"Insured vs. Insured" Exclusion in D & O Policy Applies to Bar Coverage for Claims Brought by a Former Director and Officer
September, 2005
The U.S. Court of Appeals for the Eleventh Circuit recently held that a D & O policy’s “insured vs. insured” exclusion bars coverage for claims brought by a former director and officer. Sphinx Int’l, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa., 412 F.3d 1224 (11th Cir. 2005).
Facts
When Sphinx incorporated in 1993, Bahram Yusefzadeh became Sphinx’s CEO and chairman of the board. Prior to Sphinx’s incorporation, Yusefzadeh met George Taylor and offered Taylor a job as an officer and director of Sphinx, along with ten percent of Sphinx’s shares. Taylor served in these positions until his employment was terminated in July 1994. Sphinx stated that it terminated Taylor’s employment because Taylor did not disclose a covenant not to compete from his former employer and misrepresented his qualifications. Taylor retained his Sphinx shares.
In July 1996, Sphinx contracted with Genesis Indemnity Insurance Co. (“Genesis”) for D & O policies. The D & O Policies contained an “insured vs. insured” exclusion barring claims made “by or at the behest of . . . any Director or Officer . . . .” The policies defined director and officer to mean “all persons who were, now are, or shall be duly elected Directors or duly elected or appointed Officers . . . .” The inception of the policy at issue was July 1, 1996.
Following missed earnings projections in 1998 and 1999, Taylor (still a Sphinx shareholder) filed a securities class action against Sphinx on November 23, 1999. Taylor then amended his complaint to include other shareholders he solicited as plaintiffs. In response to Taylor’s lawsuit, Sphinx sought coverage under the D & O policy issued by Genesis. Genesis denied the claim based on the “insured vs. insured” exclusion. Genesis argued that because Taylor was a former director and officer, coverage was barred by the exclusion. The district court granted summary judgment to Genesis on this ground.
Analysis
On appeal, the Eleventh Circuit rejected Sphinx’s arguments, specifically addressing three of them.
Sphinx’s first argument was based on the D & O policy language. Sphinx argued that Taylor was not a “duly” elected officer and director because the term “duly” requires perfect procedure and substance, and Taylor did not disclose a covenant not to compete and misrepresented his qualifications. In analyzing this argument, the court recognized that under Florida’s plain-meaning rule, insurance contracts must be construed in accordance with the plain language of a policy unless there is an ambiguity. In order to find the plain meaning of the term “duly,” the court relied on the dictionary definition of the term, which was defined as “in due manner, time and degree” and concluded that the term “duly” was not ambiguous. The fact that the policy did not expressly define “duly” was not determinative, as faliure to define an operative term in a policy does not necessarily render the term ambiguous. Finding that the procedures by which Taylor was elected were conducted in a “due manner, time and degree,” the court concluded that the term “duly” unambiguously indicates that Taylor was a “duly” elected officer and director.
Sphinx’s second argument focused on a perceived conflict between the text and the rationale for the “insured vs. insured” exclusion. The original rationale behind the exclusion was to bar coverage for “collusive” suits, such as suits in which a corporation sues its officer or director in an effort to recoup the consequences of business mistakes. Sphinx argued that this rationale should trump the text of the policy. However, the court recognized that as a corollary to Florida’s plain-meaning rule, Florida courts do not look behind unambiguous policies in search of countervailing rationales. Thus, the court held that because the language of the exclusion is unambiguous, it would not focus on the purported "purpose" of the exclusion, but would apply the exclusion as written.
Sphinx’s third argument asserted that even if the court applies the “insured vs. insured” exclusion to bar coverage, it should only exclude that percentage of the claim attributed to Taylor and cover the remainder attributable to the other plaintiffs. Sphinx relied on Level 3 Communications, 168 F.3d 956 (7th Cir. 2001), a case in which six shareholders and one former director sued their company. The Seventh Circuit found that the “insured vs. insured” exclusion barred coverage for only the former director’s claim. However, the Sphinx court found the facts in Level 3 Communications too dissimilar to be decisive here. The former director in Level 3 Communications was merely a passive shareholder who joined a larger suit, whereas in this case, Taylor brought the suit and recruited every other plaintiff. In addition, the “insured vs. insured” exclusion in Level 3 Communications excluded claims “brought or maintained by or on behalf of any Insured,” whereas in this case, the exclusion was much broader, excluding claims “by or at behest of . . . any director or officer . . . .” Recognizing Florida’s plain-meaning rule, the court held that it would not place limitations upon the plain language of a policy exclusion simply because it thinks it should have been written another way. The court consequently concluded that the “insured vs. insured” exclusion barred coverage for suits brought by a former director and officer and affirmed the district court’s ruling.
Learning Point:
A court applying Florida law will stringently consider the plain meaning of the terms in an insurance contract, even if a term is not defined in the policy or the insured’s position is “logical.” Looking to the Florida Supreme Court’s holding on this point in Swire Pac. Holdings, Inc. v. Zurich Ins. Co., 845 So. 2d 161 (Fla. 2003), the Eleventh Circuit stated pointedly that the “Florida Supreme Court would be . . . suspicious of Sphinx’s attempt to secure coverage for suits by former directors and officers. Sphinx’s request to read the policy differently essentially asks a court to rewrite it, which is something we will not do.” •
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