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Because a directors and officers policy’s “insured vs. insured” clause bars coverage for a claim filed by a company’s former director and does not extend to cross-claims, an insured cannot maintain a bad faith cause of action, a federal appeals court held March 27, reversing a trial court and setting aside a jury award ( American Medical International Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa., Case No. 97-56562, 9th Cir.). American Medical International Inc. (AMI) owns and operates hospitals and medical research facilities. When the company was sold, several AMI shareholders filed class actions against Harold Williams, Lee Pearce and other board members alleging misconduct in the handling of the sale. Pearce filed a cross-claim against Williams and AMI over his failed bid to buy the company. UNDERLYING LITIGATION AMI used money from a Harbor Insurance Co. primary policy to settle the shareholders’ suits for approximately $8.74 million. AMI attempted to use, and was denied, proceeds from a National Union Fire Insurance Company of Pittsburgh excess policy to settle Pearce’s cross-claim. National Union offered to pay Pearce $5 million on the condition that Pearce release Williams from the action but continue pressing claims against AMI. Any amount Pearce won from AMI would then be deducted from National Union’s payment. Although AMI objected to the offer, Pearce accepted it and released his claims against Williams. Subsequently, AMI settled with Pearce for $16 million, $11 million above the guarantee offered by National Union. AMI sued National Union for breach of contract and bad faith. A jury found the insurer liable on both counts, awarding no damages for the breach of contract but awarding AMI $12 million for the breach of the covenant of good faith and fair dealing. On appeal, the 9th U.S. Circuit Court of Appeals affirmed the jury’s award. The U.S. Supreme Court, however, granted certiorari and remanded the case for further consideration. The U.S. District Court for the Central District of California reinstated its judgment. National Union appealed again. The 9th Circuit noted that when it reviewed the case previously, it dismissed National Union’s appeal without considering its coverage defenses. Since then, the California Supreme Court in Waller v. Truck Insurance Exchange (11 Cal.4th 1, 900 P.2d 619 [1995]) held that where there is no coverage under a policy, an insurer is not liable for bad faith. Because of that ruling, if National Union can establish that its policy did not cover any losses AMI might have incurred in reimbursing Williams in connection with Pearce’s cross-claim, AMI cannot state a bad faith cause of action. The appeals court rejected National Union’s argument that the jury verdict was inconsistent with Waller. The case instead turns on whether the District Court correctly held coverage exists for AMI for losses incurred defending against Pearce’s cross-claim. If so, the jury’s finding that AMI suffered no damages as a result of the breach of contract did not preclude its concurrent finding of damage for bad faith. EXCLUSION APPLIES The “insured vs. insured” exclusion bars coverage for claims “brought against one or more past, present or future directors or officers, by the corporation, its subsidiaries or successors or by one or more past, present or future directors or officers.” When Pearce filed his cross-claim, he was a past director of AMI, and Williams, a defendant, was on the board. However, AMI argued that Pearce was not acting in his capacity as a director when he filed suit or during the events that gave rise to it. The court agreed with AMI that when the cross-complaint was filed, Pearce was seeking redress for harm in his capacity as a bidder and not for harm he suffered in his capacity as a director. DUAL CAPACITY As to whether the policy distinguishes between Pearce’s dual capacities, the court noted that the policy limits coverage to alleged misconduct by directors acting in their official capacity. “Thus, without question, the policy in this case did not cover Williams’ actions outside the scope of his directorial capacity,” according to the court. “In contrast, there is no such express ‘capacity’ limitation concerning the other side of the equation. Nothing in the policy specifies that a former director filing a claim, such as Pearce, must also have acted in his capacity as a director in order to trigger the ‘insured-versus-insured’ exclusion.” Unlike the insuring clause, the exclusion does not contain a capacity limitation, the court continued. “On the contrary, its extension to both past and future directors suggests that it is not similarly limited. The reference to ‘past director’ does not really contemplate capacity at all, since a past director has no official role as such. The more natural reading of the term is, therefore, as a description of the person who was formerly a director, an interpretation that … leads to the conclusion that the policy did not acknowledge dual capacities for this particular purpose.” NO OBLIGATION Without language limiting the clause to suits brought by present or former directors seeking recovery for harm suffered in their capacities as directors, “we find that the policy did not extend to Pearce’s cross-complaint. Consequently, National Union owed no obligation to AMI and its actions could not have frustrated AMI’s attempt to collect benefits. We are thus compelled to conclude that since there was no potential for coverage, the decision in Waller bars AMI’s claim for breach of the implied covenant of good faith and fair dealing,” the 9th Circuit held. National Union is represented by John G. Roberts Jr. of Hogan & Hartson in Washington, D.C., and Peter Abrahams of Horvitz & Levy in Encino, Calif. AMI is represented by Ronald M. Oster and Scott M. Flicker of Paul, Hastings, Janofsky & Walker in Los Angeles. (c) Copyright 2001 Mealey Publications, Inc.

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