Insurer Not Estopped from Asserting Policy Defenses Where Insured Had Duty to Defend; Insured-v.-Insured Exclusion Does Not Bar Coverage for Claims by Former Shareholders

An Illinois federal court, applying Illinois law, has held that an insurer who declined to advance defense costs was not estopped from asserting policy defenses in a coverage action later filed by the policyholder corporation.  Vita Food Prods., Inc. v. Navigators Ins. Co., 2017 WL 2404981 (N.D. Ill. June 2, 2017).  The court also held that the policy’s prior notice provision precluded coverage for the underlying lawsuit, filed during the 2009 policy period, because it related back to a 2007 letter that the corporation tendered to the insurer during a prior policy period.  In addition, the court held that the security holder exclusion barred covered to the extent that the claimants against the corporation were shareholders at the time the original claim was first made.

The insured corporation received a letter from a shareholder in 2007 alleging that its directors had violated their fiduciary duties in agreeing to issue stock to one of the directors on “very favorable prices and terms.”  The letter urged the corporation to adjust the terms of the deal and requested documentation regarding the deal.  The company reported the matter to its directors and officers liability insurer as a notice of circumstance that could lead to a claim, and the insurer agreed to treat the letter as such.  In 2009, 24 former shareholders filed a complaint against six directors asserting racketeering, breach of fiduciary duty and negligence claims arising out of a 2009 merger in which outstanding shares were sold to the same director for an allegedly inadequate price.  The insurer denied coverage under the 2009 policy on the grounds that it arose out of wrongful acts that were the subject of a claim made prior to the policy period.  The insured filed suit seeking coverage under the 2007 and 2009 policies.

The insured argued that the insurer was estopped from raising any policy defenses because it did not provide a defense to the underlying action, relying on the Illinois rule under Employers Ins. of Wausau v. Ehlco Liquidating Trust that an insurer may not simply refuse to defend an insured, but instead must either defend under a reservation of rights or seek a declaratory judgment that the policy does not provide coverage for the claim.  The court rejected this argument, distinguishing between an insurer’s duty to defend and the duty to advance defenses costs in the policy at issue, noting that the policy specifically stated that the insured corporation had the duty to defend claims.

The court also held that the 2007 letter constituted a “claim,” rather than just a notice of circumstances that could lead to a claim, because it was a demand for non-monetary relief.  The court determined that the 2009 lawsuit arose out of the same or related “wrongful acts” as the 2007 letter, as both alleged breaches of fiduciary duty arising out of the same transaction.  The two therefore constituted a single claim first made during the 2007 policy period, and the prior notice exclusion in the 2009 policy barred coverage for the lawsuit.

With respect to the 2007 policy, the insurer contended that no coverage was available based on the security holder, or insured-v.-insured, exclusion, because two of the plaintiffs in the suit were directors of the insured corporation.  The exclusion contained an exception stating that it did not preclude coverage where the security holder bringing the claim acted totally independent of and without the solicitation, assistance, active participation or intervention of any director or officer of the company.  The court held that the exclusion applied only to the claims of the two directors, reasoning that the policy’s allocation provision specifically provided for segregation of covered and non-covered claims.

The insured corporation asserted that the exclusion could not apply to those claimants that were former shareholders.  The court agreed, but held that the relevant time period to consider the claimants’ shareholder status was at the time the 2007 demand letter was sent.  The court could not determine which claimants were shareholders at the time of the letter, but held that, to the extent the claimant shareholders were shareholders at the time of the 2007 letter, the policy did not afford coverage as to their claims.