September 01, 2004
By Glenn D. West and Stephen A. Radin
Reprinted From Aspen Corporation Bulletin
The United States Court of Appeals for the Fifth Circuit’s recent two-to-one decision in TIG Specialty Insurance Co. v. PinkMonkey.com Inc., 375 F.3d 365 (5th Cir. 2004), holds (1) that the chairman, chief executive officer and majority shareholder of a start-up internet company gained a personal profit by securing funds from investors for the company – not himself – and thereby triggered a personal profit exclusion in the company’s directors and officers (“D & O”) insurance policy, and (2) that the D & O policy personal profit exclusion excluded coverage not just for the insured chairman, CEO and majority shareholder found to have gained a personal profit, but also for all other insured directors and officers.
The decision, construing Texas law and written by Circuit Judge Emilio M. Garza and joined by Circuit Judge Rhesa H. Barksdale – together with a strongly worded dissent written by Circuit Judge Charles Willis Pickering, Sr. – illustrates:
- the possibility that courts may deem substantial shareholders of a corporation who obtain investments for the corporation to have gained a personal profit from these investments;
- the careful parsing of words that often characterizes D & O coverage litigation;
- the fact that D & O insurers often try to deny coverage – and sometimes succeed – where insured directors or officers are found to have engaged in improper conduct; and
- that directors and officers who have done nothing wrong – and whose own conduct triggers no policy exclusion – may find themselves without insurance due to the actions of an insured other than themselves.
The decision involved a start-up business and a Texas statute that arguably provides grounds for limiting the decision’s reach, particularly in the context of the breach of fiduciary duty and federal securities law claims often brought against directors or officers.
Nevertheless, two practice points should be emphasized.
First, directors and officers of start-up and private equity funded businesses and their counselors, however, would be well advised to review their D & O policies and consider taking steps to ensure that securing investments for a corporate or other business entity does not give rise to a personal benefit triggering a personal profit exclusion. An endorsement such as the following would accomplish this goal:
Nothing in the Personal Profit Exclusion in § __ of this Policy excludes coverage for any claim against any Insured for personal profit, remuneration or advantage the Insured derives as the result of an investment of funds in [the Company] if no profit, remuneration or advantage is gained by the Insured as a result of the investment other than as a shareholder or owner of the entity.
Second, and particularly important from the perspective of outside directors – D & O policies should be reviewed to ensure coverage for innocent directors and officers for conduct that may trigger a personal profit exclusion with respect to any other director or officer. Many policies already include language addressing this issue by specifically providing that “the facts pertaining to and knowledge possessed by any Insured shall not be imputed to any other Insured” for the purpose of the personal profit and other similar exclusions. Where such language is not present in a policy, an endorsement as simple as the following would be sufficient:
Nothing in the Personal Profit Exclusion in § __ of this Policy excludes coverage for any claim against any Insured who did not himself or herself gain any personal profit, remuneration or advantage to which that Insured was not legally entitled.
The PinkMonkey.com case involved a jury verdict against Patrick Greene, the chairman, chief executive officer and majority shareholder of PinkMonkey.com, a start-up internet company having four employees and operating out of a garage, for statutory stock fraud under Section 27.01 of the Texas Business and Commerce Code in connection with a capital investment by five individuals in PinkMonkey.com. “In order to find Greene liable for statutory stock fraud” under this particular Texas statute, “the jury was required to find that he ‘benefited from the false representation or promise,’” and a personal profit exclusion in PinkMonkey.com’s D & O policy, issued by TIG Specialty Insurance, read, in full, as follows:
This insurance does not apply to any Claim made against any Insured arising out of any of the following: . . .
L. Any Claim based upon, arising from, or in consequence of an Insured having gained in fact any personal profit, remuneration, or advantage to which such Insured was not legally entitled.
In a ruling joined by all three judges on the Fifth Circuit panel that decided the case, the court held that the personal profit exclusion barred coverage for Greene.
The court stated that the term “benefit” in the statute was “synonymous” with the terms “profit” and “advantage” in the policy exclusion and that a majority shareholder in a small start-up company “gains a personal advantage from a sizeable capital investment in the company because it gives the majority shareholder the opportunity to become the owner of a successful business.” In support of his proposition, the court cited Jarvis Christian College v. Nat’l Union Fire Ins. Co., 197 F.3d 742, 747 (5th Cir. 1999), a case holding that an investment in a new business accrues to the personal advantage of the owner of a 49% interest in the business “by infusing his business with substantial investment capital by which to operate his business.”
As a result, the court found, “Greene’s statutory stock fraud conviction indicates that he gained in fact a personal profit or advantage.” Greene was not legally entitled to this “personal profit or advantage,” the court also found, because “[a] defendant is not legally entitled to an advantage or profit resulting from his violation of law if he could be required to return such profit” and “[t]he remedies for a violation of § 27.01 include the equitable remedy of rescission, which requires the return of any money paid.”
The court accordingly held that “[b]ecause return of the capital investment in PinkMonkey could have been required, there was no legal entitlement to the capital investment,” that “Greene’s fraud resulted in the capital investment, which led directly to his personal advantage,” and that “Greene was not legally entitled to profit from his fraud.” Coverage for Greene therefore was excluded by the personal profit exclusion.
Other Directors and Officers
The court divided with respect to PinkMonkey.com’s other directors and officers, who did not themselves obtain an improper profit or gain, but who had settled claims or been found liable for violations other than § 27.01 “based upon Greene having gained an advantage to which he was not legally entitled.”
The majority held that the “plain language” of the personal profit exclusion barred coverage for all directors and officers, not just Greene. The court reasoned as follows:
The exclusion does not require that the claim be based upon the Insured,that Insured or such Insured having gained a personal profit or gain, but based upon an Insured having gained a personal profit. Although the terms “the Insured,” “that Insured” or “such Insured” preceding personal profit would indicate the same insured as the claim is brought against, the Personal Profit Exclusion uses the more general term “an Insured.” This indicates that coverage is excluded for all Insureds, not merely the Insured who profited.
The court added that “[b]y considering the entire provision, it is clear that a claim arising out of an Insured having gained personal profit is not limited to a claim against the Insured who profited.” The court explained that the exclusion uses “the specific term ‘such Insured’ to indicate the same insured as previously referred to, when it states that the claim must arise from ‘an Insured having gained in fact any personal profit . . . to which such Insured was not legally entitled.’” The court stated that the “use of more specific language within the same provision” indicates that “‘an Insured’” does not necessarily refer to the same insured against whom the claim was brought.”
Accordingly, the majority concluded, “[i]f the claims against . . . the other officers/directors are claims against Insureds arising out of Greene’s personal profit, then the Personal Profit Exclusion is applicable to . . . the other officers and directors.”
The majority also held that the personal profit exclusion excluded coverage with respect to PinkMonkey.com (which was covered under the policy for its own liability pursuant to a securities claim endorsement) because the policy’s “Limits of Liability” provision stated that “[a]ll claims arising from the same Wrongful Act or interrelated or continuous Wrongful Acts of one or more Insured[s] shall constitute a single Claim.” The majority found that the claims against Greene and the claims against the corporation arose from the same wrongful act – i.e., misrepresentations made to obtain capital – and thus constituted a single claim, and, “[a]s such, the claim against the Company is also a claim against an Insured.”
Judge Pickering’s dissent disagreed with the majority’s conclusion with respect to the claims against PinkMonkey.com’s directors and officers other than Greene and the claims against PinkMonkey.com.
Judge Pickering stated that the personal profit exclusion was “susceptible of more than one reasonable interpretation” and that “well established” law requires that “we must resolve the uncertainty by adopting the construction that most favors the insured.” Judge Pickering pointed to cases holding that “[i]n particular, exceptions or limitations on liability are strictly construed against the insurer and in favor of the insured” and that “[t]he court must adopt the construction of an exclusionary clause urged by the insured as long as that construction is not unreasonable, even if the construction urged by the insurer appears to be the more reasonable or a more accurate reflection of the parties’ intent.”
Judge Pickering reasoned as follows with respect to the same language in the personal profit exclusion that the majority held excluded coverage for all directors, not Greene:
This Exclusion uses the word “Insured” three times. Each time the word “Insured” is singular. Each time it is used, it is modified by a different adjective. Chronologically, “Insured” is modified by “any,” “an,” and “such.” According to the dictionary, “any” means “one,” singular, but it can mean “some,” plural. “An” is clearly singular. “Such insured” refers back to “an insured.” So, the third time the word “insured” is used in the exclusion it clearly refers back to the second time the word insured is used.
According to the dictionary definition, the word “any” can be interpreted as being singular or plural. Consequently, appellants’ contention that it is to be construed as being singular is not unreasonable. Bolstering appellants’ interpretation is the fact that each time the word “insured” is used, it is singular and that the words “such insured” refer back to “an insured.” Again, interpreting the word “any insured” as being singular, and “such insured” as referring back to the specific insured who profited or gained inappropriately, appellants’ construction of the exclusionary clause is not unreasonable.
Accordingly, it is not unreasonable to interpret the EXCLUSION as excluding from coverage only a claim against the single insured who gained a profit or advantage to which he was not legally entitled.
Judge Pickering stated his view that that the interpretation of these words advocated by the insured directors and officers (other than Greene) “is not only a reasonable interpretation, but in the mind of this writer, it is more consistent with the wording of the exclusion.” Judge Pickering also stated that “it is incongruous” to construe an insurance policy in a way that excludes coverage against certain insureds if they are sued alone but not if they are sued jointly with an insured who has received a personal benefit.
Judge Pickering also disagreed with the majority’s reliance upon the policy’s “Limits of Liability” provision – providing that “all claims arising from the same wrongful act or interrelated, repeated, or continuous wrongful acts of one or more Insureds shall constitute a single claim” – “in order to get around the fact that the wording of the exclusion only excludes a claim against an ‘insured’ and not the company” in a policy that, “by its own terms, provided for separate coverage as to each insured and the company.”
Judge Pickering stated that this provision “is not found in the Definition section of the policy,” which “gives the word ‘claim’ an entirely different definition”: “a written demand for monetary damages, including the institution of suit or a demand for arbitration.” Judge Pickering stated that where a term is defined one way in the “Definition” section of an insurance policy and in another way in the “Limits of Liability” section, “it is not unreasonable to construe th[e] definition of ‘claim’” in the Limits of Liability provision “as being applicable only to the Limits of Liability” and “to interpret this as limiting the insurer’s limits of liability and not the extent of coverage.”
Judge Pickering concluded as follows:
If one uses the definition of “claim” as defined in the Definition section of the subject insurance policy and interprets the word “any” as being singular as the word is defined in the dictionary, the exclusion would read as follows: This insurance does not apply to “a written demand for monetary damages, including the institution of suit” made against “any insured” (one insured) arising out of any of the following: any suit based upon, arising from or in consequence of an insured (one insured) having gained in fact any personal profit, remuneration, or advantage of which such insured was not legally entitled.
Judge Pickering stated his view that “[t]o read the word ‘company’ into this exclusion is less reasonable than to read the company out of the exclusion since TIG clearly knew how to amend the policy and in fact amended the Definition section by the Endorsement in several respects.”
Finally, Judge Pickering took particular issue with the majority’s assertion – quoted above – that “[a]lthough the terms ‘the insured’ ‘that insured’or ‘such insured’ preceding personal profit would indicate the same insured as the claim is brought against, the personal profit exclusion uses the more general term ‘an insured’ and that “[t]his indicates that coverage is excluded for all insureds, not merely the insured who profited” (emphasis added by Judge Pickering). Judge Pickering stated that this statement by the majority “proves the point of this dissent”:
Whether the words “an insured” indicates that coverage is excluded for all insureds is not the test. The test is whether or not there is another reasonable interpretation of the exclusion which is to be particularly construed against the insurer. The exclusion is not expressed in clear and unambiguous language as Texas law requires. . . . The majority finds that the words “an insured” indicates that coverage is excluded for all insureds. The majority notes that the terms “the insured,” “that insured” or “such insured” would indicate the same insured as the claim is brought against, thus providing coverage to appellants. The majority then chooses between these two indications.
In Judge Pickering’s view, “[i]t is not enough that an insurance policy indicates that an exclusion is involved.” Rather, “the exclusion must be stated in clear and unambiguous terms.”