A New York court has clarified a ruling establishing that Texas law requires issuers of directors & officers (D&O) liability policies to advance defense costs incurred in connection with covered and non-covered causes of action interposed in the same lawsuit.

The recent ruling, issued by the U.S. District Court for the Southern District of New York, could have significant implications for the insurance industry, according to Patton Boggs senior litigation partner John W. Schryber, who argued the case.

“For years, D&O insurers have sought to impose ‘allocation’ conditions on policyholders who purchased D&O policies without any allocation clause,” Schryber said in a prepared statement. “This ruling should bring an end to the insurers’ practice of seeking allocation under a policy that does not contain an allocation clause.”

The Feb. 13 ruling from U.S. District Judge Richard J. Holwell clarifies a decision the court entered two months earlier in the case, where the judge ruled that a suit against Uncle Julio’s restaurant chain contained a covered cause of action, breach of fiduciary duty, and an excluded cause of action, breach of contract.

Howell also ruled that Travelers Insurance, the issuer of Uncle Julio’s D&O policy, was not only required to advance defense costs allocable to the covered cause of action, but also any defense costs that might be allocable to the non-covered cause of action. The insurer then moved for clarification of the bases for this latter aspect of the December 2008 ruling.

Howell, in the clarification, agreed that the policy required advances of defense costs incurred in connection with a Claim and “the policy’s definition of Claim … clearly contemplates the equivalence of the word ‘lawsuit’,” according to the ruling. Under this interpretation Howell ruled that the insurer’s duty to advance extends to “the entire lawsuit.”

By operation of these rulings, the insured stands to recover in excess of $1 million for the insurer’s breach of its duty to advance defense costs, Schryber said.