A New Jersey appellate court, applying New Jersey law, has held that the capacity exclusion in a directors and officers policy precluded coverage for a settlement of lawsuits alleging that an insured director defrauded a shareholder in a related non-insured company when the director acted in a dual capacity as the majority shareholder of the insured company and a director of both the insured and non-insured companies. Mist Pharmas., LLC v. Berkley Ins. Co., 2024 WL 3333916 (N.J. Super. Ct. App. Div. July 9, 2024).
The insured pharmaceutical company and one of its directors, who was also its majority shareholder, were defendants in a lawsuit brought by a shareholder of a related, but non-insured entity in which the director was also a director and shareholder. The plaintiff shareholder alleged that the director used the insured company as a middleman in transactions to defraud the plaintiff.
The insurer agreed to cover a percentage of legal fees incurred given the limited allegations against the insured company and the director in his insured capacity, but it reserved rights under the policy's capacity exclusion, which precluded coverage for any Loss in connection with a claim made against any insured:
based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving any Wrongful Act of an Insured Person serving in their capacity as director, officer, trustee, employee, member or governor of any other entity other than an Insured Entity or an Outside Entity, or by reason of their status as director, officer, trustee, employee, member or governor of such other entity.
The insured company filed a declaratory judgment action seeking coverage under the policy. After the trial court concluded that the insurer had a duty to defend the insureds, the company sought consent to settle and indemnification for the underlying actions, and then waiver of the consent-to-settle provision. The insurer denied the requests, citing a lack of information justifying a contribution by the insurer to the settlement. The company settled the actions without the insurer's consent and subsequently sought a declaration that there was coverage for the settlement. The trial court held that the insurer unreasonably withheld its consent to settle and that it could not raise the capacity exclusion as a coverage defense.
The appellate court reversed the trial court's decision. The appellate court held that the insurer did not unreasonably withhold its consent to settle given the policy's capacity exclusion, as the settlement involved non-insured entities, and the insurer had reserved its right to deny coverage based on the exclusion. It therefore could raise the exclusion as a coverage defense. The court then held that the capacity exclusion barred coverage for the settlement because the alleged wrongful acts in the underlying actions stemmed from the director's self-dealing in which he acted in a dual capacity for the non-insured entity and as a majority shareholder of the insured company. As such, the appellate court held that the claimed loss arose from and could not have occurred but for the director's conduct in his non-insured capacities and therefore coverage was barred.
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