A recent New Jersey Superior Court decision highlights the risks policyholders face when officers or directors serve dual-capacity roles, such as participating on boards for multiple companies.

In Mist Pharmaceuticals LLC v. Berkley Insurance Co., Mist Pharmaceuticals obtained a $2 million directors and officers liability policy from Berkley. The policy provided coverage for the company’s current and former officers and directors. It also contained a broad “capacity” exclusion that barred coverage for any claim:

based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving any Wrongful Act of an Insured Person serving in their capacity as director, officer, trustee, employee, member or governor of any other entity other than an Insured Entity or an Outside Entity, or by reason of their status as director, officer, trustee, employee, member or governor of such other entity.

Mist Pharmaceutical’s chairman of the board controlled several other entities, including a company named Akrimax, of which he was a director. Mist Pharmaceuticals entered into various agreements with third parties to acquire distribution rights for certain drugs. Those rights were then assigned to Akrimax, which would assist with the commercialization of the drug. One of those third-parties, CelestialRX, sued Mist Pharmaceuticals and its chairman, alleging that the chairman engaged in self-dealing that defrauded it. The lawsuit alleged that the use of Mist Pharmaceuticals as a “middleman” lacked a business purpose and that it was only involved so that the chairman could take a cut of the sales between CelestialRX and Akrimax.

Mist Pharmaceuticals sought coverage under its D&O policy. Berkley reserved its rights to deny coverage under the capacity exclusion, citing the lawsuit’s allegations that the chairman had been acting in a dual-capacity as both chairman of Mist Pharmaceuticals and a director of Akrimax. Mist Pharmaceuticals eventually sought Berkley’s consent to settle, which Berkley refused to provide. The lawsuit settled for $12 million without Berkley’s consent.

Mist Pharmaceuticals filed a declaratory judgment action against Berkley, seeking a declaration that the settlement was covered. The trial court granted summary judgment in Mist Pharmaceuticals’ favor, finding Berkley’s decision to withhold consent was unreasonable. The trial court did not analyze the capacity exclusion because it decided that Berkely breached its duty to indemnify, thereby waiving its policy defenses. 

Berkely appealed, and the New Jersey Superior Court reversed, finding the capacity exclusion did, in fact, exclude coverage under the policy. The appellate court noted that Berkley’s decision to withhold consent was not unreasonable in light of the capacity exclusion. 

Turning to the application of the exclusion, the court held that the lawsuit alleged the chairman was acting both in his capacity as a director for Akrimax, which is not an insured entity, and a shareholder of Mist Pharmaceuticals. His wrongful acts allegedly arose out of his conduct in a capacity other than as an executive of Mist Pharmaceuticals, the insured company. The court cited other decisions that similarly applied capacity exclusions, including the Eleventh Circuit’s decision in Langdale Co. v. National Union Fire Ins. Co. of Pittsburgh, Penn., 609 Fed. Appx. 578 (11th Cir. 2015). The court held that like the loss in Langdale, the loss claimed by Mist Pharmaceuticals under the policy “arose from and could not have occurred but for [the chairman’s] conduct in his capacity as a director of Akrimax,” triggering the capacity exclusion.

The court’s decision in Mist Pharmaceuticals highlights the breadth and pitfalls of capacity exclusions, which is one of several provisions that can be invoked to limit or exclude coverage where insured individuals are not sued solely in an insured capacity. Policyholders should review the terms of their policies and discuss them with their broker and coverage counsel to understand the availability and scope of potential coverage for individuals who may be targeted in claims alleging acts on behalf of both insured entities and uninsured entities to help avoid gaps in coverage.