Exception to Insured v. Insured Exclusion for “Any Claim Brought by” Certain Former Directors Does Not Apply to Restore Coverage for Shareholder Derivative Action

In a win for Wiley’s client, the California Superior Court has held that an exception to an insured v. insured exclusion for “any Claim brought by any director . . . of a Company who has not served in such capacity . . . for at least two (2) years prior to such Claim being first made” does not apply to restore coverage for a shareholder derivative action. Int’l. Walls, Inc. fka Art.com, Inc. v. Allied World Assurance Co. (U.S.) Inc., CGC-20-587590 (Cal. Super. Ct. Nov. 1, 2021). The court therefore granted the insurer’s motion for partial judgment on the pleadings and denied the insured’s motion for summary adjudication. 

The underlying shareholder derivative action was filed on behalf of an online retail company by two former directors of the company, one of whom had not served as a director for over two years. The company’s insurer denied coverage for the derivative action under the policy’s insured v. insured exclusion, which bars coverage for suits brought by or on behalf of one insured (the company) against another insured (the company’s board of directors).

In the ensuing coverage litigation, the company argued that an exception to the insured v. insured exclusion for “any Claim brought by any director . . . of a Company who has not served in such capacity . . . for at least two (2) years prior to such Claim being first made” (the “Capacity Exception”) applied to restore coverage for the derivative action. In response, the insurer argued that the Capacity Exception does not restore coverage for the derivative action because, by its plain language, it does not apply to derivative actions brought “on behalf of” an insured. The insurer further argued that, even if the Capacity Exception did apply to derivative actions, it would be inconsistent with the derivative claim exception to the insured v. insured exclusion, which provides that coverage for shareholder derivative actions is restored “only if such action[s] [are] brought and maintained without the solicitation, approval, assistance, active participation or intervention of any Insured or any Affiliate thereof” (the “Derivative Claim Exception”). The insurer argued that the Derivative Claim Exception would trump the Capacity Exception as the more specific provision under California law. 

The court agreed with the insurer and held that the insured’s reliance on the Capacity Exception was misplaced. The court determined that the Derivative Claim Exception makes clear that shareholder derivative actions are covered “only if” an insured does not participate, which was not the case here. The court further determined that the Derivative Claim Exception “would be rendered essentially meaningless under plaintiff’s construction, which would allow a party to simply locate an officer/director who has not served in that capacity (nor acted as a consultant) for a couple of years and add[] them as a named plaintiff to generate coverage.” The court concluded that it “cannot countenance such an artifice.” Accordingly, the court held that the insured v. insured exclusion barred coverage for the derivative action under the policy.

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