Capacity Exclusion Does Not Bar Coverage for Claims for Misconduct Allegedly Motivated By Outside Capacity

A California federal district court has held that a capacity exclusion in a D&O policy did not bar coverage for a claim against insured executives alleged to have taken actions for the benefit of another company because they were sued for breaching their duties to the insured company, not the other company. Abrams v. Allied World Assurance Co. (US) Inc., 2023 WL 2214175 (N.D. Cal. Feb. 24, 2023). The court also held that a major security holder exclusion did not apply because the requisite ownership at the time the claim was deemed made was less than the threshold, even if the lawsuit was not made until after the ownership threshold for the exclusion had been exceeded.

In 2020, a shareholder of an insured software company filed a books and records demand. Then, one year later, the shareholder filed a lawsuit asserting that insured executives breached their fiduciary duties by taking actions to benefit another company to the detriment of the insured’s shareholders. The claimant had previously owned less than 10% of the company’s stock when it first made the books and records demand, but by the time of the lawsuit, the shareholder had increased its total ownership to 48.8%. The insured tendered both matters to its D&O insurer, which denied coverage for the lawsuit.

In the ensuing coverage action, the court granted partial summary judgment in favor of the insureds after finding that two exclusions did not apply. First, the court rejected an insurer’s argument to apply an exclusion for loss attributable to any “actual or alleged act or omission of any Insured Person serving in any capacity other than as an Executive,” reasoning that the breach of fiduciary duty claims were solely based on the executives’ actions in their capacities as insured executives (even though they were allegedly motivated by their roles in the other company). Second, the court rejected the insurer’s argument that coverage was barred by an exclusion for claims made by “any past, present or future security holder of the Company, … who owns or owned as of the date of the Claim, … a 10% or more equity interest in the Company.” In so ruling, the court focused on the date of the initial books and records demand as the “date of the Claim” given that the lawsuit related back to that demand, and it rejected the insurer’s argument to apply the exclusion if the claimant maintained the 10% ownership interest during any point in the claim’s existence.