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RISKVUE ARCHIVE | INDUSTRY WATCH >DIRECTORS & OFFICERS LIABILITY (D&O)
Interrelatedness Provisions in Directors’ and Officers’ Insurance Policies: An Enlightened View in Pennsylvania
By Richard J. Bortnick
Congress designed the Private Securities Litigation Reform Act of 19951 to discourage frivolous securities fraud lawsuits. Despite Congress’s commendable intentions, corporations and their directors and officers continue to confront an ever-growing number of securities fraud and other lawsuits and monetary demands, many of which have no factual or legal basis. Faced with such claims, director and officer defendants have sought coverage under their corporation’s Directors’ and Officers’ Liability Insurance policies (“D&O Policy”) for such “claims”2 and for any “loss”3 resulting therefrom.
While the typical D&O Policy includes definitions of the complementary terms “claim” and “loss,” questions often arise as to whether a policyholder, when faced with multiple potentially related “claims” or “losses” occurring during different policy periods, is entitled to coverage under more than one D&O Policy.4 When more than one policy covers a claim or series of claims, the policyholder can access each such policy’s limit of liability, thereby increasing the amount of insurance available to pay the “loss.”
The same question also arises with respect to retention amounts5 in D&O Policies. If a court determines that a grouping of lawsuits filed during different policy periods constitutes a single “claim” which impacts only one policy, the policyholder would have to pay only one retention amount. Conversely, if litigants file multiple suits or make several demands during different policy periods, such suits or demands could be considered to constitute separate “claims,” in which case the policyholder would typically have to pay a separate retention amount under each implicated policy.
Generally, the resolution of these issues depends on whether the subject claims are sufficiently related to fall within a D&O Policy’s definitions of “related” or “interrelated” wrongful acts. In the past, courts frequently ignored and/or misinterpreted a D&O Policy’s “interrelatedness” provisions to achieve a result favorable to the insured. Thus, in those cases where a policyholder and its insurer disputed the limits of liability issue, courts overwhelmingly held that claims based upon seemingly related facts, transactions and events were neither “related” nor “interrelated,” and that, as a consequence, the policyholder was entitled to receive multiple D&O Policies’ limits of liability. In so deciding, the courts maximized the insurance proceeds available to the policyholder and, as a result, minimized the policyholder’s personal exposure arising from underlying “claims” against them.6
On the other hand, courts addressing the “interrelatedness” question in the retention context frequently found that seemingly unrelated “claims” made during different policy periods arose from a common nexus of facts. As a result, the policyholder was required to pay only one retention amount with respect to such “claims.”7
Recently, however, the Pennsylvania Supreme Court recognized the possibility that, under the proper factual circumstances, a D&O Policy’s “interrelatedness” provisions may preclude coverage where the suit is based upon conduct that was the subject of a “claim” in a prior policy year. Anglo-American Ins. Co. v. Molin, 547 Pa. 504, 691 A.2d 929 (1997). As a consequence, the Court found that (where the facts so dictate) a D&O policyholder may be entitled to only a single D&O Policy’s limit of liability, rather than the aggregate limits of two different D&O Policies covering different time periods. The Pennsylvania Supreme Court’s willingness to examine and fairly interpret a D&O Policy’s “interrelatedness” provision in conjunction with the facts presented, instead of automatically rejecting an insurer’s coverage arguments, represents a departure from prior precedent and practice.
A Typical D&O Policy’s “Interrelatedness” Provisions
The typical D&O Policy’s “interrelatedness” provision is illustrated by London Market Policy Form L(88)RL (1988):
More than one Claim involving the same Wrongful Act or Interrelated Wrongful Acts of one or more Directors and Officers shall be deemed to constitute a single Claim and such single Claim shall be deemed to have been made solely within the earliest of the following Policy Years:
(1) the Policy Year in which the earliest Claim involving the Same Wrongful Act or Interrelated Wrongful Acts is first made, or
(2) the Policy Year in which the Claim involving the same Wrongful Act or Interrelated Wrongful Acts shall be deemed to have been made[.]
Many D&O policies also contain complementary provisions which state that a policyholder is entitled to the limits of liability from only one policy, rather than multiple limits under policies that cover different time periods, if claims are “related” or “interrelated”:
Claims based on or arising out of the same act, interrelated acts, or one or more series of similar acts, of one or more of the Directors or Officers shall be considered a single loss and the insurer’s liability shall be limited to the limit of liability [per loss] stated in clause 4(b) and 4(c).8
Likewise, many D&O Policies may address the “interrelatedness” concept in their retention provisions:
Losses arising out of the same act or interrelated acts of one or more of the insureds shall be considered a single loss and only one retention amount shall be deducted from the aggregate amount of such losses.9
In turn, some D&O Policies, like the London Market’s 1988 D&O policy form, define the term “interrelated wrongful acts” as “wrongful acts which have as a common nexus any fact, circumstance, situation, event, transaction, or series of facts, circumstances, situations, events or transactions.”10
Notwithstanding these clear and unambiguous terms and definitions, courts routinely used artificial distinctions11 or rules of construction12 to construe a D&O Policy’s “interrelatedness” provisions to maximize a policyholder’s coverage, or, alternatively, minimize a policyholder’s obligations to pay a D&O Policy’s retention amount. The Anglo-American Court declined to rubber stamp such a result-oriented approach and opened the door for courts to interpret and apply fairly a D&O Policy’s “interrelatedness” provisions in accordance with the policy language.
A Change in Outlook
Anglo-American involved separate “claims made” D&O Policies that insured the directors and officers of Corporate Life Insurance Company (“Corporate Life”) during two different, consecutive, policy periods. The “1993 Underwriters’” D&O Policy covered claims made during the 1993 policy period (the “1993 Policy”). The “1994 Underwriters’”, D&O Policy responded to claims made during the 1994 policy period (the “1994 Policy”). Both D&O Policies excluded coverage for claims made:
based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving:
(1) any Wrongful Act or any fact, circumstance or situation, event or transaction which has been the subject of any notice given prior to the effective date of this Policy under any prior policy, or
(2) any other Wrongful Act whenever occurring which, together with a Wrongful Act which has been the subject of such notice, would constitute Interrelated Wrongful Acts.13
Both D&O Policies defined the term “Interrelated Wrongful Acts” as “wrongful acts which have as a common nexus any fact, circumstance, situation, event, transaction or series of facts, circumstances, situations, events or transactions.”14
In 1993, Corporate Life’s directors and officers notified the 1993 Underwriter of a potential claim based upon a petition (the “Opposition Petition”) filed by the Pennsylvania Department of Insurance (“DOI”).15 The Opposition Petition included allegations that Corporate Life’s directors and officers (the D&O’s): (1) falsified books, (2) misrepresented that Corporate Life was solvent and was complying with applicable rules and regulations; (3) schemed to strip Corporate Life of its assets; (4) engaged in self-dealing; and (5) hid key documents from the Department, all of which were defined as “wrongful acts” in the 1993 Policy.16
In 1994, the DOI filed a writ of summons17 against the D&O’s. The DOI thereafter filed a complaint against the D&O’s (the “Maleski complaint”) alleging, among other things, that they had: (1) breached their fiduciary duties; (2) committed fraud by concealing the true financial condition of Corporate Life; (3) negligently managed and controlled Corporate Life; (4) wasted Corporate Life’s assets through self-dealing; (5) diverted Corporate Life’s opportunities; and (6) breached contracts with Corporate Life.
The D&O’s sought coverage for the Maleski complaint under the 1994 Policy. The 1994 Underwriters responded by filing their own complaint against the D&O’s, seeking a declaration that the 1994 Policy’s “interrelated” provision precluded coverage for the Maleski complaint (the “Coverage Complaint”). Upon receipt of the Coverage Complaint, the D&O’s moved for a preliminary injunction directing the 1994 Underwriters to pay their legal fees in the Maleski action. The Pennsylvania Commonwealth Court granted the injunction and ordered the 1994 Underwriters to pay the subject defense expenses.18 In so ruling, the Commonwealth Court summarily reasoned that the allegations in the Maleski complaint were not “interrelated” to the claims in the Opposition Petition because (1) the Opposition Petition was brought by the Insurance Commissioner acting as an insurance regulator while the Maleski action was brought by the Insurance Commissioner acting as a statutory liquidator and (2) there were numerous allegations in the Maleski action which were not included in the Opposition Petition.19
On appeal, the Pennsylvania Supreme Court recognized that under Pennsylvania law, “the right to relief must be clear” for an injunction to issue. In analyzing whether the D&O’s satisfied this heavy burden, the Supreme Court focused on and compared the factual underpinnings of the Maleski complaint and those of the Opposition Petition.20
Based on the record presented, the Supreme Court found that a “viable argument” could be made that both pleadings were grounded on claims that the D&O’s were “raping the insurance company and that their conduct involved numerous violations of the law.”21 The Court also noted that the Opposition Petition made it clear that the D&O’s were engaged in a “systematic scheme to divert more than $20 million of Corporate Life’s assets, which could establish a common nexus or theme”22 with the Maleski complaint. As a result, the Supreme Court concluded that the D&O’s failed to meet their burden of proving that they had a clear right to recover against the 1994 Underwriters. Accordingly, the Supreme Court reversed the Commonwealth Court’s decision and remanded “for trial on the underlying issues in the [1994 Underwriters’] declaratory judgment action.”23
Conclusion
While the Pennsylvania Supreme Court’s decision in Anglo-American Ins. Co. v. Molin ultimately was based on procedural grounds, the Court’s consideration of and willingness to literally interpret the subject D&O Policy’s “interrelatedness” provision is significant to insurers and policyholders alike. In a clear departure from the conclusory, result-oriented approaches followed by many other courts, the Pennsylvania Supreme Court recognized that a court must examine the facts of each case closely and faithfully to determine whether a D&O Policy’s “interrelatedness” provisions apply.
Both policyholders and insurers can benefit from a court’s fair reading and application of a D&O Policy’s “interrelatedness” provision. On the one hand, insurers will be able to (1) limit their exposure to those claims they intended to cover; and (2) accurately project their future losses. At the same time, policyholders may benefit from such an approach through (1) reduced premiums; and (2) more reasonable settlements with underlying plaintiffs. 24 
Notes
1 The Private Securities Litigation Reform Act of 1995” (“PSLRA”) altered procedures for bringing class action lawsuits under the federal securities laws. The reason for this change by Congress was the belief that the plaintiff’s bar had seized control of class action lawsuits, bringing frivolous suits on behalf of only nominally interested plaintiffs in the hope of obtaining a quick settlement. Senate Report No. 104-98, 104th Congress, reprinted in 1995 U.S.C.C.A.N. 679, 687-690. Section 101(b) of the PSLRA amended the Securities Exchange Act of 1934 by adding Section 21D, which imposes disclosure requirements on the plaintiff and creates mechanisms for appointment of a lead plaintiff. See 15 U.S.C. '78u-4.
2 The Standard Chubb Executive Protection Policy (the “Chubb Policy”), Form 14-02-0943 (1992), defines “Claim” as:
(i) a written demand for monetary damages, (ii) a civil proceeding commenced by the service of a complaint or similar pleading, (iii) a criminal proceeding commenced by a return of an indictment, or (iv) a formal administrative or regulatory proceeding commenced by the filing of a notice of charges, formal investigative order or similar document.
3 The Chubb Policy defines “Loss” as:
“the total amount which any Insured Person becomes obligated to pay on account of each Claim and for all Claims in each Policy Period and the Extended Reporting Period, if exercised, made against them for Wrongful Acts for which coverage applies, including, but not limited to damages, judgments, settlements, costs and Defense Costs.”
4 D&O Coverage is generally provided on a “claims made” basis. A “claims made” policy covers only those claims which are made while the subject policy is in effect. On the other hand, coverage is “triggered” under an “occurrence”-based policy by bodily injury or property damage that occurs during the policy period. Johnston, Directors’ and Officers and Related Forms of Liability Insurance, printed in Securities Law Techniques '122.03[1][2][c] (A. Sommer ed. 1990 'Supp. 1992).
5 A policy retention acts much the same way as a deductible. The policyholder pays the first portion of any claim-related expense. The insurance company’s obligation, in turn, inures when the policyholder has paid or satisfied the retention amount.
6 See, e.g., Eureka Federal Sav. & Loan Assoc. v. Am. Casualty Co. of Reading, 873 F.2d 229, 234-35 generally, 234-35, not 234-235 (9th Cir. 1989) (holding that loan transactions, under bank’s aggressive loan policy, were not “interrelated acts,” and each loan constituted a separate loss with a separate limit of liability under the policy); Okada v. MGIC Indemnity Corp., 823 F.2d 276, 282-283 (9th Cir. 1986) (holding that loan transactions, which caused the failure of a bank, were not “interrelated acts,” and that each loan constituted a separate loss, subject to a separate limit of liability under the policy); McCuen v. American Casualty Co., 946 F.2d 1401, 1407-1408 (8th Cir. 1991) (holding that 17 loan transactions were not “interrelated acts,” and each loan constituted a separate loss with a separate limit of liability under policy); Home Ins. Co. of Illinois (New Hampshire) v. Spectrum Info. Technologies, Inc., 930 F.Supp. 825, 847-848 (E.D.N.Y. 1996) (holding that three securities actions did not result from “the same wrongful act or interrelated, repeated or continuous wrongful acts,” as in an earlier securities action against the company, which concerned misstatements about a licensing agreement, and as such, were subject to limits of policies in effect when the three actions were reported to insurer); Nat’l Union Fire Ins. Co. of Pittsburgh v. Ambassador Group, Inc., 691 F.Supp. 618, 621-624 (E.D.N.Y. 1988) (holding that claims made in second year of policy were not “interrelated” to claims made in first year of policy, and thus were subject to aggregate limit for second year of policy, even though all claims involved allegations of wrongdoing and were related to the demise of a corporation and its subsidiaries); North River Ins. Co. v. Huff, 628 F.Supp. 1129, 1130-1139 (D.Kan. 1985) (holding that loan transactions, each involving a similar method of “loan swaps,” were not “interrelated acts,” and each loan constituted a separate occurrence with a separate limit of liability under the policy).
7 See, e.g., Atlantic Permanent Federal Sav. & Loan Assoc. v. Am. Casualty Co. of Reading, 839 F.2d 212 (4th Cir. 1988) (holding that several claims on different loans arose out of a series of “interrelated acts” in the planning and carrying out of a bank’s home improvement loan program, entitling the insurer to only one retention amount under policy), cert. denied, 486 U.S. 1056, 108 S. Ct. 2824, 100 L. Ed.2d 925 (1988).
8 See Okada v. MGIC Indemnity Corp., supra, 823 F.2d at 278-279 (emphasis added).
9 See Nat’l Union v. Ambassador, supra, 691 F.Supp. at 622 (emphasis added).
10 Under this policy form, “Wrongful Act” means:
. . . any actual or alleged negligent act, error, omission, misstatement, misleading statement, neglect or breach of duty by the Directors or Officers, individually or collectively, in the discharge of their duties solely in their capacities as Directors or Officers of the Company.” Id.
11 See note 6, supra.
12 See, e.g., Home Ins. Co. of Illinois (New Hampshire) v. Spectrum Info. Technologies, Inc., 930 F.Supp. 825, 848 (E.D.N.Y. 1996); McCuen v. Am. Casualty Co., 946 F.2d 1401, 1407-1408 (8th Cir. 1991).
13 Anglo-American Ins. Co., 547 Pa. at 510, 691 A.2d at 932 (emphasis added).
14 Id.
15 The DOI previously had suspended Corporate Life’s operations based upon its finding that Corporate Life was insolvent. Following settlement negotiations in 1993, Corporate Life requested a rule to show cause why a proposed settlement agreement should not be enforced against the DOI. Pennsylvania’s Insurance Commissioner responded by filing an Opposition Petition, which opposed enforcement of the settlement agreement.
16 The Insurance Commissioner subsequently filed a petition to liquidate Corporate Life based on wrongful diversion of corporate assets, control by dishonest persons and willful violation of Pennsylvania law. Id. at 509, 691 A.2d at 931. This petition, however, did not seek relief against Corporate Life’s directors and officers. Id.
17 In Pennsylvania, an action may be commenced by filing a writ of summons against a party. Pa. R. Civ. P. 1007. Following, the plaintiff files a formal complaint against the defendant(s). Pa. R. Civ. P. 401.
18 In granting the injunction, the Commonwealth Court found that the D&O’s right to relief against the 1994 Underwriters was “clear”, a prerequisite under Pennsylvania law. Anglo-American Ins. Co. v. Molin, 673 A.2d 986, 994 (Pa. Commw. 1996).
19 Id., 673 A.2d at 993.
20 691 A.2d at 933.
21 Id. at 934.
22 The court did not find dispositive the fact that many of the allegations contained in the Maleski complaint were not included in the Opposition Petition.
23 Notwithstanding its finding that an injunction was inappropriate, the Supreme Court, in dicta, noted that it was “equally plausible” that both sides could prevail on the merits, depending on the facts presented.
24 Typically, plaintiffs and their attorneys are willing to settle D&O cases for amounts close to the applicable limits of primary insurance coverage.
ABOUT THE AUTHOR
Richard J. Bortnick is a partner in White and Williams LLP and a member of the firm’s Commercial Litigation and Insurance Coverage Practice Groups. Rick specializes in Directors and Officers, Long Term Exposure and Bad Faith coverage matters. He also counsels insurance companies on domestic and international coverage issues and represents insurers and non-insurers in general commercial and SEC-related matters. Rick has lectured and written frequently on directors and officers liability and other coverage issues.
riskVue | The webzine for risk management profesionals
August 1999
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