In an insurance coverage action filed recently in the U.S. District Court for the Eastern District of North Carolina, an insured seeks an order directing its D&O insurer to pay defense costs and indemnify it, if it is found liable, in an action brought by a former director. Arsenal Digital Solutions Worldwide, Inc. v. American Int’l South Ins. Co., No. 09-CV-00143, complaint filed (E.D.N.C. Raleigh Div. Mar. 30, 2009).

In the underlying action brought by plaintiffs Kevin Pollard and Meghan Marie Pollard (the “Pollard Action”), two shareholders in Arsenal Digital Solutions Worldwide, Inc. (“Arsenal”), one of whom is also a former officer and director of Arsenal, allege that Arsenal, its directors and officers and several other defendants, acted wrongfully in a series of merger deals involving Arsenal and certain of its subsidiaries. The plaintiffs assert causes of action in conspiracy, negligent misrepresentation, fraud, breach of fiduciary duty, violation of state laws and a minority shareholder claim. In addition, plaintiffs seek rescission of certain alleged mergers and disgorgement of profits following the rescission.

According to Arsenal’s complaint, Arsenal timely notified its D&O insurer of the Pollard Action and sought full coverage under its D&O policy and the insurer denied coverage for defense and indemnity of the Pollard Action based on, among others, the “insured v. insured” exclusion in the policy. The Policy’s so-called I v. I exclusion states the insurer is not liable for a claim that “is brought by an Insured or by the Company; which is brought by any security holder of the Company, whether directly or derivatively, unless such security holder’s Claim is instigated and continued totally independent of, and totally without the solicitation of, or assistance of, or active participation of, or intervention of, any Insured.”

Arsenal argues that Kevin Pollard, a former officer and board member of Arsenal, has filed suit in his personal capacity as a security holder and not in his capacity as a past director or officer. In support of this argument, Arsenal cites Mr. Pollard’s complaint, which alleges that he was an officer until late spring 2001 and served as board member until 2006, all before the Pollard action was filed in November 2007. Arsenal further alleges that the insurer’s reliance on the I v. I exclusion to deny coverage as to the other underlying plaintiff, Meghan Pollard (Mr. Pollard’s wife) was unsupported because Ms. Pollard is not and never was an officer and director of Arsenal.

For a copy of the complaint, please click here.

In its answer, the insurer denies the allegations and asserts, among other affirmative defenses, that the damages sought in the Pollard Action are uninsurable as a matter of law and therefore not covered under the Policy’s definition of “Loss”; that the damages sought in the underlying action constitute disgorgement not covered by the Policy and are further excluded by the Policy’s personal profit and fraud exclusions; and that the claim is barred by the policy’s I v. I exclusion.

For a copy of the answer please click here.