In a recent, unpublished decision, in a case in which coverage was sought for a suit filed against the insured by a shareholder, the District Court of New Jersey held that that two causes of actions were covered, while the remaining two claims were excluded from coverage under the terms of the policy. However, the court did not venture further into how to allocate, leaving it up to the parties to determine how best to allocate the defense costs in the ongoing litigation. With respect to the attorneys' fees for bringing the coverage action, however, the court was not inclined to consider allocation at all. Though the insured established coverage for only half of the causes of action, the court held that was sufficient to allow recovery of all its fees in pursuing coverage. Foodtown Inc. et al. v. National Union Fire Insurance Co., No. 05-3627 (D.N.J. Aug. 20, 2008).

In 2005, Foodtown filed a lawsuit (the "Coverage Litigation") seeking a declaration that its D&O insurer was obligated to pay the costs to defend Foodtown and Foodtown's directors and officers in a lawsuit brought by Food King, Inc., a shareholder of Foodtown (the "Underlying Litigation"). In its motion for summary judgment in the Coverage Litigation, the D&O insurer argued that coverage was not available for the Underlying Litigation because the "Insured v. Insured" exclusion in the D&O policy excluded coverage for claims by shareholders of Foodtown on behalf of the insured company (i.e., shareholder derivative actions) when brought with the assistance of an insured individual or entity. The insurer also asserted that at least one cause of action was not covered by virtue of an exclusion for loss arising out of claims against a specific entity, Twin County Grocers.

The court looked to the nature of the relief sought in deciding whether the causes of action in the Underlying Litigation were direct, and therefore not subject to the Insured v. Insured exclusion, or derivative, and, because they were brought with the assistance of an insured, therefore subject to the exclusion. It held that one of the causes of action was excluded on the basis that it was derivative in nature because, in those three causes of action, all the Foodtown shareholders allegedly suffered from the alleged wrongs by Foodtown's board. Three other causes of action were direct, because the harm alleged was to Food King only. It further held that the exclusion for loss arising out of claims against Twin County Grocers served to exclude one of the three direct causes of action. The court ordered that the D&O insurer and Foodtown allocate among themselves the appropriate amount of covered and uncovered defense fees in the Underlying Litigation, as they were in the best position to do so. (Because the Underlying Litigation had not yet been resolved, there was no need to consider allocation of a settlement or judgment).

The decision is perhaps most interesting for what the court apparently concluded but did not specifically address. First, the court appears to have determined that each cause of action, rather than the entire complaint, constitutes a "claim" for purposes of determining whether the policy exclusions apply. Second, the court did not address how the parties were to determine an appropriate allocation of defense fees other than noting that the parties themselves should undertake the task. The court did not explicitly suggest whether an allocation should be based on the relative exposure faced by the insured under each cause of action, or whether only those additional expenses incurred by virtue of the uncovered claims should be excluded - two methods of allocation commonly referred to as "relative exposure" and "larger settlement" respectively. By its decision that the parties are best positioned to determine allocation, the court appears to have recognized that a simple allocation formula based solely on the number of covered causes of action would likely not be appropriate. Instead, the court's decision may be read to imply that consideration of whether one cause of action represents greater liability exposure (and higher defense expenses) than another would be necessary to arrive at an appropriate allocation. In that sense, by allowing the parties to determine an allocation, the court may be implying that the "relative exposure" method should be used.

As noted above, the good news for the insurer stops there. While the court scored it as two for the insurer and two for the insured, it was not inclined to allow partial fees based on partial success in the coverage litigation, but instead allowed the insured all of its reasonable fees.

For a full copy of the decision, please click here.