The Texas Supreme Court recently reversed a divided Texas appellate court in resolving a dispute over the meaning of an “insured vs. insured” exclusion in a Directors and Officers policy issued by Great American Insurance Company. Great American Insurance Co. v. Primo, 60 Tx. Sup. J. (2017).

The issue was whether an assignee of the insured’s rights under the policy “succeeded to the interest” of the insured for the purposes of triggering the exclusion. The Texas Supreme Court ultimately ruled in favor of Great American, holding that the insured vs. insured exclusion was applicable and that Great American was not required to pay another insured’s defense costs.

The case arose when Named Insured Briar Green, a condominium association, discovered what it believed to be financial improprieties on the part of former Briar Green director and treasurer, Robert Primo. Briar Green claimed Primo misappropriated funds, and it submitted a claim for the loss to its fidelity insurer, Travelers. Travelers paid the claim in exchange for an assignment of Briar Green’s rights and claims against Primo.

Travelers then sued Primo and a litigation explosion ensued. The opinion is somewhat unclear factually, but it appears that Primo may have ultimately been vindicated vis-à-vis the allegation of misappropriation of funds.

Primo, a former director and therefore an insured under the Great American policy, sought defense costs from Great American in the Travelers lawsuit. Because Travelers succeeded to Briar Green’s interest in the lawsuit, Great American denied coverage under the insured vs. insured exclusion, which excluded coverage for claims made by an insured against an insured and those made “by, or for the benefit of, or at the behest of [Briar Green] or . . . any person or entity which succeeds to the interest of [Briar Green].”

Primo sued Great American for breach of contract and bad faith, among other things. The trial court granted summary judgment to Great American, but the appellate court concluded an entity that “succeeds to the interest” of another in the insurance context was equivalent to being a “successor in interest” in the construction context, where a successor in interest is one who inherits the assignor’s liabilities as well as its rights. The court therefore held that the exclusion was inapplicable and that Great American must pay Primo’s defense costs.

The dissenting judge, Judge McCally, pointed out that equating “successor in interest” with an entity that “succeeds to the interest” re-writes the exclusion and narrows it considerably. She also noted that one of the purposes of the insured vs. insured exclusion is to prevent collusive lawsuits by insureds, and that if all an insured had to do to avoid the exclusion was to assign its rights under the policy to a third party, collusive lawsuits would actually be encouraged.

The Texas Supreme Court agreed with Judge McCally and reversed the appellate court. Utilizing the plain meaning rule of insurance policy interpretation, it refused to insert language into the policy that was not there and held that Travelers succeeded to Briar Green’s interest in the lawsuit, making the exclusion applicable.

It also analyzed the context surrounding the purpose of the exclusion, which is generally understood to be intended to preclude coverage for lawsuits between directors, officers, and the companies they serve. As happened in this case, such lawsuits can often become highly emotional and expensive, which is why the intent is usually to exclude them from coverage. The Court also agreed that the appellate court’s decision would have the effect of encouraging collusive lawsuits instead of discouraging them. Accordingly, Great American had no duty to pay for Primo’s defense costs based upon the insured v. insured exclusion.