The Hidden Dangers of Providing Indemnity – Loss of Insurance Coverage

The Hidden Dangers of Providing Indemnity – Loss of Insurance Coverage

      A recent decision has highlighted a hidden danger inherent in agreeing to provide indemnity to corporate officers and directors, namely the possible invalidity of the insurance policy purchased to fund that indemnity obligation.  Lake Cumberland Resort Community Association, Inc. v. Auto Owners Insurance Co., No. 2010-CA-001725-MR, 2012 WL 1758108 (Ky. App. May 18, 2012) (Not to be Published).

      The Lake Cumberland Resort Community Association (the “Association”) purchased a directors and officers policy from Auto Owners.  The Association, a nonprofit corporation, provided in its articles of incorporation (this provision is not from the opinion but rather from the articles as posted on the Secretary of State’s website):

The Association shall indemnify its directors and officers and may indemnify its employees and agents, to the fullest extent permitted by law, from and against any and all of the expenses or liabilities incurred in defending a civil or criminal proceeding, or other matters, including advancement of expenses prior to the final disposition of such proceedings and amounts paid in settlement of such proceedings, and the indemnification provided for herein shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any by-law, article, agreement, vote of Members or disinterested directors or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent, and shall inure to the benefit of the heirs, executors and administrators of such a person and an adjudication of liability shall not affect the right to indemnification for those indemnified.  The foregoing right of indemnification shall be in addition to and not exclusive of all other rights to which such director or officer of the Association may be entitled.

      Disenchanted members of the association filed suit objecting to the manner in which the association was being managed, including pleas that the board be replaced and that the incumbent directors be required to provide an accounting of all expenditures and seeking the recovery of funds for which a proper accounting could not be made. Auto Owners provided a defense, but as well intervened in the action, seeking a determination that an exclusion to coverage existed and in fact it had no obligation to provide coverage.  Auto Owners prevailed on summary judgment, and this appeal followed.

The decision turned upon a policy exclusion as to:

Any claims for which your officer of director receives indemnity from [the community association] or has a right to be indemnified by [the community association]

(Bracketed language is as it appears in the opinion.)   Clearly the Association’s articles of incorporation provided indemnity to its officers and directors.  Auto Owners argued “that this policy provision clearly excludes coverage of claims for which an officer or director of the community association receives indemnity from the association or has a right to be indemnified by the association.”  In turn the Association argued that the “indemnity exclusion cannot be enforced because it renders the coverage provided by the policy completely illusory and contravenes public policy” and “defeats their reasonable expectations for coverage.” 

 

 

      Finding in favor of Auto Owners, the Court of Appeals wrote:

The exclusion for indemnity in the policy endorsement was triggered solely by the provisions of the community association’s own articles of incorporation.  While corporations, both for-profit and non-profit, are authorized by statute to include indemnity provisions like the one utilized by the community association in this case, they are not required to indemnify their directors and officers.  In this case, the community association chose to indemnify its directors and officers in its articles of incorporation.  The community association and its board were in the best position to review the corporate documents – including the articles of incorporation – at the time that they contracted for and purchased their insurance policy.  The community association remained at liberty to amend the articles at any time to eliminate the indemnification of its directors and officers in light of the clear and unambiguous indemnity exclusion in its insurance policy.  Had it done so, it could have prevented the triggering of the exclusion about which it now complains.  Under the circumstances, we cannot agree that the exclusion renders the policy’s coverage illusory or that it contravenes public policy in any manner.  Nor can we agree that it defeated any reasonable expectations for coverage because of the clear and unambiguous nature of its language. (emphasis in original).

      It is manifest that those representing companies buying D&O coverage need to be sure that limitations such as this are not in the policies.  At the same time there remains unresolved the question of how the rule of this case will be applied vis-à-vis the mandatory indemnification provisions (e.g., KRS § 271B.8-520) of the various acts.