How Capacity Exclusion and the Definition of Wrongful Act Impact Portfolio Company Directors
It has been over a year since the Superior Court of Delaware issued its ruling in Goggin, et. al. vs. National Union Fire Insurance Company (Del Sup. Nov. 30, 2018), and there have been numerous commentaries written about this case addressing the capacity exclusion and the definition of the term wrongful act.
Many commentators have recognized that the capacity exclusion contained in the National Union policy at issue precludes coverage for directors who sit on corporate boards as representatives of hedge and venture capital funds, or are involved in rescue financing, also known as portfolio company board members. The capacity exclusion, relied upon in Goggin precluded coverage for claims:
“(g) alleging, arising out of, based upon or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity, other than as an Executive or Employee of a Company, or as an Outside Entity Executive of an Outside Entity.”
The introductory language of this exclusion is expansive and the Delaware court applied a “but-for” test to the “arising out of” wording of the exclusion and determined that coverage was precluded for the two U.S. Coal’s portfolio company board members. The capacity exclusion as relied upon in this case was viewed by the Delaware Superior Court to be clear and unambiguous.
Some argue, however, that the capacity exclusion was too broadly interpreted and failed to take into account the fact that the Goggin outside directors were expressly sued in their capacity as directors of the insured entity. That remains an issue to be argued for another day. Presently, it’s possible that the exclusion could be omitted in other D&O policies, or modified through amendatory endorsements, as negotiated between D&O underwriters and insurance brokers. Based upon discussions with industry contacts, although we are experiencing a tight market, select D&O underwriters may be willing to exercise some flexibility in applying and/or crafting the capacity wording more liberally, thereby allowing for limited coverage of portfolio company board members.
However, this case also raises issues as to the intent and scope of the term wrongful act as defined in most D&O policies. The National Union Executive Edge policy, which was applied in Goggin, defines wrongful act as follows:
“(i) With respect to any Executive of an Organization, by such Executive in his or her capacity as such or any matter claimed against such Executive solely by reason of his or her status as such.”
The significance of this defined term is that it is incorporated within the Insuring Agreements. Therefore, the burden of proof initially falls on the policyholder to establish that a claim made falls within the purview of the applicable Insuring Clause. The defined term wrongful act found in the National Union policy does not necessarily support the coverage limitation of Exclusion “g.” Some policies that define the term wrongful act may be even more restrictive than the National Union policy and directly preclude coverage for portfolio company board members.
There are other policy forms where the definition of wrongful act appears more clear, if not less restrictive in addressing the capacity issue. For example, Endurance American Insurance Company’s policy, known as Primary Management Liability Insurance For Public Companies defines wrongful act to mean:
1. any error, misstatement, misleading statement, act, omission, neglect, or breach of duty actually or allegedly committed or attempted by any of the Insured Persons in their capacity as such, or in an outside Position, or with respect to Insuring Agreement C, by the Company, or
2. any matter claimed against the Insured Person solely by reason of their serving in such capacity or in an Outside Position.
Similarly, the Chubb Primary Directors & Officers and Entity Securities Liability Insurance policy defines the term wrongful act to mean:
A) any error, misstatement, misleading statement, act, omission, neglect, or breach of duty committed, attempted, or allegedly committed or attempted by:
1. an Insured Person in his capacity as such; or
2. for purposes of any coverage afforded under Insuring Clause (C), Entity Securities Coverage, by the Organization; or
B) any other matter claimed against an Insured Person solely by reason of serving in his capacity as such.
Although the wording of the Endurance and Chubb policies are similar to that of the National Union policy, the layout of these endorsements unmistakably supports the proposition that the Endurance and Chubb policy wordings should both be applied as two disjunctive parts, thus treating capacity as bifurcated. That being: “…in their capacity as such,” or “solely by reason of (their) serving in such capacity.” This manifest separation read as creating a broader universe in which a D&O can function and be covered, expanding the scope of a D&O’s capacity, defined under the policy. A claims professional, would evaluate coverage under the two policies as such. In applying Endurance’s and Chubb’s Definitions of the term wrongful act to the Goggin case, and deleting or modifying the capacity exclusion, the portfolio company’s board members challenging coverage arguably acted “in his (i.e. their) capacity as such” as directors of U.S. Coal when they purportedly breached their fiduciary duties to it. This is consistent with Part 1 of Endurance’s and Part A of Chubb’s definitions of wrongful act. At the very least, and barring any applicable exclusion, the portfolio company board members would have been entitled to a defense based on the presumption that they breached no duties of loyalty and did not act with dishonest intent.
Had the policyholder sought coverage under an Endurance or Chubb policy, or another policy with similar or more liberal wrongful act wording and a deleted or less expansive capacity exclusion, possibly restricting the introductory language to actual conduct based upon the predicate act, one could have advocated a stronger case for coverage. It would have had the effect of initially allowing the policyholder to meet one’s initial burden of establishing that coverage falls within the purview of the applicable insuring clause, shifting the burden of proof onto the insurer, or at the very least, creating an ambiguity that would typically be interpreted against the scrivener of the contract. As such, it is reasonable to expect that the insured could have at least laid out an argument for advancement of defense costs, as the duty to defend exceeds the duty to indemnify.
Therefore, when evaluating possible coverage under a D&O policy, especially when considering the coverage available to portfolio company board members, one should look beyond the language of the policy exclusions and also pay attention to the definition of the term wrongful act. Of course, each case is unique onto itself, and there may be other variables that may impact the outcome of a case or a claims professional’s evaluation of coverage.