In a prior post in which I discussed the “basic value proposition” of D&O insurance, I noted that among the five indispensable elements required in order for coverage under a D&O insurance policy to exist is the requirement that the individual seeking coverage must have been acting in an Insured Capacity. The prerequisite that the Insured Person must have been acting in an Insured Capacity at the time of the alleged Wrongful Act arises from the fact that individuals act in a number of different capacities; it is only conduct undertaken in their capacity as an officer or director of the insured company for which the insurance policy provides coverage.
A July 3, 2021 decision by Southern District of New York Judge Gregory H. Woods, applying New York law, provides a good illustration of how individuals may be acting in multiple capacities, and underscores the fact that while the insurance under a D&O policy is only available when the insured is acting in his or her capacity as a director or officer of the insured company, coverage is not entirely precluded if the individual is acting in dual or multiple capacities. A copy of the Judge Woods’s opinion can be found here.
Aegis Defense Services, LLC (Aegis U.S.) was a subsidiary of Hestia, B.V (Hestia). The majority shareholders of Hestia – Spicer, Day, and Bullough – were officers of Aegis U.S. In July 2015, GardaWorld Consulting (UK) Limited (GardaWorld) acquired all of the outstanding shares of Hestia. The purchase agreement pursuant to which GardaWorld acquired Hestia provided for certain earn-out payments if Hestia met performance criteria.
In August 2017, the selling shareholders of Hestia (including Spicer, Day, and Bullough) sued GardaWorld with respect to the earn-out payments. GardaWorld filed a counterclaim against Spicer, Day and Bullough (but not the other selling shareholders of Hestia) alleging that the three had made misrepresentations in connection with the sale of Hestia. The counterclaim asserted claims against the three individuals for fraud and for aiding and abetting fraud related to the sale. Judge Woods’s opinion in the subsequent insurance coverage action quotes extensively from the counterclaim; among other things, the portions of the counterclaim Judge Woods quoted highlight the fact that the misrepresentations alleged in the counterclaim related to the financial statements and financial condition of AEGIS.
The three individuals provided notice of the counterclaim to Aegis U.S.’s D&O insurer. Importantly, the named insured in the policy is Aegis U.S., and not Hestia. The D&O insurer denied coverage for the counterclaim, on the theory that the counterclaims against the three were based on alleged actions undertaken by them in their capacities as representatives of Hestia, and not in the capacities as officers of Aegis U.S. The three individuals disputed the insurer’s position, but the insurer refused to change its position. Interestingly, the individuals also submitted the counterclaim to Hestia’s D&O insurer; Hestia’s D&O insurer accepted coverage for the counterclaim to a limited extent, relating to the individuals’ actions as representatives of Hestia.
The three individuals filed an action against Aegis U.S.’s D&O insurer, seeking a judicial declaration that the insurer’s policy covered the claims against the individuals and that the insurer was obligated to provide the individuals with a defense to the extent Hestia’s insurer was not defending them. The three individuals filed a motion for judgment on the pleadings and the insurer filed a motion to dismiss.
The Relevant Policy Provisions
The policy defines the term “Wrongful Act,” in pertinent part, as follows:
with respect to any Executive or Employee of a Company, [a Wrongful Act is] any breach of duty; neglect, error, or misstatement, misleading statement, omission or act by such Executive or Employee in their respective capacities as such, or any matter claimed against any Executive or Employee of a Company solely by reason of his or her status as an Executive or Employee of a Company.
Policy Exclusion 4(g) provides the following:
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 July 3, 2021 Opinion
In a July 3, 2021 opinion, Judge Woods granted the three individuals’ motion for judgment on the pleadings and denied the insurer’s motion to dismiss, holding that “the duty of an insurer to defend unless it can be determined with certainty that a claim is not encompassed within an insurance policy”; because he “cannot conclude with certainty that the Counterclaims fall outside the scope of coverage provided by the Policy,” the individuals are entitled to judgment on the pleadings with respect to their application for a declaratory judgment.
In making his ruling, Judge Woods noted that the definition of “Wrongful Act,” on which the insurer sought to rely in their insured capacity arguments, contains two clauses separated by the disjunctive conjunction “or.” While the second clause – which refers to any matter claimed against an Executive or Employee “solely by reason of his or her status as an Executive or Employee of a Company” – is “unambiguous,” the insurer’s reliance on the second clause is a “red herring.” The second clause “does not dictate the results in this case; the first clause does.”
With respect to the first clause of the definition of “Wrongful Act” – that is any breach of duty, neglect, error, etc., “by such Executive or Employee in their respective capacities as such” – there is, Judge Woods concluded, a “reasonable possibility that the conduct alleged in the Counterclaims constitutes a ‘Wrongful Act’ as described in the first clause.”
In support of this conclusion, Judge Woods cited the fact that the misrepresentations alleged in the counterclaims related to Aegis U.S.’s business; the misrepresentations were included in Aegis U.S.’s financial statements; and that the misrepresentations were alleged to have been made by Aegis U.S..
Judge Woods said it “may reasonably be inferred that the plaintiffs acted in their roles as executives of Aegis U.S. in preparing the misleading financial statements of the company that were later provided to GardaWorld,” adding that the counterclaims “clearly point” to misstatements in the Aegis U.S. financial statements, “which may attributed to the plaintiffs acting in their capacity as executives of the company.”
Judge Woods noted further that the second counterclaim, for aiding and abetting fraud, expressly referred to the individuals’ status as shareholders of Hestia. He noted that the presence of this “limiting language” in the second counterclaim “suggests that no such constraint should be read into the first counterclaim.”
Because the counterclaims “describe misstatements made by plaintiffs in their roles as executives of Aegis U.S., and the first counterclaim is not necessarily limited to misstatements made by the plaintiffs in their capacity [as officers of Hestia], the Court cannot conclude as a matter of law that the Counterclaims do not implicate ‘Wrongful Act’ for which the plaintiff may seek indemnification under the policy.”
Finally, Judge Woods also found that he “cannot conclude as a matter of law that the Counterclaims fall within the scope of exclusions 4(g).” The conduct that is implicated in the counterclaims, Judge Woods said, “may have been undertaken solely in their capacities as officers of Aegis U.S.” Because there remain “legitimate questions of fact regarding the capacity in which the plaintiffs were acting when undertaking the conduct at issue in the Counterclaims” there is “a reasonable possibility that the exclusion does not apply.”
The outcome of this insurance coverage dispute was, in the end, very fact-specific, in that Judge Woods’s conclusions turned on his reading of the counterclaim plaintiff’s allegations in the underlying litigation. Nevertheless, the insurance dispute and the issues involved highlight the importance of “capacity” issues when it comes to determining D&O insurance coverage.
D&O insurance coverage disputes over capacity issues are actually quite common because directors and officers of many companies frequently act in multiple capacities. Think for example of the representative of a private equity firm serving on the board of one of his or her firm’s portfolio companies. Individual officers often have multiple roles within a corporate hierarchy – including, for example, overlapping roles between a corporate parent and a corporate subsidiary. For an example of another recent insurance coverage dispute involving capacity issues within the context of a corporate parent and a corporate subsidiary, please see my recent post (here).
As I noted at the outset of this post, the fact that an individual must have been acting in an insured capacity in order to trigger coverage is a well-established principle, as is the corollary principle that coverage is not triggered if the insured is not acting in an insured capacity. However, I do have a problem when a carrier takes the position that coverage is entirely precluded merely because an insured was acting in dual or multiple capacities. As I noted in the preceding paragraph, it is quite common for corporate directors and officers to be acting in dual or multiple capacities; because it is common, in my view it is not appropriate for any carrier to take the position that merely because an individual was acting in multiple capacities that coverage is entirely precluded, and not just precluded to the extent of the activity in uninsured capacities.
The carrier here undoubtedly felt its position here was justified by the policy language involved, which highlights the real problem here. I have in prior posts (for example, here) noted my concerns with the specific policy language at issue here. The use of the word “solely” in the definition of “Wrongful Act” and the breadth of the preamble in the exclusion (“based upon, arising out of, attributable to”) lend themselves to over-extensive application, as in fact the position the insurer took in this case demonstrates.
Judge Woods’s reading of the “Wrongful Act” definition correctly identified that the two clauses in the definition are written in the disjunctive, so that satisfaction of either clause in the definition is sufficient to meet the policy requirement. Nevertheless the breadth of the policy wording, both in the definition and in the exclusion, is troubling, particularly to the extent the insurer will (as it did here) seek to rely on the language to try to preclude coverage entirely, even with respect to actions the individual was in fact undertaking in an insured capacity. So I have said it before and I will say it again, the language on which the insurer sought to rely here troubles me.