The opinion of the court was delivered by: David G. Trager United States District Judge
This case arises out of a dispute regarding control over Northern Services Group ("NSG"). NSG is a non-profit corporation that manages nursing homes and assisted living facilities. It is associated with a religious congregation known as Chevre Liady Nusach Hoary ("Chevre"). Plaintiffs believe they were improperly expelled from the board of NSG after NSG settled a dispute over its non-profit status with the IRS. This expulsion generated two law suits and a counterclaim, all in state court ("the underlying actions").
Defendant Executive Risk Indemnity, Inc. ("Executive Risk") insured NSG and its board members as part of a directors, officers and trustees liability policy ("DO&T policy"). As part of this policy, Executive Risk is responsible for the legal defense costs of current and former board members of NSG so long as certain criteria are met. The plaintiffs claimed coverage for the costs they have incurred and will incur related to the underlying actions but Executive Risk denied their requests for coverage. In this action, plaintiffs sue for a declaratory judgment to the effect that Executive Risk must cover their defense costs for the underlying actions, among other things.
Defendant has moved for summary judgment, requesting a declaration that it is not required cover plaintiffs' defense costs. Plaintiffs have cross moved for summary judgment and request a declaration that defendant is required to cover their defense costs. For the reasons stated below, defendant's motion for summary judgment is granted and plaintiffs' motion is denied.
(1) The Closing Agreement between NSG and the IRS NSG is a non-profit corporation organized to manage various nursing homes and assisted living facilities. Def. Ex. 7 at 1. NSG was originally founded as a not-for-profit corporation without any members. Def. Ex. 19 at 6. However, Chevre maintains that in 2004, NSG's bylaws and certificate of incorporation were amended to install Chevre as the sole member of NSG. Id. at 6-9. As explained further below, several board members dispute whether Chevre continues to be a voting member of NSG following further amendments to NSG's bylaws in 2006. Id.
In any event, as of 2004, NSG was a tax-exempt non-profit under 26 U.S.C. § 501(c)(3). See Def.'s Rule 56.1 Statement ("Def. 56.1 St.") ¶ 4; Pl.'s Rule 56.1 Statement ("Pl. 56.1 St.") ¶ 4. The IRS, however, revoked this status in 2005 and NSG challenged this revocation in federal court that July. Def. 56.1 St. ¶ 4-5; Pl. 56.1 St. ¶ 4-5.
Rather than litigate the dispute, the IRS and NSG decided to settle the matter and agreed on terms (the "Closing Agreement"). Def. Ex. 6. Under the Closing Agreement, the IRS agreed that NSG would retain its § 501(c)(3) tax exempt status as a non-profit. Id. at 15. In return, NSG was obliged to enact governance reforms. Id. at 1-17. In particular, NSG agreed to change the composition of its board to ensure that eight of its thirteen directors were independent of Chevre and the Rabbi in charge of Chevre and had not been an officer or director of Chevre. Id. at 3. NSG also agreed to follow specified procedures in setting board member and executive compensation, including an independent audit to determine whether the existing compensation was reasonable. Id. at 9-12. The Closing Agreement was executed on April 7, 2006, and was signed by Morris Klein, NSG's Executive Director. Id. at 16-17.
(2) The Underlying Actions and the Demand for Coverage
About six months after the execution of the Closing Agreement, a battle for control of NSG erupted between Joseph Grunwald, then-Chief Financial Officer of NSG; Chevre, as NSG's sole member; and several NSG board members. In December 2006, this battle led to two legal actions implicating the insurance policy issued to NSG by Executive Risk. These actions, and the differing accounts of what led up to them, are described below.
a. The First State Declaratory Judgment Action: Chevre v. Grunwald
In November 2006, Chevre, NSG and three putative board members (collectively "Chevre") filed suit in state court against Grunwald and nine individuals they alleged had been removed from NSG's board. See Def. Ex. 3 esp. ¶ 9-19 (hereinafter "Chevre v. Grunwald"). Chevre sought a declaratory judgment that the nine individuals were no longer NSG board members and had no authority to act on behalf of NSG. Id. at ¶ 50. For ease of identification, this group of purportedly terminated board members will be referred to as the "Disputed Board Members." The facts listed in this section regarding the nature of the Chevre v. Grunwald dispute are taken from the complaint in that action.*fn1
The complaint first explained the events leading up to NSG's settlement with the IRS. Prior to the suit, NSG's nonprofit, tax-exempt status had been repeatedly examined by the IRS, which had issued "adverse determination" letters. Id. at ¶ 23-33. Defendant Joseph Grunwald's actions were among the factors that caused the IRS to issue these adverse determination letters. E.g., id. at ¶ 23-24, 28, 32. Grunwald was attempting to have NSG's non-profit status revoked so he could privatize it for his own benefit. E.g., id. at ¶ 29. After extended negotiations, NSG was able to resolve its disagreements with the IRS and entered into the Closing Agreement, which imposed "certain governance requirements" on NSG in exchange for retention of its non-profit status. Id. at ¶ 35.
In November 2006, following the execution of the Closing Agreement, Grunwald declared that he wanted to retire from his duties at NSG and demanded that his "equity" in NSG be bought out. Id. at ¶ 36. The complaint explains that the plaintiffs -- presumably the NSG board members bringing suit and/or representatives of Chevre -- responded that such a buyout would (1) violate New York law regarding non-profit corporations and (2) violate the Closing Agreement. Id. at ¶ 37-38. After this, Grunwald stacked the board with individuals who wanted to change NSG's charitable purpose - i.e., with the Disputed Board Members. Id. at ¶ 39. This stacking resulted in a board that was not sufficiently independent and therefore violated the Closing Agreement. Id. at ¶ 40. Grunwald and the Disputed Board Members did this in order to cause NSG's tax exempt status to be revoked so that Grunwald could privatize the entities for his own benefit. Id. at ¶ 41.
Chevre then called a member meeting "to insure that the Board not take any action that would be in violation of its fiduciary duty to NSG's sole member [Chevre]." Id. at ¶ 42. At that meeting, Chevre used its authority as NSG's sole member to expel the Disputed Board Members. Id. at ¶ 44. However, the Disputed Board Members continued to attempt act on behalf of NSG, prompting Chevre to institute the declaratory action Chevre v. Grunwald to stop the Disputed Board Members from taking further actions that might harm NSG's not-for-profit status. Id. at ¶ 47, 49-50.
Chevre v. Grunwald was dismissed in December 2006 upon a finding that Chevre had failed to give adequate notice of the meeting where the Disputed Board Members were purportedly dismissed from the board. Pl. Ex. H at p. 2-3. Chevre then held another meeting and again dismissed the Disputed Board Members after providing notice. Def. Ex. 12 at p. 1.
b.The Second State Declaratory Judgment Action: Gluck v. Chevre
After Chevre's second meeting purporting to dismiss them, the Disputed Board Members filed suit in state court,*fn2 on behalf of NSG, against Chevre and NSG's Executive Director, Morris Klein, on or about January 10, 2007. Def. Ex. 4 at p. 1. The complaint in this second state court action, hereinafter "Gluck v. Chevre," explained differently the dispute that transpired as a result of the Closing Agreement. The facts described below are taken from this complaint.
Contrary to the allegations in the Chevre v. Grunwald complaint that Grunwald purged NSG's board in order to have NSG's non-profit status revoked or his equity purchased, the Gluck v. Chevre complaint ascribed the changes in the composition of NSG's board and its bylaws to a desire to preserve NSG's non-profit status and comply with the Closing Agreement. It first recited the history of the Closing Agreement and emphasized the necessity of complying with it to preserve NSG's financial viability. Def. Ex. 4 at ¶ 4. It stated, "[w]ere the Company to default under the Closing Agreement and lose its federal not-for-profit status, it could not continue in business. First, it would owe more than $10 million in taxes . . . ." Id. at ¶ 26.
The complaint went on to explain that the Closing Agreement barred Chevre's active involvement in NSG. It stated that the IRS at one point -- although the time and place are not specified -- informed NSG in writing that Chevre "inserting itself as a member of the Company and dismissing directors violates the Closing Agreement and thereby places the Company in jeopardy of losing its not-for-profit status." Id. at ¶ 4. Indeed, the Closing Agreement required that NSG's board contain at least eight independent board members -- that is, board members not closely affiliated with Chevre -- out of thirteen total members. Id. at ¶ 4, 28.
In June of 2006, two months after the Closing Agreement was executed, NSG's board took steps to "effectuate the Closing Agreement" by changing the bylaws so that they mandated the proportion of independent directors required by the Closing Agreement. Id. at ¶ 32. However, after two of the original thirteen board members declined to serve, two new directors -- both now Disputed Board Members -- were elected by the board in November 2006 in compliance with the procedures set forth in NSG's amended bylaws and the Closing Agreement. Id. at ¶ 34-35.
Because Morris Klein falsely told some board members that the Closing Agreement required Chevre to be a member, the board's June 2006 amendments to the bylaws included Chevre as a member of the corporation with but with no voting power. Id. at ¶ 33.*fn3 Then, in contravention of what the Disputed Board Members believed was Chevre's non-voting membership status, Chevre purportedly disbanded the board, removing the Disputed Board Members without notice, on November 20, 2006. Id. at ¶ 36, 37. As a result of this allegedly invalid act, the Disputed Board Members, still acting as the board of NSG, removed Chevre entirely as a member of NSG at a November 30, 2006 meeting. Id. at ¶ 41. At this same meeting, another independent director resigned, an inside director was removed, and two new directors were appointed to fill these vacancies (now both Disputed Board Members). Id. at ¶ 39-40.
The Disputed Board Members then held another board meeting at which they fired Morris Klein on December 7, 2006, because he had put the Closing Agreement in jeopardy by misleading the IRS, among other misdeeds. Id. at ¶ 42, 48. On December 27, 2006, Chevre held a second member meeting and again purportedly removed the Disputed Board Members from NSG's board, after proper notice. Id. at ¶ 45-47. This removal prompted the Disputed Board Members to file Gluck v. Chevre in state court, seeking a declaratory judgment that they are still members of the board, that Chevre is not a member of the corporation and that Morris Klein does not act on behalf of NSG. Id. at ¶ 54.
c. The Counterclaim in Gluck v. Chevre
In response to the Disputed Board Members' allegations in Gluck v. Chevre, Chevre and Morris Klein brought a counterclaim on January 31, 2007.*fn4 Def. Ex. 5 ¶ 110. The facts alleged in this counterclaim, which mirror those in the Chevre v. Grunwald complaint, are described below.
The counterclaim again alleges that NSG's tax difficulties were brought on, in part, because of the activities of Joseph Grunwald. See, e.g., id. at ¶ 82. It then emphasizes the portions of the Closing Agreement that required governance changes in NSG, including an examination of NSG's executive compensation. Id. at ¶ 90, 95.
Prior to the Closing Agreement, Grunwald was receiving over $600,000 in total compensation while working about ten hours per week for NSG. Id. at ¶ 96-97. Chevre and Klein told Grunwald he would have to increase his hours, reduce his compensation and refund any excess compensation. Id. at ¶ 98. Grunwald then demanded that his "equity" be purchased. Id. at ¶ 99. Chevre responded that such a purchase would violate New York non-profit law and the Closing Agreement. Id. at ¶ 100-01.
At this point, and at Grunwald's behest, NSG's board elected new membership that was not sufficiently independent to satisfy the requirements of the Closing Agreement. Id. at ¶ 102-04. In response, Chevre held a member meeting on November 20, 2006, at which it removed the Disputed Board Members in order to ensure that the board took no actions that were "in violation of the directors' fiduciary duties . . . ." Id. at ¶ 105-07. When the Disputed Board Members brought Gluck v. Chevre to challenge their removal, Chevre and Klein asserted the counterclaim, requesting a declaratory judgment that the Disputed Board Members were not directors and could not take any further action on behalf of NSG. Id. at ¶ 110. Both parties in Gluck v. Chevre moved for summary judgment. This was denied by the New York trial court on ...