D&O Insurance Does Not Cover Lender's Claim Against LLC Manager on His Guaranty of LLC's Debt

The Washington Court of Appeals ruled this week that a limited liability company’s directors and officers (D&O) insurance policy did not cover a claim by a lender against the LLC’s manager on the manager’s guaranty of the LLC’s debt. Sauter v. Houston Cas. Co., No. 66809-9-I, 2012 WL 1699447 (Wash. Ct. App. May 14, 2012).

S-J Management, LLC, a Washington LLC, entered into a loan agreement with Commerce Bank in 2008. Michael Sauter, the LLC’s CEO and manager, signed the loan documents on behalf of the LLC as its manager, using “Michael J. Sauter, Manager of S-J Management, LLC.”

As was required by the loan agreement, Sauter also executed and delivered to the lender a guaranty of the LLC’s borrowings. Sauter’s guaranty appeared to be in his personal capacity – it referred to him as “Michael J. Sauter,” and that was how he signed it.

Later the LLC could not repay the loan, and the lender demanded payment from Sauter on his guaranty. The LLC agreed to indemnify Sauter, but it was insolvent and could not indemnify him. The LLC tendered the lender’s demand on Sauter’s guaranty to Houston Casualty Company, the D&O policy insurer. Houston Casualty denied coverage.

Sauter sued Houston Casualty for declaratory relief and damages, to enforce the policy. The trial court ruled on summary judgment that the D&O policy did not provide coverage for Sauter’s obligation on the guaranty.

The Court of Appeals ruled, in a nutshell, that the D&O policy applied only to acts performed by a manager in his official capacity as a representative of the LLC, that the D&O policy did not insure against losses incurred when a manager acts in his personal capacity, that Sauter’s guaranty was executed in his personal capacity, and that therefore the policy did not cover the lender’s claim against Sauter.

Kevin LaCroix’s post on his blog The D&O Diary, here, provides a more detailed description of the court’s analysis, as well as a good discussion of D&O policies and the kinds of disputes that can arise when there is a question whether the officer was acting in an insured capacity.

Sauter had argued that he executed the guaranty “because he was SJM’s CEO and Manager,” and because the loan agreement required the LLC to obtain a guaranty from Sauter. Sauter, 2012 WL 1699447, at *5. The court found his purpose to be unavailing. The dispositive issue was that Sauter was acting in his personal capacity when he executed the guaranty, and D&O insurance only covers officers and managers when they act in a representative capacity, on behalf of the entity.

The case should remind us that good intentions are not enough to transform the undertaking of a personal obligation, which is intended to benefit an entity, into an action in a representative capacity on behalf of the entity. One’s purpose in acting does not determine the capacity in which one acts, when the act consists of signing a written guaranty in one’s own name with no indicia that the guarantor is signing in a representative capacity.