Stem, Inc. v. Scottsdale Insurance Company

Background

Stem, Inc. sued its liability insurer, Scottsdale Insurance Company, over Scottsdale’s refusal to defend or indemnify Stem in an underlying California lawsuit. The underlying lawsuit named three current and former Stem directors as defendants and asserted claims for breach of fiduciary duty, conspiracy, and unjust enrichment. The plaintiffs alleged that Stem did not allow them to participate in financing opportunities, which diluted their equity interests. They also alleged self-dealing by one director.

Stem had notified Scottsdale of facts concerning the Series B Financing in 2014. After the underlying lawsuit was filed in 2017, Stem tendered the lawsuit to Scottsdale. Scottsdale denied coverage under the 2013–2014 and 2016–2017 policies, relying primarily on the policy’s Insured v. Insured exclusion because one plaintiff, Stacey Reineccius, had formerly been a Stem director. The underlying lawsuit remained ongoing when Stem filed this action.

Stem brought claims for breach of contract and tortious breach of the implied covenant of good faith and fair dealing. Stem sought declaratory relief and punitive damages. Scottsdale moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), arguing that the complaint did not state a claim because the policy exclusions left no potential for coverage.

Court’s Analysis

Under California law, an insurer must defend when an underlying lawsuit seeks damages that potentially fall within the policy’s coverage. The insurer bears the burden of establishing that there is no such potential. The court examined the underlying complaint and the policy provisions cited by Scottsdale.

The court rejected Scottsdale’s argument that the Insured v. Insured exclusion eliminated coverage. Although Reineccius was a former insured director, the court found that the underlying lawsuit fell within an exception for a former director or officer suing solely as a securities holder, where the claims arose from wrongful acts occurring after that person left the company. The court treated allegations about events before Reineccius’s 2011 settlement as background because those matters had been resolved. The court therefore did not address Stem’s alternative argument that the policy’s allocation provision would provide coverage for claims by the other plaintiffs.

The court also rejected Scottsdale’s argument that the contract exclusion eliminated all potential coverage. The underlying plaintiffs asserted tort claims, and the court explained that coverage depends on the facts alleged, not only on the legal labels attached to the claims. The plaintiffs allegedly received the shares Stem had agreed to issue under the settlement agreement; they instead claimed that later financing transactions diluted their equity. Scottsdale therefore had not shown that the losses were amounts owed directly under a written contract.

The court agreed that some requested relief was not covered. California law does not permit insurance for the return of money or property wrongfully acquired, and the policy excluded punitive damages. But the underlying lawsuit also potentially involved attorneys’ fees, costs, and losses connected to the breach-of-fiduciary-duty and conspiracy claims. The court held that an uncovered unjust-enrichment or disgorgement claim did not eliminate the potential for coverage for the entire lawsuit. The policy’s allocation provision addressed claims involving both covered and uncovered matters.

Finally, the court found that Stem adequately alleged bad faith. Stem alleged that Scottsdale failed to investigate important coverage issues and intentionally denied a defense despite knowing of its coverage obligations. The court also found that Stem adequately pleaded a basis for punitive damages under California law.

Disposition

The court denied Scottsdale’s motion to dismiss. This ruling allowed Stem’s breach-of-contract, bad-faith, and punitive-damages allegations to proceed at the pleading stage. The order did not finally determine which losses would ultimately be covered or the amount of any recovery.