California Court of Appeal Upholds "Prior Or Pending Action" D&O Policy Exclusion

ML Direct, Inc. v. TIG Specialty Insurance Co., 2000 WL 284063

In a case of first impression under California law, the Second Appellate District of the California Court of Appeal has ruled that the commonly used "prior litigation" exclusion in a claims-made Directors' & Officers' liability policy is "not ambiguous" and extends to any pre-policy period litigation which bears a "factual relationship to a claim made during the policy period," even if the insured person on whose behalf coverage is sought was never party to the prior action. This ruling, when combined with a 1998 decision by Judge Saundra Brown Armstrong of the United States District Court for the Northern District of California in Juszkiewicz v. Federal Insurance Company, 1998 WL 476263 (applying Tennessee law), which rejected a contention that the "prior litigation" exclusion was too "broad and vague" to be enforced, should provide substantial comfort to D&O insurers in California when faced with claims relating to or arising out of pre-policy proceedings.

Nancy Shalek an officer and director of ML Direct, was named as a defendant in a securities fraud class action. The class plaintiffs had plead their claims were based in part on an earlier NASD disciplinary proceeding and an earlier SEC federal district court action, both of which had alleged misconduct regarding securities sales. Neither Shalek nor ML Direct were parties to either prior proceeding.

TIG Specialty had issued a D&O policy to ML Direct. ML Direct sought coverage for Shalek for the class action, which was filed after TIG's policy issued. TIG denied the claim on grounds that the class action arose directly out of the NASD and SEC proceedings, that both of those proceedings were filed before the TIG policy was issued and that TIG's D&O policy contained a "prior litigation" exclusion stating:

This insurance does not apply to any Claim made against any Insured arising out of any of the following A. Any litigation, proceeding, or administrative act or hearing brought prior to or pending as of the Prior or Pending Litigation Date as shown in Item 8 of the Declarations, as well as any future litigation, proceeding, administrative act or hearing based upon any such pending nor prior litigation, proceeding, administrative act or hearing or derived from the essential facts or circumstances underlying or alleged in any such pending or prior litigation, proceeding, administrative act or hearing. . . .

TIG filed a declaratory relief action and won summary judgment. Shalek and ML Direct appealed. The Court of Appeal affirmed. In doing so, it concluded that while TIG's policy "phrasing is inelegant, [it is] an insurance policy, not literature [and] the meaning of the [prior litigation exclusion] seems clear enough." The Court held that the class action without question was "based on or properly connected to" the NASD and SEC proceedings, and therefore the exclusion applied. The Court rejected Shalek's and ML Direct's assertion that the exclusion was ambiguous in its reach. The court also rejected the assertion that the prior litigation exclusion was limited to proceeedings of which the insureds were aware.

Finally, the Court rejected the contention that the "prior litigation" exclusion was at odds with a D&O policy's retroactivity provisions. The Court easily harmonized a general grant of coverage for claims arising out of pre-policy acts with the exclusion's bar to coverage for prior acts which had already generated some type of pre-policy "litigation, proceeding, administrative act or hearing."

[Note: When the Ninth Circuit affirmed Judge Armstrong's decision in Juszkiewicz in an unpublished opinion (203 F.3d 831, 1999 WL 1044330, *2), it rejected a similar "public policy" argument that a "prior litigation exclusion denies the insured the benefit of "retroactive coverage."]