A trial court in New York has granted summary judgment for a group of D&O insurers seeking a declaration that policies issued to AR Capital, LLC (“AR Capital”) do not provide coverage for settlements and consent judgments in actions alleging false and misleading SEC filings by VEREIT, Inc. (“VEREIT”), which is a real estate investment trust sponsored and managed by AR Capital. See XL Specialty Ins. Co. v. AR Capital, LLC, Case No. 650018/2019, 2021 N.Y. Misc. LEXIS 444 (N.Y. Supr. Ct., Feb. 2, 2021). The court’s ruling enforces the insured capacity limitation within the D&O policies’ definition of Wrongful Act, the exception of SEC disgorgement amounts from covered Loss, and an insured capacity exclusion.

After VEREIT announced in late 2014 that it had discovered errors in its financial statements filed with the SEC, VEREIT shareholders filed securities class actions against VEREIT and four of its directors and officers. VEREIT shareholders also filed a derivative action against those directors and officers. And, the SEC brought an enforcement action against VEREIT and one of the individual defendants. In September and October 2019, the parties settled the civil actions for well over $1 billion. The SEC’s enforcement action resulted in consent judgments requiring disgorgement of certain securities and more than $19 million in cash.

Because the individual defendants were not only directors and officers of VEREIT, but also directors and officers of AR Capital and its subsidiaries, AR Capital and the individual defendants (the “AR Capital parties”) sought coverage for the individual defendants’ share of the civil action settlement payments under the D&O policies issued to AR Capital. The AR Capital parties argued that those policies afforded coverage because the civil actions alleged that the individual defendants, as directors and officers of AR Capital and its subsidiaries, enriched themselves at the expense of VEREIT by causing VEREIT to make improper and inflated payments to AR Capital and its subsidiaries.

The court disagreed. It noted that the policies cover Loss resulting from a Claim for a Wrongful Act, which is defined as “any actual or alleged act, omission, misstatement, misleading statement, neglect, or breach of duty by any Insured Person while acting in his or her capacity as... an Insured Person of the Company [i.e., AR Capital or its subsidiaries]” or “any matter asserted against an Insured Person solely by reason of his or her status as a director or officer of the Company.” The court then found that the individual defendants signed the SEC filings at issue in the securities class actions “in their capacities as directors and officers of VEREIT, not AR Capital.” It also found that, in the derivative action, the individual defendants “were sued for breaching their fiduciary duties to VEREIT as members of VEREIT’s board of directors, not to AR Capital.” As such, the court determined that “the individual defendants only faced liability in their VEREIT capacities” that was not covered by D&O policies issued to AR Capital.

The court also held that the consent judgments entered in the SEC enforcement action were not covered. It noted that J.P. Morgan Securities, Inc. v. Vigilant Insurance Co., 166 A.D.3d 1, 8, 84 N.Y.S.3d 436 (1st Dept. 2018), held based on the United States Supreme Court’s decision in Kokesh v. Securities and Exchange Commission, 137 S. Ct. 1635 (2017), that SEC disgorgement is a penalty that is uninsurable as a matter of law and does not fall within the definition of Loss under D&O insurance.

Finally, the court held that coverage for the settlements and consent judgments was precluded by the policy’s Exclusion (I), or Capacity Exclusion, which provides that the insurers “shall not be liable to make any payment for Loss in connection with any Claim made against an Insured Person... based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving an Insured Person acting in their capacity as a [sic] Insured Person of any entity other than the Company [i.e., AR Capital or its subsidiaries].” The court noted the unambiguous and broad meaning of the phrases “based on” and “arising out of” used in the Capacity Exclusion. It determined that, applying a “but for” test as those phrases require, the exclusion bars coverage. Because the individuals were sued for signing false and misleading SEC filings as directors and officers of VEREIT, and for breaching their fiduciary duty as directors and officers of VEREIT, the court found that those suits would have failed but for the individual defendants’ acts in capacities as directors and officers of VEREIT. The court also noted the even broader meaning of the phrase “in any way involving” used in the Capacity Exclusion, and found that “the exclusion applies because the claims in the underlying actions ‘in any way involve’ the individual defendants’ acts in their uninsured capacities for VEREIT.”