"Everything has its limit - iron ore cannot be educated into gold,” Mark Twain famously said.  In this two-part series, we’re ‎going to explore one limit on protection from risk using insurance.

We’ve written frequently about the need for companies and their executives to protect themselves from lawsuits using insurance and indemnification.  In our writing on SuitsbySuits, the most common types of insurance we discuss are directors’ and officers’ insurance (which protects directors, officers, and sometimes companies against litigation arising out of the directors’ and officers’ work on behalf of the company) and employment practices liability insurance (which defends companies and executives against litigation arising from employment discrimination, wrongful termination, and other types of claims).

Insurance is a good way to transfer the risk of certain types of claims to an insurer, and it’s something company executives need to consider.  But, as Twain reminded us, everything has its limit.  This series of posts is about an executive at a charitable foundation, who found one limit of the foundation’s directors and officers’ (D&O) and employment practices liability insurance last week – when a court held that the insurer didn’t have to pay his legal bills in cases against him, because those cases arose out of actions he took outside of his role as an executive.  Technically speaking, he was not an “insured person” under the policies.

Sounds generic, right?  What’s so interesting about this?

Well, let’s add some facts to the story: the executive is Jerry Sandusky; the charitable foundation is The Second Mile, and the underlying criminal and civil cases arise from allegations that Sandusky sexually abused multiple victims over several years while working as an assistant coach with Penn State’s fabled football program.

Now it’s more interesting, even if the underlying allegations are very disturbing.  And while the factual basis of Sandusky’s battle with his foundation’s insurer is, hopefully, not something regular readers of this space encounter, the result of this insurance dispute points out a valuable lesson for every executive that has transferred the risk of litigation to an insurer: every insurance policy has limits on what it will cover.

We’ll turn to the lessons to be drawn from this case in our second post, but first let’s look at the background of Federal Insurance v. Sandusky.  You likely recall Sandusky’s story: he was convicted on 45 charges of sexual abuse.  You may also have heard that outside of the criminal case, Sandusky is a defendant in a case called Doe v. The Second Mile, Gerald Sandusky, and Pennsylvania State University, in which plaintiff Doe alleges Sandusky sexually abused him over one hundred times, and seeks damages for the abuse.

What you may not know is that Sandusky’s foundation, The Second Mile, had D&O and employment practices liability insurance with Federal Insurance Company.  Those policies provided that they would indemnify and advance defense costs for criminal and civil cases alleging “wrongful acts” done by people in their “Insured Capacity.”  They define “Insured Capacity” as “the position or capacity of an Insured Person,” which in turn is “a natural person who was, now is or shall be an Executive or Employee of” The Second Mile, “while acting in his or her capacity as such.”

Here’s where the insurance policies and the allegations against Sandusky come together.  The grand jury’s report in the criminal case against him describes Sandusky as the founder of The Second Mile, and in Doe’s civil complaint, Doe alleges Sandusky met Doe at Second Mile events, and that some of the sexual abuse occurred “during the course of activities of Second Mile.”

Sandusky, facing mounting legal bills for his defense in the criminal and civil cases and fearing a judgment against him in the civil case, sought coverage for those cases under the Federal policies, arguing that the sexual abuse allegations against him arose out of his conduct while he was acting in his “Insured Capacity.”

Not surprisingly, Federal Insurance disagreed, and filed a suit against Sandusky in the federal court for the Middle District of Pennsylvania.  Federal asked the court to declare each side’s rights and duties under the insurance contracts – which is why the type of suit it filed is known as a declaratory judgment action.

In Part 2, I’ll look at the limit in the insurance policies that Sandusky ran into, and how the court reached its decision.  I’ll also look at the lessons the ruling has for every non-Sandusky person, and non-Second Mile organization or business, that has insurance.