Insured Versus Insured Exclusion – Court Looks to Conduct for D&O Liability Coverage

As they say, “it is not how you describe something, but what really happened that is important.”

A recent opinion from the federal district court in the Northern District of Illinois highlights the operation of the insured versus insured exclusion found in many insurance policies providing directors & officers liability coverage. Walz v. Federal Insurance Company, 2004 WL 2452713 (N.D.Ill. October 29, 2004).

In addition, the court’s opinion also illustrates the detailed scrutiny employed by the court in considering the coverage issues. Specifically, the court focused on the facts and conduct identified in the underlying complaint rather than the descriptions or causes of action assigned by the underlying plaintiff.

After an individual serving as chief executive officer and president was discharged from his position at an insured company, he brought suit against the current members of the board of directors. One of the directors, Walz, tendered the defense of the case to Federal Insurance Company, which agreed to accept the defense subject to a reservation of rights. Federal agreed to provide a defense under a policy providing employment practices liability and directors and officers liability coverages.

After the former chief executive officer filed an amended complaint, Federal withdrew its defense and relied upon the insured versus insured exclusion to deny coverage. In response, Walz pursued coverage from Federal Insurance Company by filing an action seeking a declaratory judgment as to coverage and monetary relief for breach of contract and vexatious and unreasonable failure in paying a claim.

As part of a separate round of briefing in the coverage case, Walz and Federal were in disagreement as to the applicability of employment practices liability coverages found within the Federal policy. The judge ruled that coverage questions concerning the employment practices liability coverage should be resolved by arbitration, as per the terms of the Federal policy. Subsequently, Federal maintained that Walz’s continued pursuit of directors & officers’ liability coverage should be stayed until the arbitration proceeding was concluded. Federal contended that the court would be unable to properly analyze Walz’s claims because the policy required a coordination of the coverages that it provided.

However, the federal judge determined he had enough information to allow the case to proceed before the arbitrator issued a decision concerning the employment practices liability coverage. In turn, Federal argued that directors and officers liability coverage was precluded for the underlying action because the policy clearly excluded coverage for “any claim against an insured brought by another insured.” In response, Walz maintained that the policy provides coverage in an insured versus insured situation where the claim is brought or maintained by an executive for the actual or alleged wrongful termination of such executive.

The court concluded that the amended complaint filed by the underlying plaintiff alleged a claim for wrongful termination, despite that the plaintiff may have styled his action in terms of tortious interference. Thus, the court concluded that the claim fell within the exception to the insured versus insured exclusion, and Federal was in breach of contract for failing to defend the underlying action. Noting that Federal had incorrectly focused on the fact that the underlying Plaintiff had advanced tortious interference claims, the Court ruled that Federal must defend and indemnify the Plaintiff for any losses incurred by the Plaintiff with respect to the underlying action subject to the policy’s total monetary limit.

Of importance, the Court was quite clear that the causes of action or legal labels assigned by a plaintiff in its complaint are not determinative of any questions concerning coverage. Instead, the focus is properly placed on whether the conduct as alleged in the complaint is at least arguably within one or more of the categories of wrongdoing that the policy covers. In this case, the Court determined that the conduct described in the underlying complaint fell within the exception to the insured versus insured exclusion. Federal’s misplaced reliance on the labels assigned to the causes of action in the complaint resulted in Walz’s successful pursuit of coverage.

For those involved in insurance coverage litigation, this case also serves a reminder to prepare or read the pleadings in a coverage case with great care.

Andrew S. Boris is a partner in the Chicago office of Tressler Soderstrom Maloney & Priess. His practice is focused on litigation and arbitration of insurance coverage and reinsurance matters throughout the country, including general coverage, directors and officer’s liability, professional liability, environmental, and asbestos cases. Questions and responses to this article are welcome at aboris@tsmp.com. The Tip of the Month runs each month on claimsguides.com.