The Delaware Superior Court handed down an important decision of particular relevance to private equity sponsors also serving as portfolio company directors. In Goggin v. National Union Fire Insurance Company of Pittsburg, PA, No. N17C-10-083 PRW CCLD (Super. Ct. Del. Nov. 30, 2018), the Delaware Superior Court held that the policy’s “capacity” exclusion unambiguously excluded coverage for claims by two directors arising out of their roles as both directors and investors in the company. Between 2007 and 2014, Goggin and Goodwin acted as directors and investors in US Coal Corporation. During their tenure as directors, in an attempt to save the failing business through debt repurchases and other capital restructuring activities, they formed two investment companies. In 2014, US Coal entered bankruptcy, and the following year a complaint was filed against Goggin, Goodwin, and their investment companies alleging breach of fiduciary duties and that Goggin and Goodwin favored their own personal interests with respect to the investment vehicles to the detriment of the portfolio company.
At the time, US Coal maintained a D&O policy and Goggin and Goodwin sought coverage under the policy. The D&O insurer acknowledged that the directors were individually covered but denied coverage on the basis that the alleged fiduciary duty claims arose from wrongdoings that did not “arise out of” their roles as directors and, as a result, the claims were excluded under the capacity exclusion in the policy. The “capacity” exclusion at issue in the policy provided that:
The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an insured…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….
The Delaware Superior Court ultimately agreed with the insurer. In so holding, the court considered the term “arising out of” in the exclusion and applied a “but for” test in determining the applicability of the D&O’s capacity exclusion clause: “the question is whether the underlying claim would have failed ‘but for’ the purportedly excluded conduct.” Specifically, in applying the test, the court concluded that but for the director’s excluded conduct, their role as members of the investment entities, the breach of fiduciary duty claims would have failed and thus, the exclusionary clause applied thereby barring coverage for the claims against them.
The bottom line appears to be that under Delaware law, a capacity exclusion may apply to preclude coverage even if the underlying claims for relief implicate the individual’s role as a corporate officer or director, as long as the core of the claims for relief arise from misconduct in a capacity other than as a director or officer. To be sure, private equity sponsors should (i) review D&O policies carefully to determine whether a capacity exclusion is included and (ii) if a capacity exclusion is present, work with insurance brokers to either limit or eliminate such exclusion.
