In a recent case, the Supreme Court ruled that:

  • directors' and officers' (D&O) liability insurance cover existed even though the plaintiff had acted in the name of the company; and
  • the main reason for the company's losses were the malicious and intentional acts of its chief executive officer (CEO).(1)

Facts

The company at the centre of the dispute, Kfar Tikva, provided adults with various degrees of developmental and mental disabilities (the dependants) with education and employment throughout their lifetimes.

In 2002 the parents of a number of dependants revealed that the company had incurred substantial debts to banks and other creditors, as well as to its employees.

On October 6 2002 this group of parents filed a motion with the Haifa District Court, requesting the nomination of a court-appointed operating manager to consolidate a recovery programme for the company.

The court appointed accountant Derman as the company's operating manager. His role was defined as 'operating manager', which had significant implications for the dispute regarding insurance policy coverage.

On January 24 2003 Derman – on behalf of Kfar Tikva – together with some of the dependants' parents, filed a claim against:

  • Aryeh Pinkowitz, who was Kfar Tikva's CEO and chair of its board of directors;
  • four company directors; and
  • Migdal Insurance Co Ltd, which had issued a D&O policy to the company for 2002.

In April 2006 the claim was amended and two accountants were added as defendants.

Arguments

Plaintiffs' allegations against directors and Migdal

The plaintiffs alleged that:

  • the company directors had allowed Pinkowitz to act freely and undertake transactions in his own interests which were unfavourable to Kfar Tikva; and
  • through their acts or omissions, the company directors had breached their duty of care as reasonable directors.

Further, the plaintiffs argued that, as the issuer of the D&O liability policy, Migdal Insurance Co Ltd, was obliged to indemnify the plaintiffs due to the directors' acts and omissions in accordance with the policy's terms and conditions.

Migdal's position regarding policy cover

Migdal declined cover under the policy, arguing that:

  • false answers and misrepresentations had been provided in the proposal form which Pinkowitz had signed on behalf of the company and its directors before the policy was issued;
  • the policy was on a claims-made basis and the circumstances of the claim had been known before the policy was issued;
  • the acts attributed to the directors (ie, malicious and intentional acts committed by one of the insureds) were excluded from coverage; and
  • according to Exclusion 4.14 of the policy, a claim filed or initiated by the company was excluded from coverage; as the operating manager had acted on behalf of the company, the claim was therefore excluded from coverage.

Plaintiffs' positon regarding Migdal's allegations

The plaintiffs rejected Migdal's position and argued that:

  • on the date on which the policy was issued, the company and its directors were unaware of any circumstances that could result in a claim against them and, therefore, no significant information had been concealed; and
  • Exclusion 4.14 of the policy contained an exemption under which a claim filed by a liquidator, receiver or authorised administrator appointed by a competent authority was covered by the policy. As Derman, who had filed the claim, was a court-appointed manager, Exclusion 4.14 did not apply.

Haifa District Court decision

The Haifa District Court accepted the claim against Pinkowitz and rejected the plaintiffs' claim against the other four directors and Migdal, stating that Pinkowitz's actions had been malicious and intentional and were therefore excluded from cover under the policy. Further, Derman did not hold a position which exempted the claim from Exclusion 4.14 and, therefore, the case was not covered by the D&O policy.

Supreme Court decision

The plaintiffs filed an appeal with the Supreme Court, which found all of the defendants liable for Kfar Tikva's losses and ordered them to pay IS17.5 million (approximately $4.6 million) in compensation.

The main issues that the Supreme Court examined regarding the D&O policy coverage were:

  • the applicability of the policy's Exclusion 4.14, considering the title of Derman's role as operating manager;
  • whether the duty of disclosure had been breached; and
  • whether the innocent directors were covered under the policy, as the malicious acts had been carried out by a single company director.

A common exclusion in D&O liability policies is the 'insured versus insured exclusion', which, among other things, excludes a claim filed by an insured party as defined in a policy or by a company against another insured party. However, this exclusion does not apply if the claim is filed by a liquidator, receiver or authorised administrator appointed by a competent authority, even if – in essence – these parties act on behalf of the company.

The logic of the exclusion is to avoid collusion between a company and its directors, who may try to use the policy to cover commercial losses. However, if the initiator of the claim has independent status representing other interests (eg, the creditors' interest), coverage is available.

The Supreme Court examined the aim of the exclusion and its exemptions and concluded that Derman's claim was covered under the D&O policy. The court ruled that there was no difference between a court-appointed administrator and a company's operating manager.

The court also stated that the dependants' parents, who had initiated the legal proceedings back in 2002 requesting Derman's appointment as Kfar Tikva's operating manager, did so due to their sincere and honest fear for the future of the company and the wellbeing of the dependants (ie, similar circumstances to when an administrator or receiver is appointed).

The purpose of appointing Derman as operating manager had been similar to that of appointing an administrator to the company. Even though the Haifa District Court had not granted Derman the full powers of a liquidator or receiver, the essence of his role had been similar to that of an administrator. As a result, policy coverage applied.

The Haifa District Court determined that in light of Pinkowitz's conduct over many years, it could be assumed that he had made false representations to Migdal when filling the proposal form submitted before the issue of the D&O policy.

The Supreme Court accepted the plaintiffs' argument and decided that logical conclusions were insufficient to determine that the duty of disclosure had been breached. Factual findings based on founded evidence would need to have been presented in order to arrive at the Haifa District Court's conclusion. In the absence of such solid evidence, the Haifa District Court judgment was overturned.

Comment

The Supreme Court ruled that, in some cases, several insureds can be insured under the one policy. In such a case, it is clear that an insured who acts maliciously will lose his or her right to policy coverage. The question raised in such a case is what happens to the other innocent insureds.

According to previous Supreme Court judgments, the two situations must be treated separately; if all insureds have a common interest then the innocent insureds will not be entitled to insurance benefits if one of them breaches the duty of disclosure or maliciously causes the insured event. However, if there is a difference between the interests of the insureds under the same policy, the innocent insureds will be entitled to insurance cover.

In Kfar Tikva, there was no common and identical interest, as Pinkowitz had acted on behalf of the company when purchasing the D&O liability policy for the directors. The purchase of the policy had been a benefit granted to the insureds and not the company – the directors' interest had therefore been different to that of the company. As a result, Pinkowitz's malicious and intentional acts did not affect the rights of the innocent directors.

For further information on this topic please contact Ronit Warshai at Levitan, Sharon & Co by telephone (+972 3 688 6768) or email (ronitw@levitansharon.co.il). The Levitan, Sharon & Co website may be accessed at www.levitansharon.co.il.

Endnotes

(1) CA 4024/13 Kfar Tikva v Pinkowitz.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.