Client Alerts
June 22, 2012

Kentucky's Court of Appeals upholds indemnity exclusion

Stites & Harbison, PLLC, Client Alert, June 22, 2012

On May 18, 2012, the Kentucky Court of Appeals rendered a decision that is important to every Kentucky entity that maintains insurance coverage for the benefit of its directors and officers.

In Lake Cumberland Resort Cmty. Ass’n v. Auto Owners Ins. Co., the Court of Appeals affirmed the Pulaski Circuit Court’s ruling that Auto Owners was not obligated to provide coverage under the directors and officers policy it maintained for the Association and its officers and directors based on a policy exclusion. The policy had an exclusion for any claim for which the Association’s officers and directors had a right to receive indemnity from the Association, and the Association’s Articles of Incorporation provided indemnification rights for its officers and directors.

The dispute arose when members of the Association brought claims against the Association, its board, and its officers relating to actions of management. The Association and its board and officers sought coverage under the Auto Owners “D & O” policy. The policy contained an exclusion for any claim for which the officer or director received or had a right to receive indemnity from the Association. The Association’s Articles of Incorporation provided for mandatory indemnification of its directors and officers to the extent permitted by law.

After initially providing coverage, Auto Owners intervened in the litigation and sought declaratory relief confirming that it had no obligation to defend the Association, its board or officers based on the policy exclusion. Concluding the insurer’s denial of coverage was proper, the Circuit Court granted the insurer’s motion for summary judgment.

The Association appealed and the Kentucky Court of Appeals upheld the Circuit Court’s decision, reasoning that the Articles of Incorporation triggered the exclusion, which the Court held was “clear and unambiguous” in the policy. The Court further held that the basis for the exclusion, the existence of the indemnity rights, was within the control of the Association, and the Association could have removed that provision from its articles at any time to eliminate the indemnification rights in light of the policy exclusion. Further, the Court noted that the Association knew (or should have known), at the time the policy was acquired, how the indemnity obligation in its articles would affect coverage under the policy.

The Court of Appeals rejected the Association’s arguments that the indemnity exclusion contravened public policy, rendered the coverage illusory and that the exclusion did not apply to the coverage claimed by the Association itself.

The ruling is significant for any Kentucky entity that maintains directors and officers insurance coverage. Every Kentucky entity with such coverage should determine whether or not such exclusion exists in its policy. If the policy has an indemnity exclusion, the entity should review its charter documents to analyze the impact that indemnification obligations therein might have on the directors and officers coverage.

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