts in an AR Capital capacity.”  The securities law violations alleged against the individuals were made against them in the capacities as director and officers of VEREIT, not AR Capital. Similarly, in the derivative actions, the individual defendants “were sued for breaching their fiduciary duties to VEREIT as members of VEREIT’s board of directors, not to AR Capital.” In concluding that the insurers were entitled to a declaration that their policies do not cover the settlements of the underlying civil actions, Judge Cohen said that “the AR parties have failed to demonstrate that their potential liability was for Wrongful Acts in an AR Capital capacity.”


In ruling that coverage for the amounts paid as disgorgement in the SEC consent judgment were precluded from coverage, Judge Cohen noted that the primary policy specifies the covered Loss does not include “matters which were uninsurable under the law pursuant to which this Policy is construed.” Judge Cohen noted that the 2018 New York intermediate appellate court decision in J.P Morgan Sec. Inc. v Vigilant Insurance (discussed here) held, in reliance on the U.S. Supreme Court’s 2017 decision in Kokesh v SEC (here) that SEC disgorgement is a “penalty” that is outside the policy’s definition of Loss. The AR Capital parties, Judge Cohen said, were not entitled to coverage for the SEC consent judgment amounts because “the SEC disgorgement is uninsurable as a matter of law.”


Finally, Judge Cohen found that even if the amounts for which the AR Capital parties sought coverage were otherwise covered under the policy, coverage would be precluded under the Insured Capacity exclusion, Exclusion I. The exclusion provides that the insurer is not liable for Loss in connection with any Claim made against an Insured Person “based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving an Insured Person action in their capacity as a [sic] Insured Person of any other entity other than the Company [i.e., AR Capital].”


Judge Cohen said that the capacity exclusion “is clear and unambiguous. Applying a ‘but-for’ test, the exclusion applies to bar coverage for the settlements” in the underlying civil actions, since the individuals were sued in those actions as directors and officers of VEREIT. Thus, the exclusion applies “because the claims in the underlying action ‘in any way involve’ the individuals defendants acts in their uninsured capacities for VEREIT.”



In deciding how you feel about Judge Cohen’s decision that coverage for the four individuals’ Loss is precluded, it may be important to keep in mind that there was a separate insurance program that was in place to insure the individual for their actions in behalf of VEREIT. Given the magnitude of the underlying settlements (as well as the likely impact of defense expenses), it would not surprise me to find out that the entire VEREIT program was exhausted by payment of losses, which in turn might explain why the AR Capital parties were trying to get coverage under the separate AR Capital insurance program.


The essence of Judge Cohen’s ruling is that because the individuals were sued for their actions as directors and officers of VEREIT, and not for actions as directors and officers of AR Capital, there is no coverage under the AR Capital D&O insurance program. That rulings, as far as it goes, is arguably unremarkable.


However, there is an aspect of this situation I do find troubling – not troubling in the context of this specific insurance dispute, but troubling as a more general matter. The insured capacity exclusion on which the insurer’s relied here is extremely broad. It precludes coverage for any Loss “in any way involving” an Insured Person acting in their capacity as an Insured Person “of any other entity.” By the same token, the Policy’s definition of the term Wrongful Act for which the policy provide coverage is specified to include any matter “asserted against an Insured person solely by reason of his or her status as a director or officer of the Company. “


The breadth of the exclusion’s preamble language and the definition’s inclusion of the word “solely” trouble me because corporate directors and officers frequently are acting in dual capacities – think for example of venture capital firm representative who sits on the board of one of the firm’s portfolio companies. It apparently was not the case here, as it seems clear from Judge Cohen’s analysis that the individuals were not acting in dual capacities. But in many other situations, individual directors and officers are acting in dual or even multiple capacities.


My concern is that in those situations, an insured capacity exclusion with the type of broad wording the exclusion at issue here has here could entirely preclude coverage for a claim, even to the extent that the individual was acting in an insured capacity. Judge Cohen’s opinion in that regard is clear, which is that claims for “in any way involving” actions in a capacity for any other entity are entirely precluded from coverage. This concern did not arise in the AR Capital coverage dispute because there the individuals apparently were not alleged to have acted in a dual capacity, but instead were sued solely in an uninsured capacity. However, in the many and frequent instances where individual directors or officers are alleged to have been acting in a dual capacity, the broadly worded exclusion could be a coverage neutron bomb. The word “solely” on the definition of Wrongful Act similarly troubles me.


To be sure, in interpreting the exclusion, Judge Cohen applied a “but for” test – that is, the pleadings in the underlying lawsuit would have failed “but for” the acts alleged against the individual defendants in their capacities as officers and directors of VEREIT. The lawsuits he said “hinged on acts undertaken in their uninsured VEREIT capacities.” So the exclusion’s preclusive effect was clear. But Judge Cohen also emphasized the breadth of the exclusion’s preamble apply the exclusion to preclude coverage for acts “in any way involving” actions in capacity for any other entity.


The real danger here is the possibility that under a policy with exclusionary language like that involved here, a claim involving allegations that an individual director or officer was acting in a dual capacity could be entirely precluded from coverage, and not just precluded to the extent the individual was acting in an uninsured capacity. The fact that individuals 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.


I have discussed the inclusion in D&O insurance policies of this same type of exclusionary language in priors posts, here and here.


Special thanks to a loyal reader for providing me with a copy of Judge Cohen’s opinion.