Side A Only DIC policies contain very few exclusions and, for the most part, that is the way these policies should be written. One exclusion, however, that has gone by the wayside with perhaps unintended consequences is the insured vs. insured exclusion.

While I do not advocate restoration of the classically broad insured vs. insured exclusion even with numerous “carvebacks”, one needs to consider the ramifications of not having at least the modern entity vs. insured person version of such an exclusion, i.e. an exclusion that will remove from coverage suits brought by the company against its own (typically former) officers and directors.

We recently concluded a contentious arbitration and mediation that illustrates the pitfalls, at least to the insurer and the purchasing entity, of not having this exclusion. The pertinent facts are as follows.

Shortly before it was acquired by K Company, W Company bought a Side A Only DIC policy from which an original insured vs. insured exclusion had been deleted without replacement. After the policy incepted, both W and K were sued by W’s former general counsel for refusing to pay her $180,000 in severance benefits pursuant to agreements in place before the acquisition. W and K (as its successor in interest) counterclaimed for breaches of fiduciary duty. While these claims arguably sought affirmative relief, it was abundantly clear that the counterclaims were asserted primarily as a defense to the claim for severance benefits. The former GC tendered the counterclaim to the Side A insurer, which began paying defense expenses. The claim was also tendered to the underlying A-B-C D&O insurers, but they successfully and correctly disclaimed coverage based upon their insured vs. insured exclusions.

The insurer and insured former officer had lengthy battles over allocation between the covered defense of the counterclaim and her uncovered claim for severance benefits. Ultimately, the dispute went to mediation before more extensive discovery and an arbitration hearing was to take place.

The insurer correctly took the position that all of the former officer’s legal expenses had to be indemnified as a matter of applicable California and Delaware corporate law, as well as the California labor code and the by-laws of W Company. Although the officer also took that position, she simply asserted in mediation that she did not care who paid her legal expenses, i.e. any combination of the insurer and the corporations would do! Essentially, the corporations effectively dropped their counterclaims shortly after the mediation commenced and offered to pay the $180K in severance benefits. The battle then devolved into one over which party would bear the officer’s legal expenses, which were approaching $500K and of which the insurer had already advanced about $150K.

The mediator was very able and despite his urging of compromise by all parties, only the corporations and the officer’s insurer made reasonable concessions. The officer refused to even drop her claim for statutory interest on the severance amounts and her counsel refused to make any meaningful concessions off their fees.

While there was no patent evidence of collusion, the officer was content to simply let the battle be one between her insurers and the corporations. At one point, the general counsel to K Company asked me how the officer got this insurance. I answered immediately and honestly that K, as successor to W Company, bought it for her! When I asked her privately how did she know to give notice to the broker and her Side A insurer when she was no longer with the company, she smugly replied that she was there when the insurance was purchased for the benefit of her and all W officers and directors.

An entity vs. insured person exclusion would have removed this dispute from coverage. Although the absence of the exclusion proved immensely helpful to the officer, there was no legitimate reason not to have it on the policy. The arbitration was at its very core a claim for severance benefits brought by the insured herself and should not have been covered for that reason. The counterclaim proved to be serendipitous for her as it opened a door to coverage, much to the regret of both insurer and her former employer.

While I appreciate the view that the policy responded just as it should, and the corporation’s desire for balance sheet protection is not part of the equation in Side A Only DIC coverage, I share this as a cautionary tale as these coverages continue to evolve and become more commonplace. In my view, an entity vs. insured exclusion would have leveled the playing field.

I would love to hear your thoughts.