Understanding the Insured vs. Insured (IvI) Exclusion
In the world of Directors and Officers (D&O) liability insurance, the Insured vs. Insured (IvI) exclusion is a fundamental provision designed to prevent the policy from being used as a mechanism for internal corporate infighting or collusive suits. At its core, the exclusion states that the insurer will not be liable for any claim brought by one insured party against another insured party. This includes claims brought by the company (the entity) against its own directors or officers, as well as suits between individual directors.
For students preparing for the practice D&O questions, it is vital to understand that the definition of an "insured" typically includes the company itself and any past, present, or future directors and officers. Without this exclusion, a company could potentially sue its own board members for a poor business decision simply to trigger the insurance policy and recoup financial losses, essentially turning a liability policy into a performance bond.
This exclusion is a cornerstone of the complete D&O exam guide because it protects the insurer from moral hazard—the risk that the insured parties might act dishonestly or collude to access the policy limits.
The Collusion Prevention Rationale
The primary purpose of the IvI exclusion is to prevent "friendly" lawsuits where an entity sues its own directors to turn a business loss into an insurance recovery. Without this exclusion, a board could effectively "self-fund" its mistakes using the insurer's capital.
The Evolution from IvI to EvI
In recent years, particularly in the context of public company D&O policies, the traditional Insured vs. Insured (IvI) exclusion has often been replaced by the Entity vs. Insured (EvI) exclusion. While they sound similar, the distinction is critical for the exam.
- IvI Exclusion: Broader in scope. It excludes claims by the entity against an insured person AND claims by one insured person against another insured person.
- EvI Exclusion: Narrower in scope. It only excludes claims brought by the entity (the corporation) against an insured person. It generally allows for claims brought by one individual director against another, provided the company is not the one initiating or funding the suit.
Public companies prefer EvI because it provides more flexibility for individual board members to seek legal recourse against one another in cases of genuine conflict, such as harassment or personal torts, without losing coverage.
Comparison: IvI vs. EvI Exclusions
| Feature | Insured vs. Insured (IvI) | Entity vs. Insured (EvI) |
|---|---|---|
| Entity sues Director | Excluded | Excluded |
| Director sues Director | Excluded | Often Covered |
| Primary Use Case | Private/Non-Profit | Public Companies |
| Risk of Collusion | Lowest risk for insurer | Moderate risk for insurer |
Crucial Exceptions to the Exclusion
Standard D&O policies contain several "carve-outs" or exceptions to the IvI exclusion. These exceptions ensure that legitimate legal actions are not unfairly barred. On the exam, focus on these three major exceptions:
1. Derivative Actions
A shareholder derivative suit is a claim brought by a shareholder on behalf of the corporation. While technically the company is the plaintiff, these suits are usually excepted from the IvI exclusion as long as the claim is brought without the assistance or solicitation of any insured person. This allows shareholders to hold management accountable.
2. Employment Practices Claims
If a former officer sues the company for wrongful termination or harassment, the IvI exclusion could theoretically apply because both parties are "insureds." However, most modern policies carve out employment-related claims to ensure that individual directors and officers have coverage for these frequent types of disputes.
3. Bankruptcy and Insolvency
When a company enters bankruptcy, a court-appointed trustee or liquidator takes over. If the trustee sues the former directors for mismanagement, insurers once argued this was an "insured vs. insured" claim (since the trustee stands in the shoes of the entity). However, most policies now specifically state that claims brought by bankruptcy trustees, receivers, or liquidators are not subject to the IvI exclusion.
Frequency of D&O Claim Sources
While internal disputes (IvI) are common, the exclusion and its exceptions shift where the actual insurance payouts occur.
Defense Costs and the Duty to Defend
It is important to note that the IvI exclusion applies to both indemnity (the final settlement or judgment) and defense costs. If a claim falls squarely within the exclusion, the insurer typically has no obligation to pay for the directors' legal fees. This creates a significant financial risk for board members involved in internal power struggles.
However, if a claim contains multiple allegations—some that are excluded by IvI and some that are covered (like a third-party claim joined to the suit)—the insurer may be required to allocate defense costs. Understanding how allocation works is a key component of the complete D&O exam guide.
Frequently Asked Questions
Yes. The definition of an "Insured Person" typically includes any person who was, is, or shall become a director or officer. Therefore, a suit brought by a former director against the current board would trigger the IvI exclusion unless a specific exception (like employment practices) applies.
In insolvency, the interests of the creditors are paramount. If the IvI exclusion barred claims by trustees, directors would have no protection when they are most vulnerable—when the company is broke and cannot indemnify them. The exception ensures the policy remains a viable asset for the estate.
It is very rare to remove it entirely for Side B and Side C coverage because of the moral hazard. However, Side A-only policies (which protect individual directors when the company cannot) often have much narrower exclusions or no IvI exclusion at all to provide the broadest possible protection for personal assets.
For a derivative suit to be an exception to the IvI exclusion, it must be brought independently. If an insured director provides secret company documents or financial backing to a shareholder to help them sue the board, the insurer may invoke the exclusion, claiming the suit was 'solicited' or 'assisted' by an insured party.