A D&O case decided by the New Jersey Supreme Court in May should get the attention of anyone who runs more than one business entity.
It certainly got mine.
The case is Mist Pharmaceuticals, LLC v. Berkley Insurance Company. At the center of it was Joseph Krivulka, chairman of Mist Pharmaceuticals. Krivulka wasn’t just involved with Mist. The underlying litigation involved more than a dozen entities he owned or controlled. Lawsuit here.
That’s hardly unusual.
I have clients where the same individual may be an officer of the operating company, manager of the LLC that owns the building, an owner of a holding company and a board member somewhere else. Add private equity, joint ventures or multiple real estate projects and the organizational chart gets complicated quickly.
The problem in Mist was that the D&O insurance didn’t necessarily travel with Krivulka as he moved between those roles.
The exclusion that mattered
Mist had a D&O policy issued by Berkley Insurance Company. Krivulka was an insured person under that policy when acting in an insured capacity for Mist.
But the policy also contained a capacity exclusion.
The underlying lawsuit alleged self-dealing involving transactions among businesses Krivulka controlled. Some of those businesses were not insured under Mist’s D&O policy.
Berkley relied on language excluding claims “in any way involving” certain wrongful acts committed by an insured person while serving another entity. The New Jersey Supreme Court ultimately found the exclusion broad enough to apply.
Think about the practical problem that creates.
An executive doesn’t necessarily stop during a business decision and think:
“Which corporate hat am I wearing at this exact moment?”
He may be thinking about the interests of the operating company, holding company and another affiliated entity at the same time.
The insurance contract may care very much about the distinction.
That is what makes this case interesting to me. Excellent analysis here.
Berkley didn’t simply show up at the end and deny the claim
Some commentary about the case makes it sound as though Berkley defended the insured for years and then suddenly discovered an exclusion when a $12 million settlement appeared.
That’s not quite what happened.
Berkley had been reserving its rights. It specifically raised the capacity exclusion and ultimately agreed to reimburse 10% of certain defense costs while continuing to maintain its coverage position.
That distinction mattered.
When the insured later argued that Berkley’s earlier participation should prevent it from relying on the exclusion, the court disagreed.
There’s a practical lesson there too. If your carrier sends a reservation-of-rights letter, don’t file it away simply because the carrier is currently paying some defense costs. The letter may be telling you that the insurer sees a fundamental coverage problem that hasn’t been resolved.
I wouldn’t respond to this case by simply asking for the capacity exclusion to be removed
That would be too easy, and in many cases probably unrealistic.
I’d start somewhere else.
Show me the organizational chart.
Then show me the people.
If John Smith owns ABC Holdings, which owns ABC Manufacturing and ABC Distribution, while John personally owns the LLC holding the real estate and also sits on the board of a company partially owned by ABC Holdings, I want to know that before we start deciding whether his D&O program works.
Then we can put the policies next to the structure and ask better questions:
Which entities are actually insured?
How does the policy define an Insured Organization and Insured Person?
What happens when an executive acts for an affiliated entity that isn’t an insured organization?
Is there Outside Directorship Liability coverage?
What happens with a joint venture?
Has the company created or acquired entities since the policy was written?
And, yes, what exactly does the capacity exclusion say?
Those aren’t hypothetical insurance questions anymore. Mist gives us a $12 million reason to ask them.
Where I think the real gap develops
Most businesses don’t wake up one morning and create a complicated organizational structure.
It happens gradually.
Someone buys a building and puts it in an LLC.
A second operating company gets formed.
An investor comes aboard.
A joint venture makes sense for a particular opportunity.
A new acquisition closes.
An executive accepts a board seat.
Five years later, the organizational chart looks nothing like it did when the insurance program was originally designed.
The D&O renewal, meanwhile, may still begin with last year’s application and last year’s policy.
That’s the part of this case I think deserves more attention than the exclusion itself.
The question isn’t simply whether your D&O policy contains a capacity exclusion. Many do.
The better question is whether your insurance program still matches the business you’re actually running.
For companies with multiple entities, I’d suggest periodically putting the organizational chart, executive roles and D&O policies on the same table and comparing them.
You may discover everything lines up perfectly.
I’d rather discover that while reviewing the program than after someone files a lawsuit.
Insurance coverage is determined by the specific policy language, including definitions, conditions, exclusions and endorsements, together with the facts of the claim and applicable law. The Mist decision involved particular policy language and allegations and should not be read to mean that every capacity exclusion will produce the same result. This article is for general informational purposes and is not legal advice.
