August Entertainment, Inc. v. Philadelphia Indemnity Insurance Company
(2007) ___ Cal.App.4th ____, 07 C.D.O.S. ______

D&O Liability Policy Did Not Cover a Corporation's Or Its Officer's Contract Liability Where the Officer Entered Into Contract Without Stating He Was Acting On Behalf Of the Corporation

The Court of Appeal, Second District, affirmed an order of the Los Angeles County Superior Court sustaining an insurer's demurrer without leave to amend. The court held the insured corporation's Directors & Officers ("D&O") liability policy did not cover the corporation's or its officer's contractual liability because the claim was not due to a "wrongful act" within the meaning of the policy.

Philadelphia Indemnity Insurance Company ("Philadelphia") had issued a D&O liability policy to InternetStudios.com, Inc. ("InternetStudios"). Under Coverage A, Philadelphia agreed to pay on behalf of directors or officers defense and indemnity costs on claims made during the policy period for any "wrongful act." "Wrongful act" was defined as any "actual or alleged error, misstatement, misleading statement, act, omission, neglect, or breach of duty committed by an Insured . . . in [his or her] capacity as a director or officer of [InternetStudios]; or . . . claimed against an Insured solely in [his or her] capacity as such." Coverage A excluded any defense and indemnity costs InternetStudios paid on behalf of a director or officer as indemnification.

Under Coverage B, the "Company Reimbursement Coverage," Philadelphia agreed to reimburse the insured for any defense and indemnity costs for "wrongful acts" to the extent InternetStudios had indemnified its directors or officers pursuant to law, contract, corporate charter or bylaws. Coverage B excluded any actual or alleged liability of InternetStudios itself.

Robert Maclean was an officer of InternetStudios, which produced, distributed and marketed films. Gregory Cascante was the president of August Entertainment, Inc. ("August"), an agent for entities that control the rights to several motion pictures. In March of 2000, Maclean and Cascante entered into an agreement whereby InternetStudios would pay August a minimum of $2 million for the distribution rights to certain films. Subsequently, InternetStudios advised August it would not perform under the agreement.

In September 2000, August sued InternetStudios for breach of contract and anticipatory repudiation. In April 2001, August amended its complaint to name Maclean as a "Doe" defendant, alleging Maclean was personally liable because he did not make it clear he had contracted on behalf of InternetStudios.

InternetStudios tendered August's lawsuit to Philadelphia which denied coverage based on the exclusion for liabilities arising from express contracts or agreements. It also declined to cover Maclean because his potential liability was individual and not as an officer or director of InternetStudios. InternetStudios, August, and Maclean subsequently entered into a settlement and assignment where they agreed, among other things, that Maclean and InternetStudios owed August $2 million under the contract plus interest, which August Entertainment would look solely to Philadelphia to recover. Maclean also assigned his rights against Philadelphia to August. Judgment was then entered against Maclean for $2,162,500.

August sued Philadelphia seeking indemnification for the judgment alleging breach of contract, breach of the covenant of good faith and fair dealing and fraud, based on Philadelphia's denial of Maclean's claim. Philadelphia demurred to the complaint and first amended complaint, contending the policy afforded no coverage because Maclean's alleged liability was based on conduct he committed in his individual capacity. The trial court sustained the demurrer without leave to amend on the ground Philadelphia's policy did not cover a corporate breach of contract. Judgment was entered for Philadelphia and August appealed. The Court of Appeal affirmed.

The Court of Appeal first held no coverage existed for a breach of contract because, under Insuring Agreement A, the policy expressly excluded actual or alleged liability of the company for breach of contract, and under Insuring Agreement B, the policy limited reimbursement coverage for directors and officers to liability arising from errors committed in their official capacity. This precluded coverage both because an officer acting in an official capacity cannot be held liable for breach of a corporate contract, and because an officer who breaches a contract in an individual capacity is not acting in an official capacity.

The Court of Appeal then rejected August's argument coverage existed because Maclean had committed a "wrongful act" within the meaning of the policy by signing the contract without stating he was an agent of InternetStudios. Relying on Oak Park Calabasas Condominium Assn. v. State Farm Fire and Casualty Co. (2006) 137 Cal.App.4th 557, the Court held the mere existence of a mistake or negligent act by an officer or director does not create coverage under the policy for breach of contract as a "wrongful act." Based on a survey of numerous foreign authorities, the court concluded a contractual obligation is a debt the corporation voluntarily accepted, and is not a "wrongful act" within the meaning of the policy.

Finally, the court noted the term "wrongful act," as defined in part one of the policy (the D&O liability insurance), did not include a breach of contract of any kind. Therefore the insured could not reasonably have an expectation that D&O coverage applied to a contract claim, whether an officer is sued in an individual or official capacity.

This opinion is not final. Though it has been certified for publication, it may be withdrawn from publication, modified on rehearing, or granted review by the California Supreme Court. Should any of these events occur, the opinion would be unavailable for use as authority in other cases.

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