Insured vs. Insured Exclusion Bars Claim By Director Who Was Not Qualified For Office
December, 2002
In a case of first impression, a district court in Florida has ruled that the insured versus insured exclusion in a director and officer liability (“D&O”) insurance policy applies to a claim brought by a former director of the insured corporation who had obtained his board position fraudulently. In Sphinx Int’l Inc. v. National Union Fire Ins. Co., 226 F. Supp. 2d 1326 (W.D. Fla.), the district court held that the person who brought the claim was a “duly elected” director, and therefore an insured for purposes of the exclusion, even though his placement on the board had been induced through fraudulent misrepresentations and he was never qualified to hold the position.
Facts
George Taylor filed a securities class action complaint in 1999 against Sphinx International, a software manufacturer. Sphinx sought coverage under a D&O liability policy which covered loss resulting from claims made against the company’s directors and officers based on their alleged wrongful acts. The policy contained an insured versus insured exclusion barring coverage for any claims made against an insured by the company or by any persons who are or were “duly elected or appointed” directors and officers of the company. The insurer denied the claim based on this exclusion and Sphinx filed suit seeking a declaration of coverage.
Analysis
Claimant Was Duly Elected
Sphinx maintained that the insured versus insured exclusion did not apply to the Taylor claim because Taylor was not a “duly elected or appointed” director or officer of Sphinx. Taylor became a director and officer of Sphinx when the company was founded in 1993. The following year, Sphinx terminated Taylor after learning he was subject to a non-competition agreement with a competitor by whom he had been employed previously and that Taylor had misrepresented his expertise. Sphinx contended Taylor was simply a de facto director and officer of Sphinx, but had never been “duly elected or appointed,” because he did not qualify for the positions and fraudulently induced his appointment through misrepresentations.
The court entered summary judgment for the insurer, finding that Taylor had been “duly elected” and that the exclusion therefore barred coverage for Taylor’s claim. The district court concluded that “duly elected” refers to insureds who attain director or officer status through regular and proper channels of corporate governance. The court ruled Taylor had been “duly elected” and held the positions until the company removed him from office. Therefore, Taylor was a former director and officer, and an insured, as defined in the policy.
Sphinx’s lack of candor on its insurance application contributed to the court’s determination that Taylor had been “duly elected” to office. The court noted that Sphinx never disclosed on its 1996 application the circumstances of Taylor’s termination and instead represented that Taylor had resigned as a director and officer of the company. Sphinx thus obtained insurance coverage for claims brought against the company based on his actions. The court held it was impermissible for Sphinx to accept the benefits of naming Taylor as a former director and officer while avoiding the negative implications of that designation.
Collusion Is Not Required
Sphinx argued in the alternative that, because Taylor and Sphinx were clearly adverse in the underlying lawsuit, Taylor’s claim was not collusive and therefore the insured versus insured exclusion should not apply to it. The court acknowledged that the insured versus insured exclusion evolved in the 1980’s to prevent friendly or collusive lawsuits brought by insured companies to force their insurance carriers to pay for poor business decisions of their officers. The court held that parties nevertheless are free to broaden the rule beyond its original rationale and that, under the terms of the policy, application of the exclusion did not require evidence of collusion in the underlying lawsuit.
The court determined that the insured versus insured exclusion applied not only to the claim brought by Taylor, but also to the claims of the shareholder plaintiffs in the derivative securities suit. Sphinx complained that such a broad interpretation of the exclusion would effectively eliminate coverage for all derivative actions. The court disagreed, noting that, under the terms of the exclusion, derivative claims could be covered provided they were not brought with the solicitation, assistance, active participation or intervention of any officer or director of the company. In this case, the court observed, the exclusion applied to the derivative claims because Taylor filed the class action and then actively solicited members of the class.
Learning Point:
Sphinx Int’l is significant because it gives a measure of clarity or certainty to the application of the insured versus insured exclusion in D&O policies. It permits insurers to apply the exclusion to claims brought by current or former directors or officers without examining the circumstances of their election to office or their qualifications for their positions.
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