Recent Developments in D&O Officer Liability Insurance


Editors

Meghan A. Adams

Superior Court, State of Delaware
Leonard L. Williams Justice Center
500 N. King. St., Suite 10400
Wilmington, DE 19801
(302) 255-0634 phone
(302)255-2273 fax
[email protected]

Carla M. Jones

Potter Anderson & Corroon LLP
1313 N. Market St., 6th Floor
Wilmington, DE 19801-6108
(302) 984-6122 phone
(302)658-1192 fax
[email protected]

Jennifer C. Wasson

Potter Anderson & Corroon LLP
1313 N. Market St., 6th Floor
Wilmington, DE 19801-6108
(302) 984-6165 phone
(302)658-1192 fax
[email protected]


Introduction

This chapter summarizes the significant case law developments from state and federal courts across the country in 2020 concerning directors’ and officers’ liability insurance coverage claims.  Noteworthy decisions included the following:

  • In re Solera Insurance Coverage Appeals, 2020 WL 6280593 (Del. Oct. 23, 2020). The Delaware Supreme Court held that an appraisal action brought under 8 C. § 262 was not covered “Securities Claim” within the definition of that term in a D&O policy. 
  • Arch Insurance Company v. Murdock, et al., 2020 WL 1865752 (Del. Super. Jan. 17, 2020). The Superior Court of Delaware held that the Larger Settlement Rule governs allocation disputes under Delaware law when the parties cannot agree on allocation between covered and uncovered claims. 
  • Pfizer Inc. v. U.S. Specialty Insurance Company, 2020 WL 5088075 (Del. Super. Aug. 28, 2020). The Superior Court of Delaware held that a settlement for less than an insurer’s policy limit did not affect attachment of higher-level excess insurance. 

Allocation

Arch Insurance Company v. Murdock, et al., 2020 WL 1865752 (Del. Super. Jan. 17, 2020).  The Superior Court of Delaware held that the Larger Settlement Rule governs allocation disputes under Delaware law when the parties cannot agree on allocation between covered and uncovered claims.  The court found that the Larger Settlement Rule best protects the economic expectations of the insured, consistent with Delaware courts’ interpretation of insurance policies as a whole, and applies even when the policy’s allocation provision references the relative legal and financial exposures of the insureds.

In this case, certain excess insurers filed a declaratory judgment action regarding, inter alia, their obligation to indemnify the insureds for settlement payments arising out of two shareholder litigations, one brought in the Delaware Court of Chancery (In re Dole Food Company, Inc. Stockholder Litigation, 2015 WL 5052214 (Del. Ch. Aug. 27, 2015) (“Dole”) and one brought in the District of Delaware (San Antonio Fire & Police Pension Fund v. Dole Food Co., Inc., No. 1:15-CV-01140 (D. Del. Dec. 9, 2015) (“San Antonio”).   Both sides filed motions for summary judgment on the issue of which allocation theory applied to the policies, since the underlying cases involved uninsured parties.  The insureds advocated for the Larger Settlement Rule.  This rule dictates that allocation between covered and uncovered claims is appropriate only if acts of the uninsured parties caused the settlement costs to be higher than they would have been, had only the insured parties settled the actions.  Under the Larger Settlement Rule, the insurers often are liable for the entire settlement unless they can demonstrate that the uncovered liability actually increased the amount of the settlement.  In contrast, the insurers argued that the insureds bore the burden of proving that a loss relating to the settlement was a covered “Loss” under the policy. 

The court first looked at the policy language and found it unambiguous but unhelpful to the question before it, because the allocation provision only addressed circumstances in which the parties agreed to an allocation.  The provision did not contain a formula or any other methodology to apply in the event that the parties disagreed.   The court also noted that Delaware case law provided no guidance on the question, but that other courts had employed the Larger Settlement Rule when adjudicating allocation disputes.  Important to the court was the overarching rationale for the rule, which was to protect the economic expectations of the insured.  The court reasoned that this rationale was consistent with the way that Delaware courts interpret policy language in other insurance disputes and consistent with the policy as a whole, which is designed to cover the insured’s compensable Loss regardless of whether others are at fault.  The Court explained that the allocation provision should be read consistently with that expectation unless it expressly contained a different allocation method, such as pro rata. 

Significantly, the court rejected the insurers’ argument that the reference to the “relative legal and financial exposure of the insureds” in the allocation provision dictated a different result, noting that this language contemplated situations in which the parties worked together to determine the proper allocation.  In addition, the court did not believe that the “relative exposure” language was inconsistent with the economic rationale behind the Larger Settlement Rule.  Finally, the court opined that because the San Antonio action was relatively simple, and damages were pled against all defendants jointly and severally, the Larger Settlement Rule was dispositive in favor of the insureds on the allocation issue.  Because the Dole complaint and settlement were more complicated, however, the court was not willing to grant summary judgment based on the factual record before it. 

Claim

ISCO Indus., Inc. v. Great Am. Ins. Co., 148 N.E.3d 1279 (2019).  The Court of Appeals of Ohio upheld that the renewal of a D&O insurance policy does not extend the time by which an insured may report a claim.  The policy at issue contained a notice provision in which the insured was required to notify the insurer as soon as possible, but no later than 90 days, after the end of the policy for the claim to be covered. The appellant argued that subsequent policy renewals extended the claim-reporting period and that a claim filed over a year and a half after receiving notice of litigation should be covered.  The court rejected this argument finding the plain language of the provision did not support this argument.

The appellant also argued that the insurer must still provide coverage if it has not been prejudiced in any way by the late notice under the notice prejudice rule.  Adopting reasoning from similar cases in which federal courts applied Ohio law, the court suggested the specific 90-day notice requirement was unambiguous and that adoption of the notice-prejudice rule would effectively rewrite the parties’ contract.  The court determined the notice-prejudice rule did not apply to D&O insurance policies with specific notice requirement deadlines.

EurAuPair Int’l, Inc. v. Ironshore Specialty Ins. Co., 787 F. App’x 469 (9th Cir. 2019).  The Court of Appeals for the Ninth Circuit, affirming the district court’s decision, found that under California law, the notice-prejudice rule does not apply to claims-made-and-reported policies.  EurAuPair International Inc., one of several federally authorized au pair programs, purchased claims-made-and-reported policies for consecutive policy periods.   The first policy required the company to report claims to Ironshore, its insurer, “as soon as practicable but in no event later than thirty (30) days after the end of the Policy Period.” Finding that this language was unambiguous as to its requirement that EurAuPair report all claims by a certain date, the court declined to grant relief to EurAuPair on equitable grounds, as the company knew of the claim within the policy period and had thirty days after the policy expired to report it yet waited sixteen months to do so.

Landmark Am. Ins. Co. v. Lonergan Law Firm, P.L.L.C., 809 F. App’x 239 (5th Cir. 2020).  Applying Texas law, the United States Court of Appeals for Fifth Circuit, reversing the district court’s ruling, found that absent a showing of prejudice, an insurer, Landmark, was not permitted to deny coverage under a professional liability policy due to the insured’s failure to comply with “immaterial” conditions of notice, where she complied with her “material” obligation to report a claim.

In the underlying action, Gaylene Lonergan, a Texas attorney, had helped a group of investors close on a real estate deal.  When the deal turned out to be a scam, the investors sued Lonergan in state court, who was covered by a Landmark policy.  While the state court case was pending, Landmark filed suit against Lonergan seeking a declaration that it did not have a duty to defend Lonergan under the policy because, among other things, she failed to “report” the claim to it during the policy period, as she was obligated to do by the policy.  As part of her application to renew her insurance policy with Landmark, a note in the claim supplement contained “a concise synopsis of the underlying dispute” herself and the investors.  Landmark argued that the claim supplement was insufficient to satisfy her obligation to “report” the claim to Landmark and the district court agreed.

On appeal, the Court of Appeals found that Lonergan did in fact report the claim.  The court focused on the fact that Landmark did not dispute that it received the claim supplement during the policy period.  Landmark argued that because the “Notice of Claim” provision in its policy obligated Lonergan to “send all claim information to: Attention: Claims Dept. [address],” and she failed to send them to the correct department, that she failed to adequately report her claims.  The court concluded that Landmark’s direction of notice to the claims department could not be considered a material condition.  Given the immateriality of the notice condition, Landmark could only be relieved of its duty to defend and indemnify only upon a showing that it was prejudiced by the breach.  Here, it could not make such a showing.

Protective Specialty Ins. Co. v. Castle Title Ins. Agency, Inc., 437 F. Supp. 3d 316 (S.D.N.Y. 2020).  The United States District Court for the Southern District of New York granted Castle Title’s motion for summary judgment and denied the Protective Specialty’s cross-motion for summary judgment. Protective Specialty underwrote two claims-made-and-reported insurance policies for Castle Title for different periods of time.  In 2015, Castle Title was served with a subpoena requesting documentation of transfers and mortgages.  In 2016, Castle Title was named a defendant in a lawsuit alleging that it had delayed the submission of real estate documents.

The instant action commenced when Protective filed suit against Castle Title seeking a declaratory judgment that Protective has no duty to defend or indemnify Castle Title in the 2016 lawsuit. Protective alleged that the 2015 Subpoena was a “claim” under the terms of the Policies, and that Castle Title failed to report it.  Protective alleged that the unreported 2015 Subpoena and the 2016 Lawsuit should be treated as “related claims,” therefore Protective had no obligation to Castle Title under the two policies. The court rejected this argument, stating that the 2015 Subpoena was not considered a “claim” as it was not issued in a “litigation or arbitration” involving professional services.  Rather, the subpoena was for the purpose of receiving a judgment, not questioning Castle Title’s professional services.  Because the 2015 Subpoena was not considered a “claim” for the purpose of “related claims,” the court dismissed this cause of action.

Protective’s second cause of action was a claim for warranty exclusion, alleging that Castle Title made a false statement on its Application for Policy (AIP), which the court dismissed because Castle Title had no reason to believe that a claim was pending against it. On its AIP, Castle Title stated that it was not aware “of any incident or circumstance which may result in a claim.”  Protective alleges that Castle Title should have known that the 2015 Subpoena was a “claim,” therefore absolving Protective of any obligation to cover Castle Title.  The court found that 2015 Subpoena was not a “claim” as defined by the Policy, nor that it met the definition of “claim” in the context of insurance contracts.

Exhaustion

Pfizer Inc. v. U.S. Specialty Insurance Company, 2020 WL 5088075 (Del. Super. Aug. 28, 2020).  The Superior Court of Delaware’s Complex Commercial Litigation Division held that a settlement for less than an insurer’s policy limit did not affect attachment of higher-level excess insurance.  The parties filed cross-motions for summary judgment seeking a determination of whether the excess insurer’s policy attached.  The excess policy at issue contained an exhaustion clause providing that the policy “shall attach only after all Underlying Insurance has been exhausted by actual payment of claims or losses thereunder.”  The Superior Court explained that Delaware consistently follows the “Stargatt Rule” that excess policies attach regardless of “whether the insured collected the full amount of the primary policies, so long as [the excess insurer] was only called upon to pay such portion of the loss as was in excess of the limits of those policies.”

The Superior Court contrasted the Stargatt Rule with an alternative approach, known as the “Qualcomm Rule.”  Under the “Qualcomm Rule,” settlements below policy limits bar attachment of a higher-level excess policy when the excess policy requires exhaustion by “actual payment of a covered loss.”  The Superior Court noted that Delaware precedent had expressly rejected the Qualcomm Rule as “contrary to the established case law” of Delaware.  Accordingly, because the exhaustion clause in the excess policy required only that the underlying policies be “exhausted by actual payment of claims,” the Superior Court held that a settlement in which an insurer pays and the insured agrees that the payment fully satisfies the policy accomplishes exhaustion through “actual payment.”

Insured

Turner v. XL Specialty Ins. Co., 2020 WL 3547954 (W.D. Okla. June 30, 2020). A federal judge from the Western District of Oklahoma entered an order granting a defendant insurer’s motion for summary judgment, finding that a former company executive’s legal expenses incurred in a separate action filed by another company executive to determine rights under a profit-sharing agreement were not covered by the company’s liability insurance policy.  The court determined that there was no coverage because the former executive, Ryan Turner, was not involved in the lawsuit in his corporate capacity and thus as an “Insured Person” under the insurance policy, but rather as an individual equity holder under the profit-sharing agreement.  As such, XL Specialties, the defendant insurer, did not breach the insurance policy when it denied coverage.

The court also found that Mr. Turner did not qualify for coverage under the policy, because he did not suffer a covered “Loss.”  Rather, even though he was named as a defendant in the declaratory judgment action, the legal fees for which he sought reimbursement did not qualify as “Defense Expenses,” finding that the claims asserted by another party in the lawsuit did not amount to Turner being in a defensive posture, but rather were asserted for the benefit of himself and another party.  Specifically, Turner had not disputed or opposed any relief sought by another party in the lawsuit.  Instead, he only asserted counterclaims and crossclaims.  Functionally, the court found that his posture in the declaratory judgment action was only nominally that of a defendant, as Turner, in actuality, sought affirmative relief.  The court noted that its conclusion was supported by numerous federal and states courts who have dealt with a similar issue: whether an insurer’s “duty to defend” includes an obligation to prosecute affirmative counterclaims and crossclaims.  Most federal and state courts, it noted, have found that an insurer’s duty to defend does not include such an obligation.

Securities Claim

In re Solera Insurance Coverage Appeals, 2020 WL 6280593 (Del. Oct. 23, 2020).  The Supreme Court of Delaware recently set forth its view of whether an appraisal action brought under 8 Del. C. § 262 is a covered “Securities Claim” within the definition of that term in a D&O policy—and the answer is no.  The Supreme Court’s holding reversed the Delaware Superior Court’s conclusions that a “violation of law” need not include allegations of wrongdoing to come within the policy, and that an appraisal action is a claim for a “violation” because it necessarily alleges a wrong; i.e., that the surviving company contravened the dissenting shareholders’ rights to the fair value of their shares.  The Supreme Court limited its holding to the “violation” issue and declined to rule on the other issues the parties briefed, including the insurers’ argument (raised for the first time on appeal) that an appraisal action does not “regulate securities.” 

The Supreme Court accepted this appeal on an interlocutory basis, after the Superior Court denied the insurers’ motion for summary judgment on coverage for an appraisal petition brought by certain shareholders seeking a fair value determination of their shares of Solera.  The Supreme Court focused on the definition of “Securities Claim” in Solera’s D&O policies—and specifically whether such claims were “violations” of law.  In determining that appraisal actions were not claims for violations of law, the Court considered the historical context of Delaware’s appraisal process, the text of 8 Del. C. § 262, and the case law interpreting the statute. 

The Supreme Court began its analysis by considering the plain meaning of the word “violation,” but reached a different conclusion in doing so than did the Superior Court.  While both the Supreme Court and Superior Court cited various dictionaries for guidance on the term’s meaning, the Supreme Court concluded that “violation” “involves some wrongdoing, even if done with an innocent state of mind.”   Because appraisal actions are intended to be a “limited legislative remedy developed initially as a means to compensate shareholders of Delaware corporations for the loss of their common law right to prevent a merger or consolidation by refusal to consent to such transactions,” the Court reasoned that these proceedings do not adjudicate wrongdoing.  To support its view, the Court recited the history of appraisal rights in Delaware, explaining that actions under § 262 are “neutral” proceedings designed only to determine the fair value of a dissenting stockholder’s stock.  The fair value can be deemed higher than the merger price, but frequently is found to be lower than the merger price, so both sides bear some risk.  And because the statute imposes few duties on the surviving company, appraisal petitions frequently contain no allegations of wrongdoing against the surviving company, including the petition at issue in Solera. 

Finally, the Supreme Court explained that a long-standing line of Delaware precedent confirms that appraisal proceedings do not include an inquiry into wrongdoing—the only issue is the value of the dissenting stockholder’s stock.  The court rejected Solera’s argument that appraisal cases have evolved to the extent that an appraisal petitioner must “show deficiencies in the sale process in order to overcome the contention that the share price reflected fair value,” making clear that there is no such presumption.  To the extent that wrongdoing relating to the transaction is relevant to the fair value determination, the court reasoned that it goes only to the deference, or weight, to be given to the merger price—allegations of wrongdoing are appropriately adjudicated through breach of fiduciary duty, fraud, or other claims, not through invocation of the statutory appraisal remedy. 

Wrongful Acts

Legion Partners Asset Mgmt., LLC v. Underwriters at Lloyds London, 2020 WL 5757341 (Del. Super. Sept. 25, 2020).  The Superior Court of Delaware’s Complex Commercial Litigation Division granted an insured’s partial motion to dismiss, requiring the insurer to advance defense costs as the allegations presented in the counterclaim asserted a risk within the policy’s coverage.  This action arose out of a lawsuit filed against Legion Partners Asset Management by a former employee, to which Legion responded with an arbitration action.  In response, the former employee filed a counterclaim, at which time Legion notified the insurer, Underwriters, of their intent to seek coverage for defense costs. Underwriters denied Legion coverage.

The court first determined that Underwriters’ duty to advance was triggered. A policy that contains a duty to advance is implicated when “an action states a claim covered by the policy” and an insurer will be required to advance costs for any litigation that falls within the policy terms.  The court also determined that Underwriters was required to indemnify Legion under the Policy because Legion sustained a “Loss” arising from a claim or counterclaim against the insured organization for a “Wrongful Act.”  “Wrongful Acts” are broadly construed to include “any actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission or act committed” by the insured organization.  The counterclaim filed by the former employee asserts that Legion “allegedly acted against its investors’ interests and violated federal laws and regulations by leaking material nonpublic information,” therefore constituting a “Wrongful Act” within the scope of the policy.  Additionally, the court determined that Underwriters had to indemnify Legion under the policy for its defense of the organization’s directors, as Legion incurred the “Loss” of defending the factual allegations lodged against its named directors.

Other Miscellaneous Cases

Korn v. Fed. Ins. Co., 2019 WL 4277187 (W.D.N.Y. Sept. 10, 2019), appeal dismissed (Dec. 19, 2019).  Applying New York law, the United States District Court for the Western District of New York held that Federal Insurance Company, an insurer, did not owe a fiduciary duty to Marc Irwin Korn, its insured, when Korn was represented by independent defense counsel in a criminal lawsuit.  It also found that Federal Insurance Company did not breach its contractual duties to Korn in paying defense costs, an action that exposed the policy limits.

Korn argued that Federal owed him a fiduciary duty based on a special relationship of trust and confidence, and that Federal’s failure to monitor his criminal defense attorneys, audit the legal fees they incurred, and replace counsel when Korn informed Federal that the firm was wasting the finances available for coverage constituted a breach of that duty.  Here, because Federal did not represent Korn in his criminal case, there was neither a legal nor factual basis to conclude that Federal assumed responsibility for his defense in any way.  Even if Korn did establish that Federal brokered the attorney-client relationship in the criminal action, it was not a rare situation in which a fiduciary duty existed.

Korn also argued that his policy required Federal to ensure that his criminal lawsuit reached a final resolution before the policy limits were exhausted.  The court found that he did not identify any language from his policy that established such a requirement, and instead held that the policy neither required Federal to ensure a swift resolution of Korn’s criminal litigation, nor could it reasonably impose such a burden unless Federal assumed responsibility for Korn’s criminal defense.  The court also found that Korn identified no obligation in the policy requiring Federal to follow its own guidelines to keep track of legal fees and oversee work performed for Korn’s benefit, noting that New York courts have consistently rejected that a cause of action based on failure to follow internal guidelines.

Hughes v. Xiaoming Hu et al., 2020 WL 1987029 (Del. Ch. Apr. 27, 2020).  The Delaware Court of Chancery denied director defendants’ motion to dismiss a derivative claim, while reinforcing that directors and officers who neglect their oversight responsibilities may be personally liable for the resulting harm to the company and its stockholders.  The plaintiff asserted that the defendants: (1) breached their fiduciary duties by willfully failing to maintain an adequate system of oversight, disclosure controls, and internal controls over financial reporting, and (2) were unjustly enriched through their excessive compensation which was based on inaccurate financial statements. 

With no demand for litigation made, the court had to determine if the omission was excused because of the directors’ inability to make an impartial decision regarding whether to pursue litigation.  To answer this, the court applied the Rales demand futility test.  Rales dictates that a director cannot exercise independent and disinterested business judgment regarding a litigation demand when potential litigation might expose the director to adverse personal consequences, including money damages.  Directors and officers responsible could be held personally liable if oversight failures result in losses to the company.

The court held that the members responsible for ensuring proper internal controls and reporting systems faced a substantial likelihood of liability because the controls in place were not meaningful and demonstrated their failure to act in good faith towards their fiduciary duty of loyalty.  In making its determination, the court emphasized that these members met minimally only to comply with federal securities laws and when they did meet, they did not discuss or implement any procedures despite having known of material weaknesses in the company’s internal controls. It found these deficiencies supported a reasonable inference that the defendants failed to provide meaningful oversight over the company’s financial statements and system of financial controls and that no disinterested and independent majority could have considered a demand, rendering demand futile.

Ferrellgas Partners L.P., et al., v. Zurich American Insurance Company and Beazley Insurance Company, 2020 WL 4908048 (Del. Super. Aug. 20, 2020).  The Superior Court of Delaware’s Complex Commercial Litigation Division entered an order requiring an insurer to immediately advance and reimburse an insured’s past and ongoing defense costs prior to a final and non-appealable money judgment.

In this action, an insured sought a declaratory judgment for advancement of defense costs pursuant to insurance policies issued by two insurers.  In a prior ruling, the court granted the insured’s motion for partial summary judgment on this issue, declaring that one of the insurers had a duty to advance defense costs.  The insurer did not file an application for interlocutory appeal of the decision.  Notwithstanding the summary judgment ruling, the insurer refused to pay the invoices that the insured submitted, arguing that the summary judgment order was not a final and non-appealable money judgment and it was unable to determine the reasonableness of the defense cost invoices because they were heavily redacted.

The court rejected the insurer’s argument, holding that the insurer must comply with the summary judgment order and immediately advance and reimburse the legal fees and costs submitted by the insured.  The court also ordered the parties to follow the protocol established by the Court of Chancery in Danenberg v. Fitracks, Inc., 58 A.3d 991 (Del. Ch. 2012) for invoice submission, review, and dispute resolution.  Finally, the court awarded the insured its fees-for-fees incurred in connection with preparing and prosecuting the enforcement motion, so as to “be made whole.”


 

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