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INSURANCE NOTES

Directors And Officers Insurer Is Not Liable For Insured's Contractual Debt

01.23.2007
In August Entertainment, Inc. v. Philadelphia Indemnity Insurance Company, 2007 Daily Journal DAR 293 (2007), the Court of Appeal ruled that a directors and officers insurer is not required to satisfy its insured's contractual obligations, reasoning that "[t]o hold the insurer liable for the contract price would be tantamount to making it a business partner of the corporation and the officer, which was not the mutual intention of the insurer and the insured under the policy."

August had offered to sell InternetStudios its distribution rights to certain films for $2 million. InternetStudios' President, Robert Maclean, wrote to August stating "we accept the offer" and "you can consider this a firm offer for the purchase of these rights."

InternetStudios subsequently disavowed the agreement, and August sued both InternetStudios and Maclean to collect the $2 million due under the agreement. August alleged Maclean was personally liable because he did not indicate in the acceptance letter that he was signing on behalf of InternetStudios and the letterhead he used did not indicate that InternetStudios was a corporation.

InternetStudios and Maclean tendered August's lawsuit to Philadelphia Indemnity Insurance Company ("PIIC"), which had issued a directors and officers policy to InternetStudios. Maclean argued that he made a mistake in signing the contract in the manner he did, and that he was thus entitled to coverage under the PIIC policy for the claim. PIIC denied coverage to InternetStudios and Maclean.

Then, InternetStudios and Maclean settled with August. They stipulated that Maclean was acting as an officer of InternetStudios in signing the acceptance letter and that InternetStudios was indebted to August in the amount of the $2 million contract price. Maclean further agreed to pay $2 million plus interest to August, a judgment was entered against Maclean, and Maclean assigned to August all his rights against PIIC. August then sued PIIC to collect on the stipulated $2 million judgment.

The trial court sustained PIIC's demurrer without leave to amend, determining PIIC was not liable for the stipulated judgment. The Court of Appeal affirmed. The Court noted that typical of D&O policies, the PIIC policy excluded breach of contract. The Court further reasoned that the liability was for a debt the corporation voluntarily accepted, not a "loss" resulting from a "wrongful act" within the policy's insuring agreement. Requiring PIIC to pay would be "letting the corporation completely off the hook" on a business deal gone wrong and would create a "moral hazard" by encouraging corporations to risk breaching their contracts.

As to Maclean, the Court reasoned he could not be liable for breach of a corporate debt and he was not entitled to coverage for his personal liability because the policy limited coverage to liability of directors and officers acting in their official capacity. The Court stated that if it were to accept August's claim, "D&O insurers could be held liable for corporate debts based on the way in which an officer signs a contract on behalf of the corporation, for example, by failing to include 'Inc.' in the company name or omitting 'by' before his or her signature."

The August decision makes a fairly strong statement that an insured corporation's failure to make a payment due under a contract is not a "loss" resulting from a "wrongful act" and does not trigger coverage under a D&O policy. That notwithstanding, the Court left the door open for future, inconsistent decisions, stating that its opinion "involves coverage under a particular D&O policy," and that "[b]roader coverage may be available."

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