Global Private Equity Newsletter - Spring/Summer 2019 Edition: Recent Developments in Acquisition Finance (Traps for Portfolio Company Directors in D&O Coverage )

Dechert LLP

Dechert LLP

A recent decision by the Superior Court of the State of Delaware highlights a risk of potential exposure to liability for individuals affiliated with private equity firms who are presumed to be covered by a directors’ and officers’ liability insurance policy (D&O Policy).

When a private equity firm designates a director to serve on the board of a portfolio company, it ordinarily expects that a D&O Policy for the portfolio company will cover claims and defense costs arising from the conduct of the designated director. Yet, when the policy contains its “capacity exclusion” in a separate provision that overrides other provisions of the policy, unexpected holes in coverage may emerge. Private equity firms should be aware of this issue, to avoid unexpected exposure.

D&O Policies: Exposed?

In Goggin v. National Union Fire Insurance Company (Goggin),1 the court ruled that two directors, Keith Goggin and Michael Goodwin (Directors), were not covered under a D&O Policy issued by National Union Fire Insurance Company of Pittsburgh (Carrier) to U.S. Coal Corporation (U.S. Coal) for certain claims brought by a Chapter 7 trustee against the Directors alleging breach of their duty of loyalty to U.S. Coal, for engaging in alleged self-dealing transactions at U.S. Coal’s expense. Specifically, the trustee asserted that the Directors were embroiled in a conflict of interest relating to their roles on behalf of certain investor entities that had made investments in U.S. Coal at their direction.


Goggin and Goodwin became directors of U.S. Coal in 2009 and subsequently formed East Coast Miner, LLC and East Coast Miner II LLC (the ECMs), purportedly in an effort to reinvigorate U.S. Coal through debt repurchases and other capital restructuring transactions. Goodwin was an investor in the ECMs, and Goggin was both a manager and investor in them. The Directors’ activities on behalf of the ECMs were the basis of the Carrier’s denial of coverage, citing an exclusionary clause in the D&O Policy based on the representative capacity in which the Directors were acting at the time. The policy’s “capacity exclusion” stated:

“The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an insured: ...

(g) alleging, arising out of, based upon or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity, other than as an Executive or Employee of a Company ...” (emphasis added)

Given that “Executive” was defined in the policy to include a director and “Company” was defined to mean U.S. Coal, the court decided that, “[the] Claim, if arising out of any acts or omissions of Goggin and Goodwin in any capacity other than directors of U.S. Coal, would be excluded from coverage.” In other words, coverage would be denied if the conduct in question was not done solely in their capacity as directors of U.S. Coal. In order to determine whether the trustee claims were covered under the D&O Policy, the court applied a “but-for” test. The court found that “but-for” the Directors’ roles as members / managers of the ECMs, the trustee claims would fail. The court held that this demonstrated that these claims arose, at least in substantial part, from the Directors’ conduct in their capacities as members / managers of the ECMs. That triggered the exclusionary clause, precluding coverage for actions in any additional capacity beyond that of director or officer of US Coal. The court acknowledged that the claims also related to the Directors’ “co-existence as . . . directors” of U.S. Coal.2

But this result seems inconsistent with the intent of the policy, inasmuch as D&O Policies generally are meant to cover the liability of an entity’s directors and officers for acts taken in their capacity as directors and officers of the covered entity -- even if such actions could also be understood as having served some additional interest or “capacity.” An individual in such a case may well have more than one constituency in view when acting, yet believe that his or her actions benefit the covered entity and are in its best interests. The rationale of Goggin seems to imply that this cannot be so, and that the two are mutually exclusive.

Variations on the Capacity Exclusion

Some D&O Policies contain the required capacity element within the very definition of the term “wrongful act”, i.e., the wrongful act giving rise to the liability in question must have been taken by the person in question when acting in the required capacity. This formulation would not typically be understood as automatically excluding coverage for an action taken partially in a second or dual capacity. That would seem to be generally in line with the intentions of the parties to D&O Policies.

Other D&O Policies include the capacity element as a separate exclusion, as was the case in Goggin. In such cases, a separate disqualifying provision appears, to the effect that actions taken in a capacity other than the specified insured capacity will preclude coverage under the policy. The issue with such a separate disqualifying clause is, as was the case in Goggin, that when it is taken literally, even a minor secondary capacity can be understood as disqualifying, so long as the secondary capacity served as one of the bases of the action in question, even if the action in question was clearly in the best interests of the covered company. It may also be noted that some policies include the capacity element both in the “wrongful act” definition and in a separate exclusion, posing the same issue. In practice, it is more common for the capacity element to be spelled out in the “wrongful act” definition than it is for it to appear as a separate exclusion or both ways.

When the capacity element appears only in the “wrongful act” definition, the resulting coverage is clearer and likely to be that intended by the parties: the policy will provide coverage whenever a claim results from a wrongful act involving the policyholder’s capacity as director or officer of the entity covered by the policy. That the policyholder could be argued to have acted also in a second capacity, or in multiple capacities, would not of itself exclude coverage under such a policy. Issues of allocation or proration might be advanced and argued in such a case, but automatic exclusion of coverage on the basis of a second capacity should not apply in such situations.

In cases in which the capacity element appears as a separate exclusion, on the other hand, as in Goggin, the mere fact that the individual acted in a second capacity as well could itself be sufficient to exclude coverage. In Goggin the court employed a “but-for” test to hammer this very point home. The court ruled that, because the claim would fail “but-for” the Directors’ roles as members / managers of the ECMs – their additional capacity – the claims in question were not covered by the policy. With a “but-for” test applied in this manner, virtually any D&O Policy that contains the capacity element as a separate exclusion would preclude coverage for wrongful acts allegedly arising – even in part – from any capacity besides the one expressly covered by the policy, irrespective of the results of the subject acts. Applying the “but-for” test in this manner therefore seems unfair to policyholders and unlikely to have been intended by the parties.

Alternative Result?

A fairer result seemingly would entail some type of ratable allocation, taking into account both the capacity covered by the D&O Policy and the additional capacity in which the individuals were also acting. In this way, the policyholders are not left completely exposed, and the insurer can limit its coverage to the degree to which the actions were taken in the capacity expressly covered by the policy. Presumably an allocation could reasonably be established by a court on a case-by-case basis, considering such factors as the number of capacities involved, the relative time the individual was spending in each, the compensation he or she was deriving from each, the intended and actual benefits accruing to the various entities involved, and/or other factors deemed relevant in the particular case.

The Goggin decision could lead to exposure for private equity firms that find their personnel on the boards of portfolio companies. Such directors of portfolio companies often will have in mind the interests of both the equity sponsor and the portfolio company. Following Goggin, if the D&O Policy in question contains a separate capacity exclusion, the director may be exposed to unanticipated liability, simply for wearing two hats. The private equity firm typically would be on the hook as well, via indemnity obligations in favor of its designee.

What this Means for Sponsors

Equity sponsors should have the “capacity exclusions” in their D&O Policies for their portfolio companies carefully reviewed when buying or renewing coverage. Disqualifications from coverage, as in Goggin, may sometimes run contrary to the reasonable commercial expectations of the parties, but proper examination of the D&O Policy in question can address the issue.

We look forward to keeping you apprised of future developments.

*The authors would like to thank Arjun Ajjegowda for providing assistance with the article.


1) C.A. No. N17C-10-083, 2018 WL 6266195 (Del. Super. Ct. Nov. 30, 2018).

2) 2018 WL 6266195, at **4, 5.

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