In T.D. Williamson, Inc. v. Federal Ins. Co., the Tenth Circuit recently affirmed a lower court’s decision that an insurer did not have a duty to defend or indemnify its insured, a pipeline company, against a former director’s lawsuit. 21-5043, 2022 WL 1112530, at *1 (10th Cir. Apr. 14, 2022). According to the appellate court, the policy’s “insured vs. insured” exclusion barred coverage. This exclusion is common in D&O policies. The exclusion generally eliminates coverage for claims by or on behalf of one insured against another insured. For instance, the exclusion may bar coverage for claims by a company against one of its executives or by former or current executives against other executives of the same company. There are various versions of the exclusion, but they usually contain exceptions, which provide for coverage in specific situations. These exceptions are frequently the subject of coverage disputes.

Indeed, in T.D. Williamson, the policyholder appealed from the district court’s decision that a directors and officers liability policy issued by Federal Insurance Company (Federal) did not cover the underlying lawsuit. The suit involved one company director who sued fellow directors, all of whom qualified as insureds under the policy. In short, the plaintiff, a director and the majority shareholder of the insured-company, sued eight other directors of the company, including his brother and sister. The plaintiff alleged that his claims were direct, but, alternatively, that they were derivative claims. The company and the individual directors who were named defendants sought coverage under the company’s D&O policy.

Federal denied coverage based on the insured vs. insured exclusion. The version of the exclusion in the D&O policy excluded coverage for claims “by an Insured Person in any capacity against an Insured[.]” T.D. Williamson, 2022 WL 1112530 at *2. The policyholder argued that the exception for claims brought as “a securityholder derivative action” restored coverage. Id. at *1. The district court found that the exclusion applied based on its plain language. The district court also found that the exception or carveout for securityholder derivative actions was inapplicable. As the appellate court explained, the district court “concluded that this case illustrated ‘the prototypical purpose of [insured vs. insured] Exclusions,” to prevent coverage of personal disputes between family members within a corporation. Id.

The Tenth Circuit reviewed the district’s summary judgment ruling for the insurer de novo, viewing the evidence and its inferences in the light most favorable to the insured. The appellate court set forth the principles that governed the coverage issues, including that unambiguous contracts are interpreted based on their plain and ordinary meaning and that when an insurance contract is ambiguous, it will be construed against the insurer and in favor of the insured. Id. at *2. Based mainly on those principles, the appellate court found that the insured vs. insured exclusion in the Federal policy was unambiguous and precluded coverage for the suit. The appellate court explained that the exclusion made clear that the policy does not cover claims “brought by an Insured Person in any capacity against an Insured.” Id. at *1. Thus, the court reasoned that as both parties agreed that the plaintiff was an “Insured Person,” the exclusion captured his lawsuit because the plaintiff was a director and his suit was against other directors and officers of the company, including his siblings. Id. at *2.

The insured-company countered that the relevant part of the exclusion applied only to direct suits and that the exclusion allowed for derivative suits because derivative claims may only be brought on behalf of corporations, and not on behalf of individual shareholders. The court rejected this argument. First, the court reasoned that the plain language of the exclusion did not distinguish between direct and derivative suits in the relevant subsection. Thus, the court was unwilling to “create an ambiguity by using a forced or strained construction.” Id. at *2. Second, the court explained that the company’s interpretation of the exclusion would require the insurer to cover all shareholder derivative suits whether they were by insureds or non-insureds, “a result which is supported by neither the language of the policy nor reason.” Id. Third, the court disagreed with an interpretation of the exclusion that equates the party who sues with the party who holds an interest in the suit. Id. at *3. Fourth, the court preferred an interpretation of the exclusion that treated the exclusionary language independently of the exception, which was in a different subsection of the provision. Id.

Separately, the company argued that the district court’s interpretation would render the shareholder derivative suit carveout superfluous. The appellate court disagreed because “not all shareholders are ‘Insured Person[s].’ Under the policy, an ‘Insured Person’ is ‘any Executive or Employee of an Organization.’” Id. Thus, in the court’s view, the plain language of the policy makes clear that the derivative suit exception still has force when a shareholder who is neither a director nor officer of the company brings the derivative suit.

T.D. Williamson highlights a common coverage dispute for companies and their directors and officers to consider when evaluating the scope of their D&O insurance. Because of the potential, sometimes obscure limitations on coverage that can exist in insurance policies, policyholders should seek to understand the full policy, including the insuring agreements, exclusions, and the exceptions to exclusions that can significantly expand or narrow coverage. This exercise may involve comparing policy language and endorsements to standard-form provisions and regularly examining whether modifications are necessary based on new or different exposures. Retaining experienced coverage counsel can help procure, renew, or modify insurance programs to mitigate risk and maximize recovery.