No EPL or D&O Coverage for Intra-Corporate Shareholder Dispute

In a win for an insurer represented by Wiley Rein, the United States District Court for the District of Maryland has held that an intra-corporate dispute between shareholders was not covered under an EPL insuring agreement because the underlying demand letter and complaint did not state a claim “for” an Employment Practices Wrongful Act, and it was not covered under a D&O insuring agreement because the claimant owned 10% or more of the outstanding shares of the insured company at the time the claim was made.  Madison Mechanical, Inc. v. Twin City Fire Ins. Co., 2019 WL 6035690 (D. Md. Nov. 14, 2019).

When the shareholders of an insured company were asked to make a series of capital contributions, one shareholder (the “ousted shareholder”) contributed a disproportionately small amount of capital.  Shortly thereafter, the remaining shareholders created a new LLC without the ousted shareholder and allegedly began transferring business from the old company to the new one.  In November 2015, the ousted shareholder sent a demand letter to the new LLC, accusing it of diverting corporate opportunities for the benefit of the LLC and to the detriment of the insured company, of which the ousted shareholder claimed he was a 13% shareholder.  A week later, the other shareholders sent the ousted shareholder a letter terminating his employment with the insured company “for cause, effective immediately” in order to trigger their rights under the shareholder agreement to demand that he sell them his stock.

The insureds did not provide notice of the November 2015 demand letter to the insurers.  In December 2015, they submitted an application to the insurer to amend their existing policy to cover the new LLC in addition to the original company and the individuals.  In that application, they represented that there were no claims pending and that they were not aware of any facts or circumstances that might lead to a claim.  The policy provided that any such existing claims, or later claims that arose from existing facts and circumstances, would not be covered.

In May 2016, the ousted shareholder filed suit against the shareholders and both companies alleging, among others, causes of action for declaratory judgment, breach of the stockholders’ agreement, oppression of minority shareholder, and breach of fiduciary duty.  The complaint alleged that the shareholder’s termination “for cause” was a ruse to force him to sell his stock to the other owners, and it did not allege any employment-related tort or seek any damages for the termination of employment.  After the complaint was filed, the insured company put the insurer on notice of the suit.  The insurer ultimately denied coverage under the 2016 Policy because the demand letter constituted a claim made during the 2015 policy period and because of the prior knowledge clause, late notice, 10% percentage shareholder exclusion, and other coverage issues.

In September 2016, the sole director of the insured company signed a resolution diluting the ousted shareholder’s ownership in the insured company to 7.006% “effective April 1, 2015,” which was before the ousted shareholder sent his demand letter.  The insured company and shareholders then filed suit against the insurer, seeking coverage for the underlying litigation and settlement.  The ousted shareholder eventually settled with the insured company and shareholders and signed a declaration that his ownership interest was diluted pursuant to the resolution.

After the first round of summary judgment briefing, the district court held that coverage was unavailable under the 2016 Policy because the claim arose out of the November 2015 demand letter, but that controversies still existed as to whether coverage was available under the 2015 Policy.

After the second round of summary judgment briefing, the district court held that coverage was unavailable under the 2015 Policy for two reasons.  First, the ousted shareholder’s demand letter was not an Employment Practices Claim for an Employment Practices Wrongful Act and did not mention employment, termination, or any employment-related relief.  The court held that, even if the complaint in the underlying litigation was to be considered, it too failed to allege a claim “for” an Employment Practices Wrongful Act – and the ousted shareholder’s request for declaratory judgment that he remained an employee did “not transform his complaint into a claim ‘for wrongful termination.’”

Second, the 10% percentage shareholder exclusion barred coverage under the D&O provision because the ousted shareholder was at all relevant times an owner of 10% or more of the outstanding shares of the insured company.  The court held that, as a matter of Maryland law, the shareholders could not avoid the percentage shareholder exclusion by “backdating” a resolution in order to dilute the ousted shareholder’s shares retroactively. The court thus held that coverage was unavailable under the 2015 Policy as a matter of law and did not address the insurer’s remaining arguments on the insured v. insured, prior knowledge, and loss history exclusions.


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