A New York trial court recently granted summary judgment to a group of excess D&O insurers seeking a declaration that their policies do not cover settlements and consent judgments the defendants paid in connection with underlying securities actions. The decision emphasizes the insured capacity limitation in the D&O policy definition of a “wrongful act” and also reinforces that amounts paid as disgorgement are uninsurable as a matter of New York law.

Continental Casualty Co., Argonaut Insurance Co., Freedom Specialty Insurance Co., and QBE Insurance Co. were part of a tower of D&O coverage issued to AR Capital LLC. AR Capital and other defendants — Bellevue Capital Partners, Nicholas Schorsch, Edward Weil, William Kahane, and Peter Budko — sought coverage from the insurers for their share of amounts paid to settle multiple consolidated securities class actions, a derivative litigation, and an SEC enforcement action.

The underlying proceedings alleged that the individual defendants committed securities violations as executives for a publicly traded real estate investment trust, now known as Vereit Inc. Vereit was managed and sponsored by AR Capital from 2011 to 2014. In 2014 and 2015, after its audit committee noticed accounting irregularities, Vereit released new versions of its prior financial statements, sparking multiple civil actions by Vereit shareholders and the SEC enforcement action. The civil litigation was settled for more than $1 billion, of which AR Capital, Schorsch, Weil, Kahane, and Budko agreed to contribute more than $200 million. The SEC enforcement action resulted in consent judgments requiring the defendants to disgorge certain securities and pay more than $30 million in cash disgorgement and civil penalties.

The insurers’ policies were issued to AR Capital as part of a $50 million D&O insurance program. Each policy followed form to a primary D&O policy issued by XL Specialty Insurance Co. The defendants tendered coverage for the settlements to the insurers, which denied or reserved rights to do so on three grounds: (1) the individual defendants are not entitled to coverage because their liability in the underlying acts was solely for acts undertaken as executives of Vereit, not AR Capital; (2) the SEC settlement constituted “disgorgement,” which is barred from coverage under New York law; and (3) even if the defendants suffered a covered loss, the “capacity exclusion” in the XL policy would operate to preclude coverage.

On the parties’ cross-motions for summary judgment, Judge Joel M. Cohen of the New York County Commercial Division ruled for the insurers in all respects.

First, as it relates to the civil litigation, it’s important to note that the defendants were only seeking indemnification for loss incurred by the individual defendants, not AR Capital. This fact was key, the court noted, because Insuring Agreement B of the XL policy only provided coverage for loss arising from a wrongful act. Wrongful act was defined as “any actual or alleged act, omission, misstatement, misleading statement, neglect, or breach of duty by any Insured Person while acting in his or her capacity as … an Insured Person of the Company” and “any matter asserted against an Insured Person solely by reason of his or her status as a director or officer of the Company.” It was undisputed that the individual defendants were insured persons and that AR Capital was a company. The issue was whether Vereit also qualified as a company. To that point, the court ruled that it did not. The court further concluded that the claims in the civil actions related entirely to conduct by the individual defendants in their capacities as Vereit executives, rather than in any capacity for AR Capital. In an attempt to counter, the defendants argued that the pleadings in the civil actions had several allegations relating to conduct undertaken in an AR Capital capacity. But the court rejected the argument, reminding the defendants that the insurers’ indemnification obligations were dictated not by the pleadings, but by the actual facts underlying the claims for which indemnification was sought. Because all liability settled in the civil litigation related to conduct undertaken by the individual defendants on behalf of Vereit, which is not a “company” under the insurers’ policies, the court declared that the settlements were not covered.

Next, with regard to the SEC enforcement action, the ultimate issue was whether the consent judgments constituted loss under the policies. Judge Cohen noted that “loss,” as defined in the XL policy, specifically excluded “matters which are uninsurable under the law pursuant to which this Policy is construed.” In 2018, the New York Appellate Division, First Department, issued a widely cited decision that amounts paid to the SEC as sanctions to disgorge the insured of its ill-gotten gains do not constitute “loss” within the meaning of an insurance policy. Here, the defendants conceded at oral argument that the entire amount of coverage sought for the SEC settlement fell under the umbrella of “disgorgement.” The court therefore declared that all such amounts were uninsurable as a matter of law and thus not covered.

Finally, although the court’s rulings on the first two issues were dispositive, even if the defendants were seeking coverage for a covered loss, the court held that the capacity exclusion in the XL policy would bar coverage in any event. The exclusion stated that the insurers “shall not be liable to make any payment for Loss in connection with any Claim … based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving an Insured Person acting in their capacity as a[n] Insured Person of any other entity other than” AR Capital. Noting that New York courts apply a “but for” test when faced with “arising out of” language, the court found the exclusion applied to bar coverage for the civil settlements because the claims against the individual defendants would have failed but for the allegations against them in their capacities as executives of Vereit, an uninsured entity. Taking it a step further, the court found the exclusion also applied because the underlying claims “in any way involve” the individual defendants’ acts in their uninsured capacities for Vereit.