For many corporate directors and officers, litigation exposure is a fact of life. Arguably, directors and officers can face personal liability for even innocent errors in judgment, and the defense costs alone can be staggering. Directors and officers (D&O) insurance offers these individuals and their companies protection from third-party claims that might otherwise impede corporate decision-making and discourage competent individuals from assuming corporate leadership positions.
Most D&O policies provide coverage for those claims made against policyholders during the policy period, unless otherwise addressed by specific provisions. In an effort to limit coverage for such claims, insurers often include an “interrelated wrongful acts” exclusion that purports to exclude coverage for claims against policyholders that are based on the same “wrongful acts” that gave rise to a prior claim made before a specified date in the policy, called the retroactive date. Properly and narrowly construed, as required by black letter principles, the exclusion often operates as intended. But the exclusion has become prone to widespread abuse: In recent years, insurers have sought to construe the concept of “interrelation” so broadly as to exclude coverage for otherwise covered claims if the complaint against the policyholder so much as mentions facts from a prior claim relating to the insured’s business.
Recently, in Emmis Communications Corp. v. Illinois National Insurance Co., No. 1:16-CV-89, 2018 WL 1410191 (S.D. Ind. Mar. 21, 2018), the U.S. District Court for the Southern District of Indiana addressed a D&O insurer’s effort to avoid coverage using a broadly construed interrelated wrongful acts exclusion. The district court’s opinion highlights what the court labelled the “absurd” consequences of reading such exclusions expansively, and helps to clarify that insurers must adopt a narrower construction in line with policyholders’ reasonable expectations of coverage, as the law requires with all exclusionary language. Id. at *11.
In Emmis Communications, the leadership of the plaintiff, Emmis Communications Corp. (Emmis), made two attempts to take the company private. Id. at *2–5. Emmis first tried to “go private” in 2010 by using outside funding to buy out private holders of its preferred stock. Id. at *2. Emmis was forced to abandon that effort when its lone funding source decided to back out of the plan. Id. The attempt and subsequent failure led to several lawsuits, including one action by Emmis’s shareholders against the firm’s directors and officers and another between Emmis, its directors and officers, and the anticipated funding source. Id. Emmis reported these lawsuits to its D&O carrier for the period, Chubb Insurance (Chubb), which agreed to cover the claims. Id. at *3.
In 2011, Emmis devised a plan to repurchase a qualified majority of its own preferred stock without outside funding. Id. at *4. Once it successfully did so, it proceeded to make changes to its articles of incorporation that disfavored the remaining holders of its preferred stock but improved Emmis’s overall capital structure and benefitted holders of its common stock. Id. at *4–5. In April 2012, five aggrieved preferred-stock holders sued Emmis, its directors, and its officers, alleging that the stock repurchase and amendment process violated federal securities law and state corporate, contract, and fiduciary law. Id. at *5.
Emmis promptly notified Chubb, which denied coverage for this second transaction and resulting lawsuit on the ground that the suit was not related to the earlier suits and thus did not come within the scope of Chubb’s policy. Id. at *6. Emmis also notified its D&O insurer for October 2011 through October 2012, Illinois National Insurance (Illinois National), which denied coverage for the opposite reason—that the 2012 suit was related to the earlier suits. Id. at *6, *8. The elasticity of the two insurers’ reading of their respective exclusions was, no doubt, not lost on the court.
Illinois National first pointed Emmis to an exclusion in its policy, upon which Illinois National relied to disclaim coverage for any loss in connection with several “Events”—defined to include every “notice of claim or circumstances as reported under [the policy] issued to Emmis . . . by Chubb.” Id. at *7. According to Illinois National, because Emmis “reported” the 2012 suit to Chubb, Emmis was barred from obtaining coverage under the Illinois National policy. Id. at *8.
As adverted to above, Illinois National also explained its view that the 2012 suit fell within a policy exclusion for claims arising out of “Interrelated Wrongful Act[s],” defined as “the same or related facts, circumstances, situations, transactions or events alleged in any of the Event(s).” Id. at *7. In support of its argument, it pointed out that in the 2012 complaint, the aggrieved shareholders described Emmis’s efforts to take the company private in 2010 and also noted that the 2012 effort was designed to achieve the same goal as the 2010 effort. Id. at *6, *11–12. Asserting that the allegations in the 2012 and earlier actions were therefore “logically connected,” Illinois National argued that the 2012 lawsuit arose out of “facts, circumstances, situations, transactions or events” at issue in the earlier complaints and was thus excluded from coverage as an “Interrelated Wrongful Act.” Id. at *11–12.
The district court disagreed with Illinois National’s arguments and granted Emmis’s motion for summary judgment. The court first noted the well-established rule that “coverage exclusion[s] [are] affirmative defense[s], proof of which is the insurer’s burden.” Id. at *8 (quoting PSI Energy, Inc. v. Home Ins. Co., 801 N.E.2d 705, 725 (Ind. Ct. App. 2004)). It then concluded that the first “Events” exclusion excluded only those claims reported to Chubb at the time that the Illinois National policy went into effect. Id. The court noted that Illinois National’s reading—that any claim reported to Chubb at any time and under any circumstances would be excluded—was unreasonable because it would allow Illinois National to decline coverage even if Emmis reported a claim to Chubb by mistake. Id. To the extent that the “Events” exclusion was ambiguous, the court noted that such language must be “construed strictly against the drafter,” in this case Illinois National. Id. at *9.
The court was no more taken with the second argument, namely, that the 2012 and prior lawsuits were sufficiently connected to warrant application of the “Interrelated Wrongful Act[s]” exclusion. The court first emphasized that interrelated wrongful acts exclusions like the one at issue cannot be read broadly: If the provision at issue “were to be applied literally, it would mean that any shared factual allegation would be sufficient to trigger the exclusion, including the allegation that Emmis is a publicly-traded corporation, or even simply that Emmis does business in Indiana.” Id. at *11. The court concluded that it “would be nonsensical” and “absurd” to read the provision “in such a way that whether Emmis had insurance coverage for a lawsuit filed against it would depend on the whim of the plaintiff’s attorney who drafted the complaint in the lawsuit.” Id.
Instead, the court stated that the interrelated wrongful acts exclusion could only be read to exclude “those claims that share operative facts with the [prior] suits.” Id. Because the activities described in the prior suits were not necessary to prove the causes of action in the 2012 lawsuit, the court determined that there was no overlap in the “operative facts”—in the court’s view, the facts from the prior suits were merely “window dressing” to the “operative facts” in the 2012 suit. Id. The court thus concluded that the 2012 lawsuit arose from a separate act, and that Emmis was entitled to coverage. Id.
The Emmis Communications decision illustrates the absurdity of broadly construing interrelated wrongful acts exclusions, as well as the need to apply narrow and commonsense boundaries to the concept of interrelatedness, as required by decades-old principles of insurance-contract construction. It also serves as a reminder to policyholders that they need not accept an insurer’s broad application of policy exclusions that would result in “nonsensical” coverage determinations. Following Illinois National’s denial, Emmis was forced to spend more than $4 million to fund its own successful defense to the 2012 lawsuit. Id. at *6. As a result of the court’s well-reasoned and proper rejection of an unworkable policy interpretation, Emmis will be entitled to the defense cost coverage it paid for. Id. at *14.