Macey, et al. v. Carolina Casualty Ins. Co., No. 08-6067 (2d Cir. June 30, 2010), see Decision
This decision from the U.S Court of Appeals for the Second Circuit created an immediate buzz in the Directors-and-Officers insurance world because the court held that the so-called "insured-vs-insured" exclusion was ambiguous, always a terrifying word for insurers. D&O insurance protects officers and directors against lawsuits alleging a wide assortment of wrongful acts while in office, usually shareholder actions in response to a stock plunge. Excluded from coverage, however, are claims brought by one D or O against another. Insurers are not keen to fund inter-corporate squabbles or revenge suits brought by a former director against the scoundrels that threw her out of office. If courts strike down the insured-vs-insured exclusion as ambiguous, insurers might have to cover a whole lot more lawsuits.
But insurers take heart. The Macey case probably does not portend the demise of the insured-vs-insured exclusion due to the unsual facts uderlying the decision. In fact, the court did not actually say that the exclusion was ambiguous. It remanded the case to the lower court to determine if the plaintiffs in the underlying lawsuit were in fact directors of the insured corporation. In other words, the court held that the exclusion might or might not apply, depending on whether the insured corporation existed when the plaintiffs were directors. The facts, you see, are complicated.
An Illinois corporation, call it CRA-Illinois, reorganized in May 2004 and merged with an investment company. It emerged as a Delaware corporation, CRA-Delaware, later that year with new majority ownership. The directors of CRA-Illinois became minority shareholders (named "Legacy Shareholders") and also became directors of CRA-Delaware but, according to the Share Purchase Agreement, only for the purpose of signing the paperwork necessary to complete the reorganization. The Agreement also required that two of the three Legacy Shareholders resign from the board in order to close the merger. The Agreement named as new directors three other inviduals (Macey et al.), who were later sued by the Legacy Shareholders.
After the merger, the company applied for D&O insurance, making the following representation:
On May 3, 2004, the company had a merger with an investment entity. A new Chariman and Chief Executive Officer was installed. The prior ownership remained in a minority capacity but were no longer participants on the Board or officers of the corporation. On August 2, 2004 a Chief Financial Officer was hired.
The policy that issued incorporated the application as part of the insuring agreement, arguably becoming a stipulation of facts in the policy. A year later, CRA-Delaware effected yet another merger, which pushed the Legacy Shareholders out completely, whereupon they sued the new directors. The defendants sought coverage, which the insurer denied based on the insured-vs-insured exclusion. The coverage action followed.
The lower court agreed with the insurer that the plaintiffs were former directors of CRA-Delaware, however slight their tenure may have been, and applied the exclusion. On appeal, however, the court said that the lower court had not looked at the record closely enough. Applying Virginia law to interpret the policy, the Second Circuit noted that an insurance provision is ambiguous if it is reasonably capable of two different intepretations. The court continued:
The parties' opposing arguments are both reasonable interpretations of when CRA-Delaware came into existence. On the one hand, [Macey, et al.] argue that CRA-Delaware came into being only at closing when it merged with CRA-Illinois, which occurred at the same time [the Legacy Shareholders] resigned, an interpretation that is captured in the [application]. On the other hand, Carolina argues that CRA-Delaware came into being at some point before the execution of all the documents and issuance of stock, and thus the Legacy Shareholders rightly fall within the "insured vs. insured" exclusionary clause. Both of these interpretations rely on the language of the Policy and are reasonable in light of the various provisions of the Policy.
The court held that the exclusion appeared to be capable of two reasonable interpretations and remanded the case to the lower court to determine if the Legacy Shareholders should be considered "insureds" under the policy. So why is this ruling not the death-knell of the insured-vs.-insured exclusion, at least in the Second Circuit, given that most courts will interpret an ambiguous policy in favor of coverage?
The court noted that there are two kinds of ambiguity: (1) when the provision is ambiguous on its face, called patent ambiguity, and (2) when the contract, though clear when written, "because of subsequently discovered or developed facts, may reasonably be interpreted in either of two ways," or latent ambiguity. Although the court does not explicitly say so, this is probably a case of latent ambiguity, which should not have much persuasive effect on future court decisions. The facts of this case are not likely to be repeated, particularly a representation in the policy itself that some individuals are not directors. A finding of patent ambiguity might start the ball rolling in other courts. Latent ambiguity may be a harder sale for policyholders.
Nonetheless, we may expect directors and officers to use the Macey decision to bolster an argument that the exclusion is ambiguous. The insured need only persuade a court that it has a reasonable interpretation favoring coverage, and finding reasonable arguments is what lawyers do.
David S. White, Thompson & Knight LLP
www.tklaw.com
