The United States District Court for the District of Minnesota, applying Minnesota law, has held that a professional liability policy's Insured v. Insured exclusion precluded coverage for a suit brought by an Insured and his non-Insured spouse. Westchester Fire Ins. Co. v. Wallerich, 2007 WL 2821656 (D. Minn. Sept. 25, 2007).

The policy provided coverage to the directors and officers of a commercial and residential real estate development company. Two of the company's investors were married, and the husband was an insured director and officer of the company. After the company's real estate investments failed, the couple brought suit against the company's other directors and officers. When the defending directors and officers sought coverage under the policy, the insurer initially denied a duty to defend. After the defendants hired coverage counsel, the insurer changed its position and agreed to accept the defense, subject to a reservation of rights. The insurer then filed a declaratory judgment action seeking a determination whether the Insured v. Insured exclusion applied.

The court first held that the wife of the insured director and officer was not an "Insured" under the policy, even though the policy's general terms and conditions provided that the "spouses . . . of natural persons who are Insureds shall be considered Insureds under this Policy; provided, however, coverage is afforded to such . . . spouses . . . only for a Claim arising solely out of their status as such and, in the case of a spouse . . . where the Claim seeks damages from marital community property, jointly held property or property transferred from the natural person who is an Insured to the spouse." The court held that the provision extending coverage to spouses created an ambiguity when compared to the D&O section of the policy, which defined Insureds as "the Company and the Directors and Officers." Because the general terms and conditions section of the policy did not define the term "Insured," the court decided that the specific definition of Insured in the policy's D&O section controlled. Thus, because the wife had never been an officer or director of the company, she was not an Insured for purposes of the Insured v. Insured exclusion.

The court then considered whether the exclusion applied to the suit because of the husband's status as an Insured. The exclusion precluded coverage for any Claim "brought or maintained by, on behalf of, in the right of, or at the direction of any Insured in any capacity, any Outside Entity or any person or entity that is an owner of or joint venture participant in any Subsidiary in any respect and whether or not collusive." The court noted that cases from other jurisdictions allowing for coverage in these circumstances relied on either the existence of an allocation clause or a determination that the suit was not collusive. Here, the policy did not contain an allocation clause, and the policy expressly provided that collusion was irrelevant. The court reasoned that allowing the presence of a non-insured plaintiff to defeat application of the exclusion would "effectively trump the unambiguous language of the 'Insured v. Insured' exclusion and would be contrary to the intent of the parties." Thus, the court held that the exclusion applied to preclude coverage because "the underlying action was not covered from the date it was filed."

The court then denied the insurer's claim to recover the defense costs it had paid prior to the coverage determination. While recognizing that many courts allow insurers that unilaterally reserve their rights to seek reimbursement of defense costs after a determination of non-coverage, the court predicted that the Minnesota Supreme Court would not allow such reimbursement unless specifically provided for in the policy.

Finally, the court considered the insured defendants' request for reimbursement for the attorneys' fees incurred in the coverage action. The court held that the insurer had breached its duty to defend when it first denied coverage because it was unclear whether the spouse was an Insured and whether the Insured v. Insured exclusion applied where one claimant was a non-Insured. Accordingly, the court concluded that the insured defendants were entitled to the attorneys' fees they incurred in seeking coverage from the time the insurer first denied coverage until the insurer reversed its position and accepted the duty to defend under a reservation of rights. However, the court held that the insured defendants were not entitled to reimbursement for attorneys' fees in connection with the carrier's declaratory judgment action because Minnesota law encourages insurers to resolve coverage disputes by filing such actions, and the court had determined that the Insured v. Insured exclusion precluded coverage under the policy.