Among the various provisions of the D&O insurance policy, one of the most litigated provisions is the Insured vs. Insured exclusion, which, in simple terms, precludes coverage for claims brought by one insured against another insured. However, the exclusion typically has several carve-back provisions preserving coverage for various kinds of claims that otherwise would be excluded. One of these carve-back provisions came into play in a court’s recent determination, applying Kentucky law, that coverage for a claim brought by a group of plaintiffs that included both insured and non-insured persons was precluded, because the claim had not been brought independently of the participation of an insured person.
A copy of Southern District of New York Judge Valerie Caproni’s December 9, 2022, opinion in the case can be found here. A January 18, 2023 post on the Wiley law firm’s Executive Summary blog about the decision can be found here.
Tarter Gate is a family business and one of several business entities under the Tarter family’s control. In 2018, several Tarter securities holder plaintiffs filed a shareholder derivative lawsuit against a number of defendants, including Josh Tarter (one of the family members) and Thomas Gregory (a Tarter business employee who is not a family member). Both Josh Tarter and Gregory are insured persons under the D&O insurance policy involved in the subsequent coverage dispute.
The plaintiffs in the 2018 lawsuit included both insured persons (e.g., Tarter family members) and a non-insured and non-shareholder entity, C-Ville Fabricating Co. In the subsequent insurance coverage litigation, Judge Caproni said, in an observation that was critical to the outcome of the coverage dispute, that it was “undisputed that [Anna Lou] Tarter Smith spearheaded the litigation from the inception.”
As an initial matter, Josh Tarter sought coverage for the 2018 lawsuit under Tarter Gate’s D&O insurance policy. A federal district court, applying Kentucky law, held that coverage for the claim against Mr. Tarter was precluded by the policy’s Insured vs. Insured exclusion. The district court’s decision was affirmed by the Sixth Circuit.
Separately from Mr. Tarter’s effort to secure coverage, Mr. Gregory sought coverage for the claims against him. Tarter Gate’s insurer denied coverage for the claims against Mr. Gregory and he initiated coverage litigation against the insurer. The insurer filed a motion to dismiss, in reliance on the policy’s Insured vs. Insured exclusion.
The Relevant Policy Provisions
The Policy’s Insured vs. Insured Exclusion precludes coverage for “Loss, including Costs of Defense, in connection with any Claim made against any Insured by or on behalf of any security holder of the Company.”
The Policy’s Insured vs. Insured Exclusion included several coverage carve-backs, providing that notwithstanding the Insured vs. Insured Exclusion, there is coverage for: “any Claim … brought by any security holder of the Company, whether directly or derivatively, if the security holder bringing such Claim is acting totally independently of, and without the solicitation, assistance, active participation or intervention of, the Company or any Insured Person.” In her opinion in the parties’ coverage dispute, Judge Peroni referred to this provision as the Assistance Exception.
The Policy’s Allocation Provision provides that “If a Claim made against any Insured includes both covered and uncovered matters, or is made against any Insured and others, the Insureds and the Insurer recognize that there must be an allocation between Loss and uninsured damages, settlement amounts and other liabilities in connection with such a claim.”
The December 9, 2022, Opinion
In a short December 9, 2022, opinion, Judge Caproni, applying Kentucky law, granted the defendant insurer’s summary judgment motion.
In reaching this conclusion, Judge Caproni noted that the parties did not dispute that because the 2018 lawsuit had been brought by three Tarter Gate security holders and at least one insured, the Insured vs. Insured Exclusion applies.
The parties disagreed, however, on which policy provision applied next. Mr. Gregory urged that the court should next consider the policy’s allocation provision, arguing that the portion of the 2018 lawsuit attributable to the claims of C-Ville is a covered matter. Therefore, Mr. Gregory contended, because the claim included “both covered and uncovered matters,” there must be an allocation.
Judge Capronit disagreed with Mr. Gregory, saying that before reaching “a provision in a separate section of the Policy,” she must first interpret the Assistance Exception to the Insured vs. Insured exclusion. She noted that although the Assistance Exception can operate to preserve coverage for claims otherwise precluded by the Insured v. Insured exclusion, “it does not provide coverage in this case because the security holders who brought the 2018 Lawsuit did not act ‘totally independently of’ insureds.” Judge Peroni noted in that regard that “It is undisputed that Ms. Tarter Smith (an insured) spearheaded the litigation from its inception.” The Assistance Exception, therefore, “is not satisfied.”
The Allocation Provision, Judge Caproni said, “does not change the analysis.” The Allocation Provision, Judge Caproni said, “does not expressly address claims brought by an insured and others.” Those kinds of claims are “expressly governed by the Insured vs. Insured Exclusion, which bars coverage for the underlying litigation as a whole unless the Assistance Exception applies.”
In reaching this conclusion, Judge Caproni not only cited the Sixth Circuit’s opinion in the earlier coverage matter that had been initiated by Mr. Tartar, but also the Eighth Circuit’s 2017 opinion in the Jerry’s Enterprises matter (discussed at length here; the Eighth Circuit, as Judge Caproni noted, applying Minnesota law, referred to its determination of a very similar coverage dispute as a “straightforward application” of an exclusion clause).
Judge Caproni ended her opinion by noting that “although the Court is cognizant that Kentucky law requires reading insurance contracts liberally in favor of coverage, it cannot adopt Plaintiff’s interpretation of the Policy without rewriting it; Plaintiff has failed to state a claim for breach of contract.”
If you were looking for a case that reflects why D&O insurers insist on the inclusion of an Insured vs. Insured exclusion in their policies, this case arguably is one. An inter-family squabble of the type involved here is the very sort of claim insurers don’t want to get involved with; these kinds of disputes can be messy, often are about more than just money, and represent nothing so much as corporate in-fighting. (To be sure, the insurers also usually say that they don’t want to insure collusive lawsuits; however, as far as I can tell, there is nothing about the underlying lawsuit to suggest that it is collusive.)
The standard Insured vs. Insured exclusion, though broad, does have certain coverage carve-backs preserving coverage for various kinds of claims for which coverage would otherwise be precluded by the exclusion. However, the Assistance Exception (as Judge Peroni called it) incorporates its own carve-back to the carve-back, providing that coverage for shareholder claims is NOT preserved unless the claim has been brought independently of an insured person. Because that was not the case here, the Assistance Exception did not apply to preserve coverage for the underlying claim.
This case involves a circumstance that a recent guest post on this site (here) referred to as a “mixed claim” – that is, a claim involving both insured and non-insured plaintiffs. The guest post’s authors observed that the “trends” in these kinds of mixed cases have been “divergent.” On the one hand, the authors noted, citing the Sixth Circuit’s opinion in Mr. Tarter’s coverage lawsuit, some courts have found that coverage for these kinds of mixed claims to be precluded, applying the same logic as Judge Peroni applied here.
On the other hand, the guest post’s authors also noted, there is another line of cases holding that in these kinds of mixed cases, the Insured vs. Insured exclusion will only apply to preclude the claims of insured person plaintiffs but NOT the claims of non-insured-person plaintiffs. The courts reaching the decisions in these kinds of cases relied on the existence of the allocation provisions in the applicable policies (which is, of course, the same argument that Mr. Gregory tried to urge here.)
As an example of a decision in this alternative line of cases, the guest post’s authors cited the Seventh Circuit’s 1999 decision in the Level 3 Communications case. In that case, the appellate court held that because the allocation provision parsed the difference between covered and non-covered matters, it was appropriate to apply this differentiating analysis to the application of the insured vs. insured exclusion.
In urging the court to find coverage, Mr. Gregory had in fact cited and relied on the Seventh Circuit’s Level 3 opinion. Judge Caproni was having none of it. She, correctly in my view, understood that the application of the Assistance Exception is analytically prior to the application of the Allocation provision; to put it another way, there is no point trying allocate between covered and uncovered matters before you have finished the process of determining whether or not there are any covered matters. As Judge Caproni also put it, you can’t move on to consider other issues until you have fully worked through how the prior issue — that is, the application of the entire Insured vs. Insured exclusion — affects the availability of coverage.
I will say this, there is probably no provision of the D&O insurance policy, other than perhaps the notice provision, that gets more of a workout in coverage litigation that the Insured vs. Insured exclusion. I started my career way back in the early 80s working on disputes over whether the Insured vs. Insured exclusion precluded coverage for claims brought by the FDIC as receiver of a failed bank against the bank’s former directors and officers. (Yes, dinosaurs roamed the earth then.) I expect that more than 40 years from now, policyholders and insurers will still be litigating Insured vs. Insured disputes.
It isn’t relevant to these parties’ dispute, but there is a version of the Insured vs. Insured exclusion that results in fewer coverage disputes. That is the so-called Entity vs. Insured exclusion, now found in many public company D&O Insurance policies. From my perspective, this version of the exclusion is far preferable than the Insured vs. Insured exclusion of the type involved here. For starters, it results in far few coverage denials and far fewer coverage disputes. If the policy at issue here had had an Entity vs. Insured policy rather than an Insured vs. Insured exclusion, there would have been no coverage dispute here because the claims against both Mr. Gregory and Mr. Tarter would have been covered.
I could bemoan the fact that the Entity vs. Insured exclusion typically is not available as an option for private company D&O insurance policies; however, I am well aware, as I noted at the outset of this discussion section, that insurers don’t want to get caught up trying to insure corporate in-fighting. The kind of intra-family squabble involved here – the kind of claim that might well come up in connection with a closely held private company – is the very kind of example of the kind of claim they don’t want to cover. Corporate in-fighting claims are almost always about more than money as a result of which they are expensive to defend and difficult to settle. So perhaps it is an idle thought, but it would be great to think about whether the private company D&O policy could be modified to include an Entity vs. Insured exclusion rather than an Insured vs. Insured exclusion – I will say it would be interesting to see how a policy written that way would price out, and what kinds of retentions might apply.