Even When “Loss” Is Defined, Insurance Policy Interpretation For Executive Agreement Claims Can Still Be Tricky

What’s a “loss?”  And, no, I don’t mean something our beloved Washington Nationals have racked up in equal number to their wins this season. 

I’m talking about a loss as defined in an insurance policy – or, as the word is used in most insurance policies that apply to employment-related claims, a capitalized “Loss.”  Believe it or not, even when this term is specifically defined in an insurance contract, it can still cause confusion.  

Confusion leads to litigation.  At least that’s what appears to have happened in the case of American Home Key v. RSUI Indemnity Company, filed earlier this month in federal court for the Northern District of Texas.  American Home Key originates mortgages – or used to originate them (it was banned from writing FHA-backed mortgages some time ago).  In any event, in November 2011, the company closed two branch offices and fired two executives that ran those offices.  The executives claimed that, under their contracts with American Home Key, they were due about three months’ worth of bonus payments – and that the company refused to make those payments.  So, the two executives sued American Home Key and its leading officers, seeking their bonus pay and “actual and compensatory damages…for breach of contract and unjust enrichment.”  The two executives also alleged that American Home Key and its officers fraudulently induced them into their employment contracts and made negligent misrepresentations. 

American Home Key and the officers had a Directors & Officers (“D&O”) liability policy when the offices closed, so they asked that insurer to do the two things that insurers are supposed to do for companies, directors and officers under D&O policies: 1) advance their defense expenses while the case is going on; and 2) indemnify them for any judgment or settlement.  (We’ve written in more detail about D&O coverage here and here).

But the D&O insurer refused to do anything in response to the suit.  It declined coverage because, in its view, the money damages the executives are seeking are – in part – excluded from the policy’s definition of “Loss.” 

Significantly, the policy defines “Loss” this way:

“Loss” means damages (including back pay and front pay), settlements, judgments…and Defense Expenses.  Loss (other than Defense Expenses) shall not include…Amounts owed under any employment contract [and] any amounts owed as wages to any Employee, other than front or back pay. 

Here’s where the confusion over meanings comes in, even though the policy contains a definition of “Loss.”  The insurer contended that since the two executives were seeking amounts due under an employment contract, there was no coverage for the suit – including the defense costs – because they were seeking something the policy just didn’t cover.  American Home Key, though, read the same definition the opposite way: it argued that it is entitled to “Defense Expenses” to help it fight off the executives’ lawsuit, because the policy excepts Defense Expenses from the language in the definition that pushes employment contract amounts and wages out of defined “Loss.”  So, the company contends, the insurer at least has to advance its defense expenses, even if what the executives are seeking is a verdict that can’t be covered under the policy at the end of the case. 

Again, confusion leads to litigation, so American Home Key filed suit against its insurer.  Which side is right in its interpretation of “Loss?”  Well, we never share our guesses on these things here at Suits-by-Suits. 

What I will say, though, is this: each side has some reasonable doctrine on its side.  American Home Key can look to what it is called the “potentiality of coverage” theory, which is an insurance interpretation principle that looks behind the actual counts alleged in a lawsuit to get a more complete picture of the alleged facts and the possible legal consequences of those facts (or as a California court put it in this 1986 case, “it is not the form or title of a cause of action that determines the carrier's duty to defend, but the potential liability suggested by the facts alleged or otherwise available to the insurer”).  American Home Key and the officers may argue (and seem to in their complaint) that the executives have alleged fraud and negligent misrepresentation and, if they prove those allegations, then the jury could award them additional forms of damages beyond lost wages or what their employment contract provides, even if they don’t ask for them now.  So, the company will likely say, the insurer has to provide defense expenses up through the end of the case, because until then the insurer can’t say for sure that there’s no possible judgment or settlement that isn’t going to be covered “Loss.” 

For its part, the insurer may argue that the executives’ lawsuit simply can’t trigger coverage, because the former executives aren’t currently seeking something that is covered under the policy.  This stricter interpretation of the policy and the complaint read together – sometimes called the “eight corners rule,” although that term is often misused – doesn’t allow for coverage of damages that the executives could have said they wanted, but only looks at what they actually asked for now. 

Either way, this will be an interesting one to watch for executives and the companies that employ them – if those companies want coverage for the suits by their suits.  

• D&O