Directors denied coverage in U.S. conflict of interest lawsuit due to capacity exclusion

CNA Hardy’s November 2018 biannual Global Risk and Confidence Survey (Survey) revealed that North American executives view cyber risk as the second largest risk their companies face, followed closely by technology concerns.

In Goggin v. National Union Fire Ins. Co., two directors of the insured corporation, U.S. Coal, also invested in the company through investment vehicles of their own creation. These investment vehicles provided debt purchase and other capital restructuring to the company. A lawsuit was filed against the directors claiming that they breached their fiduciary duties to the company by providing unfair investment terms to the investment vehicles, stemming from their conflict of interest being both directors of, and investors in, U.S. Coal.

The directors claimed defence cost reimbursement under the D&O policy. The insurer denied coverage, pointing to the ‘capacity exclusion’ on the policy, which precluded coverage for loss “alleging, arising out of, based upon or attributable to” wrongful conduct of an individual insured while acting in any capacity outside their insured capacity (i.e. as an executive or employee of U.S. Coal). The insurer argued that the directors were not acting solely in their insured capacity when the wrongdoing occurred, but that they were also acting in their uninsured capacity as investors. The court ultimately sided with the insurer, applying the “but-for” test in its analysis – the directors would not have faced the conflict of interest allegations in the lawsuit “but-for” their positions as investors in the investment vehicles. As such, the lawsuit was excluded from coverage by the capacity exclusion – the allegations against the directors arose out of their uninsured investor positions with the investment vehicles. The court also found that the wording of the exclusion was unambiguous, and furthermore that “arising out of” is a far-reaching term in Delaware law. 

A D&O liability insurance policy can provide financial protection for board members and executives when faced with breach of fiduciary duty claims. However, as demonstrated by this U.S. case, the capacity in which the insured individual is acting at the time the wrongful conduct occurs can complicate coverage in some cases, depending on the wording and exclusions contained in the insurance policy at issue. While ‘capacity exclusions’ aren’t present on all D&O policies, they do exist and can, as demonstrated, cause unexpected coverage denials for insureds. An experienced insurance broker can review your company’s D&O insurance policy and advise on the potential implications of any relevant exclusionary language.