Directors' Bankruptcy Does Not Relieve D&O Insurer of Obligation to Defend

Individual unit owners of the Landing Condominiums of Waukesha, Wisconsin, claimed in a lawsuit that the condominium association's directors and officers had breached their fiduciary duties. The directors sought bankruptcy protection and were dismissed from the case.

State Auto Insurance Company, which had issued a D&O endorsement to a CGL insurance policy to the association, argued that there was no insurance coverage available for the owners' claims because, as the directors no longer were parties to the action, they could incur no personal liability such that there was no "loss" under the endorsement.

The trial court concluded that the directors' dismissals effectively had discharged their liability, declared that State Auto had no duty to defend or indemnify any of the parties, and dismissed all claims against it. The owners appealed on the ground that, under the D&O endorsement, an insured's bankruptcy did not relieve State Auto of its obligations.

The D&O endorsement

The D&O endorsement's insuring agreement provided that State Auto:

will pay on behalf of directors, officers, and trustees "loss" arising from any claims made against them, individually or collectively, by reason of their "wrongful acts."

"Wrongful act" was defined as any:

[a]ctual or alleged act, breach of duty, error, omission, misleading statement or misstatement attributed to … [a]ny director, officer or trustee while acting in their [sic] capacity as such." 

As it pertained to the directors, "loss" was defined as:

any amount the insured director or officer is obligated to pay because of their [sic] legal liability, either actual or asserted, due to an alleged "wrongful act." 

The endorsement also provided:

Conditions 1. through 4. of Section IV—Conditions are replaced by the following:

1. Bankruptcy. Subject to exclusion j. the bankruptcy or insolvency of the insured…will not relieve us of our obligations under this policy. 

 

The appellate court's decision

The appellate court reversed.

In its decision, it rejected State Auto's contention that because a "loss" was the amount the directors were legally liable for, the directors' dismissal from the case, whether for seeking bankruptcy protection or for any other reason, had nullified the personal liability necessary to trigger D&O coverage.

The appellate court explained that the "point of the D&O endorsement" was to protect the association against malfeasance by the directors. The appellate court acknowledged that the directors had been dismissed before being found liable, but it stated that the harm the owners had alleged in their complaint was due to the directors' alleged wrongful acts and could have ripened into a compensable loss but for the bankruptcy. That was the coverage for which the association had paid State Auto, "even in the event the directors sought bankruptcy protection." The appellate court added that the "touchstone of coverage determinations" was "the reasonable expectations of the insured."

According to the appellate court, the owners' allegations against the directors fell "squarely within the ambit of what the D&O endorsement was purchased to safeguard." The point of the policy's bankruptcy provision, the appellate court concluded, was that "the court need not call the directors to financial task. State Auto has agreed to assume that liability."

The case is Hollingsworth v. Landing Condominiums of Waukesha Ass'n, Inc., Nos. 2013AP888, 2013AP1538 (Wisc. Ct.App. March 5, 2014).

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