The D&O Diary

The D&O Diary


D&O Insurance: Contractual Liability Exclusion Precludes Coverage for Negligent Misrepresentation Claims

Posted in D & O Insurance

floridaIn an October 20, 201 opinion (here), Middle District of Florida Judge Roy B. Dalton, Jr., applying Florida law, entered summary judgment for a D&O insurer, holding that the insurer was not liable for the stipulated judgment its insured had entered because the policy’s broad contractual liability exclusion precluded coverage for the underlying claims of negligence and misrepresentation that had been asserted against the insured.




Land Resources LLC (LRC) was a land development company that eventually went bankrupt.  James Robert Ward was an executive of LRC. In connection with certain land development projects in Georgia, Tennessee and North Carolina, two bond companies issued subdivision bonds on behalf of LRC to guarantee the completion of the projects. As part of the bond issuance, Ward and LRC executed a General Agreement of Indemnity (GAI) under which they indemnified the bond companies for liabilities and costs the bond insurers incur in relation to the bonds.


LRC defaulted on the bonds and the bond issuers sued Ward alleging that he was liable for the bond issuers’ losses. The bond issuers alleged that Ward had caused LRC to default by negligent acts errors and omissions (the negligence claim) and had induced the bond issuers to issue to bonds by negligently failing to disclose LRC’s financial condition to the bond issuers (the misrepresentation claim). The bond issuers’ initial complaint also included a claim against Ward for indemnification under the GAI, but the bond issuers’ amended complaint omitted the indemnification claim.


Ward submitted the lawsuit to LRC’s D&O insurer. The D&O insurer denied coverage for the claim under the policy’s contractual liability exclusion. Ward entered into a settlement of the underlying lawsuit whereby he agreed to a stipulated judgment of $40 million and assigned his rights under the policy to the bond issuers. The bond issuers then sued the insurer seeking to recover the amount of the judgment.  The D&O insurer moved for summary judgment, arguing that there was no coverage under its policy for the bond issuers’ claims against Ward.


Exclusion 4(h) of the policy provided that the insurer “shall not be liable to make any payment for Loss in connection with a Claim made against an Insured … alleging, arising out of, based upon or attributable to any actual or alleged contractual liability of the Company or any other insured under any express contract or agreement.”


The October 20 Opinion


In moving for summary judgment, the insurer argued that Exclusion 4(h) precluded coverage for the claims against Ward because the losses claimed in the underlying action arose out of Ward’s and LRC’s breaches of their contractual obligations under the GAI and the bonds.  The bond issuers argued that the defendants’ arguments take construction of the Policy “to a tortured extreme, arguing that the mere utterance of the word ‘bond’ or ‘contract’ by Plaintiffs in this action sucks the claim in the protective ambit of the exclusion” and ignores the “legal legitimacy of Plaintiffs’ tort claim which stand independently of any contractual liability.”


Judge Dalton agreed with the insurer, saying that “this court finds that the phrase ‘arising out of’ as used in Exclusion 4(h) is unambiguously broad and preclude coverage for purported tort claims that depend on ‘the existence of actual or alleged contractual liability’ of an insured ‘under any express contract or agreement.’”


He added that the insurer had introduced evidence that the “purported negligent misrepresentation claim” in the underlying lawsuit “depended on (and was not merely incidental to) Ward’s and LRC’s contractual liability under the GAI, the Bonds and the various developmental agreements.” He also noted that the bond issuers conceded that their tort claim arose out of defaults on the Bonds, their losses arose from the contractual liability of Ward and that they would have suffered no losses had Ward performed his obligations. He also found that the bond issuers’ argument that “there never would have been any contracts” were it not for Ward’s negligent misrepresentations “finds no support in the cited deposition testimony and interrogatory responses.”


Although he did not need to reach the issue, he went on to rule that even if there were coverage under the policy, the insurer would be entitled to summary judgment because the settlement of the underlying lawsuit (which took the form of a so-called Coblentz agreement between the claimant and the insured and involved the insured’s assignment of policy rights) “was reached by collusion or an absence of effort to minimize liability.”  He noted a “plethora of evidence indicating that enforcement of the Coblentz agreement in this case would be contrary to Florida law.”


In reaching this conclusion about the settlement agreement, Judge Dalton noted, among other things that Ward obtained benefits “beyond the mere conclusion of the Underlying Action”; that Ward had not “endeavored to minimize the amount of the judgment” (and noting that Ward had settled with two bond issuers for relatively nominal amounts); and that Ward had defenses to the underlying action.




I suspect that many readers will find the outcome of this case surprising, as claims of negligence and negligent misrepresentation are the very sorts of claims for which policies of this type are purchased. But as I noted in a prior post discussing an earlier decision in which another court held that the contractual liability exclusion precluded coverage for a negligent misrepresentation claim, the outcome of the coverage analysis is attributable to the sweeping breadth of the exclusion’s omnibus preamble. In the prior case as in this case, the courts held that coverage was precluded because of the breadth of the “based upon, arising out of” language.


The disconcerting thing about this application of the exclusion is that it implies that the exclusion could preclude coverage for any claim in which any sort of a transaction is involved. The trouble is that many of not most D&O claims involve some sort of a transaction that includes some sort of a contract or agreement or understanding. If the “based upon, arising out of language” sweeps as broadly as Judge Dalton’s opinion seems to imply, the exclusion potentially could block the coverage for which the policy was intended.


One remedy for the potential over-breadth of the exclusion would be to substitute the word “for” in lieu of the “based upon, arising out of language.” However, many carriers will insist on using the broad preamble for the contractual liability exclusion and will refuse the narrower “for” language. Given the extent of the preclusive effect that courts have found in interpreting contractual liability exclusions with broad omnibus preambles, policy forms using the narrower “for” wording are, in this respect, superior  from the policyholder’s perspective, particularly if carriers whose policies have the broader wording try to apply the exclusion to preclude a broad range of types of claims.


As I suggested in my earlier post, I think the “for” wording is more consistent with the purposes for including a contractual liability exclusion in a D&O policy. An exclusion with the “for” wording makes it clear that insurers do not intent to pick up the insured company’s contractual liability, without extending the exclusion’s preclusive effect to a broad range of tort claims alleging different types of wrongful misconduct.


From my days as a coverage attorney on the insurance company side, I retain a basic dislike for the kind of settlement Ward entered with the bond insurers. These kind of deals always felt like an attempt to try to set up the insurer. Just the same, I found Judge Dalton’s conclusion that the settlement agreement here was collusive a little unexpected, and not just because he didn’t need to reach the issue. While I see his point about the $40 million amount of the stipulated judgment, the rest of his reasoning to me seems off the mark.


The insurance company had denied coverage, Ward had to look out for his own interests as best he could, no thanks to the insurer. What obligation did he have to try to negotiate a better deal for the benefit of the insurer? What possible expectation could the insurer have in that in reaching a settlement he should have to “minimize” the amount of the settlement or try to assert defenses he may have? Why shouldn’t he be able to extract as many benefits out of the settlement as he could? The amount of the settlement arguably may support a conclusion that the settlement was conclusive, but I am not as persuaded by the other grounds on which Judge Dalton relied support his conclusion that the settlement was collusive.


An earlier post in which I set out a broader overview of the contractual liability exclusion can be found here.  

Many Companies’ Most Significant Regulatory Risks Are Not in Their Home Country

Posted in Regulatory Enforcement

globeWhen Chinese regulators hit GlaxoSmithKline with a $489 million penalty last month – the largest corporate penalty ever in China – it set off alarm bells around the world. Among other things it sent out a “wake-up call for global companies that assumed that their main regulatory risk is in their home countries,” according to a commentator quoted in an October 21, 2014 Bloomberg article entitled “Hong Kong is Hot Spot for U.S. Lawyers as Probes Rise” (here). The GSK penalty is just one of several developments that have triggered fears of increased regulatory enforcement action in China and elsewhere, that, according to the Bloomberg, has led to increased concerns in corporate executive offices and increased opportunities for lawyers and law firms in Hong Kong and elsewhere. 


A critical aspect of the GSK bribery action in China is that it has triggered investigations in both the U.S. and the U.K. as regulators in those countries look into whether the company broke their anti-bribery laws. These circumstances provide just one example of how regulatory and enforcement actions in one country increasingly can lead to regulatory actions in multiple countries. Another example of this phenomenon is the investigation whether Wall Street’s hiring practices in China and Hong Kong violated anti-bribery laws. The issues are also being investigated in the U.S. as well. The ongoing investigations into Libor benchmark rate manipulation and foreign exchange rate manipulations are other examples where regulatory investigations quickly crossed borders and became multi-jurisdictional. 


The upshot of al this is that a regulatory investigation in one country can lead to what one commentator in the Bloomberg article called “industrial strength investigations,” involving agencies in the U.S., Europe and Asia. These trends are only likely to accelerate as additional countries – including, for example, India, Indonesia and Thailand – step up efforts on anticorruption, antitrust and sanctions. 


The point of the Bloomberg article is that this regulatory enforcement trend has fueled a boom for lawyers, as the cross-border investigations require the involvement of lawyers and law firms that can coordinate responses the investigations in the various jurisdictions. In addition, companies interested in trying to head off problems before they arise have been willing to enlist the services of lawyers to provide compliance and training services. 


There are a number of interesting points in the Bloomberg article, particularly the point that increasingly companies’ greatest regulatory risks may not be in their home country. Even if the risks outside the home country are not greater, it is certainly true for many companies that their regulatory risks are not limited to those in their home country. As regulators everywhere become more active on anti-bribery and other issues, the risk of regulatory action is now widespread and dispersed, and includes not only the risk of a regulatory action outside a company’s home country, but also includes the risk of a cross-border, multi-jurisdictional regulatory action. 


In many instances the onset of a regulatory action will not trigger a company’s D&O insurance policy, although it usually will trigger a claims notice from the company to its insurer. But as a regulatory action progresses into an enforcement proceeding, the D&O insurance may become a factor, at least for defense costs – particularly if individuals are targeted in the investigation or named as defendants in an enforcement action. So even though the D&O policy will not in most instances provide insurance for regulatory fines and penalties, it could nevertheless prove to be important even if just on a defense cost basis. 


An additional factor be kept in mind as well is that regulator and investigative action can, as is noted in the Bloomberg article, be followed by a follow-on civil action against company management, which likely would trigger the D&O policy, or even possibly insolvency proceedings, which again could lead to actions that might trigger the D&O policy.  


The risk of the follow-on civil action coming in the wake of a regulatory investigation is a phenomenon I have noted frequently on this blog — including in particular the risk of follow in civil actions in the U.S. following regulatory actions and investigations outside the U.S, as discussed here


I happen to think that the increasing global regulatory enforcement activity is one of the important emerging trends in the corporate liability arena. These developments have very important liability implications both for non-U.S. companies in their home countries and operating abroad, and for U.S. companies operating overseas. For D&O underwriters, these developments have important underwriting implications. And for policyholders and their advisors, these developments raise important and challenging questions about the availability and effectiveness of their insurance to respond to these emerging regulatory claims in all of the jurisdictions in which the claims might arise. 


More About Dark Pool Trading: If you have not yet read the article entitled “The Empire of Edge” in October 13, 2014 issue of The New Yorker (here) about the insider trading investigation of S.A.C. Capital and the conviction of former S.A.C. trader Mathew Martoma, you will want to set aside some time and read it carefully. It is absolutely fascinating, particularly on the questions surrounding Martoma’s motivations. 


Among many other very interesting details in the article is its account of how S.A.C. Capital took advantage of trading on a private “dark pool” trading platform to unwind its massive positions in the securities of Elan and Wyeth — just ahead of public disclosures of clinical trial setbacks in a promising Alzheimer’s therapy the companies were pursuing – without attracting attention to its trades: 


When the market opened on Monday, Cohen and Martoma instructed Phil Villhauer, Cohen’s head trader at S.A.C., to begin quietly selling Elan and Wyeth shares. Villhauer unloaded them using “dark pools”—an anonymous electronic exchange for stocks—and other techniques that made the trades difficult to detect. Over the next several days, S.A.C. sold off its entire position in Elan and Wyeth so discreetly that only a few people at the firm were aware it was happening. On July 21st, Villhauer wrote to Martoma, “No one knows except me you and Steve.” 


[T]he next evening, word of the ambiguous results hit the news wires. Tim Jandovitz, a young trader who worked for Martoma, watched in dismay as the news appeared on his Bloomberg terminal in Stamford. He checked Panorama [an S.A.C. portfolio monitor], which showed that S.A.C. still held huge positions in Elan and Wyeth. Jandovitz believed that both he and Martoma had just lost more than a hundred million dollars of Steven Cohen’s money—and, along with it, their jobs. The next morning, he braced himself and went to the office. But when he consulted Panorama he saw that the Elan and Wyeth shares had vanished. Some time later, Martoma informed Jandovitz that S.A.C. no longer owned the stock.



Barclays Libor-Scandal Securities Suit Survives Renewed Dismissal Motion

Posted in Libor Scandal, Uncategorized

barclaysThe Libor-scandal based securities suit filed against Barclays and certain of its directors and offices will now be going forward. The case was initially dismissed, but on appeal the Second Circuit vacated a part of the dismissal ruling and returned the case to the district court for further proceedings. The defendants filed a renewed motion to dismiss. In an October 21, 2014 order (here), Judge Shira Schindlin denied the defendants’ motion, holding that the plaintiffs’ allegations of scienter were sufficient to meet the pleading requirements. The lawsuit, filed on behalf of investors who purchased Barclays American Depositary Receipts (ADR) in the United States, will now proceed.



On June 27, 2012, Barclays announced that it had entered settlements with regulators in the United States and the United Kingdom relating to the Libor-manipulation scandal. Barclays agreed to pay fines totaling more than $450 million and admitted for the first time that between August 2007 and January 2009 the bank had in its Libor submissions underreported the interest rates it was paying.


As discussed in greater detail here, on July 10, 2012, Barclays shareholders filed a securities class action lawsuit in the Southern District of New York, against Barclays PLC and two related Barclays entities, as well as the company’s former CEO, Robert Diamond; and its former Chairman Marcus Agius. (Former Group Chief Executive John S. Varley was added as a defendant later). The complaint, which can be found here, was filed on behalf of class of persons who purchased Barclays ADRs between July 10, 2007 and June 27, 2012.


The plaintiffs’ complaint alleges that the bank willfully misrepresented the bank’s borrowing costs between 2007 and 2009 and knowingly submitted false information for purposes of calculating Libor. The plaintiffs allege that by underreporting the bank’s interest rates, the bank misrepresented the bank’s financial condition. The plaintiffs also allege that the defendants misleadingly stated that the company had established adequate internal controls. (For a detailed background regarding the Libor rate setting process and the allegations regarding Libor’s alleged manipulation refer here.) The defendants moved to dismiss the complaint.


In a May 13, 2013 opinion (discussed here), Judge Scheindlin granted the defendants’ motion to dismiss.  The plaintiffs appealed. As discussed here, in an April 25, 2014 decision, the Second Circuit affirmed the dismissal ruling in connection with the allegedly misleading statements regarding the bank’s internal controls. However, with respect to the remaining allegations concerning  the alleged underreporting of the bank’s borrowing costs,, the appellate court vacated the district court’s dismissal based on her finding that the plaintiffs had not adequately pled loss causation. The appellate court said “While expressing no view on the ultimate merits of plaintiffs’ theory of loss causation, we hold that the court below reached these conclusions prematurely.” On remand to the district court, the defendants filed a renewed motion to dismiss.


The October 21 Order

In her October 21 order, Judge Scheindlin denied the defendant’s motion to dismiss, holding that the plaintiffs had adequately pled scienter as to Barclays and as to Diamond, and had adequately pled control person liability allegations as to Agius and Varley.


In concluding that the plaintiffs had adequately pled scienter as to the Barclays entities, Judge Scheindlin examined the plaintiffs’ allegations that Barclays submitted inaccurate Dollar Libor figures that underreported the bank’s borrowing costs. The plaintiffs also allege these inaccurate submissions were made at the direction of senior management. The plaintiffs’ allegations regarding the Libor submissions drew heavily on the factual recitals in the documents prepared in connection with the regulatory settlements.


Judge Scheindlin said that “Barclays’s repeated, long-term and knowing submission of false rates suggest far more than an intent to violate [British Banking Authority] rules. Rather the conduct constitutes strong circumstantial evidence of conscious misbehavior or recklessness.”(Citations omitted). The complaint’s allegations “are sufficient to give rise to a strong inference that the danger was either known to Barclays or so obvious that Barclays must have been aware of it.” (Citations omitted). She added that the complaint “also plausibly alleges Barclays’s motive – to counter negative perceptions about its borrowing costs and, more generally, its financial condition.”


Taken together, Judge Scheindlin said, the allegations, “give rise to a cogent and compelling inference that Barclays falsified the LIBOR submissions because it understood their likely effect on the market.” She rejected the innocent motive that the defendants sought to suggest – that is, that Barclays was merely attempting to correct a misrepresentation in the market about Barclays’s financial health. She said that the inference of scienter is “cogent and at least as compelling as the competing inference of innocent intent suggested by Defendants.”


Judge Scheindlin also found that the plaintiffs’ scienter allegations against Diamond were sufficient. The plaintiffs alleged that in October 2008, following a conversation with a Bank of England official, Diamond had ordered another executive to understate LIBOR submissions so that Barclays would not be an outlier on its reported interest rates among the rate setting banks. The plaintiffs also sought to rely on statements Diamond had made in an October 31, 2008 conference call with analysts about Barclays borrowing rates.


In concluding that the allegations regarding the instructions to the other executive to understate the bank’s LIBOR submissions met the Second Circuit’s “motive and opportunity” test for pleading scienter, Judge Scheidlin said that “the complaint’s allegations, including its historical context, provide a clear motive; the fact that Barclays made false LIBOR submissions following Diamond’s instructions evince opportunity.”  With respect to the statements in the analyst conference call, Judge Scheindlin noted that Diamond’s conversation with the Bank of England and instructions to the bank executive took place just two days before the conference call and his instructions to the bank executive, which she said is “inconsistent with the truth of either of the statements” Diamond allegedly made in the conference call on which the plaintiffs seek to rely.” The “inconsistency, together with the conduct alleged, creates a cogent and compelling inference that – at the very least – Diamond acted recklessly.”


With respect to the control person liability allegations against Agius and Varley, Judge Scheindlin noted that “while merely identifying the title of a corporate officer is insufficient to state a claim,” the Complaint “describes sustained and long-running misconduct that was known to management, including high-ranking corporate officers.” These allegations, Judge Scheindlin were sufficient to state a claim against Agius and Varley for control person liability.



Of the many different financial institutions caught up in the Libor scandal, Barclays is the only one that is involved in a Libor-scandal related securities class action lawsuit – most of the other banks involved in the scandal do not have securities that trade on the U.S. exchanges, and of the banks that have securities trading in the U.S, Barclays is the only one to be hit with a securities suit. (As noted here, one Libor-scandal claimant, the Charles Schwab Corporation, has filed an individual action in California state court seeking to recover damages from the Libor rate-setting banks on a number of theories, including under Section 11 of the ’33 Act.)


When this case was dismissed at the outset, it looked as if Barclays was going to be able to avoid any potential liability under the U.S. securities laws for alleged misrepresentations concerning its Libor submissions. However, when the Second Circuit reversed a portion of the dismissal ruling, it meant that the case was returning to the district court for further proceedings. In light of Judge Scheindlin’s latest order, the case will now be going forward as to all of the defendants.


The Libor-related litigation generally, including the consolidated Antitrust litigation pending in the Southern District of New York, has had many twists and turns, and this case is no exception. Discovery in this case will now go forward.  For securities litigation plaintiffs, the name of the game is to get past the dismissal motions stage with at least some portion of the case intact, which the plaintiffs here have accomplished. While the next procedural stage is discovery, the likely direction of the case undoubtedly reflect the fact that securities cases almost always settle, a fact on which the plaintiffs undoubtedly will be pushing as the case goes forward.


This case is not the only securities suit that Barclays is facing in the Southern District of New York. As discussed here, in July, Barclays was also named as a defendant in a securities class action lawsuit arising out of the bank’s “dark pool” private securities trading venue. Barclays is also one of the many defendants named in the “Flash Boys” high frequency trading securities class action lawsuit, as discussed here.


Russian Drivers: I am sure many readers saw the terrible story about the plane crash in Russia in which Total SA’s Chief Executive Officer Christophe de Margerie was killed, along with three of the plane’s crew members. According to news reports, the crash occurred after the business jet in which de Margerie was traveling struck a snow plow on a runway. The driver of the snow plow reportedly was drunk  — apparently along with the airport’s dispatchers, according to a detailed account on Fortune magazine’s website.


According to Wikipedia (here), Russians consume about 18 liters 4.8 US gal) of spirits a year, more than double the 8 liters (2.1 US gal) that the World Health Organization considers dangerous. All of that alcohol consumption has its consequences. In June 2009, the Public Chamber of Russia reported over 500,000 alcohol-related deaths annually.


As the tragic death of de Margerie shows, all too often the consumption of alcohol results in vehicle- related deaths. It is one thing to recite these statistics. It is another thing altogether to see what is actually happening on Russia’s roads. There is no way to know how many of the drivers shown in the following  video are under the influence of alcohol, but watch it and see if you think I am jumping to conclusions is suggesting that an awful lot of these drivers have been drinking . By the way, these videos exist because pretty much everybody in Russia has a dash camera as way of substantiating what has happened in the event of an accident (as you can tell from the video, accidents happen frequently). 


Dismissal Granted in Cyber Breach-Related Derivative Suit Filed Against Wyndham Officials

Posted in Cyber Liability

wyndham Along with the separate derivative lawsuit filed against Target Corporation’s board, the cyber breach-related derivate action filed against Wyndham Worldwide Corporation’s board has been closely watched as representative of a potential new area  liability exposure for corporate directors and officers.  However, in an October 20, 2014 opinion, District of New Jersey Judge Stanley Chesler, applying Delaware law, granted the defendants’ motion to dismiss the plaintiff’s complaint. A copy of Judge Chesler’s opinion can be found here.



As discussed here, the derivative lawsuit filed against the Wyndham officials relates to the three data breaches the company the company and its operating units sustained during the period April 2008 to January 2010. As discussed here, the company is already the target of a Federal Trade Commission enforcement action in connection with the breaches. A prior ruling that the FTC action can proceed is currently on appeal; to the Third Circuit.


Judge Chesler’s opinion recites that after the breaches occurred, the board and its audit committee met multiple times to discuss the company’s cyber security. The company hired a technology company to investigate the breaches and to make recommendations. Between the time of the second and third breach the company began implementing the recommendations.


In November 2012, the plaintiff sent the Wyndham board a letter demanding that it bring a lawsuit based on the breaches. The board hired the law firm of Kirkland & Ellis to investigate the plaintiff’s demand. The law firm found after investigation that the demand was not well grounded. In March 2013, the board voted not to pursue the demanded lawsuit.  In June 2013 the plaintiff presented a second demand letter, which the board rejected in August 2013 for the same reasons it had rejected the initial demand. The plaintiff filed his lawsuit in February 2014.


In the derivative lawsuit complaint, the plaintiff alleges that “in violation of their express promise to do so, and contrary to reasonable expectations,” the company and its subsidiaries “failed to take reasonable steps to maintain their customers’ personal and financial information in a secure manner.” The complaint goes on to allege that the individual defendants “aggravated” the damage to the company by “failing to timely disclose the breaches in the Company’s financial filings.” The complaint notes that the company did not first disclose the breaches until July 25, 2012, over two-and-a-half years after the third breach occurred.


The complaint alleges that the defendants’ failure to implement appropriate internal controls designed to detect and protect repetitive data breaches “severely damaged” the company and resulted in the FTC enforcement action. The FTC action, the complaint notes, “poses the risk of tens of millions of dollars in further damages.” The company’s failure to protect its customers’ personal information “has damaged its reputation with its customer base.”


The complaint asserts substantive claims against the individual defendants for breach of fiduciary duty; corporate waste; and unjust enrichment. The defendants moved to dismiss the plaintiff’s complaint.


The October 20 Opinion

In his October 20 Opinion, Judge Chesler granted the defendants’ motion to dismiss with prejudice. The defendants had argued that the board’s refusal to pursue the plaintiff’s demand was a good-faith exercise of business judgment, made after a reasonable investigation. Judge Chesler agreed.


The plaintiff had tried to argue that the board’s decision to reject the demand was not in good faith because it was based on the advice of the Kirkland & Ellis law firm, the same firm that represents the company in the FTC action. Judge Chesler rejected the plaintiff’s argument that the law firm’s representation of the company in the FTC action put them in a conflict of interest since the firm’s obligation in the two matters were identical. Judge Chesler also rejected the plaintiff’s argument that the demand put the company’s general counsel in a conflict of interest, finding that there was nothing in the demand to suggest that it exposed the general counsel to liability, and indeed did not even mention the general counsel. Judge Chesler also found that the plaintiff had failed to allege any facts to support the allegations that the general counsel’s role included responsibility for the company’s cyber security program.


Judge Chesler also rejected the plaintiff’s argument that the board’s decision to reject the shareholder demand was based on inadequate investigation. The Court said that “in light of the ample information the Board had at its disposal when it rejected Plaintiff’s demand, and considering the numerous steps the Board took to familiarize itself with the subject matter of the demand, Plaintiff has also failed to make this showing.” Based on their various actions after the breaches occurred, the board’s members were “well versed on the allegations,” but they did not merely reject the allegations in the plaintiff’s demand. Instead, the board and audit committee hired outside counsel to investigate and they met separately to discuss the results of the investigation.


Judge Chesler concluded by observing that “given the business judgment’s rule’s strong presumption, court uphold even cursory investigations by boards refusing shareholder demands.” Here, Judge Chesler said, “the Court finds that the WWC’s Board had a firm grasp on Plaintiff’s demand when it determined that pursuing it was not in the corporation’s best interest.”



When this lawsuit and the derivative lawsuits against the Target board were filed, there was a great deal of speculation about whether cyber risk represented an emerging area of exposure for the directors and offices of companies that experience cyber breaches. Cyber risk may yet emerge as a significant area of D&O liability exposure. But Judge Chesler’s opinion is a reminder of just how difficult it is for plaintiffs to survive the initial pleading hurdles in derivative lawsuits like the one the plaintiff filed here.


With the demand requirement and with the protections of the business judgment rule, plaintiffs face some difficult obstacles in just trying to overcome the preliminary motions. The outcome of this case may or may not discourage plaintiffs in other cases from trying to pursue claims against the boards of companies that experience cyber breaches, but this case hardly suggests that the potential liability of boards of cyber breach companies is a promising new area for plaintiffs’ lawyers.


It is probably worth noting that the derivative lawsuit that was filed several years ago against Heartland Payment Systems following that company’s cyber breach was also dismissed. Unless and until the plaintiffs’ lawyers score some successes in these kinds of cases, the outlook would have to be — based on the evidence so far – that this does not appear to be a particularly promising area for plaintiffs’ lawyers.


This case does provide some interesting insight into steps that companies that experience a cyber breach can take to try to protect their boards from potential liability related to the breach. Judge Chesler appeared to consider it significant that the board and the audit committee had met multiple times to discuss the breaches, to try to find out what had happened and to try to take remedial steps. By the time the demand latter arrived, the board could argue that its decision making about the demand was well-informed. Obviously, the board’s reliance on the investigation of outside counsel also helped them make the argument that their decision not to pursue the lawsuit was made in good faith.


There will much more to be told on the question of whether or not cyber liability represents a significant exposure for the boards of companies that experience a data breach. The lawsuit here does indeed suggest that boards can get sued following a cyber breach. Judge Chesler’s opinion highlights the fact that boards that are sued in these kinds of cases have substantial defenses that will difficult for plaintiffs to overcome.


A Whole Bunch of Interesting Litigation and Enforcement Statistics and Analyses

Posted in Securities Litigation

graphicA single case may involve a host of interesting issues but sometimes the important lessons can only be discerned when many cases are considered collectively. This past week saw the release of some interesting analyses of aggregate litigation and enforcement statistics, each set of which told some interesting tales to tell and identified some important trends.


The SEC’s FY 2014 Enforcement Statistics

The first of these sets of statistics was presented in the SEC’s October 16, 2014 announcement of its Fiscal Year 2014 enforcement statistics. (The 2014 fiscal year ended on September 30, 2014.) The SEC reported that it filed a “record” number of enforcement actions in 2014 involving a “wide range of misconduct” and including a “number of first-ever cases.”


During FY 2014, the SEC filed 755 enforcement actions, which represented a 10% increase over the 686 enforcement actions filed in FY 2013. In FY 2014, the agency also obtained orders totaling $4.16 billion, compared to $3.4 billion in 2013. By way of comparison to the statistics for FY 2013 and FY 2014, in FY 2012 the agency filed 734 enforcement actions and obtained orders totaling $3.1 billion in disgorgement and penalties.


The agency identified at least two significant factors driving the increase in enforcement actions. The first was the agency’s use of “new investigative approaches and the innovative use of data and analytic tools” and the second was the agency’s expansion into a number of new areas based on “first time cases.”


With respect to the use of data and analysis, the press release quotes SEC Chair Mary Jo White as saying that “the innovative use of technology – enhanced use of data and quantitative analysis – was instrumental in detecting misconduct and contributed to the Enforcement Division’s success in bringing quality actions.”


The kinds of “first-ever cases” identified in the press release included “actions involving the market access rule, the ‘pay-to-play’ rule for investment advisers, an emergency action to halt a  municipal bond offering, and an action for whistleblower retaliation.”


The press release also quotes SEC Chair White as saying that “aggressive enforcement” will remain a “top priority” and quotes the head of the SEC Enforcement Division as saying that he expects “another year filled with high-impact enforcement actions.” Going forward, the SEC Enforcement head said, the agency will “continue to bring its resources to bear across the entire spectrum of the financial industry.” Ominously, for the clients of the readers of this blog, he noted that among other things the agency will focus on bringing “cases against gatekeepers.”


The SEC’s press release includes a detailed recitation of various enforcement initiatives and accomplishments during the year. Among other things, the press release notes that during FY 2014 the agency’s whistleblower program awarded nine whistleblowers with total awards of approximately $35 million (the bulk of which was a single $30 million award, the largest ever, as discussed here).


Among other accomplishments, the press release cites the agency’s success during the fiscal year in “holding gatekeepers accountable,” noting that during the year it “held attorneys, accountants and compliance professionals accountable for the important roles they play in the securities industry.” The report also highlights the fact that during the year the agency “obtained the highest-ever FCPA penalties against individuals.”


With respect to the agency’s new policy of requiring individual admissions of wrongdoing as a condition of settlement of cases involving “particularly egregious conduct,” the press release notes that during the fiscal year that it had “demanded and obtained acknowledgements of wrongdoing under the admissions policy announced in the previous fiscal year.”


Alix Partners 2014 Litigation and Corporate Compliance Survey

On October 16, 2014, the business advisory firm Alix Partners released the report of its 2014 Litigation and Compliance Survey. The report is the result of a June 2014 survey of general counsel and compliance officers at companies in the United States and Europe with annual revenues of $250 million or more. The report underscores the fact that companies of this size in both the US and Europe are experiencing increased levels of litigation activity and incurring increased litigation costs. The firm’s October 16, 2014 press release can be found here and the Survey Report itself can be found here.


According to the report, 32 percent of respondents reported an increase in the number of legal disputes in which their companies were involved in the 12 months preceding the survey. The five most frequent types of commercial disputes in which the respondents said their companies were involved in the preceding twelve months were: contract (58%); employment (50%); intellectual property or patent infringement (33%); accounting/financial reporting/disclosure (19%); and insurance (19%). (The results totaled greater than 100% because the survey allowed respondents to select multiple categories.)


A particularly interesting observation from the survey responses of the European respondents is that many companies are seeing increases in cross-border disputes, with 35% of European respondents reporting that the number of cross-border disputes had risen during the preceding 12 months.


Interestingly, 8% of all respondent and eleven percent of European respondents reported that their companies were involved in bet-the-company disputes during the preceding 12 months. The top five types of bet the company disputes in which the respondents reported that their companies were involved were: contract disputes (50%); intellectual property (38%); class action (38%); antitrust (31%); and securities (13%). (Results totaled greater than 100% because of the selection of multiple categories.) Among the European respondents reporting that their companies were involved in bet-the-company litigation, the most frequently reported categories were contracts (71%) and class actions (57%).


All of this litigation activity has led to an increase in litigation spending. 47% of all respondents reported that spending at their companies for litigation had increased in the past year and 38% reported that their litigation departments had grown in the past year. Among the European respondents, half said that their companies had increased spending and 37% reported an increase in the size of their companies’ litigation departments.


As a resulting of the growing litigation threats and the mounting litigation spending, many companies are implementing measures to try to detect potential problems. In particular, increased regulatory oversight has encouraged many companies to increase their focus on preventive measures.


Academics’ Review of Plaintiffs’ Firms Effectiveness in Merger Objection Litigation

Based on their review of M&A-related litigation over a ten year period, a trio of academics has concluded that the top plaintiffs firms obtain the best results for shareholders, because they aggressively litigate their cases. In their October 2014 paper entitled “Zealous Advocates or Self-Interested Actors?: Assessing the Value of Plaintiffs’ Law Firms in Merger Litigation” (here), Case Western Reserve University Professor C.N.V. Krishnan, U.Cal Berkley Law Professor Steven Davidoff Solomon, and Vanderbilt Law Professor Randall Thomas reviewed a sample of 1,739 merger objection class action lawsuits filed between 2003 and 2012, in order to assess the effectiveness of the plaintiffs’ law firms. The results of their analysis, summarized in an October 15, 2014 article on the Vanderbilt University Web Site entitled “Top Class-Action Law Firms Are Worth Hiring, Study Says” (here), showed, according to one of the study’s authors, that “the presence of one of the top plaintiffs’ law firms is significantly and positively associated with a higher probability of lawsuits success.”


The paper’s authors divided the plaintiffs law firms into groups they denominated “top-10” and “non-top-10” using “various reputation measures” The authors then further divided to top firms into “top-5 firms” based on their “popularity with informed plaintiffs and proven ability to obtain large attorneys’ fees awards” The authors then analyzed the results in the various lawsuits in their litigation database, from which they concluded that the involvement of one of the top five firms was very strongly correlated with what the authors described as lawsuit success. The authors said that these results hold even after controlling for selection bias – that is, the likelihood that the top law firms get to pick the better cases that have higher chances of success.


The authors concluded that the top plaintiffs’ law firms achieve the best results because the top firms are significantly more active in prosecuting cases than other plaintiffs firms, which adopt more passive strategies. The top firms’ more active prosecution of the cases is evidenced by the fact that they file more documents in their cases and the fact that they “have fewer cases dismissed, win more procedural motions and obtain more substantive settlements.”  The lower tier firms, by contrast, appear to file lawsuits “in hopes of generating a quick settlement and avoiding the expense of trial,” with the settlements of the type that “many times are believed to profit the law firms more than their clients.”


As one of the authors quoted in the Vanderbilt web site article puts it, “not all plaintiffs’ law firms are alike and lawmakers, judges and regulators should act accordingly.” The authors’ research, they state, should give courts “guidance about the appropriate method for selecting lead counsel in shareholder class action litigation.”


Special thanks to a loyal reader for sending me a link to the Vanderbilt web site.



The SEC’s statement that its filing of a record number of enforcement actions during the past fiscal year was attributable in part to the agency’s “innovative use of data and statistical tools” is interesting. Since the agency announced the initiation of financial reporting task forces and implementation of data analytic tools to detect indicia of potential accounting fraud (dubbed in the media as “Robocop,”  about which refer here), there has been speculation that these initiatives could lead to an upsurge in enforcement activity. Although the agency’s fiscal year report does not directly link the increase in the number of enforcement actions to these initiatives, the SEC”s press release certainly does suggest that these initiatives represent a significant part of the agency’s enforcement actions during the past year. It seems likely that there will be more of this in the months and years ahead.


The SEC report’s emphasis on its actions targeting individuals and gatekeepers is certainly ominous for the interests of this blog’s readers. The agency’s focus on individuals and gatekeepers could, among other things, represent a real threat to the public company officers and directors.


The Alix Partners survey report is interesting not just because it documents that many companies are experiencing increased litigation activity and litigation spending, but also because it shows that these developments are not limited just to the more litigious United States. The fact that an even greater percentage of the European respondents to the survey than U.S. respondents reported that their companies were involved in bet-the-company litigation is surprising, and the fact that the European reported that their companies are experiencing increased litigation activity and litigation spending at about exactly the same levels as the U.S. respondents strongly suggests that the forces shaping the litigation environment in the two arenas may be similar — and even perhaps that the natures of the two environments may be converging. If nothing else, it may become harder over time to contend that litigiousness is a curse unique to the U.S. business environment.


Finally the academics’ analysis of the plaintiffs’ law firms’ results in merger objection litigation may not be surprising – it is hardly unexpected that top law firms produce better results – but their analysis is nonetheless interesting. If nothing else, their analysis substantiates a point that many of the more prominent plaintiffs’ firms frequently make about how many of the litigation ills of which the business community so frequently complains are the results of the actions of the bottom feeder law firms. The academics’ analysis provides support for the argument that the frivolous lawsuits filed only to try to extract a quick fee are the handiwork of the lower tier law firms. The academics report also provides some support for the arguments that some of the top firms often make, which is that their efforts produce real shareholder value and provide real protection for shareholders. The problem of course is to eliminate the frivolous unproductive litigation without eliminating the lawsuit that produce real benefits for shareholders.

Advisen Releases Third Quarter Corporate and Securities Claims Trends Report

Posted in Securities Litigation

PrintContinuing an recent downward trend, corporate and securities litigation filings during the third quarter declined, both compared to the prior quarter and compared to the third quarter last year, according a new report from Advisen, the insurance information firm. In its report, entitled “D&O Claims Trends: Q3 2014” (available here), Advisen reports that corporate and securities litigation declined 18 percent compared to the second quarter and 48 percent compared to the third quarter of 2013. This year’s filings are on pace for the third consecutive year of declining filing activity, as the wave of litigation that followed the financial crisis recedes into the past. However, the report does note that securities class action filing activity rose during the third quarter compared to the second quarter.


Unlike other published litigation reports, the Advisen claims update attempts to track not just securities class action litigation activity, but all corporate and securities litigation filing activity. So, in addition to securities class action filings, Advisen seeks to track, for example, shareholder derivative litigation and securities enforcement litigation, among other things. The Advisen report also tracks securities litigation brought on behalf of individuals (rather than on behalf of a class) and also attempts to track corporate and securities litigation outside the U.S. as well. Because the Advisen report tracks litigation activity other than just securities class action litigation activity, the data reporting  and conclusions in the Advisen report will differ from other published reports.


The Advisen report states that during the third quarter all corporate and securities litigation filings declined for the second consecutive quarter, putting 2014 on pace for its third straight year of annual aggregate declines. Third quarter filings not only declined by almost one-fifth (18%) from the second quarter, but third quarter filing activity is nearly half of what it was during the third quarter of 2013. The 48% year over year quarterly decline is the largest since before the financial crisis.


Nearly all classes of litigation that Advisen tracks declined in the third quarter compared to the second quarter. One exception is securities class action litigation, which increased to 52 filings in the third quarter from 43 in the second quarter. Because securities class action litigation activity picked up while other types of litigation declined, the percentage of all corporate and securities litigation filings represented by securities class action litigation increased. Securities class action litigation represented 21 percent of all corporate and securities litigation during the quarter, which is the highest quarterly percentage of total cases since 2009 and which exceeds the annual average of 15 percent since 2004.


Companies in the financial services industry were the most frequent targets for corporate and securities lawsuits in the third quarter. Fully one third of all third quarter filings were against companies in the financial services sector. Other industries that were active in the third quarter were: information technology (15%); industrials (14%) and consumer discretionary (13%).


The absolute number of merger objection lawsuit continued to decline in the third quarter, continuing a trend that began in 2011. At the current pace, it appears that the number of merger objection lawsuits will decline for the third year in a row in 2014. But while the Advisen report tracks the number of merger lawsuits, it does not track the number of mergers, leaving open the possibility that the number of merger of lawsuits has declined because the number of mergers has declined. Another factor may also be at work; in the past, mergers often attracted multiple lawsuits. It is possible that the aggregate number of merger objection lawsuits is declining because the number of separate lawsuit filed with respect to each merger deal is declining. The more interesting statistic is the percentage of all merger deals that attract at least one lawsuit. In recent years, the percentage of deals attracting at least one lawsuit has approached 100%. Because the Advisen report discusses only the absolute number of merger lawsuits, it does not shed any light on the more important question of the percentage of all merger deals attracting at least one lawsuit.


The general message of the Advisen report is that overall corporate and securities litigation filing levels are declining. Certainly relative to the high water mark of financial crisis-related litigation in 2011, filing activity is down. But evaluating the relative levels of filing activity arguably is a matter of your point of reference. Exhibit 1 in the Advisen report, a bar graph showing annual filing activity, makes the point. The exhibit shows that while filing activity is down relative to the financial crisis-related peak it also has returned to pre credit crisis-related levels. So another way of looking at the filing activity levels is that –rather than saying that the filing activity levels are declining — the filing activity has returned to more normal levels after the huge surge of litigation that followed the financial crisis.


Advisen Quarterly Claims Trends Webinar: On Thursday October 16, 2014, I will be participating in Advisen’s Quarterly Claims Trend Webinar. This free event will take place at 11 am EDT. Also participating in the seminar, in which the panelists will discuss the important trends in corporate and securities litigation, will be Jed Melnick, a leading corporate and securities litigation mediator and Managing Partner, Weinstein Melnick LLC, and Joseph E. White III, Co-Founder & Attorney at the Saxena White law firm. The event will be moderated by Jim Blinn of Advisen. Information about the seminar, including registration, can be found here.


IPO Companies and Fee-Shifting Bylaws

Posted in IPOs

stockmarketticker2One of the more interesting recent developments in the D&O liability arena has been the emergence of issues surrounding fee-shifting bylaws. As readers will recall, in May 2014, the Delaware Supreme Court in the ATP Tours case upheld the validity of a non-stock corporation’s bylaw imposing attorneys’ fees on an unsuccessful claimant in an intra-corporate lawsuit. Legislation to limit the Court’s decision’s effect to non-stock corporations was quickly introduced in the Delaware legislature, but the proposed legislation has been tabled until the legislative session resumes in 2015. While the question of the validity of these kinds of bylaws under Delaware remains on hold, some companies have continued to press ahead. Among the companies adopting fee shifting bylaws is none other than Alibaba, the IPO superstory of 2014.


As discussed in a September 30, 2014 post by Denver Law School Professor J.Robert Brown on the Race to the Bottom blog (here), Alibaba’s Amended and Restated Memorandum and Articles of Association (which can be found here) provide in Article 173:


Unless otherwise determined by a majority of the Board, in the event that (i) any Shareholder (the “Claiming Party”) initiates or asserts any claim or counterclaim (“Claim”) or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Company and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits in which the Claiming Party prevails, then each Claiming Party shall, to the fullest extent permissible by law, be obligated jointly and severally to reimburse the Company for all fees, costs and expenses (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the Company may incur in connection with such Claim.


As Professor Brown points out, Alibaba is a Grand Cayman corporation, so the pending legislative developments in Delaware are irrelevant to the validity of Alibaba’s fee-shifting bylaw. In addition, as a Grand Cayman corporation, the company and its directors and officers are not subject to the same kind of state court litigation as domestic U.S. companies and their directors and officers. So it would seem that this bylaw is targeted at securities lawsuits. However, it should also be noted that the bylaw applies by its terms to claims against the company itself  (as opposed to its directors and officers) and that it requires only reimbursement of fees to the company by unsuccessful litigants.


Shareholders of Alibaba might well have reason to be concerned about this bylaw provision, because of the practical barriers it creates for any shareholder who might want to allege that the company misled investors and thereby violated the federal securities laws. However, for the shareholders to be concerned about the bylaw, they would have to know about it. As Professor Brown notes, the company’s IPO prospectus apparently neglected to mention the existence of this bylaw provision.


Nor is Alibaba the only recent IPO company to include a fee-shifting provision in its bylaw. As Alison Frankel discusses in her October 9, 2014 post on her On the Case blog (here), Smart & Final, a grocery store chain that went public last month, and ATD Corp, a tire distributor that in August filed to go public, have also adopted charter provisions that “shift the cost of defending shareholders’ claims to investors who sue and lose.” Interestingly, both Smart & Final and ATD Corp. are Delaware corporations, so the validity of their bylaw provisions will depend on the outcome of the pending legislative processes in Delaware. These companies join a number of other smaller public companies that have amended their bylaws to include fee-shifting provisions (as discussed here).


According to a Professor Brown’s September 28, 2014 post on the Race to the Bottom blog (here), the Smart & Final fee-shifting provision appears in the company’s articles of incorporation and expressly refers to actions against the company’s officers, directors and employees, so presumably it would apply to shareholders’ derivative lawsuits as well as other state court shareholder litigation.


As Frankel points out, the questions of the validity of these kinds of bylaw provisions may be different for IPO companies than for other publicly traded companies that amend their bylaws to include these kinds of provisions. For the publicly traded companies, shareholders may try to object that the bylaws were amended without their consent. For IPO companies, the defendants “will argue that their founding corporate documents told shareholders what to expect.” (Although that argument may carry less sway if, as seems to be the case with Alibaba, shareholders were not in fact informed about the existence of the provisions).


The more interesting question in all of this may be where the SEC was on these issues. In the past, the SEC seemingly at least, had been quite attentive to these kinds of initiatives. For example, as discussed here, when The Carlyle Group sought to go public in 2012 with, as was disclosed in its preliminary registration statement, a bylaw requiring the arbitration of shareholder disputes, the company ultimately was forced to revise its bylaw to remove the provision under pressure from the SEC. These prior events raise the question of how the various companies recently were able to complete their public offerings with fee-shifting bylaws, which in Alibaba’s case apparently were not even disclosed in the Prospectus


As Frankel notes in her blog post, even if the SEC has been quiet on these issues in the past, that may be about to change. The SEC’s Investor Advisory Committee apparently is taking up these issues. Among other things it may be expected that at least the agency will require companies to do a better job disclosing the existence of these kinds of bylaws.


In any event, it seems clear that these issues are going to continue to percolate, regardless of what the Delaware legislature ultimately does on the pending legislation. For starters, regardless of what the Delaware legislature does, these issues will continue to arise in connection with other companies – like Alibaba for example — to which Delaware’s laws do not apply. In addition, legislative and judicial developments in other jurisdictions could have their own impact; as I noted in a recent post, Oklahoma’s legislature recently adopted a provision authorizing Oklahoma corporations to extend loser-pays to all shareholder suits involving board members.


It remains to be seen where all of this well lead. I suspect that going forward there will be increased scrutiny on these issues for IPO companies and that companies with fee-shifting bylaws that are attempting to go public will likely be called out on the issue, assuming that is that the SEC continues to allow the IPOs of companies that have these kinds of bylaws to proceed.


The larger issue is whether or not the developments portend a significant revision of what is known as the American Rule, whereby it has been the practice in this country that each litigation party will bear its own costs. As companies increasingly seek to introduce their own form of litigation reform through revision of their own bylaws, and as courts and legislatures evolve their response to these kinds of bylaw provisions, there is a possibility that these developments could work a major change to the traditional American Rule on attorneys’ fees.  Which in turn could have a significant impact on the corporate litigation environment.

Book Review: The Global Directors and Officers Deskbook

Posted in Director and Officer Liability

global directors 2The increasing globalization of business and commerce presents significant opportunities and major complications. The complications run across a wide variety of issues. Among other things, the complications arising from an increasingly global economy include concerns relating to the liabilities of companies’ directors and officers across jurisdictions. These concerns can vary widely depending on the countries in which the companies are involved.


Assessing and allowing for the legal differences between different jurisdictions can be challenging. Among other things, the laws regarding indemnification vary widely in different countries. The availability and procedures for class action litigation are also very different in different countries. The types, availability and applicability of D&O insurance also varies as well.


Fortunately, a new resource is available to help those struggling to identify the important issues affecting the liability of directors and officers in different jurisdictions. The resource is a American Bar Association publication entitled “The Global Directors and Officers Deskbook,” (here) which was edited by my good friend Perry Granof, director of Granof International,  and Henry Nicholls, who is senor counsel at the Cohon & Pollack law firm. The book provides an overview of the directors and officer liability landscape in 28 countries, including the United States, Canada and 26 other countries


Each of the chapters in this timely and helpful book addresses a different country. Each chapter follows a common format; the topics addressed in each chapter are: Statutory and Regulatory Framework: Indemnification; Regulatory Proceedings and Shareholder Representative Actions; Insolvencies, Arbitration and Alternative Dispute Resolution; and Insurance Issues.


The 28 countries addressed in the book are arranged regionally, with five countries from Africa and the Middle East (including Egypt, Israel, Nigeria, Saudi Arabia, and South Africa); seven countries from Asia/Pacific (including Australia, China; Hong Kong; India; Japan; Singapore; and South Korea); eight countries in Europe (including France, Germany, Italy, Netherlands, Russia, Spain and the United Kingdom); six countries in Latin America (including Argentina, Chile, Brazil, Colombia, Mexico, and Peru), as well as Canada and the United States.


I know from reviewing several of the chapters that the overview provided by each of the chapters is very useful. For example, the chapter on India provides a helpful discussion of the new Companies Act of 2013, which recently replaced the Companies Act of 1956.Among other things, the new Companies Act has introduced the concept of shareholder class actions. These and similar kinds of important observations are provided in each of the various chapters.


I was very pleased to note in reviewing the book how many of the chapters were written by friends and professional acquaintances. The India chapter was written by Burzin Somandy, whom readers may recall was my host and tour guide during my recent visit to Mumbai. The book’s regional coordinator for Europe and co-author of the U.K. chapter is my good friend Nilam Sharma of the Ince & Co. law firm. The Israel chapter was co-authored by Rachel Levitan with whom I have had much professional contact over the years. The China chapter was co-authored by Arthur Xiao Dong, whom I met for the first time during my 2012 visit to China. Other chapters were written by industry colleagues whom I have been fortunate to meet through PLUS. From my perspective, the book is clearly the work of knowledgeable and experienced industry veterans.


I would like to thank Perry Granof for the opportunity to review this book. I know that just about everyone in the D&O liability insurance industry will find this book to be indispensable.


D&O Insurance: Insured vs. Insured Exclusion Applicability to FDIC Failed Bank Claim Held Ambiguous

Posted in D & O Insurance

caliAs I have previously noted on this blog, one of the recurring D&O insurance coverage issues arising during the latest bank failure wave has been the question whether the Insured  vs. Insured Exclusion precludes coverage for claims brought by the FDIC in its capacity as receiver for a failed bank against the failed bank’s former directors and officers. In denying coverage for these kinds of claims, the D&O carriers argue that because the only basis on which the FDIC has the right to assert these claims is that it “stands in the shoes” of the failed bank, the Insured vs. Insured (IvI) Exclusion precludes coverage. The FDIC and the individual directors and officers argue that the question whether exclusion precludes coverage for the FDIC claims is ambiguous, and therefore the exclusion cannot be applied as the carriers contend.


As these cases have unfolded in various courts across the country, the rulings have gone both ways – some courts have found that the exclusion applies, while others have found that it is ambiguous and does not apply.


In an October 8, 2014 Opinion (here), in the latest ruling on these issues, Central District of California Judge Andrew Guilford, addressing these issues in the coverage litigation filed in connection with the FDIC’s lawsuit against the former directors and officers of Pacific Coast National Bank, held that the question of whether the IvI Exclusion precludes coverage for claims brought by the FDIC in its capacity as receiver of the failed bank is ambiguous.



Pacifica Coast National Bank of San Clemente, California failed on November 13, 2009. In November 2012, the FDIC, as the failed bank’s receiver filed a civil action against five of the bank’s former directors and officers, alleging negligence, gross negligence and breaches of fiduciary duty in relation to various loans the bank had made ad that allegedly resulted in millions of dollars of losses to the bank. The individual defendants sought coverage for the claims under the bank’s D&O insurance policy. The D&O insurance carrier, in turn, filed an action seeking a judicial declaration that there was no coverage under the policy for the FDIC’s claims. The FDIC moved for summary judgment in the coverage litigation and the individual defendants jointed in the FDIC’s motion. The insurer filed a cross-motion for summary judgment.


In denying coverage, the insurer relied on two policy provisions, the IvI Exclusion and the Unpaid Loan Carve-Out. The IvI Exclusion provided in pertinent part that the policy does not provide coverage for any claim against an Insured “brought by or on behalf of any Insured or Company [including the Bank] in any capacity.” The exclusion had a carve-back that preserved coverage for “a Claim that is a derivative action brought or maintained on behalf of the Company by one or more persons who are not Directors or Officers and who bring and maintain such Claim without the solicitation, assistance or active participation of any Director or Officer.”


The Unpaid Loan Carve-Out provides that the Loss as defined in the policy does not include “any unrepaid, unrecoverable or outstanding loan, lease or extension of any credit to any Affiliated Person or Borrower.”


The October 8 Opinion

In his October 8, 2014 Opinion, Judge Guilford denied the insurer’s motion for summary judgment and granted the motion for summary judgment of the FDIC and of the individual directors and officers. Judge Guilford held that the two policy provisions on which the insurer relied are ambiguous and therefore cannot serve as a basis to deny coverage.


With respect to the IvI Exclusion, Judge Guilford said that the fact that the exclusion is ambiguous when applied to the FDIC in its capacity as receiver of a failed bank “is evidenced by the fact that courts considering this exclusion have reached varying conclusions.” Noting the many decisions that have similarly concluded that the exclusion is ambiguous, Judge Guilford said that “there can be little doubt that repeated disputes over the IvI Exclusion have placed insurers on notice that it is ambiguous.”


Judge Guilford went on to note that “the insurance company has the ability, as a repeat party to these contracts, to ensure that ambiguities are eliminated over time.” The insurer “had the opportunity to make clear in the Policy that the IvI Exclusion applied to the FDIC-R, and it could have done so with a simple statement.” Judge Guilford noted that, in fact, the carrier “provides an optional regulatory exclusion – not included on the policy here – that explicitly names the FDIC.”


Judge Guilford expressly rejected the insurer’s argument that the IvI Exclusion applies because the FDIC “stands in the shoes” of the failed bank for which it is acting as receiver.” Though the U.S. Supreme Court had said in the O’Melveny & Myers v. FDIC decision that the FDIC as receiver “stands in the shoes” of the failed bank, the question to be answered under the IvI exclusion is whether or not the FDIC acting as the receiver of a failed bank is acting “on behalf of” the failed bank; the Supreme Court’s decision “doesn’t tell us whether ‘on behalf of’ means the same thing as ‘stands in the shoes.’”


Judge Guilford also found an ambiguity on the question of whether or not coverage for this claim was in any event preserved by the derivative claim coverage carve-back to the IvI Exclusion. Judge Guilford noted that the FDIC as receiver also succeeds to the rights of the failed bank’s shareholders. Even if, as the insurer argued, the FDIC’s lawsuit technically is not a derivative action, the question remains of on whose behalf the FDIC brings the claims. Judge Guilford said that “even if the procedure by which the FDIC-R asserts the claims differs from the derivative action available to shareholders,” the policy should cover the claims “if the FDIC-pursues them under its authority to recover losses on behalf of shareholders.”


Finally, Judge Guilford rejected the insurer’s argument that the Unpaid Loan Carve-Out precluded coverage for these claims because the damages the FDIC sought in the underlying action were in the amount of unpaid loans. Judge Guilford said that Carve-Out does not unambiguously apply to cases where tortious conduct results in damages that might happen to be in the amount of unpaid loans.



Judge Guilford’s opinion in this case stands in interesting contrast with the August 19, 2013 decision of Northern District of Georgia Judge Richard W. Story in the Community Bank & Trust coverage action, in which Judge Story held that the Insured vs. Insured exclusion in the D&O insurance policy at issue in that case unambiguously precluded coverage for the FDIC’s lawsuit against the bank’s former directors and officers. Judge Story’s decision is discussed in greater detail here.


On the other hand, Judge Guilford’s opinion is consistent with an earlier ruling from a different judge in the same judicial district. On January 4, 2014, Northern District of Georgia Robert L. Vining, Jr. held in the Omni National Bank coverage action that because of the “multiple roles” in which the FDIC acts in pursuing claims against the former directors and officers of a failed bank, there is “ambiguity” on the question whether the FDIC’s lawsuit as the failed bank’s receiver triggers the insured vs. insured exclusion. For further background on Judge Vining’s decision, refer here.


Similarly to Judge Vining, in October 2012, District of Puerto Rico Judge Gustavo Gelpi declined to dismiss a direct action the FDIC had brought under the Puerto Rico direct action statute against the D&O insurer of the failed Westernbank, noting that the FDIC has authority under FIRREA to act on behalf of a number of different constituencies and therefore that “the FDIC”s role as a regulator sufficiently distinguishes it from those whom the parties intended to prevent from bringing claims under [the Insured vs. Insured] Exclusion.” (For more about Judge Gelpi’s decision, refer here.)


Judge Guilford not only acknowledged the existence of this split in the case authority but he expressly relied on  it in concluding that the exclusion’s application to claims asserted by the FDIC-R is ambiguous, observing that the fact that the exclusion is ambiguous “is evidenced by the fact that courts considering this exclusion have reached varying conclusions.” This argument, taken together with the increasing weight of the cases that have concluded that the exclusion’s applicability to the FDIC-R is ambiguous, may increasingly make it more difficult for insurers to argue that the exclusion is not ambiguous.


Judge Guilford’s observation that the carrier could have easily precluded coverage for claims asserted by the FDIC by the inclusion of a regulatory exclusion is interesting. It is true that in the process of policy placement, the question of whether or not there is “regulatory coverage” tends to focus on whether or not the policy has some form of regulatory exclusion. Policies that do not have regulatory exclusions are preferred over policies that do. This marketplace distinction between policies that have the regulatory exclusion and that do not would be meaningless if coverage for FDIC claims is nevertheless precluded by the IvI Exclusion, whether or not the policy has a regulatory exclusion. Given this practical dynamic in the day-to-day insurance marketplace, there is some merit to the argument that the carrier ought not to be able to preclude coverage indirectly for a claim it could have but did not exclude expressly.


I will say I am less persuaded by Judge Guilford’s conclusion that even if the IvI Exclusion operates to preclude coverage for the FDIC’s claims coverage is nevertheless preserved by the application of the exclusion’s carve-back for derivative claims. The carve-back clearly was meant to apply to derivative claims. The FDIC’s lawsuit is not asserted as a derivative claim; it is a direct action. Judge Guilford’s analysis of this issue seems forced to me and unnecessarily fuzzies up the issue.


As long as the D&O insurance carriers hold out the hope that they might be able to persuade a court to reach the same conclusion that Northern District of Georgia Judge Richard Story reached in his August 2013 decision in the Community Bank & Trust case – that is, that the IvI exclusion unambiguously precludes coverage for the FDIC’s claims as receiver of a failed bank against the bank’s former directors and officers – they will continue to try to contest coverage in reliance of the exclusion. However, with each decision that the exclusion’s applicability to the FDIC’s claims is ambiguous, the argument will get harder and harder for the carriers to sustain. At some point, the cumulative weight of the case decisions could reach the point where the argument simply becomes unsustainable – that is, of course, unless the insurers can notch up some victories for the contrary position.


Book Review: “Berkshire Beyond Buffett”

Posted in Warren Buffett

bbbWhat Warren Buffett has accomplished at the head of Berkshire Hathaway is nothing short of astonishing. Not only has he built a massive company, but he has done it while maintaining an unparalleled reputation for business integrity. The man is an American business icon. He is also mortal. Buffett is now 84 years old. The question of what happens to Berkshire after Buffett moves on has weighed on the company for years – indeed, the rating agency Fitch has long highlighted as a risk of the company that so much depends on Buffett, whose departure, they aver, can only diminish the company’s value. These kinds of questions will only grow in coming years as Buffett ages further. (In the interests of full disclosure, I should add that I am a Berkshire shareholder, so these questions are not mere idle concerns for me.)


Will all of magic really disappear once the Sage of Omaha is no longer at the helm? In his new book, “Berkshire Beyond Buffett: The Enduring Value of Values” (here), George Washington University Law Professor Lawrence Cunningham takes up this question with admirable enthusiasm. Based on his comprehensive overview of the incredible company that Buffett has built, Cunningham concludes that what makes Berkshire unique is not Buffett himself; rather, it is the culture of the company. Berkshire, according to Cunningham “has distinct features and a strong corporate culture that will endure beyond Buffett.’


Cunningham reaches this conclusion based on a wide-ranging inspection of the company’s many wholly owned subsidiaries. Based on this review, Cunningham concludes that the seemingly diverse collection of subsidiaries share a set of common traits that are “distinctive, durable – and unique to Berkshire” and that “will allow Berkshire to endure beyond Buffett’s departure.”


For “mnemonic power,” and with only a little strain to make it work, Cunningham has reduced the list of common traits to a nine-letter acrostic that just happens to spell out the word “Berkshire.” The traits are: Budget Conscious; Earnest; Reputation; Kinship; Self-Starters; Hands off; Investor Savvy; Rudimentary; Eternal. That is, Buffett has assembled a group of companies led by managers that share his commitment to thrift; that value the autonomy and long-term commitment involved in Berkshire’s ownership; and that share his commitment to maintaining a reputation for integrity.


Over several interesting and readable chapters, Cunningham examines various Berkshire subsidiaries to show how they exemplify these characteristic traits. Cunningham presents the subsidiaries’ stories as a series of case studies. The stories include the histories of many familiar Berkshire companies, such as See’s Candies and GEICO. The stories also include interesting descriptions of some companies that may not be as familiar, such as FlightSafety International, MiTek, and Forest River. The companies’ stories are presented as a series of short vignettes that read like parables – each one coming as it does with its own moral lesson.


Not that Cunningham’s review is simply a panegyric. Cunningham is careful to consider several notable stumbles that have occurred along the way. Cunningham closely examines problems that arose at Gen Re after the company was acquired by Berkshire. He is also critical of both Buffett’s and Berkshire’s handling of the unusual circumstances that led to the departure of David Sokol, after Sokol had made a massive investment in the shares of Lubrizol before recommending to Buffett that Berkshire consider buying the company. In Cunningham’s view, the stumbles represent circumstances where Berkshire or Buffett uncharacteristically strayed from the company’s fundamental principles – in the end, reinforcing how critical the fundamental principles are to the company’s value and success. 


Cunningham also optimistically suggests that some of the measures that Buffett has recently put in place have laid the groundwork for a smoother transition. For example, he notes that in recent  years Buffett has brought in Todd Coombs and Ted Wechsler as sub-portfolio managers, as one of several steps that Cunningham suggests provide “the promise of durability” that will ensure that Berkshire continues to thrive after Buffett is gone.


One particularly interesting part of Cunningham’s analysis is his consideration of the Marmon Group, which is a large industrial conglomerate that was founded by the Pritzker family. Berkshire took over ownership of the company in anticipation of the passing of the company’s long-standing leaders. As Cunningham notes, Marmon was not only a perfect fit for Berkshire, but the two companies were built in very similar ways. Both had grown by acquisitions, undertaken in a careful and controlled way. Both were founded and developed by powerful leaders who left an indelible mark on their companies.


While there are also important differences between the two companies, Marmon, Cunningham suggests, provides one potential model for the post-Buffett Berkshire Hathaway. Cunningham notes one particular step the Pritzkers took as they prepared their companies for their departure.They organized the company into sectors supervised by divisional Presidents, who could create and implement strategy across the business segments. Based on the Marmon example, there is, Cunningham asserts, “good precedent for believing that even such a vast and decentralized enterprise can endure well beyond its founders.”


Cunningham also makes an interesting point about the business activities of a number of the subsidiaries. While Buffett has many praiseworthy talents, his true genius is capital allocation. He has made an astonishing number of successful acquisitions. As a result, Berkshire represents a great collection of companies that will continue to produce revenue and profits long after Buffett is gone. My concern has always been that after Buffett is gone, his successors may be unable to repeat his incredible deal making acumen. Cunningham points out that a number of companies in Berkshire’s portfolio – companies as diverse as MiTek, Forest River and Lubrizol – have been very acquisitive since their own acquisition by Berkshire. The managers of these and several other companies in the Berkshire group have proven to be very successful dealmakers in their own right. Maybe there will never be anyone with quite the touch that Buffett has, but the company will still continue to be able to deploy its capital in ways that grow the company’s value and contribute to the company’s success, even after Buffett is no longer on the job.


The bottom line for Cunningham is that in Berkshire Buffett has assembled a set of businesses and business managers that will give the enterprise enduring value; as he puts it, you can take Buffett out of Berkshire, but you can’t take Berkshire out of the subsidiaries.


In the book’s Epilogue, Cunningham does sound notes of caution. He allows that after Buffett, we must accept that there will be “slippage.” He observes that: “Deals may not come Berkshire’s way. Offers Berkshire makes may not be on terms as agreeable as they have been. Negotiations may be less favorable.” But returns will not be disappointing, and there will be no justification for dismembering the company or taking other radical steps. In the end, Cunningham concludes, Berkshire transcends Buffett and the company will be his enduring legacy.


I have to say I found Cunningham’s analysis interesting and reassuring Just the same, I do worry what the future may hold for the company, both in the near and longer term. In the near term, I worry about the company as Buffett remains at the helm. My household happens to include an aging relative who is exactly the same age as Buffett. She could not be relied upon to organize a bowl of Wheaties even if you spotted her the bowl, the cereal box, the milk and the spoon. Buffett by contrast is aging well, but the years have their own weight and cannot be gainsaid. The transition to the post-Buffett era could prove difficult not because the change will take place abruptly; it could prove difficult because the pre-departure era could prove to be far longer than is good for the company.


I also worry about the ownership base. One of the keys to Buffett’s great success is that he managed to build a shareholder base for his company that shares his business philosophy, that is willing to take a long-term view, and that knows better than to insist that the company’s management meet various short term goals. The shareholders have been amply rewarded for acquiescing in these views. Will the shareholders be as patient with new managers who lack Buffett’s track record and credibility – particularly if the new managers feel compelled to go in new or different directions? Will the new managers feels constrained in the making the changes that different times may require?


For all of the company’s great past success, a period of uncertainty lies somewhere ahead for the company in the not too distant future. In reading Cunningham’s book, I was reminded of something that one of the Berkshire subsidiary Presidents once said to me. The individual said that when Buffett dies, the company’s share price could plunge, perhaps dramatically. When that happens, the individual said, raise all the cash you can and buy as many shares as you can, because once the dust has settled and some time has passed, the world will figure out that Berkshire will still be a great company, even after Buffett is long gone. I happen to believe that assessment is true. Cunningham’s interesting book provides the explanation why that is so.  


Readers who lilke me are particularly interested in Warren Buffett will want to note that Professor Cunningham is the author of the excellent topically indexed anthology of Buffett’s annual letters to Berkshire shareholders, “The Essays of Warren Buffett,” which I reviewed in an earllier post, here.