D&O insurance policies typically extend coverage to “duly elected or appointed” directors and officers. But what happens if the proper election or appointment procedures were not followed yet the individual served as a director anyway? Is that person a “director” for purposes of D&O insurance coverage? How about for purposes of the Insured vs. Insured exclusion? These are the questions that a federal district court, applying Idaho law, addressed in a case involving individuals whose board appointments were procedurally flawed but whose board membership was subsequently ratified by corporate conduct. The court concluded the individuals are “directors” within the meaning of the policy, and so lawsuits brought by the individuals against the company and other board members represent insured vs. insured claims for which coverage is precluded by exclusion. A copy of the court’s March 15, 2024, decision can be found here. (Hat Tip to Paul Curley of the Kaufman, Borgeest, & Ryan law firm for his March 16, 2024 LinkedIn post about the case, here.)

Background

In 2017, Divinia Water entered into a loan agreement with Michael Breen and Ronald Mezzetta, a condition of which was electing Breen and Mezzetta to its board of directors. The board as then constituted unanimously agreed that Breen and Mezzetta should be added to the board. However, contrary to the requirements of Idaho law and the company’s own by-laws for the election of a director without an in-person meeting, a number of the shareholders never signed an approval for the addition of the directors to the board. (Divinia mistakenly believed it had correctly followed the bylaws and law by having the majority of its shareholders execute a written approval.)

Thereafter, Breen and Mezzetta participated as directors at board meetings. Their names were listed as company directors in SEC filings and in the company’s annual report to the Idaho Secretary of State.

In 2020, Breen and Mezzetta were removed from the board and they filed two lawsuits against Divinia and its certain of its directors and officers. Davinia submitted these lawsuits to its D&O insurer as claims under its policy. The insurer denied coverage for the claims under the policy in reliance on the policy’s insured vs. insured exclusion.

The exclusion precludes coverage for “any Claim brought or maintained by or on behalf of … a Team Member in any capacity.” For relevant purposes, the term “Team Member” is defined as any “Executive,” and the term “Executive” is defined as “any natural person who was, is or shall be a duly elected or appointed: 1. Director, officer, or member of the board.”

Divinia, which had in the meantime filed for bankruptcy, initiated an adversary proceeding in the bankruptcy court seeking a judicial determination that the insurer must provide coverage for the underlying lawsuits.

Following trial, the bankruptcy court issued findings of fact and conclusions of law, in which the bankruptcy court concluded that the insured vs. insured exclusion precluded coverage for the claims. Although the bankruptcy court concluded that Breen and Mazetta were not “duly elected or appointed” at the time they were initial seated on the board, Divinia, though yearslong conduct in treating Breen and Mezzetta as directors, had “ratified their election or appointment.” Based on its finding of ratification, the bankruptcy court concluded that Breen and Mezzetta qualified as “Team Members” and therefore the insured vs. insured exclusion applies.

Divinia sought to have the district court review the bankruptcy court’s findings and conclusions. Divinia argued to the district court that the phrase “duly elected or appointed” does not encompass subsequent ratification, and that even if ratification could constitute due election or appointment, the board itself did not have authority to ratify the prior deficient election; only the shareholders who had not originally voted on the election could ratify their election. The insurer argued that “duly elected or appointed” means “in proper time, place, and manner” and includes subsequent ratification of the election. The insurer argued further that the board had the authority to ratify the prior election.

The March 15, 2024, Decision

In a March 15, 2024, opinion, District of Idaho Judge Amanda K. Brailsford adopted the bankruptcy court’s findings of fact and conclusions of law in their entirety. Judge Brailsford expressly affirmed the bankruptcy court’s conclusion that coverage for the underlying claims was precluded by the policy’s insured vs. insured exclusion.

In reaching this conclusion, Judge Brailsford rejected Divinia’s argument that a director is “duly elected or appointed” only if the proper procedures were followed at the time of the appointment. Judge Brailsford reviewed Idaho law to the effect that ratification “is recognized as a regular and proper channel of corporate governance” and that “the effect of ratified act is essentially the same as an act that was authorized.” As Judge Brailsford herself put it “significantly, ratification ‘relates back’ to the original act, making it valid from the beginning.” Because the ratification makes Breen and Mezetta’s appointment to the board valid from the beginning, the two “attained their status as directors through regular and proper procedures, and therefore they were “duly elected or appointed” within the meaning of the policy.

She added that “ratification if a mechanism for curing any procedural infirmities in the ‘election’ or ‘appointment’ of a person to a board of directors, and, in turn, making such person ‘duly’ elected or appointed within the meaning of the policy.”

Finally, Judge Brailsford rejected Divinia’s argument that only the shareholders that hadn’t originally voted the two individuals to the board could ratify the individuals’ election to the board. Judge Brailsford noted that the board of directors had the authority to nominate additional board members by unanimous consent, under both the company’s bylaws and Idaho law. Because Divinia, through its board, had the authority to appoint the two to the board in the first place, Divinia had the authority to ratify Breen’s and Mezetta’s addition to the board without obtaining the unanimous consent of all Divinia’s shareholders.

Discussion

It is worth noting that in this case, Divinia was in the position of arguing that Breen and Mezzatta were not duly appointed or elected directors, in order to try to avoid the preclusion of coverage under the insured vs. insured exclusion. However, it is very easy to envision a slightly different set of circumstances in which Divinia would have instead been arguing that the two in fact were duly elected or appointed directors.

Imagine if instead of being the plaintiffs in the underlying lawsuit, Breen and Mezzetta were the defendants. It is easy to imagine in those circumstances Divinia arguing that notwithstanding the procedural defects in their election, that they nevertheless qualified as directors and officers and therefore entitled to insurance coverage under the policy.

Judge Brailsford’s opinion reflects a her perception that Divinia may have in fact been shaping its characterization of the Breen’s and Mezzetta’s roles to try to maximize coverage. As Judge Brailsford put it, “Divinia gained a clear advantage from having Breen and Mezzetta as member of its Board.” Among other things, the company was able to secure a loan from them by having them on the board. The company, Judge Brailsford said, “now seeks to take the apparently inconsistent position” that the two were never duly elected or appointed – a position “it can take only because it failed to follow its own Bylaws and proper procedures” for adding Breen and Mezzetta – “in order to nullify an otherwise applicable exclusion.” Judge Brailsford said she is “skeptical that Divinia should be allowed to take this inconsistent position in furtherance of its own advantage and to [the insurer’] disadvantage.”

For me, the important thing about the court’s holding here is the perspective it provides on the “duly elected or appointed” language. To paraphrase the court’s holding, “duly elected or appointed” means elected or appointed by whatever procedure or process is sufficient under applicable law and the applicable by-laws to make the election or appointment effective. If ratification of a previously procedurally defective process is not only sufficient to cure the defect but to cure the process as though it had been proper from the outset, then ratification is sufficient to effect an election or appointment. Moreover, the election or appointment is sufficient regardless of whether the question is to determine whether or not they are entitled to coverage under the policy or if the question is whether coverage for claims by them against other directors and officers is precluded by the insured vs. insured exclusion.