D&O Insurer Has Duty to Defend Where Counterclaim Allegations Against Directors Arguably Involve Insured Capacity

Applying New York law, the United States District Court for the Southern District of New York has held that a D&O insurer had a duty to defend a counterclaim that at least arguably made allegations of wrongful conduct against insured executives in their capacities as such. Spicer v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2021 WL 2809601 (S.D.N.Y. July 3, 2021).

In connection with the sale of a company, former shareholders of the company sued the acquiring company regarding the application of an earnout provision in the purchase and sale agreement. The acquiring company filed a counterclaim against three of the purchased company’s shareholders, who were also executives of the purchased company’s subsidiary, alleging that those individuals misrepresented the financial condition of both the parent and subsidiary companies, causing the acquiring company to purchase the parent company at an inflated price. The three individuals tendered the counterclaim to the D&O carriers for both the purchased company and its subsidiary.  The subsidiary’s insurer denied coverage, alleging that the counterclaim did not allege “Wrongful Acts,” which required that alleged conduct be taken by the subsidiary’s executives or employees “in their respective capacities as such” or involve “claims against such Executive or Employee solely by reason of his or her status as an Executive or Employee of the Company.” The subsidiary’s insurer also denied coverage based on the “capacity” exclusion, which barred coverage for losses in connection with claims “alleging, arising out of, based upon or attributable to any actual or alleged act or omission of an Individual Insured serving in any capacity other than as an Executive or Employee of a Company[.]”

In ensuing coverage litigation, the court held that the allegations in the counterclaim created at least a potential for coverage, triggering the duty to defend. Relying on the first prong of the “Wrongful Act” definition, which unlike the second prong, did not include the word “solely,” the court concluded that it could be reasonably inferred that the individuals were acting in their insured capacity as executives of the subsidiary when they provided misleading financial statements with respect to the subsidiary. With respect to the “capacity” exclusion, the court concluded that legitimate questions of fact remained regarding the capacity in which the individuals were acting when undertaking the conduct alleged in the counterclaim.