Why a Clear and Unambiguous Exclusion to an Insurer not Always Clear to a Court

Ambiguity Makes Exclusion Uninforceable

Directors and Officers Liability Insurance policies (D&O) protect directors and officers of a corporation from damages resulting from their wrongful acts as defined by the policy.

In EMSI Acquisition, Inc., as assignee of Mark S. Davis and Robert P. Brook v. RSUI Indemnity Company, a Hong Kong limited liability company v. ESMI Holding Company, c/o The Corporation Trust Company, RSUI Indemnity Company, No. 18-2712, United States Court of Appeals for the Third Circuit (September 19, 2019) EMSI-Acquisition (“Acquisition”), purchased 100% of the stock of another company named EMSI.

Shortly after acquiring EMSI, Acquisition discovered that certain EMSI officers misrepresented EMSI’s financials during the purchase negotiations. Acquisition sued, seeking damages. The officers settled, paying Acquisition some money and assigning Acquisition their rights under a Directors and Officers insurance policy held by EMSI. Acquisition sought indemnification from that policy’s issuer, RSUI Indemnity Company.

RSUI argued Acquisition cannot recover, citing several policy terms in support. The District Court disagreed with RSUI, and it granted judgment in favor of Acquisition.

ANALYSIS

EMSI held a liability insurance policy with RSUI designed to indemnify its directors and officers from any liability stemming for their work on behalf of the company. With its acquisition looming, EMSI modified the terms of that policy: It set the policy coverage end date to be the same as the acquisition closing date, and exercised an option to set the discovery period for covered acts to six years after the closing date.

The first is the Major Shareholder Exclusion, which states that the insurer will not be liable for any claim “brought by or on behalf of individuals or entities that own, beneficially or directly, five percent (5%) or more of the outstanding stock of the Insured Organization.” EMSI furnished a list of shareholders meeting that standard when it acquired the policy.

The second relevant clause is the Merger and Acquisition clause, which provides that if “[a]ny person or entity . . . shall acquire an amount of more than fifty percent (50%) of the voting power for the election of directors . . . then this policy shall continue in full force and effect for any Wrongful Act occurring prior to the effective time of the Transaction.”

The policy defines loss as “damages (including back pay and front pay), settlements, judgments (including pre- and post-judgment interest on a covered judgment) and Defense Expenses.”

After the sale closed, Acquisition alleged that EMSI officers had made fraudulent representations to Acquisition prior to the sale, and sued. As the assignee, Acquisition is now in the position of suing RSUI to indemnify it for the payments the officers made to it.

RSUI refused to indemnify Acquisition under the policy. RSUI believes that the Major Shareholder Exclusion bars Acquisition — as the 100% shareholder of EMSI — from bringing a claim. It also asserts that the officers’ settlement payment is not a “loss” under the policy’s definition.

The District Court concluded that the policy was ambiguous as to whether the Major Shareholder Exclusion bars Acquisition from bringing a claim. Because Delaware law resolves ambiguity in an insurance policy in favor of coverage, the District Court granted judgment in favor of Acquisition.

Insurance contracts, like all contracts, are interpreted as a whole and construed to give effect to the parties’ intentions. Contract provisions are ambiguous when they are “reasonably or fairly susceptible to different interpretations or may have two or more different meanings.”

The District Court concluded, however, that the exclusion was ambiguous as to whom it applied. In doing so, it relied on several facts.  Acquisition contends that the better reading of the policy is to understand the Major Shareholder Exception to apply to the major shareholders at the time RSUI issued the policy. RSUI vehemently disagreed with the legal basis for this, arguing that the discovery extension cannot convert a policy from a claims-made to an occurrence-based policy.

However, as the District Court said, “the ambiguity in the [Major Shareholder Exception] is not a matter of whether the [policy] bar[s] claims by Major Shareholders, but, instead, is a function of who those Major Shareholders are.” If the Major Shareholder Exception bars the major shareholders at the time the policy was issued, then the question of whether the policy was claims-made or occurrence-based is irrelevant; the same set of shareholders would be excluded no matter how the policy was characterized.

The Third Circuit concluded that the provision is ambiguous. Because ambiguity resolves in favor of coverage, it affirmed the District Court’s judgment.

The District Court, reviewing the underlying complaint in this case, found that the settlement payments were “in part payments made due to alleged tortious misrepresentations made by” the EMSI officers. Since some of those misrepresentations were made during the acquisition’s due diligence period, the District Court found that the claims based on those misrepresentations at least might not give rise to indemnification under the acquisition contract. It therefore held that the settlement payments were not excluded by the policy.

ZALMA OPINION

Writing a clear and unambiguous policy of insurance – using plain or “easy to read” wording – is almost impossible when faced with the creativity and brilliance of many policyholder lawyers. D&O policies are difficult to deal with after the insured and the insurer agree to change the terms, limitations, and exclusions while an acquisition is in progress. Because the change resulted in an unclear – as read by the Third Circuit as ambiguous – exclusion the insurer lost the ability to apply the exclusion. It isn’t nice, may not even be fair, but interpretation by courts is the best solution available for insurance coverage disputes.


© 2019 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

Over the last 51 years Barry Zalma has dedicated his life to insurance, insurance claims and the need to defeat insurance fraud. He has created the following library of books and other materials to make it possible for insurers and their claims staff to become insurance claims professionals.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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