Second Circuit Affirms Judgment That Insured v. Insured Exclusion Bars Coverage After Jury Finds Plaintiff Was Duly Elected or Appointed as a Director

Applying both New York and Nevada law, the United States Court of Appeals for the Second Circuit has held that an insurer correctly denied coverage under its directors and officers liability policy based on the insured v. insured exclusion.  Intelligent Digital Sys. L.L.C. et al. v. Beazley Ins. Co., 2017 WL 4127540 (2d Cir. Sept. 19, 2017).  This conclusion was reached despite arguments that the exclusion was ambiguous, or, in the alternative, that because the company’s bylaws were not followed, the claimant was not “duly elected or appointed” as a director of the company under the meaning of the Policy.

The insured company and directors were sued by an individual who had previously sold his own company’s assets to the insured company upon issuance of a $1.5 million promissory note and a seat on its Board of Directors. He was also hired as a consultant to the company.  Within months of starting, however, this new director announced he was resigning and then sued for payment owed under the promissory note against the company and the other five directors.

After the insurer denied coverage based on the insured v. insured exclusion, the parties settled the underlying action, with four directors agreeing to pay a total of $75,000 and all five directors agreeing to the entry of judgments against them in amounts exceeding $2 million, with the now-ex director becoming an assignee of the directors’ rights under the company’s D&O policy.  The ex-director then brought suit against the insurer seeking indemnification for the unpaid judgments.

At trial in the coverage action, a jury found that the plaintiff had been duly elected or appointed to the Board within the meaning of the Policy’s insured v. insured exclusion, and final judgment was entered for the insurer.  On appeal, the issues presented were (1) whether the insured v. insured clause applied and (2) assuming it did, whether the plaintiff was duly elected or appointed a director.

The appellate court first concluded that the insured v. insured clause did in fact apply to this case, rejecting the plaintiff’s contention that at a minimum the exclusion was ambiguous because it could be read as applying only to claims brought by directors in their capacities as directors.  Applying New York law to the interpretation of the Policy, the court explained that the exclusion, on its face, exempts from coverage “any” claim brought by, on behalf of, or at the direction of an insured director, unless the claim is employment-related.  The court added that the plaintiff’s consultant agreement specifically provided that the plaintiff was a consultant and not an employee, so the employment-related exception did not apply.

The court then turned to the question of whether the plaintiff was “duly elected or appointed” as a director to constitute a “Director[] and Officer[]” as defined by the policy.  In the court’s view, “[t]he plain meaning of the phrase ‘duly elected or appointed’ in the Policy’s definition of ‘Directors and Officers’ is that directors must be duly selected, by vote or appointment, in accordance with proper procedures.”  In dismissing the plaintiff’s contention that the policy language was ambiguous the court concluded that the omission of “de facto” directors from the definition did not render the policy ambiguous.

Finally, the court addressed the plaintiff’s argument that the insured company’s bylaws governing appointment of a new director were not followed and thus that the plaintiff was not “duly elected or appointed.”  The court rejected this argument.  Applying Nevada law to the contract, the court concluded that the bylaws were not ambiguous, and contrary to the plaintiff’s suggestion, the reference to “newly-created directorships resulting from any increase in the authorized number of directors” did not explicitly require more formal action than that which was already taken by the Board.  Further, as explained by the court, even if there were ambiguity in the bylaws, the question whether the plaintiff was duly elected or appointed as a director was answered in the affirmative by a jury based on largely undisputed evidence, including that all five directors were present at the Board meeting where the transaction and appointment was approved; that the plaintiff thereafter began serving as a director, sought confirmation that he was covered by the policies, attended three Board meetings, and was paid for his services; and that, in various filings with government agencies, the insured company represented that the plaintiff was a director.

Accordingly, the appellate court affirmed the district court’s judgment in favor of the insurer.