A federal court held that an insurer was not obligated to provide coverage for a bankruptcy proceeding alleging self-dealing by two restaurant founders based on the prior notice exclusion in a D&O policy. 

The underlying lawsuit was filed by a Chapter 7 trustee (the “Trustee”) on behalf of a restaurant against its founders and their affiliated entities (the “Founders”), alleging, among other things, breach of fiduciary duty for using the restaurant’s funds and personnel for their personal benefit. The lawsuit sought compensatory and exemplary damages, recovery of fraudulent transfer, and punitive damages. The Founders sought coverage from their D&O Insurer.

The Insurer denied coverage for the lawsuit citing the prior notice exclusion, which broadly precluded coverage for claims “in any way involving” or related to prior wrongful acts that were reported under a prior policy. The Insurer argued the exclusion applied because the lawsuit was related to a draft complaint that was reported to the prior D&O insurer, which alleged breach of fiduciary duty. The Insurer further argued the lawsuit was not a Claim first made during the policy period at issue because the allegations were interrelated with those in the draft complaint. The Trustee intervened in the coverage litigation and argued that the Insurer had a duty to defend because the lawsuit at issue contained new allegations, such as aiding and abetting the usurpation of corporate opportunities. 

Ultimately, the court agreed with the Insurer, finding that the lawsuit was sufficiently related to the draft complaint and thus constituted a single claim and triggered the prior notice exclusion. Although the lawsuit included allegations that were not present in the draft complaint, the court found that the “allegations are similar, involving the same overall nexus of facts and law, and, at minimum, having an incidental relationship to the allegations in the draft complaint.” The matters were interrelated despite the new allegations because they merely expanded on the wrongful acts alleged in the draft complaint.

A court, applying Illinois law, held that once a sublimit was met, the carrier was no longer obligated to pay any additional costs incurred related to the claim regardless of the policy’s aggregate limits. 

The Insured, a hospital, and several officers and employees were investigated by U.S. Department of Justice and the Illinois Attorney General for irregularities surrounding its COVID-19 vaccination program. The Insured agreed to indemnify all but one individual for their legal costs in responding to the investigation and provided notice of the investigations to its D&O carrier. 

The carrier agreed to advance defense costs under the policy’s Regulatory Claim Endorsement and determined the state and federal investigations were related, and thus would be treated as a single Claim. The Endorsement defined Regulatory Claims, in part, as “a search warrant, subpoena, notice of investigation, or contact letter.” Regulatory Claim Coverage, per the policy, was subject to a sublimit that applied to all Defense Costs on account of all Regulatory Claims and was "part of and not in addition to the Company's maximum aggregate Limit of Liability for all defense costs on account of all claims."

After eventually paying the sublimit. The carrier argued that it paid the maximum liability for all regulatory claims under the D&O coverage provided, that no further coverage was triggered, and even if further coverage were triggered, it would be otherwise excluded. The Insured argued that the Executive Indemnification and Entity Coverages were also triggered and, therefore, the full limits of the policy must have been available. It also argued that, under the carrier’s policy interpretation the Regulatory Claim Coverage Endorsement, “rather than being a guaranteed extension of coverage - is a backdoor exclusion that bars any coverage for subpoenas in the base [D&O Section]” and must be construed narrowly.

Ultimately, the court agreed with the carrier’s interpretation. Finding that “an insured cannot recover amounts above a sublimit providing a ‘maximum’ limit for a type of claim by asserting that the claim triggers multiple other insuring clauses.” The court found that the plain meaning of a sublimit refers to a limit within a limit and “allowing a claim that is within the meaning of a sublimit to remain governed by the overall policy limit would render the sublimit (along with every other sublimit and exclusion) ineffective, which is contrary to Illinois law.” Therefore, the unambiguous language of the policy did not require the carrier to pay for any additional unreimbursed costs incurred in connection with the Regulatory Claim in light of the sublimit.