The New Jersey Supreme Court affirmed an appellate ruling that allowed a D&O insurer to withdraw coverage under a capacity exclusion after it had reserved rights from the start.
The case involved Mist Pharmaceuticals, the named insured under a Directors and Officers insurance policy. The policy treated the chair of Mist’s board of directors as an insured person. It also included a capacity exclusion.
That exclusion barred coverage for claims involving a Wrongful Act by an insured person acting as a director, officer, trustee, employee, member or governor of any entity other than an insured entity.
The dispute started after another company, partly owned by the chairman, filed direct and derivative claims against Mist, the chairman and several other entities he owned or controlled.
The plaintiff alleged that the chairman and his paper companies carried out a self-dealing scheme and improper transfers that diverted profits away from the plaintiff entity.
Mist and other chairman-owned companies hired defense counsel. Mist then tendered the claim to its D&O insurer. The insurer first agreed to defend under a reservation of rights. It stated that only Mist and the chairman qualified as insureds under the policy. None of the other defendant entities qualified as insured entities.
The insurer also warned that the capacity exclusion barred coverage for allegations tied to the chairman’s roles at any company other than Mist.
The insurer later withdrew coverage for the claims against Mist. It based that decision on allegations it said Mist knew before the policy period began. When the insurer withdrew coverage, it also told Mist it would not participate in mediation.
Mist sued the insurer for coverage. It alleged breach of the policy, estoppel and bad faith, and it sought a declaration that the policy covered the claims. The insurer raised the capacity exclusion as an affirmative defense. It also filed counterclaims seeking reimbursement for defense fees it had already paid in the underlying litigation.
During the coverage action, Mist asked the insurer to join a global settlement negotiation. The parties reached a settlement without the insurer’s participation. The trial court later found that the insurer owed Mist both a defense and indemnity for the settlement.
The insurer appealed. The Appellate Division reversed the trial court. Mist then petitioned the New Jersey Supreme Court for certification. The court granted review and affirmed the Appellate Division’s reversal.
Before the New Jersey Supreme Court, the insurer argued that the capacity exclusion barred coverage because the claims centered on the chairman’s self-dealing as a director of the plaintiff entity, not his role as a director of Mist. That distinction carried the case.
The court separated two types of exclusions. Some exclusions require evidence of a causal link between an excluded act and the alleged loss. Others do not. The court placed this capacity exclusion in the second group because the policy language did not require proof that the excluded conduct caused the loss.
The court instead focused on the phrase in any way involving. It held that the exclusion barred coverage where the allegations in the underlying action in any way involved a wrongful act by an insured person acting in a role for another entity.
The claims focused on the chairman’s acts and omissions as a director of the plaintiff entity, not as Mist’s director. On that basis, the court found the allegations fell within the exclusion and barred coverage.
A dissent reached a narrower reading. It concluded that the exclusion barred coverage only for wrongful acts the insured person committed in an uninsured capacity. Under that view, the policy would still respond to claims based on acts he committed in his insured capacity as Mist’s director.
The majority rejected that approach. It held that the exclusion barred any claim in any way involving a wrongful act committed because of an insured person’s status as a director or officer of another entity.
That wording mattered. Even if some claims partly involved the chairman’s role at Mist, the claims also involved alleged unfair dealing between Mist and an uninsured entity he controlled. Since each claim involving Mist also involved alleged wrongful acts by the chairman in his capacity as an officer or director of an uninsured entity, the court found the capacity exclusion applied to the claims as a whole.
The court also rejected Mist’s bad-faith and estoppel arguments. It held that the insurer did not act in bad faith when it declined to participate in the global settlement. Once the insurer correctly determined that the exclusion barred coverage, it had no obligation to contribute policy limits toward the settlement.
The reservation-of-rights record mattered too. The insurer reserved rights under the operative exclusion at the beginning of the defense. It later relied on that reservation when it denied coverage.
The court found that sequence allowed the insurer to withdraw coverage and defeated Mist’s estoppel theory.
For D&O insurers, the ruling gives capacity exclusions sharper force in disputes involving common control, related companies and allegations of insider dealing across insured and uninsured entities. For insureds, it narrows room to argue that partial insured-capacity conduct preserves coverage when the same claims also involve uninsured-capacity conduct.
