A Texas intermediate appellate court, applying Texas law, has held that an insured-versus-insured (IvI) exclusion did not bar coverage for an arbitration award because the underlying dispute arose from alleged wrongful employment practices, bringing the claim within an exception to the exclusion.  Prophet Equity LP v. Twin City Fire Ins. Co., 2019 WL 3886651 (Tex. App. Aug. 19, 2019).  The court also determined that the insurer had not met its burden of proving that any portion of the arbitration award constituted uncovered loss such that an allocation should be imposed.  Id.

The managing member of a two-person private equity firm removed his minority partner from his role as the firm’s COO.  The minority partner responded with a demand letter alleging wrongful termination and asserting that the majority partner had spread false rumors about him to harm his reputation and career.  Following a failed mediation, the minority partner instituted an arbitration in which he alleged that the majority partner fired him to interfere with his contract rights and partnership benefits, and also that the firm misrepresented the actions that he took as COO that led to his termination.  Significantly, the minority partner also asserted derivative claims on behalf of the firm.

The arbitration panel found partially for the minority partner and ordered that the defendants pay his arbitration fees and costs, that the majority partner pay $5.04 million to the minority partner (without specifying the basis), and that the majority partner pay the firm for its fees and costs in defending the arbitration.  When an excess carrier on the firm’s private equity professional and management liability insurance program disputed coverage, coverage litigation ensued.

On appeal of summary judgment in favor of the insurer, the court reversed.  First, after acknowledging that the claim – which was brought by one Insured against two other Insureds – implicated the IvI exclusion, the court ruled that an exception to that exclusion for a claim “brought by one or more of the Insured Persons for Wrongful Employment Practices” applied.  The court expressly rejected the insurer’s argument that the derivative claim – which was not asserted by an “Insured Person” but, effectively, was asserted by an entity Insured – was the relevant “Claim” for purposes of analyzing coverage.  Instead, the court determined, the “entire arbitration” was “rooted in [the minority partner’s] termination as a single Claim beginning with [his] initial demand letter.”  Because that Claim was prosecuted by an Insured Person (the minority partner), and “includes the entire process from start to finish,” the exception to the IvI exclusion applied to the entire matter.

Finally, the court addressed allocation, rejecting the insurer’s argument that the insureds failed to allocate between covered and uncovered amounts.  As an initial matter, the court held that the insurer bore the burden to prove that an exception to the “loss” definition applied, concluding that the exception was in the nature of an exclusion even though it was included within the policy’s definitions section.  Ultimately, the court held that the insurer failed to meet its burden to distinguish between covered and uncovered loss.