Insured vs. Insured Exclusion Carve-Out Preserves Coverage For Private Equity Firm

Dallas Appellate Court Holds Exception to Exclusion Applied to All Losses, Including Derivative Claims, in Connection With Wrongful Termination Claim

(February 2020) - In Prophet Equity LP v. Twin City Fire Ins. Co., the Fifth District Court of Appeals in Dallas, Texas held that the insureds were entitled to payment from the second-level excess carrier for the wrongful termination of the investment firm's partner by the firm's majority partner. In 2008, Russ Gatlin and George Stelling formed Dallas private equity firm, Prophet Equity (Prophet), along with other related entities (The Prophet Entities). In 2011, Gatlin removed Stelling as the firm's Chief Operating Officer and as President of Prophet Portfolio Company. In response, Stelling sent Gatlin a demand letter alleging wrongful termination and defamation.

After mediation failed, the dispute was submitted to arbitration where Stelling added derivative claims against Gatlin on behalf of The Prophet Entities. The arbitrators granted relief of $7.7 million, which Gatlin and Prophet paid. In turn, they sought recovery under three employment practices liability polices - the primary, excess, and second-level excess. The primary and first-level excess paid the claim. The second-level excess, Twin City Fire Insurance Company (Twin City), denied coverage based in part on the subject policy's insured versus insured exclusion. Gatlin and Prophet Management sued Twin City for breach of contract and bad faith.

The trial court granted summary judgment in favor of Twin City based on the subject policy's insured versus insured exclusion, which barred coverage for any claim "by or on behalf of any Insured in any capacity...." However, the exclusion contained eleven exceptions, and on appeal, Gatlin and Prophet argued that the exclusion's carve-out for claims "brought by one or more of the Insured Persons for Wrongful Employment Practices" applied. Twin City argued that the exclusion applied because Stelling's derivative claims were asserted on behalf of The Prophet Entities, not an Insured Person capable of invoking the exception. The Appellate Court described the parties' interpretation of the provision at issue as "two ships passing in the night."

Reversing the trial court, the Dallas Court of Appeals rejected Twin City's argument that the insured versus insured exclusion precluded coverage, holding instead that the policyholders had satisfied the burden of establishing that an exception for a claim...