Conduct Exclusions Inapplicable Absent Finding of Insured’s Dishonesty or Intent to Deceive
The United States District Court for the Southern District of California, applying California law, has held that: (i) a D&O policy’s dishonesty exclusion did not bar coverage where the judgment at issue did not include a finding that the insured was dishonest or acted with intent to deceive; (ii) a profit exclusion did not bar coverage where the judgment was not “due to” the insured’s theft; and (iii) the insured’s prior criminal conviction did not constitute an interrelated claim because the policy was ambiguous as to whether “claims” subject to the interrelated acts provision included criminal proceedings. Parkside/El Centro Homeowners Ass’n v. Travelers Cas. Ins. Co. of Am., 2023 WL 2705834 (S.D. Cal. Mar. 29, 2023).
From 1988 to 2014, the insured property manager stole more than $300,000 from her employer, a homeowners’ association. In 2014, the district attorney filed a criminal action against her, and the insured ultimately pled nolo contendere to a criminal charge of embezzlement. At around the same time, the manager filed a complaint in state court against the homeowners’ association on employment-related claims. The association filed a cross-complaint naming the manager as a defendant and asserting a claim of breach of fiduciary duty against her. The cross-complaint also named as cross-defendants three of the association’s former directors who were responsible for supervising the manager. The state court ultimately entered judgment against the former directors, but not against the property manager. According to the statement of decision, the directors stipulated to liability for claims alleging “negligence, a contractual breach, a negligent breach of fiduciary duty, and other alleged negligent conduct.” Following entry of the judgment, the directors assigned their rights under their D&O policy to the homeowners’ association, which tendered notice to the D&O insurer. The insurer denied coverage for the claim.
In the ensuing coverage litigation, the court held that the dishonesty and profit exclusions did not apply, and the manager’s criminal prosecution was not an interrelated claim barring coverage.
First, the court determined that the dishonesty exclusion did not bar coverage. The exclusion applied “if judgment adverse to your ‘Directors’ or ‘Officers’ in ‘suit’ [sic] brought against them, will establish that their affirmative dishonesty or actual intent to deceive or defraud was material to the cause of action so adjudicated.” Because the association’s damages were caused by the “negligent conduct” of the former directors, and the judgment did not turn on any finding of the property manager’s “affirmative dishonesty” or “actual intent to deceive,” the court concluded that the exclusion did not apply. The court rejected the argument that the adverse judgment from the cross-complaint established the property manager’s dishonesty by inference.
Second, the profit exclusion – which applied to claims “due to” an insured gaining any personal profit to which it was not legally entitled – did not bar coverage. The court determined that the phrase “due to” was ambiguous. Under the circumstances, the court ruled that applying the exclusion narrowly to encompass only claims requiring a showing of illegal personal gain provided the broadest reasonable expectation of coverage. Because the judgment was not against the property manager but instead arose out of the negligence of the directors, the elements of the claim did not require a finding of illegal personal gain, so the profit exclusion did not apply.
Third, the court determined that the property manager’s prior criminal conviction did not constitute an interrelated claim first made before coverage incepted. The court deemed the policy ambiguous because it referenced only “civil claims” in the coverage grant and did not distinguish among claim types in the interrelatedness provision. Under the circumstances, the court applied a narrow interpretation of “claims” to mean only civil claims, thus precluding consideration of a criminal action in the context of a relatedness analysis.