Insured v. Insured Exclusion Applied to Preclude Coverage for Lawsuit Where Plaintiffs Included Both Insureds and Non-Insureds Under D&O Policy

By Kathryn A. Formeller, Esq. of Tressler LLP

Insured v. Insured exclusion applied to preclude coverage for an entire claim even where the underlying claim involved a lawsuit by an Insured Person and other plaintiffs who were not Insured Persons against other Insured Persons. Jerry’s Enterprises, Inc. v. U.S. Specialty Ins. Co., No. 14-1951 (D. Min. Sept. 22, 2015).

This coverage dispute arises out of a lawsuit brought against Jerry’s Enterprises, Inc. (Jerry’s) and two members of its board of directors by a third member of the board, Cheryl Sullivan, and her two daughters. Jerry’s is a closely-held corporation that primarily owns and operates grocery stores. The company was founded by Gerald A. Paulsen. Paulsen gifted non-voting shares in the company to his three children, Sullivan, LuAnn Cornell and Charlotte Shadduck. He also gifted non-voting shares to his grandchildren, including Sullivan’s two daughters Kelly and Monica. Upon Paulsen’s death, ownership in Jerry’s was divided among a testamentary trust and his children and grandchildren. Sullivan had been an employee at Jerry’s and had become a member of Jerry’s Board subsequent to her father’s death. Sullivan, however, only served as a director for a few months, until the company redeemed her shares and the shares of her two daughters.

Sullivan and her daughters filed a lawsuit against Jerry’s and its Board members, Shadduck and Kent Dixon, alleging that the Board took several wrongful actions against Sullivan and her daughters to force them to redeem their shares below fair value. The parties ultimately reached a settlement. Jerry’s sought coverage for the settlement and attorneys’ fees incurred in defending the suit from its D&O insurer. At the time, Jerry’s had a D&O policy with U.S. Specialty Insurance Company (U.S. Specialty). U.S. Specialty denied coverage and refused to indemnify Jerry’s for the settlement or pay Jerry’s defense costs, contending that the claim was excluded from coverage under the Insured v. Insured exclusion. Jerry’s filed suit against U.S. Specialty for breach of contract. The parties filed cross-motions for summary judgment.

U.S. Specialty argued that the Insured v. Insured exclusion applied despite the fact that the underlying lawsuit was brought by Sullivan (an Insured Person) and her two daughters (who were not Insured Persons). U.S. Specialty contended that because Sullivan personally sought relief under each of the seven counts in the underlying complaint, no portion of the underlying complaint was “brought and maintained independently of, and without the solicitation, assistance or active participation of…any Insured Person.”

On the other hand, Jerry’s argued that the exclusion was ambiguous and should be construed against U.S. Specialty. Specifically, Jerry’s contended that Sullivan did not constitute an Insured Person because she was not a “traditional director,” but rather only a nominal director. Jerry’s reasoned that Sullivan automatically became a director upon her father’s death, served for only four months, and never participated in Board meetings or voted on any matters. Jerry’s further argued that the exclusion did not preclude coverage for the underlying lawsuit because Sullivan was acting in her capacity as a shareholder, not in her capacity as a director, in bringing her claims. Finally, Jerry’s claimed that the exclusion should not apply because it is limited to collusive actions.

The policy precluded coverage for any claims:

Brought by or on behalf of, or in the name or right of…any Insured Person, unless such Claim is:
(1) brought and maintained independently of, and without the solicitation, assistance or active participation of, the Insured Organization or any Insured Person,
(2) brought or maintained by an Insured Person for contribution or indemnity and directly results from another Claim covered under this Policy, or
(3) for an actual or alleged Employment Practices Wrongful Act.

The policy defined “Insured Person” as “any past, present or future director, officer, managing member, manager or Employee of the Insured Organization, including any person in a position which is the functional equivalent thereof with respect to any entity included within the definition of Insured Organization located outside the United States.” “Employee” was defined as “any individual whom the Insured Organization compensates by salary, wages and/or commissions and whose labor or service is engaged by and directed by the Insured Organization, including seasonal, volunteer and part-time employees.”

The U.S. District Court for the District of Minnesota rejected Jerry’s arguments, concluding that the policy language unambiguously applied to preclude coverage for the underlying lawsuit. First, the District Court determined that Sullivan was an Insured Person for purposes of the Insured v. Insured exclusion. The court found Jerry’s interpretation of the term “director” to be unreasonable, noting that there was nothing in the policy that limited the definition of “Insured Person” as claimed by Jerry’s.

The court next turned to Jerry’s argument that the exclusion did not apply to preclude coverage because in bringing her claims, Sullivan was acting in her capacity as a shareholder, not in her capacity as a director. The court noted that the policy included three exceptions to the exclusion, none of which included a situation in which an otherwise Insured Person brings a claim primarily or solely in his or her capacity as a shareholder. The court also noted that other courts have frequently upheld the Insured v. Insured exclusion in the context of shareholder actions.

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