A New York appeals court recently granted partial summary judgment in favor of the insureds, finding that excess directors and officers insurers, Westchester Fire Insurance Co., Aspen American Insurance Co. and RSUI Indemnity Co., must advance the defense costs for former executives of the insured entity. The decision is the most recent victory for policyholders in connection with D&O insurance claims asserted in the wake of alleged securities violations and accounting fraud at related real estate investment firms, which have resulted in millions of insurance recoveries for the company and its officers and directors (as previously reported here and here).

In the underlying lawsuit, former directors and officers of a real estate investment trust firm, RCAP Holdings LLC, were sued by the successor entity, RSC Creditor Trust, which claimed that the executives drove RCAP into bankruptcy. Upon exhaustion of more than $30 million in D&O coverage for settlements in other cases, the former executives looked to the excess insurers to continue to advance defense costs on their behalf. The insurers denied the claim and filed suit seeking a declaration that the policies’ “insured versus insured” exclusion precluded coverage.

The court refused and ruled that the executives were entitled to coverage for defense costs. Under the policies, the insurers agreed to advance defense costs until “final disposition” of the underlying action. The court declared that where the underlying complaint alleges facts that could potentially bring a claim within coverage of the policy, the insurer has a duty to advance defense costs. Relying upon the plain language of the policies and established New York law, the court stated that “[t]he duty to provide defense costs must be construed broadly in favor of the policyholder and exists whenever a complaint against the insured alleges claims that may be covered under the insurer’s policy.” Because the underlying action is possibly covered under the policies, the court ruled that the insurers are obligated to advance defense costs until “final disposition” of the underlying action.

Additionally, the court applied established rules of insurance policy interpretation in finding that the insured versus insured exclusion did not apply. The exclusion bars coverage for cross-suits among insureds with several exceptions, including the “bankruptcy exception” for claims asserted by bankruptcy trustees or “comparable authority.” The insurers claimed that the bankruptcy exception did not apply to the successor trust RSC. The court disagreed, concluding that the bankruptcy exception “applies to restore coverage” and that, if the insurers intended to exclude such claims from creditors, they could have clearly done so.

The decision highlights the fact that, while this very commonly cited exclusion is broad, the many exceptions can be equally as broad, especially in the bankruptcy context. As with any directors and officers policy, the coverage is dependent on the specific language at issue and facts alleged in the underlying complaint. Moreover, the opinion makes it clear that when a policy provides a duty to advance defense costs, if there is any possibility of coverage based on the allegations, insurers must pay defense costs at least through final resolution of the underlying action. In those instances, the issue of coverage cannot be fully resolved until such a final disposition.

This post was also written by Meagan R. Cyrus.