California Federal Court Holds Coverage Barred By Prior Notice Exclusion and Related Claims Provision

The United States District Court for the Central District of California, applying California law, granted an insurer’s motion for summary judgment, concluding that (1) the policy’s prior notice exclusion applied; and (2) the lawsuit noticed under the claims-made policy was properly deemed a Claim first made before the policy incepted. Scottsdale Ins. Co. v. Beachcomber Mgmt. Crystal Cove, No. 8:22-cv-01300-JWH-KES, 2025 WL 257599 (C.D. Cal. Jan. 21, 2025). The court further held that, although the underlying plaintiff purportedly sought compensatory damages, the amounts sought were restitutionary in nature and thus uninsurable under California law.

The insured company purchased a directors and officers liability insurance policy for the policy period from September 1, 2019 to September 1, 2020, (the “2019 Policy”). During that policy period, the insured sought coverage for a draft complaint prepared by the Official Committee of Unsecured Creditors in the insured’s bankruptcy case (the “Draft Complaint”). The Draft Complaint purported to assert claims against two of the company’s officers for breaching their fiduciary duties by making decisions over the course of numerous years that were not in the best interest of the company or its creditors. The bankruptcy court subsequently appointed a Chapter 7 Trustee, who first became aware of the Committee’s draft complaint in April 2020.

Effective November 1, 2020, a different insurer issued a new claims-made policy to the insured (the “2020 Policy”). On March 11, 2021, during the policy period of the 2020 Policy, the Trustee filed a lawsuit against the company’s directors and officers, alleging they had breached their fiduciary duties to the company and its creditors, including by usurping opportunities belonging to the company for their own personal benefit. The insurer under the 2020 Policy denied coverage for the Trustee’s lawsuit, including on the bases that (1) the policy’s prior notice exclusion applied; and (2) the lawsuit and the Draft Complaint constituted a single Claim first made before the 2020 Policy incepted.

In the ensuing declaratory judgment action filed by the insurer under the 2020 Policy, the court granted summary judgment for the insurer. As an initial matter, the court held that the prior notice exclusion, which barred coverage for any claim “alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving . . . any Wrongful Act, fact, circumstance, or situation which has been the subject of any written notice given under any other policy of which this Policy is a renewal or replacement or which it succeeds in time,” was “plain, clear, and conspicuous.” Notwithstanding the Trustee’s addition of allegations in its complaint that did not appear in the Committee’s Draft Complaint, the court determined that the prior notice exclusion nonetheless applied because it “broadly incorporates wrongful acts that ‘in any way involve’ the prior noticed claim.” According to the court, the inclusion of the “in any way involving” language in the exclusion “maximally expand[s] the enumerated categories of acts that are excluded from coverage.”

The court also held that the Trustee’s lawsuit and the Draft Complaint were “sufficiently related” that they constituted a single Claim first made before the 2020 Policy incepted pursuant to that policy’s “Related Claims” provision, which stated that “all Claims arising out of the same Wrongful Act and all Interrelated Wrongful Acts shall be deemed a single Claim.” The 2020 Policy defined “Interrelated Wrongful Acts” as Wrongful Acts that “have as a common nexus any fact, circumstance, situation, event, transaction, cause or series of facts, circumstances, situations, events, transactions or causes.” According to the court, both complaints alleged that the company’s officers breached their fiduciary duties; some allegations in the Trustee’s complaint were “directly reproduced” from the Committee’s draft complaint; and the additional allegations in the Trustee’s complaint “unmistakably have an incidental relationship to the allegations in the [Trustee’s] Complaint.”

Finally, the court denied the Trustee’s motion for summary judgment that the insurer had breached its duty to defend, holding that the Trustee’s complaint did not seek covered Loss, where California public policy prohibits the payment of punitive damage awards by insurers, and it is “well established” under California law that “one may not insure against the risk of being ordered to return money or property that has been wrongfully acquired.” Here, the court rejected the Trustee’s argument that it “also sought compensatory damages,” observing that, in deciding whether a certain remedy is insurable, the court “must look beyond the labels of the asserted claims or remedies.” According to the court, “[de]spite the superficial label ‘damages,’ at its essence the [Trustee’s] Complaint seeks restitution in the form of money and property to be returned to [the company].” Because “that type of loss cannot be insured,” the court held that the Trustee’s complaint did not seek covered Loss.