Small Words, Big Consequences: Avoiding Traps That May Eliminate D&O Coverage For Innocent Policyholders

A recent court ruling serves as a reminder that the smallest of words — an, the, any or such — may determine whether a D&O policy exclusion applies to a policyholder's claim. In TranSched Sys. Ltd. v. Fed. Ins. Co., CA 12-939-M, 2013 WL 3974134 (D.R.I. Aug. 2), the court considered whether a jury verdict of intentional misrepresentation triggered a D&O policy's fraud exclusion. The policy excluded coverage "based upon, arising from, or in consequence of any deliberately fraudulent act or omission or any willful violation of any statute or regulation by such Insured . . . ." The court focused in part on the specific language that excluded coverage for the enumerated acts by "such Insured." The court concluded that the modifier "such" limited the application of the exclusion to the specific insured who was subject to the jury verdict, and therefore the triggering of the exclusion would not preclude coverage for other insureds.

The TranSched case provides yet another example of the difference that seemingly minor changes in D&O policy language can have on coverage, particularly in the case of the application of so-called "bad acts" exclusions (generally for fraud, criminal acts or illegal profit). Thus, whether the bad acts of one insured operate to preclude coverage for other innocent insureds may turn on whether the insured, an insured or any insured first triggered the bad acts exclusion. See e.g. Chacon v. American Family Mut. Ins., 788 P.2d 748, 751 (CO 1990) (holding that "unlike the phrase 'the insured,' the phrase 'any insured' unambiguously expresses a contractual intent to create joint obligations and to prohibit recovery by an innocent co-insured."); Michael Carbone, Inc., v. General Accident Ins. Co., 937 F.Supp. 413, 419 (E.D.Pa. 1996) (holding that "the punchline is this: the term 'the insured' means, and means only, the person claiming coverage, or [to put it another way] only the person coverage for whom is the issue."); Medill v. Westport Ins. Corp., 49 Cal.Rptr.3d 570, 580 (Cal. 2nd Dist. Ct. App. 2006) (California cases have determined that the phrases "any insured" or "an insured" unambiguously preclude coverage to all persons covered by the policy if any one of them engages in excludable conduct.).

The existence of severability provisions in D&O policies may also provide false comfort against the risk of coverage potentially being eliminated for innocent insureds through the use of "small" words in a bad acts exclusion. A...