In August 2017, a US federal court ruled that the ordinary meaning of ‘majority interest’ in a liability policy where cover is extended to all companies in which the named insured holds a majority interest is a financial interest, either direct or indirect, of greater than 50% and not only absolute ownership or a controlling interest. Because there is an ambiguity in the term, one has to look into the ordinary meaning of majority interest.

During 2008, American Capital Ltd, a private equity firm, requested cover for underlying product liability lawsuits against Scientific Protein Laboratories (SPL), a pharmaceutical company in which American Capital held the majority of the convertible preference shares which were convertible at any time into majority voting stock. The litigation related to the manufacture of a tainted batch of heparin, a blood thinning drug, which had led to many deaths and serious injuries worldwide. The drug had been manufactured through a joint venture with a Chinese subsidiary. American Capital claimed  indemnity and defence costs under the policy but the insurer denied the claims saying that it had no obligations against American Capital and its subsidiaries because the policy excluded joint ventures from coverage and American Capital did not directly own SPL.

The dispute related to the interpretation of the term ‘majority interest’ and whether the parties intended the ‘majority interest’ clause to apply to the sort of indirect majority interest American Capital held over SPL. The insurer argued that the term required absolute ownership or a controlling interest. It said that if the court found that American Capital held a majority interest in SPL, this would mean that it held a majority interest in hundreds of other companies in which American Capital had invested. The insurer argued that this would lead to an absurd result that the policies covered all these companies and the premium charged would be too low for general liability insurance of the business of American Capital’s portfolio companies.

American Capital’s argument was that insurers were deliberately ignoring the plain language provisions of the policy relating to majority interest. If majority interest required direct ownership as contended by insurers that would render the term superfluous.

Insurers should be careful how widely they extend cover to unknown entities.

The court agreed with the insured and said that any equity stake above 50% regardless of the voting rights of American Capital was sufficient to constitute majority interest and that SPL was therefore a named insured under the policy terms and ordered the insurer to cover the defence costs.

The court also said that the joint venture exclusion did not relieve the insurer of a potential duty to defend. Since the litigation only concerned the issue of defence costs, the question of indemnification of the insureds by the insurer in the heparin suits was not decided.

A South African court is likely to have come to the same conclusion on this wording. Insurers should be careful how widely they extend cover to unknown entities.

The case is Charter Oak Fire Insurance Co. et al. v American Capital Ltd.