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XL prevails in insured vs. insured D&O coverage dispute

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An XL Group Ltd. unit is not obligated to indemnify a bankrupt banking corporation’s liquidation trust under the “insured-versus-insured” exclusion in its directors and officers liability policy, says a federal appeals court in a divided opinion.

Lansing, Michigan-based Capital Bancorp Ltd., which had owned community banks in 17 states, went bankrupt following the financial crisis, and a liquidation trust was created to pursue the estate’s legal claims, according to Tuesday’s ruling by the 6th U.S. Circuit Court of Appeals in Cincinnati in Indian Harbor Insurance Co. vs. Clifford Zucker et al.

Capital had obtained a one-year management liability insurance policy from XL unit Indian Harbor Insurance Co., based in Stamford Connecticut, in September 2011, about a year before it filed for bankruptcy, and the insurer twice extended the policy.

The contract included an insured-versus-insured exclusion that excluded from coverage “any claim made against an insured person … by, on behalf of, or in the name or right of the company or any insured person.”

In August 2014, liquidation trustee Clifford Zucker sued former Capital Bancorp chairman and CEO Joseph Reid and his daughter, Cristin Reid, who was president, for $18.8 million, charging they had breached their fiduciary duties to Capital through a number of improper actions.

Mr. Zucker notified Indian Harbor of the litigation and the insurer responded by filing suit in U.S. District Court in Lansing, Michigan, seeking a declaratory judgment the trust’s claims fell within the insured-versus-insured exclusion. The District Court ruled in Indian Harbor’s favor that the exclusion applied, and the trust appealed.

The majority opinion by the divided three-judge panel of the 6th Circuit notes that many liability insurance contracts contain insured-versus-insured exclusions.

“These exclusions limit management liability insurance to claims by outsiders, prohibiting coverage for claims by people within the insured company,” says the ruling.

 “A company thus cannot hope to push the costs of mismanagement onto an insurance company just by suing (and perhaps collusively settling with) past officers who made bad business decisions,” said the ruling.

“As Zucker and the Reids see it, a debtor in possession is legally distinct” from the pre-bankrupt company, “making the insured-versus-insured exception inapplicable to Capital or its assignee,” said the majority opinion.

However, the opinion said, “a lawsuit by Capital as debtor in possession on behalf of the bankruptcy estate remains a lawsuit ‘by’ Capital and thus would still fit within the insured-versus-insured exclusion,” said the majority onion, in affirming the District court’s ruling.

The dissenting opinion states: “The assigned trustee in the case should have the same right to be exempt from the insured-versus-insured exclusion as a court-appointed trustee.

“The plain language reading of the insurance contract in this case and Sixth Circuit precedent both support that finding. Because this decision makes it harder for companies to emerge from bankruptcy with a consensual plan of reorganization, I respectfully dissent.”