Back in the 80s and 90s, during the environmental insurance coverage wars, each side (insurance companies and policyholders) frequently accused the other of trying to insert imaginary language into insurance policies after losses had happened. Many lawyers put their kids through college arguing about the meaning of the words “sudden” and “accidental,” for example, in the standard-form pollution exclusion.

Both sides were fond of quoting from “Alice in Wonderland” in their legal briefs, and particularly this passage:  “’When I use a word,’ Humpty Dumpty said, in rather a scornful tone, ‘it means just what I choose it to mean—neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master—that’s all.’”

It eventually got to the point where we all declared a moratorium, by agreement, on any future Lewis Carroll references.

I still occasionally quote Lewis Carroll in briefs, though, when insurance companies seem to be engaging in “post-loss underwriting.” I see that pretty often these days in computer fraud claims (where insurance companies argue that their policies required an actual “hack” into their policyholder’s computer systems, even though the policy says nothing of the sort). But you can find post-loss underwriting creeping through many types of coverage disputes, and I often wonder where the insurance industry would be if defense-friendly judges stopped letting carriers get away with it.

In a recent Delaware case, for example, the Court essentially decided to rewrite an exclusion in a Directors & Officers Liability Policy to create a restrictive test as to whether coverage would be provided.

Before I go further, let me discuss what D&O coverage is supposed to do.  This is what the website of a major carrier (The Hartford) says, for example: “Directors and officers (D&O) liability insurance protects the personal assets of corporate directors and officers, and their spouses, in the event they are personally sued by employees, vendors, competitors, investors, customers, or other parties, for actual or alleged wrongful acts in managing a company.  The insurance, which usually protects the company as well, covers legal fees, settlements, and other costs. D&O insurance is the financial backing for a standard indemnification provision, which holds officers harmless for losses due to their role in the company. Many officers and directors will want a company to provide both indemnification and D&O insurance.”

The Hartford website gives many examples of the types of claims for which coverage is supposedly provided, including breach of fiduciary duty resulting in financial losses or bankruptcy; misrepresentation of company assets; misuse of company funds; fraud; failure to comply with workplace laws; theft of intellectual property and poaching of competitor’s customers; and lack of corporate governance.

Anyway, that’s what the people selling this type of insurance generally say.  The people handling claims often have a different point of view, and they sometimes find kindred spirits in the judiciary.

Goggin v. National Union (which you can read here), for example, involved two former directors (Goggin and Goodwin) of a bankrupt entity called U.S. Coal Corporation.  During their terms as U.S. Coal investors and directors, Goggin and Goodwin tried to reinvigorate US Coal through debt purchase and other capital restructuring, in part by forming two investment vehicles, called the ECM Entities.

The reinvigoration efforts didn’t work, and the Bankruptcy Trustee later alleged that Goggin  and Goodwin had engaged in self-dealing with respect to the ECM Entities, diverting assets for personal gain.  For purposes of D&O insurance, the key point to remember here is that Goggin and Goodwin formed the ECM Entities while acting as directors of U.S. Coal, ostensibly in an effort to help resuscitate U.S. Coal.

Goggin and Goodwin duly submitted the claim to National Union, their D & O carrier, requesting a defense.

National Union denied coverage, relying on a so-called “capacity” exclusion.  The exclusion removes coverage for 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, or as an Outside Entity Executive of an Outside Entity.”  (Emphasis mine.) Since Goggin and Goodwin supposedly formed the ECM Entities as part of U.S. Coal’s recovery efforts, while serving as executives of U.S. Coal, the exclusion seems to be irrelevant, right?  Wrong.

Notice that the words “but for” are nowhere to be found in this exclusion. Undeterred, the Court decided that it would employ a “‘but-for’ test to determine if a claim ‘arises out of’ a manufacturer’s product in a product liability suit.” Of course, this was not a product liability suit. It was an insurance coverage suit, and the policyholder is entitled to the benefit of the doubt when it comes to insurance policy language that can be construed in more than one way. The Court wrote, though: “[T]he Trustee Claims – which give rise to this declaratory action – would not have been established ‘but-for’ Goggin and Goodwin’s alleged ECM-related misconduct. Indeed, the alleged formation and use of the ECM Entities to engage in self-interested dealing benefiting themselves and those ECM Entities, all at the expense of U.S. Coal, are no collateral matters but rather the core of the Trustee Claims. ‘But for’ Goggin  and Goodwin’s roles as managers/members of ECM Entities, the…Claims would fail.”

Of course, “but for” Goggin and Goodwin’s roles as directors of U.S. Coal, the claims would also fail.  The Bankruptcy Trustee brought the claims, after all, on behalf of U.S. Coal, for Pete’s sake.

This case nicely illustrates a big problem that policyholders sometimes face.  I’m not singling out the Delaware judge who wrote this decision, but I note from reviewing his bio that he was a government lawyer and prosecutor for 20 years before ascending to the bench. Many judges do not have a background in insurance law, and substitute their own experience and analogies for how policies are supposed to work. Here, the judge used the tenets of product liability law to construe an insurance policy, which is a comparison of apples to oranges.   Viewed through the correct prism of insurance law, the allegations of the underlying case should never cause a forfeiture of coverage unless and until they’re proven to be true, and unless and until the actual misconduct clearly and unequivocally supports the application of a policy exclusion.  Until then, in general, the insurance company should be providing a defense.

I guess the main lesson here is, think carefully before taking a Board position.  If something goes wrong, your carrier may not be there to help you.  And do everything you can to prevent claims from happening in the first place. Honesty is always the best “policy.”  (See what I did there??)