The Insured vs. Insured exclusion is one of the standard exclusions in D&O insurance policies (although these days at least in public company D&O insurance policies, the exclusion is framed as an Entity vs. Insured exclusion). Disputes often arise with respect to the Insured vs. Insured exclusion. In the following guest post, Ivan Rodriguez, Underwriting Lead with CelerityPro, Elan Kandel, Member, Bailey Cavalieri LLC and James Talbert, Associate, Bailey Cavalieri LLC, take a look at a situation that frequently results in Insured vs. Insured coverage disputes – that is, so-called “mixed” actions, in which the plaintiffs include both insured and uninsured persons. I would like to thank the authors for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.
Insured vs. Insured or “IvI” exclusions are a mainstay of directors and officers (“D&O”) policies. Typically, they provide that the insurer is not liable to indemnify or defend a claim brought by or on behalf of an insured, subject to various carveouts. As the name suggests, IvI exclusions reflect the principle that D&O policies are intended to cover external threats, rather than infighting among the insureds.[i] Another often-cited rationale for IvI exclusions is that they serve to eliminate coverage for collusive lawsuits (i.e., “suits in which a corporation sues its officers or directors in an effort to recoup the consequences of their business mistakes”).[ii]
While the rationales for including IvI exclusions are straightforward, their treatment by reviewing courts often is not. In particular, insurance coverage issues often arise in connection with underlying lawsuits that are brought by a mix of insured and uninsured plaintiffs (so-called “mixed actions”). This article explores two divergent judicial trends that have emerged to either restrict or broadly apply the IvI exclusion’s applicability in those circumstances.
Several jurisdictions broadly apply IvI exclusions in the context of mixed actions. Most recently, in Tarter v. Navigators Ins. Co., 2021 U.S. App. LEXIS 32175 (6th Cir. Oct. 25, 2021) (applying Kentucky law) (unpublished), the Sixth Circuit held that the presence of one uninsured entity in an internecine family business dispute did not serve to obviate the application of the policy’s IvI exclusion. The IvI exclusion in the D&O policy at issue in Tarter provided, in relevant part, that the insurer was not be liable to make any payment of Loss, in connection with any Claim made against any Insured by or on behalf of any Insured or any security holder of the Company whether directly or derivatively, if the security holder bringing such Claim is acting totally independently of, and without the solicitation, assistance, active participation or intervention of, the Company or any Insured Person.[iii] At the district court level, the court held that presence of one Insured Person was sufficient to trigger application of the IvI exclusion and bar coverage for the underlying action in its entirety. Alternatively, the court found that coverage is also precluded because the other plaintiffs, all of whom were only security holders, brought the lawsuit with the active participation of the insured person plaintiff. On appeal, the Sixth Circuit approved the trial court’s reasoning.
In reaching its decision, the court considered two distinct lines of authority concerning IvI exclusions in the context of mixed actions. Ultimately, it followed the line of cases starting with Sphinx International, Inc. v. National Union Fire Insurance Co., 412 F.3d 1224 (11th Cir. 2005), in which the Eleventh Circuit found an underlying lawsuit was precluded from coverage by an IvI exclusion, notwithstanding the fact that the insured plaintiff was accompanied by a number of uninsured plaintiffs and had a relatively small stake in the litigation. Sphinx and its progeny reason that it is not a court’s place to rewrite an unambiguous exclusion in favor of insureds seeking coverage.
In contrast to Tarter and the Sphinx line of cases, a number of cases in other jurisdictions hold that where a policy contains an allocation clause, the policy’s IvI exclusion will only bar coverage for the individual claims of the insured plaintiffs, but that the insurer must provide coverage for the remaining claims asserted by uninsured plaintiffs. The rationale for this position was first expressed in Level 3 Communications, Inc. v. Federal Ins. Co., 168 F.3d 956 (7th Cir. 1999). There, the Seventh Circuit was troubled by the potentially broad effect of the IvI exclusion’s wording, recognizing that it would eliminate coverage if the insured “were merely an unnamed class member in a securities class action, with a stake of $10 in the outcome of the suit.”[iv] To reconcile this “truly whacky result” with the clear terms of the exclusion, the Seventh Circuit looked to the policy’s “allocation provision,” which required a “fair and proper allocation” where a claim involves covered and uncovered matters. Because the policy’s allocation provision parsed covered and uncovered portions of a claim, the Seventh Circuit concluded that it was appropriate to apply a similar analysis to the IvI exclusion, such that it would only bar coverage for that portion of the underlying settlement that was ultimately paid to the single insured plaintiff. A number of other courts have followed Level 3.[v] Even in cases where the policy does not include an allocation provision, several courts have required insurers to segregate claims and apply IvI exclusions in proportion to the number of insured versus uninsured plaintiffs.[vi]
However, in contrast to Level 3, Sphinx and its progeny note that an allocation provision can only be implicated after coverage has been established—i.e., after the it has been determined that a claim implicates the insuring agreement and is not excluded.[vii] Thus, when a mixed action is barred from coverage by the plain and unambiguous terms of an IvI exclusion, courts following Sphinx find that the analysis must end there and any reference to the allocation clause represents an improper attempt to rewrite an exclusion.
As it currently stands, the majority of jurisdictions have yet to decide on whether—and under what circumstances—an allocation requirement should be imputed to an IvI exclusion. While it can be argued that the question of whether to impute an allocation requirement to a policy’s IvI exclusion is determined to a large extent by a particular court’s view on how to balance policyholder expectations against strict adherence to contract language, insurers and policyholders alike should strongly consider discussing the potential impact of the various wordings currently utilized in the insurance market during the underwriting process. Additionally, insurers and policyholders may also wish to consider utilization of choice of law and venue provisions and modifications to the allocation provision to obviate or minimize the risk of coverage litigation resulting from the issues discussed in this article.
The opinions expressed in this article are solely those of the authors and not those of Bailey Cavalieri LLC or CelerityPro. In addition, nothing in this article is meant to influence, convey or imply a coverage position by any insurance carrier on any past, current or future claim. This article also does not constitute or provide legal advice.
[i] See, e.g., Level 3 Communs. v. Fed. Ins. Co., 168 F.3d 956, 958 (7th Cir. 1999) (acknowledging that insured vs. insured exclusions’ purpose is to exclude coverage for those “disputes that erupt when members of a corporate, as of a personal, family have a falling out and fall to quarreling”).
[ii] Level 3, 168 F.3d, at 958.
[iii] Tarter, 2021 U.S. App. LEXIS 32175, at *12-13
[iv] Id. at 958.
[v] See, e.g., Home Federal Savings & Loan Assoc of Niles v. Federal Ins. Co., 2007 U.S. Dist. LEXIS 68558, at *13-14. (N.D. Ohio Sept. 14, 2007) (relying on the policy’s allocation provision to find that the IvI exclusion barred coverage for that portion of a claim made by a former director of the insured company, but not that portion of a claim made by uninsured shareholders of the insured company).
[vi] See, e.g., Lloyd Chartrand v. Ill. Union Ins. Co., 2009 U.S. Dist. LEXIS 77222 (N.D. Cal. Aug. 28, 2009) (While the policy lacked an explicit allocation clause, the court recognized that “under California law, all insurance policies incorporate principles of allocation.” On that basis, the court held that the IvI did not preclude coverage for an underlying suit instituted by both insured and non-insured claimants.)
[vii] See, e.g., PowerSports, Inc. v. Royal & Sunalliance Ins. Co., 307 F. Supp. 2d 1355, 1362 (S.D. Fla. 2004) (“Allocation clauses only become relevant in the event that a loss involves both covered and uncovered claims. Whereas this action involves uncovered claims only, the allocation question is moot.”); Jerry’s Enters. v. United States Specialty Ins. Co., 845 F.3d 883, 890 (8th Cir. 2017) (recognizing that an allocation provision is incapable of restoring coverage that has been excluded under the plain terms of an exclusion).