A New York Federal judge recently ordered a directors and officers liability insurer to pay $4.5 million that an investment firm had spent defending an arbitration proceeding brought by a former executive. The court found that allegations of constructive termination and related retaliation triggered an exception to the D&O policy’s insured-versus-insured exclusion for employment-related wrongful acts, rejecting the insurer’s argument that, notwithstanding the former executive’s count for constructive termination, his status as an “Insured Person” triggered the exclusion where the majority of counts in the arbitration related to alleged breaches of the firm’s operating agreement.  

Background

At issue in Seabury FXOne v. U.S. Specialty Insurance was the insured-versus-insured exclusion. Those exclusions bar coverage for any claim made against one insured by another insured. The intent of the exclusion is to prevent collusion among insureds to collect policy proceeds. However, most insured-versus-insured exclusions contain numerous exceptions for things like claims brought by successors-in-interest (e.g., liquidators, bankruptcy trustees, receivers or, creditor committees), claims by former insureds, or claims for employment-related wrongful acts. The Seabury policy included one such carve out for claims alleging an actual or alleged “Employment Practices Wrongful Act,” which was defined to include discrimination, retaliation, sexual harassment, workplace harassment, workplace tort, wrongful termination, or violation of the Family and Medical Leave Act.

A former Seabury executive alleged in various oral and written demands that the company had engaged in serious corporate misconduct, including breach of his employment contract and interference with efforts to perform his duties as CEO. He further alleged that he had been retaliated against, was cut off from obtaining access to important materials to stop the abuse, and other wrongful conduct demonstrating a constructive discharge. The company and the former executive first mediated and then engaged in arbitration in an attempt to resolve his claims. The arbitration demand sought relief for breach of an operating agreement governing his rights as a majority stakeholder, breach of fiduciary duty, shareholder oppression, and breach of his employment agreement as a result of constructive termination.

Seabury submitted the claim for coverage under its D&O policy, but U.S. Specialty disclaimed because the executive’s claims fell within the insured-versus-insured exclusion and were not subject to any exceptions, including for any Employment Practices Wrongful Acts. Seabury filed a coverage action for U.S. Specialty’s breach of the insurance contract. The parties filed cross-motions for summary judgment, centering around the operation of the policy’s insured-versus-insured exclusion.

Decision

Seabury argued that the operative “claim” included not only the arbitration but also the executive’s mediation demand and other oral and written demands. Those claims identified no less than three Employment Practices Wrongful Acts, including wrongful termination, workplace tort, and retaliation. The “gravamen” of the case, Seabury argued, was the executive’s loss of power as an employee and not as a shareholder, triggering the employment-related carve out to the insured-versus-insured exclusion. U.S. Specialty took a narrower view, arguing that the “claim” at issue stems solely from defense costs incurred in the arbitration, which it concluded arose from a shareholder dispute rather than Employment Practices Wrongful Acts. According to the insurer, “this was not an employee action at all.”

The court agreed with Seabury. It first noted that the policy provides that all claims arising out of the same facts are considered a single claim. In other words, where an insured incurs defense costs from multiple demands, proceedings, or arbitrations stemming from the same facts, the policy treats the costs incurred as one “claim” for the purposes of coverage. In Seabury’s case, the court explained, the record made clear that the factual basis for the claim and subsequent arbitration proceedings was the same—both stemmed from the purported misconduct by Seabury that resulted in various alleged breaches and the improper termination of the former executive. The mere fact that the circumstances giving rise to Seabury’s claim included various types of accusations in addition to allegations concerning wrongful termination and other wrongful employment actions did not render the claim beyond the scope of the Employment Practices Wrongful Act exception to the insured-versus-insured exclusion.

Takeaways

Insured-versus-insured exclusions are common in modern D&O and other management liability policies. But as shown in Seabury, policies can be procured with critical exceptions to the exclusion that carve out substantial coverage for claims against the company by other insureds. Not all policies are the same, and even standard forms can be modified and enhanced to add new exceptions or expand existing exceptions. For instance, does the policy provide appropriate carve outs for successors-in-interest in the event of insolvency or bankruptcy? If the policy has an exception for claims by former insureds, is it restricted to only certain classes of insured persons or by how long ago the individuals left their position? If the company has foreign operations, does the exclusion account for jurisdictions where insured-versus-insured exclusions may be prohibited by law?

These are only a few of the issues that can arise in evaluating claims involving other “insureds.” Also critical is understanding how policy provisions may work together to provide coverage for a claim. In Seabury’s case, the policy’s “related” claim provision supported the company’s view that the entirety of the claim fell within the exception to the insured-versus-insured exclusion. Engaging experienced coverage counsel and other risk professionals during the policy placement and renewal before a claim arises can help negotiate policy language to broaden potential coverage and mitigate the risk of unexpected coverage disputes.