An exclusion in an insurance policy eliminates coverage for certain acts, property, types of damage, or locations.
Generally speaking, an “Insured vs. Insured Exclusion” (often part of a Directors and Officers (D&O) liability policy) excludes coverage for claims brought against directors and officers by other directors and officers of the same company. This exclusion is often referred to as an intra-insured exclusion.
The Insured vs. Insured Exclusion
There are times when a company will sue its former officers and directors by virtue of being covered by D&O Insurance. In doing so, the company can benefit by filing claims against its former officers and directors and recover insurance proceeds. The purpose of the Insured vs. Insured Exclusion is to protect the insurance company from claims that may arise from directors and officers of the same company suing each other. The exclusion will provide a clear definition of who is not covered by the policy and prevents directors and officers from using the policy to their own advantage. It also ensures that the insurance company is not liable for claims that arise from internal disputes between directors and officers of the same company. Yet, what about the officer and director who perhaps was not negligent or did not breach a fiduciary duty to the company and was named in an all-encompassing lawsuit against other officers and directors some of whom have unclean hands.
Further, it is not uncommon for officers and directors to be sued when the company has filed bankruptcy, and many times the claim is it’s the primary if not sole asset in the estate that may result in some recovery to creditors. The Insured vs. Insured Exclusion will come into play just as it did in Walker County Hospital Corporation v. Brown (In re Walker Cnty. Hosp. Corp.), Adv. Proceeding No. 22-3099, 2024 Bankr. LEXIS 2440, 2024 WL 4394508 (Bankr. S.D. Tex. Oct. 3, 2024).
Beware of Ambiguity
In Walker County Hospital Corporation, after Walker County Hospital filed bankruptcy, as the debtor in possession, it sued its former CEO. The CEO tendered the Complaint to the insurer. The insurer refused coverage, citing the Insured vs. Insured Exclusion. The CEO filed a cross-claim against the insurer seeking a declaration that the insurer was obliged to provide a defense. The insurer filed a motion to dismiss the cross-claim, contending that the Insured vs. Insured Exclusion deprived the former CEO of insurance coverage.
The motion to dismiss was denied. Though the exclusion provided that there would be no coverage for a claim “brought by or on behalf of any Insured,” there was an exception in the event the claim was brought on behalf of a trustee, examiner, receiver, or similar official for the company or its assignees.
Of note: the bankruptcy judge cited the Fifth Circuit Court of Appeals, which held that coverage shall be provided “[i]f any allegation in the complaint is even potentially covered by the policy.” Evanston Ins. Co. v. Legacy of Life, Inc., 645 F.3d 739, 745 (5th Cir. 2011), certified question answered, 370 S.W.3d 377 (Tex. 2012) (Emphasis in original). Further the bankruptcy judge noted that if just one claim is covered under the policy, the insurer is required to defend the officers and/or directors, and if there is any ambiguity, then the exception must be narrowly construed. City of Coll. Station, Tex. v. Star Ins. Co., 735 F.3d 332, 337 (5th Cir. 2013).
Here, the ambiguity in the policy came into play where the definition of an insured included a debtor in possession and yet, an exception to the exclusion included a bankruptcy trustee and similar official. The bankruptcy judge stated that a debtor in possession was found to be a “similar official” to a bankruptcy trustee under the exception. Finding an ambiguity existed and citing the Fifth Circuit (wherein any ambiguity in the policy must be construed against the insurer and in favor of the insured), the bankruptcy judge ruled that the exception overrode the Insured vs. Insured Exception and thus, the insurer was required to defend the CEO.
Does Your Policy Contain the Insured vs. Insured Exclusion?
So, the takeaway here is that it is extremely important for officers and directors to first review their policies and ensure the policies do not include the Insured vs. Insured Exclusion. This may prove problematic as the exclusion has become the norm in a majority of policies. Nevertheless, if the proposed policy has such an exclusion, then ensure there is an exception which covers trustees, receivers, and such other similar officials and their assignees. Otherwise, going bare in D&O litigation can become disastrous and unaffordable, and some cases force unintended consequences.
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