Legal developments in D&OReprints
When it comes to directors and officers liability insurance coverage litigation, a few key areas often pose challenges to insurers and to policyholders.
Three significant issues that often arise in D&O disputes have recently been the subject of judicial developments:
• Whether a settlement constitutes insurable “loss” under a D&O policy
• Various cases interpreting the definition of “professional services” as used in D&O policies
• Cases addressing the application of the “insured v. insured” exclusion in unusual circumstances
Insurability of ‘loss’
D&O insurance policies provide coverage for “loss,” a defined term that typically includes settlements and judgments. As determined by the 7th U.S. Circuit Court of Appeals in Level 3 Communications Inc. v. Federal Insurance Co. in 2001, “a ‘loss’ within the meaning of an insurance contract does not include the restoration of an ill-gotten gain.” This is the case for a number of reasons, including that an insured has not “lost” anything when he or she returns what he or she never should have had in the first place, as well as because of the moral hazard of allowing insurance coverage for such damages. Judge Richard Posner’s statement in Level 3 remains generally accepted as a principle by courts throughout the country. As such, by way of example, a settlement or judgment representing the return of ill-acquired lost profits would not constitute an insurable “loss” under insurance policies.
In the past few years, however, a few courts have attempted to distinguish the circumstances presented in Level 3. These courts held that particular settlements did not constitute “restitution,” notwithstanding arguments by the insurer to the contrary. For example, in 2015 a Delaware trial court in Gallup Inc. v. Greenwich Insurance Co. held that it was insufficient for an insurer to point to the allegations in the underlying complaint as evidence that the settlement represented the return of ill-gotten gains, and required the insurer to provide evidence that the settlement was restitutionary.
In 2016, another Delaware trial court held that a settlement payment did not constitute disgorgement in the absence of a “conclusive link” proving that the insured committed misconduct. In TIAA-CREF Individual & Institutional Services L.L.C. v. Illinois National Insurance Co., the court did note, however, that “a different outcome in which disgorgement payments are deemed insurable might result when parties settle under different circumstances.” Nevertheless, most courts use the allegations of a claimant’s complaint to determine whether a settlement or judgment is restitutionary in character. And, as noted, the TIAA-CREF and Gallup courts both allowed for the possibility that a settlement might constitute uninsurable restitution in other circumstances. As such, policyholders and insurers should closely examine the law of the relevant jurisdiction and the facts of a particular case in order to determine whether coverage could be available for a particular settlement.
What are ‘professional services’?
Whether a given activity constitutes a “professional service” is often important in D&O insurance for two separate reasons.
First, many D&O policies contain a professional services exclusion that bars coverage for suits arising from an insured’s professional services. Second, some policies may be “blended” — meaning that they afford both traditional D&O insurance as well as traditional errors and omissions insurance, the latter of which usually affords specified coverage for errors and omissions in rendering an insured’s professional services.
In 2015 in Goldberg v. National Union Fire Insurance Co. of Pittsburgh, Pa., a Florida trial court ruled: “(T)he term ‘professional services’ unambiguously refers to services unique to a specific profession.” Two recent cases illustrate the distinction between services that are “unique” to a given profession and services that are not.
In Goldberg v. National Union, a group of directors and officers of an insured bank were alleged to have engaged in managerial acts in furtherance of a Ponzi scheme by one of their customers. For instance, one of the officers was alleged to have “disregarded obvious warning flags, red flags, and overt warnings from some subordinates” about the Ponzi scheme. The directors and officers sought coverage under a D&O policy, asserting that the professional services exclusion did not bar coverage because they were engaged in “purely internal management and regulatory functions — not services for others.” The court disagreed, stating that any failure by the directors was “done in order to” facilitate the insured’s banking services for its customer. As such, these acts “arose out of” professional services performed by the insured.
However, not every act by a professional will constitute a professional service. This is illustrated by the decision in a 2016 5th U.S. Circuit Court of Appeals decision in Edwards v. Continental Casualty Co. There, an insured lawyer received a portion of a client’s personal injury settlement with the client’s employer pursuant to a contingent fee arrangement.
The employer later sued to rescind the settlement agreement on the grounds that the client had feigned his injuries. The employer also sought the return of funds from the client’s lawyer, even though it alleged that the lawyer was unaware of the client’s conduct. In this case, the court held that the suit did not arise from an “act or omission” by the lawyer in rendering professional services. Rather, the lawyer was only named in the suit because he received the settlement funds at issue, not because he made some mistake in his conduct as a lawyer.
Edwards was a 2-1 decision, demonstrating that where to draw the line between acts connected to professional services and those not connected can sometimes be debatable. As such, directors and officers should consider carrying both D&O and E&O insurance to limit potential gaps in coverage.
‘Insured v. insured’ exclusion
Most D&O policies contain an “insured v. insured” exclusion, which bars coverage in connection with disputes brought by one insured against another. Among other purposes, such exclusions limit the potential for collusive disputes among various insured parties under a policy. They also avoid insuring against intrafamily disputes within an insured company.
The applicability of the insured v. insured exclusion is not always clear-cut. To take one example, is a claim brought by the FDIC as receiver for a failed insured bank against the former directors of that insured bank a claim brought “on behalf of” one insured against another?
Courts have recently come out on different sides of this issue. Last year, in St. Paul Mercury Insurance Co. v. Federal Deposit Insurance Corp., the 9th U.S. Circuit Court of Appeals decided that the exclusion was ambiguous as to the FDIC, and therefore held that the exclusion did not preclude coverage.
However, courts analyzing different policy language have interpreted the exclusion differently. In Hawker v. BancInsure Inc., a California trial court considered whether an exclusion barring coverage for “a claim by, or on behalf of, or at the behest of, any other insured person, the company, or any successor, trustee, assignee or receiver of the company” barred coverage for claims brought by the FDIC as receiver against insureds. Here, the policy language specifically referred to any “receiver” of the company.
Accordingly, the court concluded that this claim for coverage by the FDIC failed.
Like those issues with receivership, issues concerning insolvency or bankruptcy of insureds have posed challenges for courts interpreting insured v. insured exclusions in recent years. For example, in 2016 in Indian Harbor Insurance Co. v. Zucker, a Michigan trial court considered whether coverage for a claim brought by a litigation trust of an insured bank against its former directors or officers was precluded by an insured v. insured exclusion that barred coverage where a claim was brought “in the name or right of” the insured bank. The court determined that it was. The court surveyed case law nationwide, and noted that there were a number of “inconsistent decisions across the country” concerning the insured v. insured exclusion.
In this case, the court held that the litigation trust’s claim was precluded. The court performed a fact-specific inquiry, and concluded that the fact that the insured bank “voluntarily” transferred causes of action to the litigation trust created a “direct connection” between the bank and the trust. Accordingly, the court held that the insured v. insured exclusion applied to bar coverage. As this illustrates, application of this exclusion is not always clear-cut, and courts will closely examine relevant policy language and the specific facts and circumstances of the matter to determine whether coverage is barred by an insured v. insured exclusion.
David H. Topol is a partner at Wiley Rein L.L.P. in Washington. He can be reached at firstname.lastname@example.org. Matthew W. Beato is an associate in the Washington office of the firm. He can be reached at email@example.com.