“Capacity” Exclusion Bars Coverage for Two Directors for Claims of Wrongdoing and Fiduciary Breaches Outside Their Insured Capacity

Applying Delaware law, a Delaware state court has held that a policy’s “capacity” exclusion precluded coverage for two directors because the claims filed against those directors would not have been established “but for” the directors’ alleged misconduct related to third-party investment entities the directors formed to control the insured company.   Goggin v. National Union Fire Ins. Co. of Pittsburgh, 2018 WL 62661195 (Del. Sup. Ct. Nov. 30, 2018).

After the coal company insured filed for bankruptcy, the trustee brought an action against two former coal company directors and the investment entities those directors had formed alleging, among other claims, breach of their duties as directors of the coal company for scheming and engaging in self-interested dealings at the company’s expense. The directors tendered these claims to the coal company’s D&O carrier.  The insurer denied coverage under the “capacity” exclusion as the alleged wrongdoing was not “solely by reason of their status” as executives of the insured due to a conflict of interest with the non-insured investment entities.

In the ensuing coverage litigation, the directors argued that the “capacity” exclusion did not apply to the allegations asserted against them and that the insurer was obligated to pay all defense and indemnity costs.  On the directors’ motion for judgment on the pleadings, they contended that even though the alleged conflict of interest existed due to their capacities and status as both directors of the insured coal company and members/managers of the investment entities, the “capacity” exclusion did not apply if the alleged wrongful action was performed in their capacities as directors of the coal company. The insurer argued that the crux of the exclusion was whether or not the sued-upon conduct “arises out of” a capacity other than that as directors of the insured.  According to the insurer, the trustee’s claims arose out of the directors’ capacity as members/managers of the entities, and it was not the case that any action per se “arose out” of their capacity as directors.

After finding the “capacity” exclusion language clear and unambiguous, the court considered the term “arising out of” and concluded that a “but for” test was appropriate to determine whether the underlying claim against the directors would have failed “but for” the purportedly excluded conduct -- their capacities as mangers/members of the investment entities.  In applying this test, the court held that, because the trustee claims would not have been established “but for” the directors’ alleged misconduct with the investment entities, the exclusionary clause applied and eliminated the insurer’s obligation under the policy.