In a recent decision, the Fifth Circuit ruled in favor of Markel American Insurance Company in a D&O liability coverage dispute centering on the application of the policy’s “Creditor Exclusion.” The panel affirmed a lower court’s holding that the exclusion precluded coverage for claims brought by lenders of the insured. Markel Am. Ins. Co. v. Verbeek, 2016 WL 5400412 (5th Cir. 2016) (Tex.). In doing so, the panel rejected arguments by the insured, which relied on changes in the lender’s position during the underlying litigation.

The underlying case involved a claim brought by a bank syndicate comprised of Regions Bank, Comerica Bank, Solutions Capital I, LP and MCG Capital Corporation (collectively, “the banks”) which issued a credit facility loan agreement to the insured, Color Star Growers of Colorado, Inc. (“Color Star”), a flower distributor. Color Star soon went bankrupt and defaulted on its obligations under the credit facility loan. The banks filed suit against Color Star’s officers, Huibert and Engelbrecht Verbeek, in Texas state court alleging that the Verbeeks fraudulently induced the banks to issue the loans by misrepresenting the financial condition of their company. In particular, the banks claimed that the Verbeeks had overstated the value of their inventory by approximately $6.6 million. According to the banks, the Verbeeks were looking at their bottom line through rose-colored glasses.

The Verbeeks tendered the lawsuit to Markel and requested a defense under their D&O policy. Markel denied coverage for the suit, citing the policy’s “Creditor Exclusion.” That exclusion pertinently stated that the D&O policy did not cover “any Claim brought or maintained by or on behalf of . . . [a]ny creditor of [the insured company] in the creditor’s capacity as such[.]” Markel filed suit for declaratory relief in federal court on the same day that it denied coverage. The district court ultimately agreed with Markel that it did not owe coverage and granted declaratory judgment in Markel’s favor.

The Fifth Circuit affirmed the district court’s ruling in an unpublished per curiam opinion. On appeal, the Verbeeks advanced two main arguments for why the Creditor Exclusion should not apply to the lawsuit brought by the banks. First, they argued that the banks did not assert claims in their “capacity” as creditors because the banks did not seek to hold them contractually responsible for the loans. The Verbeeks also argued that the Chapter 9 liquidation plan “stripped” the banks of their rights as creditors of Color Star. However, the court rejected these arguments. The court held that although the Verbeeks were not being asked to repay the loan, the dispute still arose entirely from the loan to Color Star. The court also found it “immaterial” that the banks were no longer asserting rights as creditors following the liquidation because the plain language of the Creditor Exclusion relied on the banks’ status at the time the claim was asserted. As the panel explained:

The fact that the state court plaintiffs may no longer have creditor rights is immaterial: they had such rights when they ‘brought’ the underlying litigation. The Verbeeks’ argument – which relies on the state court plaintiffs’ current status as purported noncreditors – rewrites the Creditor Exclusion such that it applies only when a claim is both ‘brought and maintained by’ a creditor. But, the Creditor Exclusion is written in the disjunctive. As such, the fact that the state court plaintiffs were creditors when they brought the suit is sufficient to trigger the Creditor Exclusion. (emphasis in original).

Additionally, the Verbeeks argued that one of the banks was suing as an “investor,” rather than a creditor, based on its own allegations. Even though the bank did plead that its loan was an “investment,” the appellate court relied on other factual allegations which showed that the expected returns were limited to the principal and interest payments on the loan. Just as a flower has the same scent no matter what it is called, a loan by any other name is still a loan, according to the Court. In doing so, the Court observed that its holding was consistent with Texas law, which requires an insurer’s duty to defend to be determined solely from the pleadings, as such rule “requires a court to focus on the factual allegations showing the origin of the damages claimed,” rather than mere labels. In sum, the panel held that the claim had been brought by the banks in their capacity as creditors. Thus, the Creditor Exclusion precluded coverage.

Notably, this decision contrasts with other recent federal appellate decisions in other circuits, which have found coverage under D&O policies for an insured’s liability stemming from unrepaid loans. See St. Paul Mercury Ins. Co. v. FDIC, 2016 U.S. App. LEXIS 18811 (9th Cir. 2016); St. Paul Mercury Ins. Co. v. FDIC, 774 F.3d 702, 710-11 (11th Cir. 2014).

One takeaway here is that the Creditor Exclusion in D&O policies may apply in circumstances beyond the traditional scenario where a lender sues an insured for past-due payments after a default. Its application also depends on the particular wording of the exclusion, which can vary between policies. When presented with claims which arise out of credit agreements, insurers should be wise to carefully consider the specific language of the exclusion, as well as the jurisdiction in which the claim is pending.