Insured-vs-Insured Exclusion Bars Coverage for Action Against Corporation Brought By Minority Shareholders Who Were Also Former Directors
Sunrise Specialty Company, Inc. v. Scottsdale Insurance Company, 2016 U.S. Dist. LEXIS 131664 (N.D. Cal. Sept. 26, 2016), reconsideration denied by, 2016 U.S. Dist. LEXIS 137109 (N.D. Cal., Oct. 3, 2016)
Categories: Directors and Officers Insurance – Insured vs. Insured Exclusion – Derivative Claim Exception
In Sunrise Specialty v. Scottsdale, the district court concluded that an Insured-versus-Insured exclusion in a Business and Management Indemnity Policy precluded coverage for a suit filed against the named insured by three of its minority shareholders, each of which were insured as former directors, precluding breach of contract and “bad faith” claims against the insurer.
Sunrise Specialty Company, Inc. (“Sunrise”) manufactures antique-style plumbing fixtures. Three of its former directors, also minority shareholders, sued the company and its CEO (who was also chairman and majority shareholder) for breach of fiduciary duty, removal of the CEO, inspections of books and records, and dissolution of the company. They alleged that the CEO had a substance abuse problem, became a recluse, and grossly mismanaged the company.
Sunrise tendered the lawsuit to Scottsdale Insurance Company (“Scottsdale”), which had issued a Business and Management Indemnity Policy to Sunrise. Scottsdale denied coverage based on the policy’s Insured-versus-Insured exclusion, as a claim “brought or maintained by, on behalf of, in the right of, or at the direction of any Insured in any capacity.” The policy defines “Insured” to include Sunrise and its “Directors and Officers,” which expressly includes “any person who was, now is, or shall become … a duly elected or appointed director, officer, or similar executive of [Sunrise], or any member of the management board of [Sunrise].”
Sunrise challenged Scottsdale’s denial, arguing that the claim potentially fell within a Derivative Claim Exception to the Insured-versus-Insured exclusion, which exception applies to a claim if it “is brought derivatively by a securities holder of the Parent Company and is instigated and continued totally independent of, and totally without solicitation, assistance, active participation of, or intervention of, any Insured.” Scottsdale reaffirmed its denial, however, concluding that the exception does not apply because the underlying action was not brought derivatively and, further, the underlying action was not instigated and continued totally independent of any Insured, as all the underlying plaintiffs were former Sunrise directors.
Sunrise sued Scottsdale for alleged breach of the duty to defend and “bad faith,” and the parties filed cross-motions for summary judgment. The district court granted summary judgment to Scottsdale, finding “the clear and explicit language of the insured-versus-insured exclusion” applies to the underlying action, and the Derivative Claim Exception does not. The court reasoned: “each of the named plaintiffs in the Underlying Action was an Insured under the Policy, so it would be nonsensical to conclude that the Underlying Action was being continued ‘totally without the solicitation, assistance, active participation, or intervention of, any Insured.’” Sunrise asserted that the underlying plaintiffs could have been “mere[] nominal parties with no active role or participation” in the underlying action despite being the sole named plaintiffs. The court was not persuaded, however, noting that “the only authorities … cite[d] for this contention are cases that distinguish between ‘active’ and ‘nominal’ participation of attorneys in effecting a settlement” and that, “[w]hile one could envision an attorney participating nominally in a settlement agreement actively negotiated by other attorneys, that possibility does not in any way bolster Plaintiffs’ argument that a lawsuit can be brought without the ‘active participation’ of each of its individual named plaintiffs.”
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