Joint Venture Qualifies as a 'Subsidiary' Where Insured Holds Partial Economic Interest But 100% of Voting Rights

Applying New York law, the United States District Court for the Southern District of New York has held that a joint venture between the insured and a capital-contributing partner constituted a “subsidiary” of the insured pursuant to the terms of its D&O policy. Scottsdale Ins. Co. v. McGrath, 2020 WL 7321503 (S.D.N.Y. Dec. 11, 2020).

The insured and a capital-contributing partner formed a joint venture of which each initially owned 50% of the economic and voting interests. The capital-contributing partner violated the terms of the operating agreement and forfeited its voting rights, but not its economic rights, on March 25, 2015. The joint venture later filed for bankruptcy, and the bankruptcy trustee filed an adversary proceeding against the capital-contributing partner and the co-manager alleging wrongful acts that occurred in July 2015. Accordingly, at all times relevant to the coverage analysis, the insured owned 50% of the economic interest and 100% of the voting interest in the joint venture.

The co-manager tendered the claim to the insured’s D&O carrier, claiming coverage as a manager of a subsidiary of the insured. The insurer determined that the co-manager was not covered on the grounds that the joint venture was not a “subsidiary” as defined in the policy during the applicable time period. Litigation followed.

The definition of “subsidiary” included two subparagraphs. Subparagraph (a) pertained to “[a]ny entity of which more than fifty percent of the outstanding securities representing the present right to vote. . . are owned by the Parent Company, directly or indirectly,” and subparagraph (b) referred to “any joint venture entity in which the Parent Company. . . has an exact fifty percent (50%) ownership of the interests. . . and. . . solely controls the management and operations of such joint venture entity.”

The court held that the joint venture was a “subsidiary” of the insured under subparagraph (a) as of March 25, 2015 because it owned 100% of the voting interest in the joint venture. Thus, the co-manager qualified as an “insured” under the Policy when the alleged wrongful acts occurred. In doing so, the court rejected two arguments made by the insurer. First, the insurer argued that voting shares did not qualify as “outstanding securities” under subparagraph (a). Citing the Securities Exchange Act, the court held that “the term security does not preclude a voting interest that is divorced from economic interest[.]”

Second, the insurer argued that because subparagraph (b) included the term “joint venture entity,” while subparagraph (a) referred to “any entity,” a joint venture could qualify as a subsidiary only if it met the requirements of subparagraph (b). The court noted that the insurer’s definition of subsidiary would include a joint venture in which the insured solely controls the management and operations, and has an exact 50% ownership interest, but would exclude a joint venture under the insured’s sole ownership and control because the insured would own more than 50% of the joint venture. The court concluded that the term “joint venture entity” in subparagraph (b) was intended to identify a subset of the term “any entity” but not “to limit the types of entities covered under subparagraph (a).” Because the insured owned 100 percent of the voting shares in the joint venture during the relevant time frame, the court held that the joint venture constituted a “subsidiary,” and the co-manager was an insured under the policy.