Third Circuit Finds Insured v. Insured Exclusion Precludes Recovery of Defense Costs

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Many corporate executives may be under the impression that the defense costs they incur when sued for actions taken in their role as officers of the company would be covered by a “Management Protection” insurance policy. The name of the insurance policy even suggests this. However, executives are not always covered by such a policy. For example, in Redmond v. Ace American Insurance Company, No. 14-3864, 2015 U.S. App. LEXIS 9392 (3d Cir. June 5, 2015) (unpublished), the Third Circuit held that defense costs incurred in a lawsuit brought against an executive by his former employer were not covered under a Management Protection policy due to an insured versus insured exclusion.

In Redmond, shareholders of Industrial Enterprises of America, Inc. (“IEAM”) brought a securities and accounting fraud lawsuit against the company. IEAM subsequently filed for bankruptcy protection and, in the role as debtor-in-possession, sued several former executives alleging a fraudulent scheme involving IEAM’s stock price. A bankruptcy trustee was later substituted as the plaintiff in the lawsuit initiated by IEAM against its former employees.

One of the former executives asked American Insurance Company to defend him (or pay for a defense) against the claims asserted by IEAM under a Management Protection policy which named both IEAM and the executive as insureds. The policy covered “misleading statement[s]” and other “act[s and] omission[s],” by the insureds and promised to pay costs arising out of civil proceedings related to such acts. The former executive sued the insurer when it refused to provide a defense. The trial court dismissed the lawsuit, however, holding that the policy’s insured versus insured exclusion precluded coverage for the former executive. The provision specifically barred coverage for any “[c]laim brought or maintained by, on behalf of, or in the right of . . . [IEAM], in any respect.”

On appeal, the Third Circuit agreed that the insured versus insured exclusion unambiguously barred coverage. Focusing on the phrase “brought by” in the exclusion, the court concluded that the term meant “commence” and because IEAM, an insured under the policy, had commenced the suit against the former executive, another insured under the policy, there was no coverage. According to the Third Circuit, the fact that the trustee was now the plaintiff in the action “does not mean the trustee initiated the suit or change the fact that IEAM commenced, or ‘brought,’ the action.”

Had the trustee initiated the suit, the outcome may have been different. Courts across the country are mixed with respect to whether the insured versus insured exclusion bars coverage for claims brought against executives by a trustee or receiver (such as regulators) of a company.

Insured versus insured exclusions are not rare, so policyholders, especially those holding, purchasing, or renewing professional liability policies, need to be mindful of them. When purchasing or renewing their policies, policyholders should consider negotiating carve outs to the exclusion to cover claims initiated or maintained by receivers, trustees, and the like.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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