Key takeaways
- On May 11, 2026, the New Jersey Supreme Court ruled that an insurer did not forfeit its right to rely on a capacity exclusion in a D&O insurance policy.
- The insurer successfully invoked the exclusion despite having partially funded years of underlying litigation.
- Prior representations by the insurer that partial coverage was available did not constitute a waiver of its contractual defenses.
- The decision limits policyholder arguments that prolonged claims handling and partial defense funding automatically waive strict policy exclusions.
The Decision
On May 11, 2026, the New Jersey Supreme Court ruled that an insurance company does not forfeit its right to enforce a policy exclusion simply because it previously funded a portion of the policyholder's defense. In Mist Pharmaceuticals, LLC v. Berkley Insurance Company, the court held that the insurer successfully retained its right to invoke a capacity exclusion in a directors and officers liability policy, despite having partially funded years of underlying litigation.
The dispute centered on whether the insurer's claims-handling conduct waived its contractual defenses. Before invoking the capacity exclusion, the insurer had represented to the policyholder that partial coverage was available and proceeded to partially fund the litigation for years. Mist Pharmaceuticals argued that this extended period of financial participation and the accompanying representations precluded the insurer from suddenly changing course and denying coverage based on the capacity exclusion. The New Jersey Supreme Court disagreed, concluding that the insurer's prior actions did not amount to a forfeiture of its policy defenses.
Why It Matters
This ruling establishes a clear boundary on the doctrines of waiver and forfeiture in New Jersey insurance disputes. If the court had ruled that advancing partial defense costs strips an insurer of its right to later assert a capacity exclusion, the decision would likely have triggered a severe chilling effect on claims handling. Insurers facing complex claims with mixed covered and uncovered allegations might have defaulted to outright, immediate denials rather than risk permanently waiving their defenses by offering partial funding.
By protecting the insurer's ability to rely on the capacity exclusion after years of litigation, the court essentially allows insurance companies to participate in a defense under a reservation of rights without an automatic penalty. For policyholders, the decision signals that early financial assistance from a carrier does not guarantee long-term coverage. A carrier can still pull the plug years into a lawsuit if the facts align with an exclusion. This shifts the burden onto policyholders to demand definitive coverage positions early in the litigation lifecycle, rather than relying on the mere fact that checks are clearing.
Who Should Care
For lawyers
Insurance coverage counsel and commercial litigators must reevaluate how they handle long-term defense funding arrangements. For policyholder attorneys, the ruling demonstrates the danger of accepting partial funding without securing a binding coverage determination or a highly specific waiver of defenses. Defense counsel appointed or approved by carriers should recognize that the insurer's financial backing remains conditional and subject to revocation based on capacity exclusions. Insurer-side counsel will likely use this decision to draft broader, more durable reservation of rights letters that explicitly preserve capacity defenses regardless of how long the carrier funds the defense.
For consumers/parties
Corporate directors, officers, and the companies that purchase D&O insurance need to understand that their safety net has strings attached. When an executive is sued, the company's D&O policy is supposed to pay for the legal defense. This decision means that even if the insurance company agrees to pay part of the lawyer's bills for years, it can still point to the policy's fine print later to stop paying. Executives cannot assume they are fully protected just because the insurance company initially opens its wallet.
Legal Background
Directors and officers insurance policies are designed to protect corporate leaders from liability arising out of their official corporate duties. However, executives often wear multiple hats. An individual might serve as a director of a covered corporation while simultaneously acting as a shareholder, a personal investor, or an officer of a separate, uninsured entity. To address this, insurers include "capacity exclusions." These provisions explicitly bar coverage for claims based on actions the executive took in a capacity other than as a director or officer of the insured company.
When a lawsuit names an executive, the complaint often blurs the lines between these various roles. Insurers typically respond by issuing a reservation of rights letter, agreeing to fund the defense while reserving the right to deny coverage later if facts reveal the executive was acting in an uninsured capacity.
The legal friction arises when policyholders argue that an insurer's conduct over time waives these reserved rights. Under general contract principles, if a party acts inconsistently with a contractual right, a court may find they have forfeited that right. In the context of insurance, policyholders frequently argue that an insurer cannot represent that partial coverage exists, fund the defense for years, and then abruptly invoke an exclusion. The New Jersey Superior Court Appellate Division previously weighed in on this dispute on July 9, 2024, in Mist Pharmaceuticals, LLC v. Berkley Insurance Company, setting the stage for the state's high court to resolve the tension between claims-handling conduct and strict policy language.
What the Court Did
The New Jersey Supreme Court squarely addressed whether the insurer's prior actions waived its contractual defenses. The court focused on the specific sequence of events: the insurer's representation that partial coverage was available, its subsequent partial funding of the litigation over several years, and its eventual reliance on the capacity exclusion.
The court held that the insurer did not forfeit its right to rely on the capacity exclusion. By separating the insurer's willingness to provide partial funding from its right to enforce the policy's structural limitations, the court determined that the insurer's actions were not inherently contradictory. The representation that partial coverage was available did not equate to a blanket waiver of the capacity exclusion. Instead, the court found that enforcing the exclusion aligned with the fundamental nature of D&O coverage, which strictly limits the insurer's exposure to acts committed in an official, insured capacity. The years of partial funding, while beneficial to the policyholder in the short term, did not rewrite the insurance contract or erase the capacity exclusion.
How It May Be Applied
Moving forward, this decision will likely alter the negotiation dynamics between policyholders and insurers at the outset of complex litigation. Because insurers now have explicit New Jersey Supreme Court backing to enforce capacity exclusions even after years of partial funding, carriers will likely become more aggressive in invoking these exclusions late in the litigation process.
Policyholders will need to scrutinize reservation of rights letters with greater intensity. If an insurer states that partial coverage is available, policyholder counsel should push for clarity on exactly which claims the insurer accepts and which exclusions it intends to preserve. We may see an increase in early declaratory judgment actions, where policyholders sue their insurers at the beginning of the underlying case to force a definitive ruling on the capacity exclusion, rather than waiting years for the insurer to pull funding.
Additionally, underwriters and brokers will need to pay close attention to how capacity exclusions are drafted. Because the courts will enforce them despite extensive claims-handling history, the specific wording of the capacity exclusion becomes the sole battleground.
Waiver and Forfeiture in Insurance Defense
| Concept | Traditional Policyholder Argument | Impact of the Mist Pharmaceuticals Ruling |
|---|---|---|
| Defense Funding | Paying defense costs for years creates an expectation of continuous coverage and waives exclusions. | Partial funding over years does not automatically forfeit the insurer's right to invoke a capacity exclusion. |
| Coverage Representations | Stating that "partial coverage is available" binds the insurer to maintain that coverage. | Representations of partial coverage do not waive specific contractual defenses like the capacity exclusion. |
| Reservation of Rights | Ambiguous or prolonged reliance on reservations can be defeated by inconsistent claims handling. | Insurers retain significant latitude to enforce exclusions late in the litigation if the policy language supports it. |
Plain-English Callout
What is a Capacity Exclusion?
In the business world, people often hold multiple roles at the same time. A person might be the CEO of Company A, a board member of Company B, and a major individual investor in Company C. When Company A buys a Directors and Officers (D&O) insurance policy, that policy is only meant to protect the CEO when they are making decisions specifically for Company A.
A "capacity exclusion" is a rule written into the insurance contract that says the insurance company will not pay for lawsuits that arise from the person's actions in their other roles. If the CEO gets sued for something they did while acting as an investor in Company C, the capacity exclusion allows the insurance company to deny coverage. The dispute in this case was about whether the insurance company lost its right to use that rule because it had already helped pay for the lawsuit for several years. The court decided the insurance company could still use the rule.
This article is general legal information and commentary about legal developments. It is not legal advice, does not address your specific situation, and is not a substitute for advice from a licensed attorney. Reading this article and contacting us through this website do not create an attorney-client relationship.
Sources & authorities
- Mist Pharmaceuticals, LLC v. Berkley Insurance Company — source
- Mist Pharmaceuticals, LLC v. Berkley Insurance Company — source
- Mist Pharmaceuticals Llc v. Berkley Insurance Company — source
Further reading
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