In an interesting decision that touches on a number of basic D&O insurance coverage issues, a federal district court judge applying Oklahoma law has ruled that a company’s management liability insurance policy does not provide coverage for legal expenses a former company executive incurred in a declaratory judgment action that had been filed by another company executive to determine the parties’ rights under a profit sharing agreement. The court concluded that there was no coverage because the individual seeking coverage had not been named as a defendant in the lawsuit by reason of his status as an insured person. Even more interestingly, the court concluded further that, even though the individual had been named as a defendant in the declaratory judgment lawsuit, he had not incurred “Defense Expenses” in the lawsuit, and therefore suffered no “Loss.” Western District of Oklahoma Judge David Russell’s June 30, 2020 redacted opinion in the insurance coverage action can be found here.

 

Background

Oil industry legend Aubrey McClendon formed American Energy Partners LP (AELP) in April 2013. Ryan Turner served as AELP’s Chief Investment Officer. McClendon, Turner, and two other individuals – Scott Mueller and Thomas Blalock – entered into an Equity and Co-Investment Agreement (ECOIA) reflecting their profit-sharing agreements relating to AELP. The parties agreed that the ECOIA applied to two subsequently formed entities, referred to collectively as SCOOP.

 

McClendon died in March 2016 in a single car accident. After various proceedings in connection with the administration of McClendon’s estate, Mueller filed an action in state court against SCOOP, Blalock and Turner. (Blalock was also named as a defendant as the personal representative of McClendon’s estate). Among other things Mueller’s lawsuit sought a judicial declaration of rights and liabilities with respect to the ECOIA, as well as damages in the form of unpaid profit-sharing. In his answer, Turner neither admitted nor disputed Mueller’s allegations. However, Turner did file his own affirmative counterclaims, cross-claims and third party claims seeking the same relief as Mueller. Ultimately, the parties entered into a confidential settlement.

 

After Turner received the Mueller lawsuit, he forwarded it to AELP’s management liability insurer, seeking coverage for the legal expenses he incurred in connection with the Mueller suit. The insurer denied coverage on the grounds that Turner had been sued by reason of his status as an equity holder of AELP and related businesses, rather than as an Insured Person, and, and therefore no claim was asserted against him for a “Wrongful Act” as defined under the policy. The insurer also said that the policy provided no coverage for expenses Turner incurred in connection with Turner’s affirmative claims in the litigation.

 

After the underlying litigation settled, Turner filed a lawsuit against AELP’s insurer seeking reimbursement for the legal expenses he had incurred in the Mueller lawsuit. The parties filed cross-motions for summary judgment.

 

Relevant Policy Language

The Policy defined the term “Wrongful Act,” in relevant part, as a “matter asserted against, or investigated or inquired with respect to, and Insured Person by reason of his or her status as an Insured Person.” The policy defined the term “Insured Person” to mean “any past, present, or future employee, director, officer, manager, partner … or member of the Board of Managers of the Company.”  The policy defines “Loss” as “damages, judgments, payments, settlements, relief or other amounts … and Defense Expenses.”

 

The June 30, 2020 Decision

In a June 20, 2020 Order, Western District of Oklahoma Judge David L. Russell granted the insurer’s motion for summary judgment and denied Turner’s motion for summary judgment.

 

In ruling on the parties’ motions, Judge Russell found that the “plain meaning” of the relevant policy language was “clear.” Though the policy definition refers to an Insured Person’s “status” rather than an Insured Person’s “capacity,” Judge Russell said that the terms were “interchangeable.”

 

Judge Russell then concluded that Turner “was not involved in the Mueller lawsuit by reason of his status as an ‘Insured Person.’” Rather, Turner was involved in the action “because of his status, or his capacity, as an individual equity holder under the ECOIA.” Although Turner acquired his stake by entering into the ECOIA with other members of AELP’s executive management team, Turner was “not sued … by reason of his membership on the Executive Management Team or because of his connection to the AELP businesses.” Because Judge Russell concluded that Turner was not involved in the Mueller lawsuit by reason of his status as an “Insured Person,” he ruled that the insurer was entitled to summary judgment on Turner’s breach of contract claim.

 

Judge Russell ruled further that even if Turner had been sued by reason as his capacity as an “Insured Person,” he did not qualify for coverage as he had not suffered a covered “Loss.” Even though Turner had been named as a defendant in Mueller lawsuit, “the legal expense for which Mr. Turner seeks reimbursement was not incurred in the Mueller lawsuit to demonstrate why Mueller had no valid case, nor to demonstrate why Mr. Mueller shouldn’t have recovered what he sought.” Mueller’s claims “did not place Mr. Turner in a defensive posture.” The pleadings in the Mueller lawsuit “demonstrated clearly that he stood in the same posture as Mr. Mueller, seeking affirmative relief” under the ECOIA. Indeed, Judge Russell even noted that Turner and has counsel had even reviewed Mueller’s complaint before he filed it with the court, nominally against Turner and the others.

 

Turner’s legal expenses “were thus not incurred in defense of Mr. Mueller’s claims, and, accordingly, Judge Russell concluded that Turner’s legal expenses are not “Defense Expenses” within the meaning of the policy, and therefore are not covered “Loss” under the insurance policy. The insurer has “no obligation under the policy to pay Mr. Turner’s legal expenses which were incurred in pursuit of affirmative relief, rather than in defense of a claim.”

 

Discussion

As I have discussed in several prior posts (most recently, for example, here), one of the important prerequisites to establish coverage under a D&O insurance policy is to show that an Insured Person has been sued for actions undertaken in an “insured capacity” (or in this case, by reason of their status as an Insured Person). This issues matters, and comes up frequently, because individuals may be, and frequently are, acting in multiple capacities. The individuals are insured only for actions undertaking in their capacities as directors and officers of the insured company, and not for actions undertaken in other capacities.

 

Judge Russell’s ruling here presents an interesting variation on this common insurance coverage themes. First, he concluded that the term used in this policy – insured “status” – is “interchangeable” with the more frequently used term of insured “capacity.” Second, even though the profit-sharing arrangements under review in Mueller’s declaratory judgment action arose out of Turner’s service as an officer of AELP, Turner was not named in the action by reason of his service as an officer, but rather by reason of his status as an equity participant in the profit-sharing agreement. Judge Russell did not put it this way, but it seems that the distinction that Turner’s relationship to the agreement and to the lawsuit pertained to his “personal” capacity (or status) rather than his officer capacity (or status).

 

As interesting as Judge Russell’s conclusions about the status (or capacity) issues are, his conclusion that Turner had not suffered a covered “Loss” because he had not incurred legal expenses defending the Mueller claim is even more interesting. This conclusion frankly troubles me. Turner was named as a defendant in the lawsuit. To be sure, he did also assert affirmative claims, and there is no doubt that he is not entitled to coverage for his pursuit of his affirmative claims. It may well be that because of the alignment of his interests with those of Mueller in the underlying lawsuit that his goals in the lawsuit both in his role as declaratory judgment action defendant and as declaratory judgment action counterclaim plaintiff were the same. However, the fact that he pursued affirmative claims does not eliminate the fact that he was a defendant in Mueller’s lawsuit.

 

My real concern here is that it is often the case that the parties’ interests in a declaratory judgment action may not have the same element of adversity that usually characterizes actions for damages. It is often the case in declaratory judgment action that the parties may be equally interested in having a court review and address their respective legal interests. However, the legal expenses the declaratory judgment action defendant must incur are real enough. While Judge Russell’s ruling about Turner’s legal expenses very much reflects the distinctive facts of this case, it still makes me uncomfortable that a court would say that legal expenses incurred by a lawsuit defendant do not represent Defense Expenses. My concern is that insurers seeking to avoid coverage of other lawsuit defendants’ legal expenses will similarly try to argue that, notwithstanding the fact that the litigant was named as a defendant in the lawsuit, that the individual wasn’t really defending and therefore is not entitled to coverage.

 

While I can certainly agree that legal expenses incurred in asserting affirmative claims generally are not covered, it is another thing entirely to say that none of the declaratory judgment action defendant’s legal expenses are covered, even though named as a defendant in the lawsuit. As I said, this conclusion makes me very uncomfortable.