A recent pair of opinions from New York and Pennsylvania shows the importance of evaluating all parts of director and officer (D&O) insurance coverage, down to each definition.  These cases, one holding for the insured and one for the insurer, demonstrate that a policy’s terms can be absolutely critical if the insured seeks indemnification for defense costs. 

In American Casualty Company of Reading, PA v. Gelb, a lower court in New York ordered an insurer to cover the defense costs of an adversary proceeding against the insured’s directors and officers related to the insured’s bankruptcy.  Even though the allegedly wrongful acts by the insured’s directors and officers purportedly caused the bankruptcy, the court found the insurer responsible for the defense costs claim because it arose after the insured’s coverage began.

The insurer, in an attempt to avoid paying the defense costs for the adversary proceeding against the insured’s directors and officers, argued that the wrongful acts that allegedly caused the bankruptcy existed before the insurance coverage began, meaning that the insurer should not have to pay those defense costs.  However, according to the insured’s policy, the insurer would not cover existing claims of the insured.  In addition, the policy treated all losses stemming from interrelated wrongful acts by the insured directors and officers as one loss.

Interpreting the insurance contract favorably for the policyholder, the court highlighted the difference in the policy between “loss” and “claim.”  Even though the insured’s actions prior to the company’s bankruptcy caused losses which occurred before the start of coverage, the claim by the company for defense and indemnity occurred during the coverage period.  The court criticized the insurer for conflating the terms “loss” and “claim” in its attempt to apply an exclusion for existing claims and pointed out that the insurer could have written its policy to effectuate the meaning that it was now trying to employ, but could not renegotiate the contract after the fact.

In an opinion much less favorable to the policyholder, a Pennsylvania court decided that an insured’s claim for defense costs against a tertiary excess insurer was inappropriate because under the terms of the policy, the insurer’s duty to defend never arose.  In Mountainside Holdings, LLC v. American Dynasty Surplus Lines Ins. Co., the court analyzed the terms of the insurance contract before deciding that the defendant tertiary insurer was not liable for the insured’s defense costs.

The insured had a tower of D&O insurance coverage consisting of three different insurers, each responsible for coverage after the previous insurer reached a threshold coverage amount.  The insured could only exhaust a layer of coverage when the “loss” was actually paid by an insurer.  The policy excluded from its definition of “loss” any loss that had been found antithetical to Pennsylvania public policy for an insurer to cover, including any “ill-gotten gains” reflecting unjust enrichment of the insured.

By paying a settlement for fraudulently overbilling medical patients, the court held that the insured had tacitly admitted it was unjustly enriched.  Therefore, paying the settlement could not be considered a “loss” under the policies, the insurer never became liable for paying the settlement amount, and the primary insurer never reached its maximum coverage amount.  This precluded the tertiary excess insurer from becoming liable for paying any of the insured’s defense costs.

These recent cases highlight the importance of ensuring the policyholder obtains the most favorable terms possible before creating a tower of D&O coverage.