California Court Considers Reimbursement of Legal Fees Under D&O Policy

In its recent decision in Clark v. Travelers Cas. Ins. Co. of America, 2015 U.S. Dist. LEXIS 114877 (C.D. Cal. Aug. 28, 2015), the United States District Court for the Central District of California had occasion to consider when an insurer’s duty to reimburse defense costs under a D&O policy is triggered.

Travelers insured the Sea Court Homeowners Association (“HOA”) under a liability policy with a D&O claims-made form. The coverage afforded under the D&O form did not include a duty to defend, stating expressly that Travelers “will not be called to assume charge of the settlement or defense of any claim or ‘suit’ brought or proceeding instituted against you or any insured.” Rather, the policy required only that Travelers indemnify the HOA for “loss,” a term defined to include defense expenses as well as any adjudicated amounts.

While the policy was in effect, HOA commenced a lawsuit against one of its former individual directors arising out of a dispute over a bank account the individual had opened in his prior capacity as the HOA’s chief financial officer. The HOA alleged that the individual, after he had been removed as a director and officer of the HOA, converted funds from the account and otherwise engaged in fraudulent and deceitful conduct. Notably, the suit alleged that the individual was acting solely for his own personal motives when he committed the wrongful acts and that he was acting in his individual capacity.

During the pendency of the underlying lawsuit, the individual brought suit against Travelers, seeking a declaration that Travelers had a duty to reimburse his legal fees associated with the HOA lawsuit. Travelers countered that because the underlying suit was brought against the individual not in his capacity as a director or officer of the HOA, he was not entitled to any such reimbursement. Travelers further argued that the declaratory judgment action was premature given that any duty to reimburse defense costs could not be determined until resolution of the underlying case, which necessarily would resolve the coverage issue.

In deciding the matter, the court agreed that application of a broad duty to defend standard was inappropriate since the Travelers policy contained no duty to defend. Instead, the court concluded that the proper analysis to be employed for determining Travelers’ duty to reimburse the individual’s out-of-pocket defense costs was under a duty to indemnify standard. As the court explained:

… defense costs are part of the overall “loss” amount that is covered under the D&O Form if it turns out that the state court finds that Clark was acting in his capacity as an HOA director when he committed the alleged actions. The D&O Form guarantees that it will indemnify those costs that constitute the covered “loss” under the terms of the insurance policy. Furthermore, the D&O Form provides that recovery under the insurance endorsement “will not be made until your liability or an ‘insured’s’ liability has been . . . rendered fixed and certain by final judgment; or . . . admitted by us in writing.” … Accordingly, Travelers only becomes obligated to pay for “loss,” including defense costs, once a final judgment has been entered on the underlying covered suit.

As such, and because the underlying case against the individual had not yet been determined, the court agreed that consideration of Travelers’ potential duty to reimburse defense costs was not yet ripe for determination.

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