A D&O policy isn’t first-party insurance; it doesn’t cover loss from Wrongful Acts absent a Claim for them

by Christopher Graham and Joseph Kelly


Directors and officers liability insurance isn’t anything like first-party property insurance. But companies sometimes treat it that way. And occasionally the issue reaches a court. And so it was in American Construction Benefits Group, LLC v. Zurich American Ins. Co. There a Texas Federal Court dismissed the insured’s claims as legally insufficient in a first opinion and second opinion, but with permission for the insured to try again.

The dispute arose from an insured limited liability company’s relationship with a member limited partnership. That member contracted with LLC to obtain reinsurance for employee group health insurance. LLC’s president obtained reinsurance, but in the renewal agreed to exclude the cost of a heart transplant for a child of member’s employee. With no reinsurance, LLC paid for the $1.2 million heart transplant, under its agreement with member. LLC then asked D&O insurer to pay the $1.2 million loss under the entity coverage, claiming the loss resulted from its president’s “Wrongful Act.”

The D&O policy’s entity-coverage insuring clause provided: “[Insurer] shall pay on behalf of [insured LLC] all Loss for which [LLC] becomes legally obligated to pay on account of any Claim first made against [LLC] during the Policy Period … for a Wrongful Act taking place before or during the Policy Period.” And as common, “Wrongful Act” included “any error, misstatement, misleading statement, act, omission, neglect, or breach of duty actually or allegedly committed or attempted [by any director, officer, or employee].” The policy also included a duty-to-defend.

The problem with LLC’s claim was that insureds can’t recover under a D&O policy for loss resulting from a Wrongful Act, if there’s no Claim for a Wrongful Act. That member sought coverage for the heart transplant from LLC was insufficient; that act didn’t qualify as a Claim for a Wrongful Act–namely, a Claim for an error, misstatement, misleading statement, act, omission, neglect, or breach of duty actually or allegedly committed or attempted by LLC’s president or another officer or employee, or a director. Member instead “sought coverage under its reinsurance contract regardless of [president’s] actions.”

That LLC’s members might bring a derivative suit to recoup loss for LLC was irrelevant. That such a derivative suit supposedly was “imminent” didn’t matter either. No derivative suit against LLC had been filed. So LLC’s suit against D&O insurer was premature. As alleged, there was no breach of contract and no “actual controversy” as required for declaratory relief.

In dismissing LLC’s contract claim, the Court focused on the absence of any Claim for a Wrongful Act:

As pleaded, [insured LLC] is not alleging that [member] made a claim against [LLC] for injury caused by [president’s] Wrongful Act. Instead, [insured] is alleging that it was injured because [president] committed a wrongful act that left it without reinsurance from [reinsurer] to cover [member’s] claim for the expenses of the transplant.

In dismissing LLC’s subsequent declaratory relief claim, alleging an “imminent” member-derivative suit, the Court explained:

Under the [Texas] eight-corners rule, two documents determine an insurer’s duty to defend—the insurance policy and the third-party plaintiff’s pleadings in the underlying litigation. If the underlying pleadings allege facts that may fall within the scope of coverage, the insurer has a duty to defend; if the pleading only alleges facts excluded by the policy, there is no duty to defend.

“Without an underlying pleading, [LLC’s] claim that [insurer] owes a duty to defend wasn’t ripe because the court can’t yet evaluate whether there’s a duty to defend.” “Generally, ‘[a] suit for indemnity does not arise until some liability is established and made fixed and certain. This does not occur until judgment is rendered or until the lawsuit is settled.” That hadn’t happened.

And as an additional reason for dismissal, the Court stressed the complaint “is devoid of any allegation that [the insured] will be harmed if this court withholds declaratory relief.”

So while entity coverage was broad, it didn’t transform the D&O policy’s fundamental nature from liability to first-party insurance.

We probably haven’t seen the end of this saga. And in the next round, perhaps a battle over coverage for resolution of an actual derivative suit? Stay tuned!

Tags: Texas, D&O, claim, loss, breach of contract, entity coverage, first party insurance, duty to defend

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