The eight-year lawsuit captioned Wojtunik v. Kealy, pending in the United States District Court for the District of Arizona, has resulted in yet another decision of interest concerning directors and officers coverage. By decision dated March 31, 2011, the court addressed the excess insurer’s arguments concerning the insured v. insured exclusion, the fraud exclusion and the insurability of rescissionary damages under Arizona law. See Wojtunik v. Kealy, 2011 U.S. Dist. LEXIS 36229

Plaintiff Wojtunik sought to collect on an $8 million settlement he obtained in his suit against International FiberCom, Inc. (“IFC”), resolving federal and state securities fraud claims he had brought against the company. The claims arose out Wojtunik’s sale of his company to IFC, which was accomplished by merging his company into a subsidiary of IFC created for the purpose of the transaction, named IFC-ANA. Wojtunik was paid $8 million in IFC stock and had some involvement in IFC-ANA’s affairs. A year later, however, IFC filed for bankruptcy, rendering his stock worthless. Wojtunik later filed suit against the directors and officers of IFC, alleging that prior to the merger, they artificially inflated the value of IFC’s stock and that they also made several misrepresentations both to Wojtunik and to the SEC concerning the financial condition of IFC. IFC’s CEO and CFO ultimately entered into a so-called Damron agreement with Wojtunik, whereby they stipulated to a judgment allowing him to proceed directly against IFC’s directors and officers insurers, including TIG, which issued a first layer excess policy to IFC on a follow-form basis.

TIG argued, among other things, that the insured v. insured exclusion in the primary policy applied to bar coverage. Specifically, TIG argued that Wojtunik became the president of IFC-ANA and thus was a director or officer of IFC as that those terms were defined by the policy. The basis for TIG’s assertion was a copy of Wojtunik’s employment agreement with IFC-ANA, which stated that upon the merger, Wojtunik would become president of the newly formed entity. IFC argued that Wojtunik was not the president of IFC-ANA. The court agreed with IFC, relying on the policy definition of “director(s) and officer(s),” which stated, in pertinent part, that the individual must be “duly elected or appointed.” While the court conceded that Wojtunik may have had responsibilities similar to that of a company president, the court ultimately found it determinative that he was never duly elected or appointed to this role by the IFC-ANA board. As such, the court concluded that Wojtunik did not qualify as an “insured” under the policy as a director or officer, and as such, the exclusion did not apply.

The court also rejected TIG’s argument that Wojtunik qualified as an insured for the purpose of the exclusion based on an endorsement to the policy that expanded the definition of “director(s) and officer(s)” to include past, present or future employees, but only for the purpose of securities claims. The court agreed that the purpose of the endorsement was to limited to broadening coverage for the purpose of defending securities claims against the company. Because the endorsement was silent as to the insured v. insured exclusion, explained the court, it could not be read as expanding the definition of “insured” as used in the exclusion.

The court also considered TIG’s argument that the policy’s fraud exclusion precluded coverage for the settlement. The exclusion applied to claims arising out of any deliberate act of fraud, “provided, however, this exclusion shall not apply unless a judgment or other final adjudication adverse to any of the Insureds in such Claim shall establish that such Insureds committed such ... deliberate fraudulent act.” The court rejected TIG’s argument that the Damron agreement could be considered a “final adjudication,” and in any event, the agreement did not contain an admission of liability. The court further relied on established Arizona precedent that a consent agreement cannot be considered the result of litigation.

Finally, the court considered TIG’s argument that the amount paid pursuant to the Damron agreement could not be considered “loss” for the purpose of the policy, but rather rescissionary damages not insurable as a matter of law. In reaching this conclusion, the court relied on a technical reading of the damages sought in the underlying complaint. Specifically, Wojtunik sought compensatory damages and punitive relief rather than rescissionary relief. This was necessitated by the fact that IFC was in bankruptcy at the time suit was filed. While IFC received the benefit of the bargain, Wojtunik could not sue IFC for rescission. Thus, the only relief available to him was to sue the IFC directors and officers individually and seek from them compensatory and punitive damages for the actions of IFC.