On August 15, 2011, the Court in Gateway v. Gulf In. Co. issued its Order and opinion on the parties’ cross-motions for summary judgment, ruling fully favorably for the insured company. Case No. 3: 10-cv-01720, USDC, S.D. Calif. (August 15, 2011).

At issue in this case was whether the legal fees and expenses of non-officer employees in their capacity solely as witnesses, and not as parties, were covered under a D&O policy. Officers of the company were defendants in the litigation brought by the SEC and were apparently otherwise covered under the policy.[1]

The pertinent policy language involved the definition of “Directors and Officers,” which included in its original definition in the policy form the following.

2.  to the extent any Claim is for . . . a Securities Law Violation, all persons who, were, now are, or shall be employees of the Company

The definition was subsequently expanded by endorsement. In particular, the following subsection was added, but subsection (2) remained as set forth above.

5.  employees of the Company. However, coverage for employees who are not directors or officers shall only apply when an employee is named as a co-defendant with a director or officer of the Company.

The Court found that these provisions in the policy were ambiguous and resolved such in favor of coverage for the fees and expenses of the employee-witnesses. The Court found that the two subsections of the definition of Directors and Officers were independent of each other and that the “co-defendant limitation” in subsection (5) pertained only to that subsection. Otherwise, the Court held that (2) provided coverage because there was a Claim for a Securities Law Violation.[2]

I would agree that when amending the definition by endorsement, for optimal clarity (2) should have been deleted and replaced with a subsection (5) worded similarly to the following.

5.  past, present or future employees of the Company, but only for a Securities Law Violation alleged to have been committed by them. However, coverage for such employees who are not directors or officers shall only apply when an employee is named as a co-defendant with a director or officer of the Company.

Finding that both insureds and insurer had advanced a reasonable interpretation of the language in light of the ambiguous wording, the Court held in favor of the insured in order to protect its reasonable expectations.

In my opinion, despite the drafting issue, it appears to me that the insured did not establish that the subpoena should have been a covered Claim under subsection (2) when viewed alone.

What are your thoughts?

[1] The policy at issue was a $15M limits policy, excess of $20M in underlying insurance that had been exhausted by payment of limits. The excess insurer had paid over $12M of its $15M limit. The instant case involved $553,875.40 in fees and expenses incurred on behalf of the employee witnesses.

[2] There may have indeed been a Claim for a Securities Law Violation, but it was not made against these employees who by virtue of (2) are deemed to be Directors and Officers. The insurer appeared to have argued this strenuously to no avail. The Court’s reliance on Polychron v. Crum & Forster Ins. Cos., 916 F. 2d 461 (8^th Cir. 1990) is unpersuasive to me. Unlike in this case, Polychron involved a policy without a claim definition and a pre –indictment subpoena upon the president, an officer, of the insured bank.