The D&O Diary

The D&O Diary


Texas Appellate Court Affirms Transocean Deepwater Horizon Derivative Suit Dismissal: An Interesting Angle on Corporate Inversion Transactions?

Posted in Shareholders Derivative Litigation

texasIn a July 24, 2014 opinion (here), an intermediate Texas appellate court, applying Texas law, affirmed the trial court’s dismissal on forum non conveniens grounds of the Deepwater Horizon disaster-related shareholder derivative suit filed against Switzerland-domiciled Transocean Limited. The court’s ruling is interesting in and of itself, but it may be even more interesting in light of the recent efforts of a number of U.S. companies to relocate their headquarters and tax domicile overseas through the increasingly controversial transaction known as a corporate inversion (for more background about which refer here).


Transocean had been founded as a U.S. company but it had after many decades of doing business in the U.S. moved its domicile overseas. It is now headquartered in Switzerland. In the shareholder derivative suit, the trial court dismissed the case, concluding that Switzerland was the more convenient forum for the plaintiff’s derivative claims. The appellate court concluded that the trial court had not abused its discretion in dismissing the case on forum non conveniens grounds.


If the Texas courts’ rulings in the Transocean Deepwater Horizon derivative suit are any indication, the many U.S. companies now moving their headquarters overseas through inversion transactions may not only realize significant taxation benefits but they may also succeed in reducing their susceptibility to shareholder derivative litigation in U.S. courts.



Transocean owned and operated the Deepwater Horizon drilling rig, located in the Gulf of Mexico. In April 2010, the rig exploded and ultimately sunk, resulting in the deaths of eleven workers as well as in a massive oil spill.


Transocean was founded in 1953 as a Delaware corporation headquartered in Houston. In 1999, the company became a Cayman Islands corporation, and in 2008 it reincorporated in Switzerland. Its stock continues to trade on American exchanges as well as on Swiss exchanges. The company’s U.S. subsidiary, which is headquartered in Houston, has thousands of U.S. employees. Of the parent company’s twelve directors, five live in Texas, three live in other U.S. states, one lives in Canada, and three in Europe. Only one of the European directors resides in Switzerland.


Margaret Richardson, a California resident, filed a derivative lawsuit against the Transocean board in Harris County (Texas) District Court. She alleged that the directors’ actions had harmed the company by causing it to incur substantial costs, liability and reputational harm. She alleged that the directors had been aware or should have been aware of the history of safety, maintenance and regulatory compliance issues – both for the company as a whole and with respect to the Deepwater Horizon rig – yet failed to take corrective actions, while making false statements to shareholders about the company’s safety and compliance record. The plaintiff asserted causes of action for breach of fiduciary duty, unjust enrichment and waste of corporate assets. The parties agree that because Transocean is a Swiss company, Swiss law applies to Richardson’s claims.


The defendants moved to dismiss the plaintiff’s action on forum non conveniens grounds. They stressed the difficulties the trial court would face in applying Swiss corporate law. The trial court granted the motion to dismiss and the plaintiff appealed.


The July 24 Opinion 

On July 24, 2014, in an opinion by Justice Michael Massengale, a three-judge panel of the Court of Appeals of the First District of Texas affirmed the trial court’s ruling, concluding that the trial court judge had not abused her discretion in granting the defendants’ motion to dismiss on forum non conveniens grounds.


In contending that the trial court judge had abused her discretion in dismissing the suit, Richardson had emphasized Transocean’s American origins; the substantial presence of its American subsidiary; the American residence of several of the company’s directors; and the significant human, economic and environmental costs to Texas from the Deepwater Horizon disaster. She argued that Transocean’s connections to Switzerland are “primarily tenuous corporate fictions,” while the activities of the company’s U.S. subsidiary affected the lives of thousands of Texans.


In assessing whether or not the trial court judge had abused her discretion, the appellate court assessed whether the trial court had considered all of the relevant private and public interest factors and whether the trial court’s balance of the factors was reasonable.


Among the private interest factors, the appellate court considered the accessibility of the evidence and witnesses. Although the Deepwater Horizon disaster took place in the Gulf of Mexico, the actions of the directors at issue in the plaintiffs’ derivative lawsuit “predominately took place in Switzerland.” Accordingly, the appellate court said, while there may be circumstances that favor a Texas forum, “the trial court reasonably could have concluded based on other facts presented – most notably that this case concerns acts of corporate governance by the board of directors of a Swiss corporation that holds it meetings in Switzerland – that the balance of private-interest factors favored litigation in Switzerland.”


The appellate court also concluded that the appellate record did not show that the trial court judge abused her discretion in weighing the public interest factors. The appellate court seemed to be particularly concerned with the problems associated with applying the law of Switzerland, a trilingual country and a civil-law jurisdiction with a code-based jurisprudence. The trial court said that given that Richardson’s suit “concerns the internal affairs of a Swiss corporation” and that the plaintiff had failed to show that the stockholders had a particular connection with Texas, and given  “the challenges of applying Swiss law in a complex, unsettled area,” the trial court “could reasonably have concluded that the public interest factors favored litigation in Switzerland.”



The Texas courts’ consideration of these forum non conveniens issues very much reflected the specific circumstance presented, particularly the perceived difficulties for Texas courts in applying Swiss law. A different set of circumstances might well have produced a different outcome, notwithstanding the fact that the defendant company in a shareholder derivative suit is domiciled outside the U.S. Indeed, as discussed here, in at least one of the many other lawsuits that the Deepwater Horizon disaster produced, the Southern District of Texas refused to dismiss at least some of the common law damages claims of BP shareholders on forum non conveniens ground, even though English law governed the shareholders’ claims. Clearly, the mere fact of a defendant company’s non-U.S. domicile is not a universal safeguard against all U.S.-based shareholder litigation.


Just the same, the most salient factor in the Texas courts’ consideration of these issues was the fact that Transocean was headquartered outside the U.S and that as a result the law of company’s domicile governed the shareholder claimant’s derivative lawsuit. These same considerations resulted in the dismissal on forum non conveniens grounds of the Deepwater Horizon disaster-related shareholders’ derivative lawsuit that had been filed against the board of BP; in January 2013, the Fifth Circuit affirmed the district court’s dismissal of the BP derivative lawsuit, as discussed here.


These dismissals of purported shareholders’ derivative lawsuits on forum non conveniens grounds are of course interesting in and of themselves, for what they say about the relative insusceptibility of non-U.S. domiciled companies to U.S.-based derivative litigation.


But I find these dismissals, particularly the dismissal of the Transcocean lawsuit, even more interesting in light of the recent wave of corporate inversion transactions, in which U.S.-based companies merge with non-U.S. companies and then move their corporate headquarters to the target company’s location. The primary motivation for these transactions is tax-related, as the lower corporate tax rates applicable in many non-U.S. jurisdictions can result in a substantial tax savings for the acquiring company.


The Transocean case shows that in addition to the intended tax benefits, a company’s move to a foreign domicile through a corporate inversion transaction may also reduce the susceptibility of the company’s board to certain types of shareholder litigation.


Transocean itself had started as a U.S. company and had maintained a U.S. headquarters for over four decades. Even though the company’s U.S. subsidiary maintained substantial operations and employed thousands of workers in the U.S., because the company was based outside the U.S. and because its significant board activities took place outside the U.S., the courts of its home jurisdiction were held to be a more convenient forum than a U.S. court for a shareholder derivative lawsuit. Because shareholder litigation is far less well-established outside the U.S., the company’s board, as a result of the company’s non-U.S. domicile, arguably faces a much reduced exposure to these kinds of shareholder suits than as a U.S.-based company.


There may be many substantial tax-related reasons for companies to engage in the type of corporate inversion transaction that is all the rage these days. (I suspect that tax considerations were behind Transocean’s overseas move as well, but the appellate court’s opinion is silent about the reasons for the company’s move.) But along with the tax considerations there may be additional benefits as well – that is, that the potential liability exposures of the acquiring company may be reduced by taken on the non-U.S. domicile of the target company.


As noted above in connection with the BP shareholder common law damages claims, the fact that a company is based outside the U.S. is not an all-purpose defense against all U.S.-based shareholder suits. Nevertheless, the Transocean example shows that a company’s move to a non-U.S. headquarters can reduce the potential liability exposures of the company’s board, at least with respect to shareholder derivative litigation.  


Though Delaware Legislature Has Tabled Action, Upcoming Judicial Review of Fee-Shifting Bylaws Seems Likely

Posted in Corporate Governance

delsealThe Delaware Supreme Court stirred up quite a bit of controversy earlier this year in the ATP Tours, Inc. v. Deutscher Tennis Bund case when it upheld the facial validity of a fee-shirting by law. The bylaw provided that an unsuccessful shareholder claimant in intracorporate litigation would have to pay his or her adversaries’ cost of litigation. The controversy seemed headed for a swift resolution when the Delaware General Assembly quickly moved to act on a measure that would have limited the Supreme Court’s ruling to non-stock corporations (meaning that it wouldn’t apply to Delaware stock corporations).  However, as discussed here, the legislature tabled the measure and now it will not be acted upon until at least January 2015.


In light of the uncertain state and indefinite future of fee-shifting bylaws under Delaware law, many lawyers have been counseling caution. For example, a July 11, 2014 memo from the Wilson Soninsi firm (here) states that in light of the “uncertain fate of fee-shifting bylaws” companies should adopt a “wait and see attitude.” Going to the heart of the matter, the memo further states that “we do not believe that directors of most Delaware corporations should adopt any specific fee-shifting bylaw at this time,” as companies  adopting a fee-shifting bylaw now could “face the possibility of later statutory amendments intended to undercut those provisions, potential investor opposition, and possible litigation risks.”


But while the prudent course for companies considering these bylaws arguably is to await further action by the Delaware General Assembly next year, at least a few companies have gone ahead and adopted some version of a fee shifting bylaw. As detailed in Tom Hals’s July 7, 2014 Reuters article entitled “U.S. Companies Adopt Bylaws That Could Quash Some Investor Lawsuits” (here), at least six companies have adopted fee-shifting bylaws. Interestingly, among these companies are two — Biolase, Inc. and Hemispherix Biopharma, Inc. — that adopted bylaws with the obvious intent of seeking to address specific ongoing doing disputes in which each of the companies is involved.


Because of the targeted nature of these bylaws and because of the ongoing disputes, it is possible that Delaware’s courts will be called upon to consider the validity of each of the company’s respective bylaws even before the Delaware legislature acts on the pending legislation next year.



As discussed in a July 22, 2014 Law 360 article (here, subscription required) Hemispherx adopted its fee-shifting bylaw in response to an ongoing shareholder derivative lawsuit. The plaintiffs filed the lawsuit in June 2013, seeking to invalidate $2.5 million in bonuses paid to board members in November 2012. The plaintiffs contend that the bonuses were not permissible under the board members’ employment agreements.


On July 10, 2014, Hemispherx’s board adopted a fee shifting bylaw attempting to impose a retroactive requirement holding shareholder plaintiffs liable for all the defendants’ costs in the event that the plaintiffs are not successful on all of their claims. The bylaw, which is detailed here, applies to any securityholder who after July 3, 2014 “initiates, asserts, maintains or continues” a derivative action or breach of fiduciary action against any current or past director, officer or securityholder and who is not successful on the merits. The bylaw also provides that the company can require a shareholder claimant to “post a surety” for the expenses incurred in defending the action.


According to a July 22, 2014 Wall Street Journal Law Blog post (here), the shareholder plaintiffs in the Hemispherx derivative suit have asked the court to invalidate the bylaw, arguing that it unfairly saddles them with financial risk. The plaintiffs argue that the company has “changed the rules in the middle of the game to place the plaintiffs and their counsel at risk not only for their own litigation costs, but for all litigation costs of the defendants back to the beginning of the case.”


The blog post quotes the company’s general counsel as saying that the bylaw was adopted to protect the money-losing developmental stage biotech company’s “scare resources,” noting that the bonuses at issue were intended to “encourage and reward hard work” and came after an 18-month period in which no bonuses were paid. The company’s outside counsel added that whatever the debated merits of fee-shifting bylaws, the right to adopt such a bylaw now exists and companies can use the bylaw “as a sword against cases that corporations themselves deem to be empty and frivolous.”



Biolase also adopted its bylaw in response to an ongoing dispute, but its bylaw is even more specifically targeted to address the dispute than the one adopted by Hemispherx. As discussed in a detailed July 8, 2014 post on Alison Frankel’s On the Case blog (here), Biolase adopted its fee-shifting bylaw as the latest step in an ongoing dispute with its former Chairman and CEO, Frederico Pignatelli, whom the company’s board ousted in June after months of legal wrangling over the composition of the company’s board.


At the same meeting at which the board ousted Pignatelli, it adopted a fee-shifting bylaw. But the bylaw Biolase adopted involves an interesting variant. Instead of applying to any shareholder claimant, the Biolase bylaw applies only to current or former directors (or anyone acting at their behest) who assert unauthorized claims against the board. In her blog post, Frankel quotes a company spokesman as saying that the bylaw was narrowly tailored in the hope of avoiding additional litigation expenses after the bitter fight to oust Pignatelli.


Pignatelli has already made it clear he is ready to continue the fight. As reflected here, Pignatelli has sent a books and records request to the company “relating to suspected wrongdoing, mismanagement and corporate governance failures by the company’s board of directors.” From the statements of Pignatelli’s counsel that Frankel quotes in her blog post, it appears that Pignatelli is primed to challenge the Biolase fee-shifting bylaw, which Pignatelli’s counsel says is “clearly designed to chill actions taken to protect all shareholders and hold the board accountable for misconduct.”



There would seem to be a pretty good chance that between the Hemispherix case and the Biolase case that at least one and possibly two Delaware courts will have to address the question of a validity of a fee-shifting bylaw for Delaware stock corporations, perhaps before the Delaware legislature acts on the pending legislation next year.


The question the courts will be called upon to address with respect to these companies’ bylaws is whether or not the Delaware Supreme Court’s decision in the ATP Tour case compels a conclusion that the companies’ respective fee-shifting bylaws are valid and enforceable. A threshold issue the courts will have to address is whether the Delaware Supreme Court’s decision, which involved a non-stock corporation, also applies to stock corporations. Although many commentators have assumed that the decision is equally applicable to stock corporations, no court has yet made that determination.


Another issue that the courts will have to address is whether the bylaws, even if valid, are enforceable. As discussed here, the Delaware Supreme Court said in the ATP Tour case that whether a fee-shifting bylaw is enforceable depends on the manner in which it was adopted and the circumstances under which it was invoked. Bylaws that are otherwise facially valid will not be enforced if adopted or used for inequitable purposes. Specifically, the Court said a fee-shifting bylaw “may be enforceable if adopted by the appropriate corporate procedures and for a proper corporate purpose.”


The claimants in the disputes with Hemispheryx and Biolase may try to argue that the respective bylaws were not adopted for proper corporate purposes but rather were merely means to try to deprive the claimants of their rights to seek legal redress through the courts. On this point, it is interesting to note that the Delaware Supreme Court specifically said that on the question of what might constitute an “improper purpose” that “the intent to deter litigation … is not invariably an improper purpose.” Fee shifting provisions “by their nature, deter litigation.” The intent to deter litigation “would not necessarily render the bylaw unenforceable in equity.”


The developments in these cases will be closely watched. As Alison Frankel said in her post about the Biolase bylaw, if Pignatelli, the former Biolase CEO, is unsuccessful in challenging the validity or enforceability of the bylaw, “more public corporations will be emboldened to enact loser pays provisions.” Either way, the outcome of the courts’ considerations of these issues could affect the Delaware legislature’s consideration of the pending legislation next year, as regardless of the outcome one side or the other is likely to pick up ammo to use in the debates surrounding the merits of the legislation – and of fee-shifting bylaws.


When the Delaware legislature tabled the proposed legislation, it seems as if the topic of fee-shifting bylaws would lie dormant until next year. For better or worse, that will not be the case. Instead, there could possibly be some significant developments before the legislature takes up the issue again.


The Halliburton Decision and D&O Insurance: One of the many questions being asked in the wake of the U.S. Supreme Court’s decision last month in the Halliburton case is what the decision’s implications are for D&O insurance. Readers interested in thinking about this issue will want to read the July 25, 2014 Law 360 article by Roberta Anderson of the K&L Gates law firm entitled “Your D&O Insurance Policy Post-Halliburton” (here, subscription required).


After summarizing and reviewing the Court’s holding, Anderson considers that decision’s D&O insurance coverage implications. Anderson also analyzes the likely insurance issues associated with the Court’s holding that defendants may present absence of price impact evidence to try to defeat class certification. She specifically reviews current insurer initiatives to address the costs for event studies that defendants will use to show the absence of price impact. Anderson’s interesting article provides a good summary of the relevant issues. 


Advisen Releases 2014 First Half Corporate and Securities Litigation Report

Posted in Securities Litigation

PrintThe level of all corporate and securities filings continued to decline in the second quarter of 2014 as filing activity returns to levels that prevailed before the financial crisis, according to the latest quarterly D&O claims activity report of Advisen. According to the report, filing levels in the second quarter reflected the “fewest securities and business litigation filings and enforcement actions in the post financial crisis era.” However, securities class action filings bounced back in the second quarter after a “downward fluctuation” in the first quarter. A copy of the Advisen report can be found here. My analysis of first half securities class action litigation filings can be found here.


It is important to understand that the Advisen report differs in significant respects from other published reports of securities litigation activity. The other published reports discuss only the levels of securities class action filings, whereas the Advisen report captures a broader sweep of corporate and securities litigation, including regulatory enforcement actions, individual securities actions, breach of fiduciary duty lawsuits and even foreign litigation. In addition, Advisen uses a counting methodology that differs from that used by other reporting sources, which count each action as a single suit no matter how many complaints are filed and no matter how many defendants are named. By contrast, Advisen “counts each company for which securities violations are alleged in a single complaint as a separate suit.” As a result of these features of Advisen’s approach, the figures Advisen reports may appear different from other reported figures.


According to Advisen, the quarterly decline in securities and business litigation filings puts filing activity in 2014 on pace for its third straight year of declines in litigation filings levels. Corporate and securities litigation filing levels declined in the second quarter by 26 percent from the first quarter of this year, and declined 25 percent compared to the second quarter of 2013, as the total number of events dropped from 303 to 227. Exhibit 1 to the report graphically depicts filings levels since 2005 and clearly shows that 2014 filing activity is on pace for its lowest level since 2008.


In contrast to the overall levels of corporate and securities litigation filing activity, securities class action litigation filings actually increased in the second quarter. According to the Advisen report, there were 44 new securities class actions filed in the second quarter, compared to 39 in the first quarter. The first-half total of 83 projects to a year-end filing total of 166, which is close to the 2013 filing level. (For example, Cornerstone Research tallied the 2013 year-end total of securities class action filings as 166.)



For the past several years, securities class action litigation as a percentage of all corporate and securities litigation had been declining. However, with the overall decline in the corporate and securities lawsuit filings and the increase in the number of securities class action litigation filings in the second quarter, the percentage that securities class action lawsuit filings represent of all corporate and securities lawsuit filings has increased. In the second quarter, securities class action lawsuit filings represented 20 percent of all filings. On an annualized basis, 2014 is on pace to be the third consecutive year in which securities class action lawsuit filings increased as a percentage of all corporate and securities litigation  filings.


While securities class action lawsuit filings are up as a percentage of all corporate and securities filings, the number of new securities class action lawsuits is down from the longer term historical average. For example, Cornerstone Research reports that the 1997-2012 average annual number of securities class action lawsuits was 192, well above the projected number of 2014 securities class action lawsuit filings of 166. According to the Advisen report, “the general decline in the number of securities class actions may be driven by factors such as a reduction in the number of companies traded on the U.S. Stock Exchange or the winding down of credit crisis litigation.”  The longer term trend “may also reflect a change in emphasis by plaintiffs’ firms.”


The sector experiencing the greatest number of corporate and securities lawsuits is the financial sector, as has been the case in every quarter since the beginning of the financial crisis. According to the Advisen report, 27 percent of all corporate and securities filings in the second quarter involved companies in the financial sector. Though this level is down compared to 2008, when financial firms were involved in 40 percent of all corporate and securities litigation, financial firms remain the leading sector for new filings.


One of the most noteworthy trends in corporate and securities litigation has been the explosion in recent years of M&A-related litigation. Various reports have noted that lawsuits are now filed in connection with virtually every M&A transaction. The most recent Advisen report notes that while M&A litigation increased dramatically through 2011, in the last two years, the trend in terms of absolute numbers of lawsuit filings has been downward. However, the report reflects only absolute numbers of M&A lawsuit filings; it does not attempt to express the M&A related litigation activity as a reflection of the levels of underlying merger and acquisition activity.


The report also notes that in the second quarter foreign firms were involved in fifteen percent of all corporate and securities litigation filings, the same level as in the first quarter. The average settlement cost for all types of cases in the second quarter was $16 million, up from $14 million in the first quarter, but well below the $41 million reported in the second quarter of 2013.


Advisen Quarterly Claims Trends Webinar: On Thursday July 24, 2014, I will be participating in a free Advisen webinar on the topic of Quarterly D&O Claims Trends. The hour-long call will begin at 11:00 am EDT. The webinar will also include Brenda Shelley of Marsh, Paul Rodriquez of Swiss Re Corporate Solutions, and Jim Blinn of  Advisen. For additional information about the webinar and to register, please refer here.


PLUS Professional Liability Regional Symposium in Singapore: On August 21, 2014, I will be participating in the Professional Liability Insurance Society (PLUS) Regional Professional Liability Symposium in Singapore. This evening  event, which will take place at the Singapore Cricket Club, will include a keynote presentation from Chelva Rajah of the Tan, Rajah & Cheah law firm. I already know that many industry professionals in the region plan to attend. I hope that everyone in the region will plan to attend and will encourage others to attend as well. Information about the event including registration can be found here.

Management Liability Insurance and Immigration Enforcement

Posted in D & O Insurance

kansasIn a May 1, 2014 opinion (here), District of Kansas Judge Sam A. Crow, applying Illinois law, held that neither the EPL insurance coverage part nor the D&O insurance coverage part of a restaurant company’s management liability insurance policy covered the defense fees incurred or the forfeiture amount ordered in an immigration enforcement proceeding that resulted in the company’s entry of a guilty plea to a criminal charge.


The court held that the immigration enforcement proceeding did not involve “Wrongful Employment Practices” as required for coverage under the EPL coverage part and did not involve a Claim within the meaning of the D&O coverage part because the criminal proceeding did not involve an adjudication of liability “for damages or other relief.” Judge Crow also held that in any event the forfeiture ordered as a result of the guilty plea was not covered under the policy.


A July 22, 2014 memorandum from the McGuire Woods law firm about Judge Crow’s opinion can be found here.



McCalla Corporation operates McDonald’s restaurants. In August 2012, McCalla learned it was a target of a U.S. Immigration and Customs Enforcement investigation. In September 2012, the company received a search warrant. The government subsequently entered a one-count criminal information against the company.


On December 3, 2012, the company entered a plea to the criminal charges, admitting among other things that McCalla’s director of operations was aware that one its McDonald’s restaurant store manager’s I-9 form identity documents were expired or invalid. Two days after the supervisor advised the manager of the problem, the manager presented the supervisor with a “resident alien” card “that the supervisor knew did not appear to be genuine” yet the supervisor took no further action. The supervisor was also aware that “it took weeks, not two days, for a foreign national to obtain a ‘resident alien’ card, giving him further reason to know that the resident alien card …was not genuine.” McCalla was ordered to pay a $300,000 fine and a $100,000 forfeiture.


McCalla sought to have its management liability insurer pay its costs of defending the criminal proceeding as well as the $100,000 forfeiture. The management liability insurer denied coverage for the claim. McCalla filed an action in the District of Kansas seeing a judicial declaration that the insurer owed McCalla a duty to defend the company in the immigration proceeding and also was obligated to pay the $100,000 forfeiture. The parties filed cross- motions for summary judgment.


The EPL coverage part of the management liability insurance policy defined “Wrongful Employment Practices” to include “wrongful failure or refusal to adopt or enforce adequate workplace or employment practices, policies or procedures.”  However, the policy further provides that Wrongful Employment Practices are covered “only if employment-related and claimed by or on behalf of an Employee, Former Employee or applicant for employment.”


The D&O coverage part of the management liability insurance policy defined the term “Claim” to mean “a civil, criminal, administrative or regulatory proceeding commenced against any Insureds in which they may be subjected to binding adjudication or liability for damages or other relief.”


The May 1 Order 

In his May 1, 2014 order, Judge Crow denied McCalla’s motion for summary judgment and granted the insurer’s motion for summary judgment.


Judge Crow held that the EPL coverage part did not cover the claim because the criminal proceeding was not “claimed by or on behalf of” an employee, former employee, or applicant, but rather was brought by prosecutors acting on behalf of U.S. regulators.  Judge Crow said that the plaintiff had not provided an interpretation of the policy that “would justify reading this plain language out of the contract, as is necessary to trigger Defendant’s duty to defend.” Judge Crow added that doing so “would defeat the purpose of EPL coverage, which is necessarily limited to enumerated acts claimed by employees, former employees and prospective employees.” Judge Crow also held that the forfeiture does not constitute covered “Loss” under the EPL coverage section.


Judge Crow held that the claim was not covered under the D&O coverage part because the criminal proceeding did not meet the D&O coverage section’s definition of “Claim.” While the term claim encompassed a “criminal” proceeding, the definition specifies that the proceeding must represent an adjudication of liability “for damages or other relief.” The Court said that the plaintiff provided “no reasonable construction” of the definition that would “permit the Court to find that the search warrant process or the filing of the information  .. could subject the Plaintiff to an adjudication of liability for damages or to an adjudication  of liability for other relief.” Judge Crow also concluded that the forfeiture did not meet the definition of Loss in the D&O coverage section.


Finally Judge Crow held that even if the insurer had breached its duty to defend under either the EPL coverage section or the D&O coverage section the plaintiff “has shown no damages from any breach of that duty.” McCalla’s criminal plea and sentencing represented “a final adjudication of a criminal act,” and therefore fell within the conduct exclusions found in both coverage sections. Even if the insurer had paid the company’s defense expenses prior to the guilty plea, the company “would need to repay those amounts now.” Judge Crow added that the company “cites no cases in which a breach of the duty to defend or to pay defense costs was found where the insured was found guilty of the criminal offense and the policy contained a criminal adjudication exclusion, as here.”



It is a statement of the obvious that immigration enforcement is a matter of serious concern for every employer in the United States. Employers undoubtedly would want reassurance that if they are hit with an immigration enforcement action that their costs of defense, at least, would be paid by their management liability insurer. Unfortunately, as was the case for McCalla here, there likely will be no management liability coverage even for defense costs incurred in defending against immigration proceedings that result in a criminal guilty plea or a criminal conviction, as no management liability insurance policies will provide coverage for an adjudicated criminal conviction. As Judge Crow noted, even if the insurer had advanced defense fees prior to the guilty plea or conviction, the insurer would be entitled to have the amount of those advanced fees reimbursed following the conviction.


However, the absence of coverage in the event of a guilty plea or conviction is hardly the end of the analysis. At a minimum, companies hit with immigration enforcement actions would want to have their defense fees advanced during the pendency of the proceeding and in any event would want to know that their defense fees would be paid if they are successful in defending the immigration enforcement action. And on that score, this case shows nothing so much as how much depends on the precise wording of the policy. Here, the specific wording of the relevant coverage parts at issue resulted in Judge Crow’s determination that there is no coverage under either coverage part. However, the relevant wordings in this policy differed significantly from other coverage terms and conditions available in the marketplace.


The policy at issue here offered coverage only for claims by employees, former employees and applicants. However, many EPL policies available in the market place include Third Party Liability Coverage, or the carriers offer Third Party Liability coverage as an option. This coverage extends the EPL coverage to claims brought by third parties. However, depending on the wording of the Third Party Coverage part, the policy might or might not extend to the type of claim here. Many EPL policies offering this coverage limit the definition of Third Parties to “natural persons.” Other polices’ definition of Third Party Claims omit criminal proceedings from the definition. Thus it would not be sufficient to bring the type of immigration enforcement action here within the scope of the EPL coverage for the policy to include Third Party liability coverage; the policy’s definition would have to be broad enough to encompass claims by the government and broad enough to encompass criminal proceedings. In addition, one or more exclusions found in the EPL coverage part might also operate to preclude coverage for an immigration enforcement action.


The possibility for coverage under the D&O coverage part is perhaps more promising. Here the insured ran afoul of an infelicitous wording in the definition of claim, where the phrase “adjudication of liability for damages or other relief” was found to modify not only “civil … administrative or regulatory” proceeding but also to modify a “criminal” proceeding. Because all of these various named types of proceedings are telescoped together into a single phrase, the impression is created that the phrase “damages or other relief” was meant to apply to “criminal proceedings.” However, for policies in which the definition of “claim” is subdivided with each of these types of proceedings having its own separate subpart, the intent of the policy is clearer and in particular there is no mistake that the phrase “damages or other relief” or its equivalent applies  to “criminal proceedings.” Policyholders whose policies have this clarifying definition of “claim,” could hope to have their costs of defending a criminal immigration enforcement proceeding advanced, and in the absence of a guilty plea, covered.


As the McGuire Woods memo linked above puts it, when it comes to coverage for immigration enforcement actions, “the particulars of the policy language dictate the extent of coverage.” According to the memo, which is quite critical of the opinion, Judge Crow’s ruling is on appeal to the Tenth Circuit.


Director and Officer Liability for Environmental Enforcement Actions: As I have noted on this blog, environmental enforcement actions can result in findings of liability against the individual directors and officers of companies that caused environmental damage or harm. In an interesting July 22, 2014 article in the Arizona State Law Journal entitled “Liability of Parent Corporations, Officers, Directors and Successors: When Can CERCLA Liability Extend Beyond the Company?” (here), Michelle De Blasi of the Gammage and Burnham law firm takes a look at the broad reach of the joint and several liability regime under the Comprehensive Environmental Response Compensation and Liability Act. (CERCLA).


The article covers a lot of ground but among other things it examines the circumstances under which directors and officers can be personally liable under CERCLA. The author also briefly reviews a number of specific cases where individuals have been held liable under CERCLA or for environmental reporting.

Guest Post: Bylaws and Arbitration

Posted in Director and Officer Liability

Allen_Claudia_2013_Color[1]For many years, business groups and corporate representatives have tried to reform shareholder litigation through legislation and case law development, with mixed success. However, in more recent years an interesting new initiative has emerged – the attempt to achieve litigation reform through amendments to corporate bylaws. This effort received a significant boost last year when the Delaware Chancery Court upheld the validity of a forum selection bylaw, designating the preferred forum for shareholder litigation.


The initiative was even further advanced earlier this year when the Delaware Supreme Court upheld the validity of a fee-shifting bylaw, which requires an unsuccessful litigant in shareholder litigation to pay their adversaries legal expenses. The future prospects for this type of bylaw are uncertain at the moment as the Delaware legislature considers whether or not to prohibit Delaware stock corporations from using this type of bylaw.


Along with these other litigation reform bylaws initiatives, the most interesting and arguably most controversial proposal is the use of bylaws requiring shareholder disputes and claims to be resolved through binding arbitration. As discussed here, several courts have now upheld the validity of these types of bylaws, which may encourage other companies to consider adopting bylaws requiring shareholder disputes to be arbitrated.


In the following guest post, Claudia Allen of the Katten Muchin law firm describes her recent article in which she reviews the legal, policy and practical issues that these kinds of mandatory arbitration bylaws present. She also reviews the obstacles that companies attempting to adopt these kinds of bylaws might face, as well as the kinds of issues that companies considering adopting these kinds of bylaws might want to take into account.


I would like to thank Claudia for her willingness to publish her guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you are interested in submitting a post. Here is Claudia’s guest post:   



                Bylaws Mandating Arbitration of Stockholder Disputes? (forthcoming Delaware Journal of Corporate Law, available at examines the legal, policy and practical issues raised by bylaws that would mandate arbitration of stockholder disputes and eliminate the right to pursue such claims on a class action basis.  The article also analyzes the limited number of arbitration bylaws that have been adopted or proposed and related case law concerning the validity and enforceability of these provisions.


                Bylaws was prompted by late June 2013 decisions from the United States Supreme Court and the Delaware Court of Chancery, which, when read together, suggested that such bylaws should be enforceable.  In American Express Co. v. Italian Colors Restaurant, the United States Supreme Court, interpreting the Federal Arbitration Act, upheld a mandatory arbitration provision, including a class action waiver, in a commercial contract.  The decision focused upon the arbitration provision as a contract subject to the FAA.  Next, the Delaware Court of Chancery rendered its opinion in Boilermakers Local 154 Retirement Fund v. Chevron Corp. The decision, which emphasized that bylaws are contracts between a corporation and its stockholders, upheld bylaws adopted by the boards of Chevron Corporation and FedEx Corporation requiring that intra-corporate disputes be litigated exclusively in Delaware courts.


                Subsequent United States Supreme Court and Delaware Supreme Court decisions addressing forum selection and a board’s unilateral power to adopt bylaws have only strengthened the argument for enforceability. For example, the United States Supreme Court views an arbitration clause as a specialized kind of forum selection clause, and in December 2013 reiterated the strong presumption in favor of the validity of arbitration provisions in Atlantic Marine Construction Company, Inc. v. United States District Court for the Western District of Texas. While Boilermakers was a Delaware trial court decision, and thus not a definitive statement of Delaware law, the Delaware Supreme Court effectively endorsed Boilermakers and the validity of board-adopted bylaws that may deter litigation in its May 2014 ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation).  That opinion upheld the validity of “loser pays” bylaws.


                In addition to complementing each other, both American Express and Boilermakers address a similar issue, namely, the explosion in class action and derivative litigation that settles primarily for attorneys’ fees, most commonly in the context of mergers and acquisitions.  Stockholders ultimately bear the costs of such litigation. Class actions and derivative lawsuits are forms of representative litigation, in which named plaintiffs seek to act on behalf of a class of stockholders or the corporation itself.  The plaintiffs are customarily represented by attorneys on a contingent fee basis, making the lawyer the “real party in interest in these cases.”  If mandatory arbitration bylaws barring class actions were enforceable, the logical outcome would be a marked decline in class actions, since the alleged existence of a class is a principal driver of attorneys’ fees.


                Bylaws analyzes potential obstacles to adopting arbitration bylaws, including the policy of the Securities and Exchange Commission staff against allowing companies with arbitration provisions in their organizing documents to go public. This policy, which does not apply to companies that are already public, is based upon the notion that stockholders would be forced to waive rights under the securities laws, thus violating the “anti-waiver” provisions in such laws. Yet, the Staff’s position is at odds with Supreme Court precedent finding that agreements to arbitrate are not waivers of substantive rights.  Corporations could, however, overcome this issue by excluding securities claims from the scope of an arbitration clause.


                Mandatory arbitration bylaws are also likely to attract significant negative stockholder sentiment, at least initially, particularly if they include a class action waiver.  This would be consistent with the reaction of consumer advocates to the Supreme Court’s decisions upholding arbitration in commercial agreement, and the initial reaction of stockholder advocates to exclusive forum and fee-shifting provisions in certificates of incorporation and bylaws.  Bylaws examines potential avenues for stockholders to express opposition, including seeking repeal.  


                Perhaps a more fundamental question is whether public companies will support arbitration.   While arbitration is often viewed by opponents as favoring corporations, and is widely used in the financial services industry, corporations have a range of viewpoints on arbitrating.  Arbitration theoretically offers speed, lower costs, confidentiality and the ability to influence the selection of the arbitrator.  However, since arbitration is final and non-appealable, except in extremely limited circumstances, it is also less predictable.  Predictability may be of less concern when the amounts in controversy are relatively small, but, in connection with securities class actions and derivative claims, the stakes can be high, making arbitration of such claims less attractive.  


                Since arbitration is fundamentally a creature of contract, Bylaws argues that there are opportunities for corporations to craft arbitration bylaws that take into account company-specific concerns, while responding to many likely criticisms.  For example, carving out claims in excess of a specified high dollar threshold, and providing that such claims would be litigated, would address company concerns about unpredictability.  Providing that arbitrators’ decisions (perhaps including brief findings of fact and conclusions of law) will be made public could, for those corporations interested in making the arbitration process more transparent, answer critics who believe that arbitration occurs in a black box and automatically disadvantages individuals. However, the inherent bias of some stockholders and corporations against arbitration is likely to make experimentation in this area slow and difficult.      


On the Frontiers of Corporate Litigation and Liability: Inversion Transactions and a Proposed Duty to Warn

Posted in Director and Officer Liability

frontierAmong the developments dominating the business headlines in recent weeks have been two unrelated stories – the rising wave of so-called “inversion” transactions in which U.S. companies acquire foreign firms to avoid U.S. tax laws and the revelation of previously undisclosed problems with the ignition switches in certain GM cars that allegedly resulted in numerous passenger deaths. While these stories are unrelated, both are generating a great deal of concern in Washington. And both represent potentially significant developments at the frontier of corporate litigation and liability.


Inversion Transactions 

On July 18, 2014, drug maker AbbVie became the latest company to enter into a business deal as part of the trend of U.S. companies acquiring overseas firms to establish headquarters outside the U.S. and avoid U.S .tax laws. As discussed in a July 19, 2014 Wall Street Journal article about the transaction (here), AbbVie will pay a total of $54 billion to acquire Shire PLC. Shire is based in Dublin and incorporated in the U.K. tax haven Jersey. By moving its headquarters overseas, AbbVie will, according to the Journal, by 2016 lower its tax rate to 13% from the current 22%. The move will also allow the company to avoid U.S. taxes upon the repatriation to the U.S. of profits earned overseas.


As discussed here, this type of transaction is known as an “inversion.” AbbVie joins a growing list of about 50 U.S. firms that have reincorporated overseas through inversion in the last 10 years, most of them since 2008. Because the transactions appear calculated to avoid U.S. taxes, they have become increasingly controversial, particularly among U.S. lawmakers.


As discussed in a July 15, 2014 Wall Street Journal article (here), the Obama administration is calling for Congress to pass legislation to restrict U.S. companies’ ability to participate in inversion transactions. Last week, U.S. Treasury Secretary Jacob Lew sent a letter to Congressional leaders calling on them to “enact legislation immediately…to shut down this abuse of our tax system.” However, the various members of Congress disagree on the appropriate solution. And there are those who are defending corporations’ resort to inversion transactions as the appropriate business response to U.S. tax laws and tax policies.


While it is hardly surprising that inversion transactions are controversial in Washington, it would seem given the tax benefits that they would be popular with shareholders, and that the last thing that would happen would be for a company announcing an inversion transaction to get hit with a shareholder suit. However, the environment for U.S. companies not only includes high rates of corporate taxation, but it also involves a certain inevitability about shareholder litigation. In this country’s litigious environment, even a transaction seemingly as beneficial for a company as an inversion apparently can generate a shareholder suit.


According to a July 17, 2014 St. Paul Pioneer Press article (here), on July 2, 2014, a shareholder of Minnesota-based Medtronic has filed a class action lawsuit in Hennepin County District Court challenging the company’s planned $42.9 billion acquisition of Ireland-based Covidien, which will result in a new company to be called Medtronic PLC. The shareholder plaintiff contends that the transaction, in which Medtronic shareholders will receive shares in the new company in exchange for their existing Medtronic shares, will result in a “substantial loss” for Medtronic shareholders. The plaintiff alleges that the shareholders will have to pay taxes on any gains on their shares, but the transaction will not generate cash out of which to pay the taxes. According to the article, the lawsuit alleges that “Medtronic shareholders will be forced to pay taxes on any gains in Medtronic stock.”


Washington lawmakers are scrambling to try to find the right response to the loss of U.S.-based companies and of U.S. tax revenues to lower tax jurisdictions. However, while lawmakers struggle to find the right legislative response, companies will continue to have significant incentives to consider these kinds of transaction, particularly where their competitors have pressed ahead with these types of deals and lowered their tax burdens. As the Medtronic lawsuit shows, companies pursuing these kinds of transactions not only risk attracting the ire of Washington lawmakers, but also may face the possibility of shareholder litigation.


GM Ignition Switches and the Failure to Warn 

According to documents released by federal safety regulators on July 18, 2014, U.S. automobile manufacturer GM knew for over 11 years about problems with the ignition switches in as many as 6.7 million vehicles but did not warn consumers or recall the switches until earlier this year.  As a result of the defect, the ignition switches can slip out of gear, shutting down the engine and knocking out power steering and brakes. Drivers can lose control of their cars, and if they crash, the air bags will not deploy. The list of recalls includes 2.6 million older small cars with faulty switches that GM has blamed for at least 13 deaths.


Like the inversion transactions, GM’s problems with the ignition switches have attracted the attention of Washington lawmakers. A Senate committee has been holding hearings and has taken testimony from key GM officials, including GM CEO Mary Barra and General Counsel Michael Millikin, as discussed here.


In addition, as discussed in a July 16, 2014 post on the Corporate Crime Reporter (here), three U.S. senators have introduced legislation that would criminalize the concealment of danger. Senators Bob Casey, Richard Blumenthal, and Tom Harkin (all Democrats) have introduced a bill entitled the Hide No Harm Act that would hold “responsible corporate officers” criminally accountable if they knowingly conceal “serious dangers” that lead to consumer or worker deaths or injuries.


The draft legislation (a copy of which can be found here) requires corporate officials who acquire knowledge of a “serious danger” involving a product or service of the company to  inform “an appropriate Federal agency” of the danger, and as soon as practicable, to warn affected employees and other individuals who may be exposed to the danger. The draft bill defines “serious danger” as a danger “not readily apparent to a reasonable person” that “has an immediate risk of causing death or serious bodily injury.”


The bill defines a “responsible corporate officer” as an “employee, director or officer of a business entity” that has “the responsibility and authority … to acquire knowledge of any serious danger” and “the responsibility to communicate information about the serious danger” to the appropriate federal agency and to employees and other individuals.


An individual who “knowingly violates” the duty to warn specified in the legislation “shall be fined … imprisoned under this title, or both.” The bill provides further that if a fine is imposed, “the fine may not be paid, directly or indirectly, out of the assets of any business entity or on behalf of the individual.”


The draft bill also provides civil liability protections against retaliation directed at individuals who report serious dangers to federal agencies, employees or other individuals.


The point of the legislation is obviously to impose liability directly on corporate officials for withholding information about serous dangers. According to the Corporate Crime Reporter, “under existing law, while the company eventually could face criminal fines, individual officers who knew about the deadly defect – but did not inform the public or federal regulators – cannot face any criminal charges.” The article cites other instances in addition to the GM ignition switch situation in which corporate officials have withheld information about allegedly unsafe products, including Pfizer’s alleged withholding of information about Vioxx and Toyota’s alleged withholding of information about its vehicles’ acceleration pedals.


While this legislation is part of a larger trend to try to hold corporate officials personally liable for corporate misconduct, it is noteworthy that the bill would impose liability only on individuals who knowingly withhold information. The legislation does not seek to impose liability simply because the individuals held senior positions at the company and had overall responsibility for the company’s operations.


The proposed bill will now proceed through the legislative process. Even though the bill is sponsored only by Democratic senators, it could make it through the Democrat-controlled Senate. But even if that were to happen, the possibility that the bill would survive the Republican-controlled House of Representatives seems less likely.


Though the legislation’s prospects are uncertain, the draft bill does represent a significant new type of potential liability for corporate officials. Individuals who face the kind of criminal charges this bill would create would of course incur significant defense expenses. These individuals likely would look to their company’s D&O insurance for payment of these expenses. D&O insurance typically will pay the individuals’ defense expenses after indictment. However, if this proposed legislation were to become law, it could be important for the bodily injury/property damage exclusion found in most D&O insurance policies to be modified, to ensure that the exclusion would not preclude coverage for these kinds of defense expenses.


Cybersecurity, the Financial System and Management Responsibility: Another development on the frontier of corporate litigation and liability has been the emergence of cybersecurity as the source of potential liability for corporate officials. As I have previously noted on this blog, earlier this year the boards of Target (here) and Wyndham (here) were hit with shareholder suits as a result of significant cyber breaches at those companies. And last month, SEC Commissioner Aguilar stressed in a speech that cybersecurity oversight is an important board responsibility, warning that boards that disregard that responsibility do so at their own risk.


On July 16, 2014, Treasury Secretary Jacob Lew became the latest official in the current administration to weigh-in on emerging cybersecurity issues. In a speech at the Delivering Alpha Conference in New York (a copy of which can be found here), Lew said that “cyber attacks on our financial system represent a real threat to our economic and national security.” He emphasized that “our cyber defenses are not what they need to be.” And while he acknowledged that the government can and should be doing more, he also stressed that “far too many hedge funds, asset managers, insurance providers, exchanges, financial market utilities, and banks can and should be doing more.”


Lew acknowledged that corporate officials are now doing more to try to address cybersecurity concerns, but he also stressed that “cyber security cannot be the concern of only the information technology and security departments. It should be the responsibility of management at all levels.” He also emphasized that if you are a business leader “you should know how strong your company’s defenses are, you should know if there are response plans in place” and “you should be getting regular reports on cyber security threats and what your company is doing to respond to these threats.”


And You Think You Have a Lot of Complications to Juggle: How about an axe, a machete and a cleaver? Or an apple, an egg and a bowling ball? Or Water? It’s Monday. Do yourself a favor — watch the video and have a laugh, along with Ron and Nancy. (Special thanks to a loyal reader for sending me a link to the video.) 

India’s Securities Regulator Imposes Massive Penalties on Satyam’s Founder and Other Executives

Posted in Director and Officer Liability

satyamOn July 16, 2014, India’s securities regulator, the Securities and Exchange Board of India (SEBI), entered an order (here) against the founder and former executives of Satyam Computer Services to disgorge over $306 million in allegedly ill-gotten gains from their role in the scheme to falsify the company’s financial statements, as well as at least $201  million in interest. A July 18, 2014 Law 360 article describing the SEBI order can be found here (subscription required).


As discussed here, Satyam was quickly dubbed the “Indian Enron” in early 2009 after the company’s founder, Ramalinga Raju, sent an extraordinary letter to the company’s board in which he admitted, among other things, that  ”the company’s financial position had been massively inflated during the company’s expansion from a handful of employees into an outsourcing giant with 53,000 employees and operations in 66 countries.” As much as 53.6 billion rupees (or about $1.04 billion) in cash that the company reported on its immediately prior financial statement was nonexistent. Satyam’s share price dropped 87 percent on the news.


Satyam, whose American Depositary Shares at the time traded on the New York Stock Exchange, was hit with a securities class action lawsuit, which also named certain of its directors and officers as defendants, as well as the company’s outside auditor, PwC.  As discussed here, in February 2011, Satyam’s successor agreed to pay $125 million to settle the claims filed against Satyam itself. In May 2011, PwC agreed to pay $25.5 million to settle the claims against the accounting firm. As discussed here, in January 2013, the claims against seven of Satyam’s outside directors were dismissed.


According to the India Real Time blog (here), the 65-page SEBI order in the Satyam case is “one of the first attempts to put all the pieces together” about the Satyam scandal. As discussed in July 16, 2014 Wall Street Journal article (here), the order alleges that Raju and his brother, with the help of the company’s chief financial officer and two others, created fake orders and falsified other company records to make the business appear more profitable, enriching themselves in the process.


SEBI said that Raju was “the chief orchestrator of the fraud” and was responsible for “deliberately conveying a false picture of Satyam Computers finances to the investing public and concerned authorities.” SEBI also said that the former Satyam executives engaged in insider trading when they sold company shares at inflated prices before the scandal broke. The order states that the executives “have committed a sophisticated white collar financial fraud with pre-meditated and well thought of plan and deliberate design for personal gains and to the detriment of the company and investors in its securities.”  The order also states that “the fraudulent acts and omissions of [the individuals] in a coordinated manner have shattered the confidence of millions of genuine and unsuspecting investors in securities of Satyam Computers and caused serious prejudice to the integrity of the securities market.”


According to the Journal, SEBI’s order can be appealed to a special securities tribunal and the country’s Supreme Court. Raju, his brother and several others have been charged with criminal offenses in connection with the scandal, in which, according to the India Real Time blog, a verdict is expected later this month.


The size of the penalty against the individuals is clearly meant to make a statement. According to the Journal, SEBI “has faced criticism from investors for a perceived lack of vigor” but “lately has seemed more assertive.” A commentator is quoted in the Journal article as stating that “this order by itself is driving a message that SEBI is going to be aggressive in dealing with fraud in the Indian Capital Markets.” (On the other hand, other commentators have criticized the regulator for dragging its feet and suggested that the order was far too late in coming.)


I find the order and size of the award interesting in a slightly different way. I have traveled around the world quite a bit in the last several years and attended industry conferences at which, inevitably, the aggressiveness of U.S. regulators is bemoaned. These comments usually include a lament about the lottery-sized penalties that U.S. regulators have imposed.


As this SEBI order demonstrates, U.S. regulators are not the only ones primed to impose large fines. Regulators everywhere, under pressure from the recent global financial crisis as well as because of the periodic outbreak of massive scandals like Satyam, increasingly are taking a more aggressive approach and increasingly are seeking to use regulatory tools to enforce their own laws and to impose penalties. These regulatory initiatives, which are emerging in countries around the world, have significant implications for companies, their executives, and their insurers.  

Despite Policyholder’s Delayed Notice, Insurer Must Cover Subsequent Claims Related to Earlier Timely Claim

Posted in D & O Insurance

eigthOn July 16, 2014, the Eighth Circuit, applying New York law, concluded that because a financial services firm’s professional liability insurance policy was ambiguous on the question whether the policy’s timely notice requirements apply to later claims related to a timely original claim, the policy provides coverage for the later claims. The district court had held that Missouri law governed the notice issue and because the insurer had not been prejudiced by the late notice, the delayed notice did not preclude coverage. The appellate court found that New York law governed rather than Missouri law but nevertheless affirmed the district court’s holding because it found the notice requirements to be ambiguous. A copy of the Eighth Circuit’s opinion can be found here.



George K. Baum & Company is a nationwide financial services firm based in Missouri with offices around the country, including in New York. Among other things, Baum underwrote various municipal bonds, representing them to be tax exempt. In August 2003, Baum became aware of an IRS investigation into twenty-three of its municipal bond issues. Baum timely advised its professional liability insurer of the IRS investigation and of the possibility of claims by municipal clients and bondholders. Baum’s insurer agreed to treat the IRS investigation as a claim under the policy. Baum ultimately settled with the IRS without admitting liability.


In 2008, Baum was hit with a series of lawsuits relating to its municipal derivatives business (the “derivatives lawsuits”). In April 2010, almost two years after the derivatives lawsuits were filed, Baum provided its professional liability insurer with notice of the suits. The insurer denied coverage for the derivatives suits on the grounds that the suits were not claims made during the period when its policy was in force.


In January 2011, Baum filed an action in the Western District of Missouri against its insurer alleging breach of contract and seeking a judicial declaration that the derivatives lawsuits were covered under the professional liability policy. Three days before its answer to Baum’s complaint was due, the insurer admitted that its earlier coverage denial on the claims made issue was in error and agreed that it would treat the subsequent derivatives lawsuits and the earlier IRS investigation as a single claim first made when the IRS investigation was launched in 2003. However, the carrier nevertheless continued to deny coverage for the derivative lawsuits on the ground — not previously raised — that the derivatives lawsuits were not timely reported to the insurer as required by the policy. The insurer filed a declaratory judgment counterclaim and parties filed cross motions for summary judgment.


The district court held that under Missouri law untimely notice is no defense to coverage in absence of prejudice and because the insurer claimed no prejudice, the delayed notice of the derivatives lawsuits did not preclude coverage. The district court also ruled that the $3 million retention applicable to “activities as an underwriter or seller of municipal bonds” applied, rather than the $1 million retention Baum contended was applicable. Both parties appealed.


The July 16 Opinion 

In a July 16, 2014 opinion written by Judge William J. Riley for a unanimous three-judge panel, the Eighth Circuit affirmed the district court’s rulings, even though the appellate court held that New York law governed rather than Missouri law.


The insurer had argued that New York rather than Missouri law applied and that under the New York law applicable at the time, an insurer asserting a late notice defense was not required to show prejudice, by contrast to Missouri law where an insurer that was not prejudiced could not assert a late notice defense. Because the policy had been (at Baum’s request) delivered to Baum’s New York address and had been issued with the requisite New York amendatories, the appellate court agreed with the insurer that New York law governed the interpretation of the policy. However, because the appellate court also found the policy to be ambiguous on the applicability of the policy’s timely notice requirements to subsequent related claims, the court rejected the insurer’s arguments on the notice issue.


The appellate court found that because the subsequent lawsuit and the IRS investigation were deemed a single claim under the policy, “all of the later filed derivatives litigation lawsuits constitute ‘a single CLAIM for all purposes,’ including notice.” The court added “we do not find any unambiguous basis in the policy” for the insurer’s proposed limitation of the phrase “all purposes” so as to carve out notice issues. Accordingly, the Court accepted Baum’s interpretation that the policy’s notice provisions do not apply to subsequent actions, such as the derivatives lawsuits, arising from the same underlying conduct as the earlier timely notified claim.  


The Court also rejected the insurer’s argument that if Baum’s theory were accepted then the policyholder would be free to delay notice of subsequent related claims for indefinite time periods. The appellate court said that “these are the complaints of a poor draftsman, and we are as unsympathetic as we expect the New York Court of Appeals would be,” adding that “it is not our role to rescue an insurer from its own drafting decisions.”


The Court also declined to consider whether or not Baum breached New York’s implied-in-law requirement of notice within a reasonable time because the insurer “failed to raise any implied notice argument in the district court or on appeal.” But even setting aside the insurer’s “waiver” of this issue, the Court said it would be “reluctant to predict a breach” of the implied requirement “in the absence of prejudice,” as, the Court noted, New York courts have been “reticent” to apply the state’s “no prejudice rule” where the insurer received timely notice of claim but arguably late notice of a lawsuit.


Finally, the Court affirmed the district court’s ruling that the policy’s $3 million retention for claims related to underwriting activities applied, rather than the $1 million retention that would otherwise have applied.



In a June 2, 2014 post (here), I noted that a New York appellate court, applying New York law, held that an insurer’s policy was ambiguous on the question of the applicability of notice timeliness requirements to subsequent related claims where notice of the first claim was timely. I also noted that the question that case presented was an “interesting issue” that “undoubtedly will come up again in the future.”


As this latest case show, the notice timeliness of subsequent related claims issue is a recurring one. The Eighth Circuit seems to have been unaware of the New York intermediate appellate court decision I referenced in the earlier post (it was a terse, three-page opinion), but the holdings of both the courts were essentially the same – that is, that the applicability of the notice timeliness requirements to subsequent claims related to an earlier timely claim is ambiguous.


Given that earlier New York appellate decision, the Eighth Circuit’s application of New York law here seems to be on solid ground. Just the same, it seems to me the insurer’s case here was always going to be tough. First of all, as I noted in my prior post linked in the preceding paragraph, notice defenses generally are disfavored by the courts (although not invariably, as noted here).


The other problem about the insurer’s position is that the insurer originally denied coverage on the basis that the subsequent derivatives lawsuits were not claims made during the applicable policy period. The insurer later walked back its coverage denial on this ground – but only after the insured had already been forced to initiate coverage litigation to compel the insurer to honor its contractual obligations. Rather than simply acknowledging coverage at that point, the carrier substituted a new basis for denying that it had not previously asserted, that is, the alleged untimeliness of notice of the subsequent derivatives claims. This belated substitution of coverage defenses put the insurer in an unfavorable light, which at least to my eyes seems to have affected the Eight Circuit’s perception of carrier’s position. (I will say that this sequence affirms the value for carriers of laying out their entire coverage position at the outset, as a later piecemeal substitution of alternative coverage defenses arguably reflects poorly on the carrier.)


There arguably is another issue that I think may supersede all of the various notice-related issues discussed in this opinion. That is, the way I read the court’s description of Baum’s initial notice, Baum not only notified the insurer of the IRS investigation but advised the insurer that the circumstances could subsequently give rise to claims. I presume that this policy like all policies of this type had a notice provision allowing the policyholder to give notice to the insurer of circumstances that may give rise to a claim and providing that if the subsequent claims do arise the subsequent claims are deemed made at the time of the notice. If as I assume was the case this policy had a notice of circumstances provision of this kind, it seems to me that Baum satisfied the notice requirements at the time of the initial  notice and that all the other arguments about the timeliness of notice are inapposite.


Setting to one side my argument about the timeliness of the notice of circumstances, there is an issue for carriers to consider in light of this opinion and the earlier New York intermediate appellate decision, which is whether they need to introduce into their policies a notice timeliness requirement for subsequent related claims. The Eighth Circuit was “unsympathetic” to the insurer’s concern that if there were no timeliness requirements  that the insured could give notice of subsequent related claims at any time, even years after the fact, on the grounds that it was not the Court’s role to “rescue an insurer from its own drafting decisions.” In other words, if the insurers don’t want policyholders to have an indefinite time within which to provide notice of subsequent related claims, then the insurers need to expressly identify the time requirements in their policies.


One final note. In his opinion, Judge Riley said that the Court would be “reticent” to apply New York’s “no prejudice rule” to cases where the insurer received timely notice of claim but arguably late notice of a lawsuit. I believe that the correct word in this context is “reluctant,” not “reticent.” The Miriam-Webster Dictionary defines “reticent” as “inclined to be silent or uncommunicative in speech; reserved.” The word “reluctant” is defined in the same dictionary to mean “feeling or showing doubt about doing something; not willing or eager to do something.”


Clearly the Eighth Circuit was feeling doubt, not inclined to be silent, about what the New York Court’s might do on the issues, so the word employed should have been “reluctant” not “reticent.”  (The reticent/reluctant confusion is one of the common errors I noted in a prior post on frequent word choice inaccuracies, here).

Guest Post: Mergers, Acquisitions, and Data Privacy: The FTC is Watching

Posted in Cyber Liability

Boeck_head_shot[1]The question of the privacy rights of consumers is an increasingly important topic. In the following guest post, Bill Boeck, Senior Vice President. Insurance & Claims Counsel for Lockton Financial Services, takes a look at recent actions the Federal Trade Commission has taken to protect consumers’ privacy rights and to enforce companies’ privacy policies.


I would like to thank Bill for his willingness to publish his article on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contract me directly if you are interested in submitting a guest post. Here is Bill’s post:




Selling your company or its assets?  These days it seems certain that litigation will follow.  If your company holds the personal data of customers, and has made promises in its data privacy policy about not selling it, then you may be hearing from the Federal Trade Commission (FTC).  You won’t enjoy it.


Companies doing business on the Internet typically have privacy policies explaining how the company will collect and use consumers’ personal information.  Various state and federal laws require them.  Those privacy policies often contain language to the effect that the company will not give the information to any third party without the consumer’s consent.


The FTC views violations of privacy policies as deceptive trade practices which are prohibited by the FTC Act.  The FTC frequently brings enforcement actions against companies for such violations.


In May 2014 the FTC sent a letter to the judge overseeing the bankruptcy of ConnectEDU, Inc. stating that the proposed sale of the company’s assets would violate the ConnectEDU privacy policy because consumer information would be sold without the consumers’ consent.


ConnectEDU is an educational technology company that helps students prepare for college and connect with career opportunities.  Students create profiles on the ConnectEDU web site that contain personal information.  The ConnectEDU privacy policy states that:


[T]he personally identifiable data you submit to ConnectEDU is not made available or distributed to third parties, except with your express consent and at your direction. In particular, the Company will not give, sell or provide access to your personal information to any company, individual or organization for its use in marketing or commercial solicitation or for any other purpose, except as is necessary for the operation of this site.


The policy allows information to be disclosed when the company or its assets are sold, but consumers must be given notice and an opportunity to remove their information.


The FTC states that their concerns would be diminished if ConnectEDU notified individuals that their information was being sold and gave them the opportunity to have the information removed.  The FTC would also be satisfied if the information was simply destroyed.  (The FTC identified a third option that would apply only in the bankruptcy context.)


The FTC’s letter is a warning to all companies being sold that they will face a potential enforcement action if consumer information is transferred to a buyer in violation of the company’s privacy policy.


The FTC isn’t the only thing companies need to worry about though.  It isn’t hard to imagine that individuals and their lawyers will bring class action suits for alleged misrepresentations privacy policies.  Such actions are being brought against companies now.


And it isn’t just companies that need to be concerned.  Their directors and officers need to worry too.  M&A-related litigation against directors and officers is depressingly common.  If directors and officers cause their company to be sold in violation of its privacy policy that violation could figure prominently in breach of fiduciary duty allegations in a shareholder lawsuit.


So what should companies do?


  • Companies should examine their privacy policies to determine whether the policies would permit personal data to be transferred if the company or its assets are sold.  If transferring the data would violate the privacy policy then a company may wish to work with their privacy counsel to change the policy to allow a transfer.


  • Purchasers of companies or their consumer data should assure that the selling companies represent and warrant that they are in compliance with their data privacy policy, and that they are authorized to transfer the consumer data to the buyer.


If a company faces a claim from the FTC or private plaintiffs it should have the consolation of its insurers’ support.  Such a claim should be covered under most good cyber policies.  Companies should consider whether their existing policy limits and any applicable sublimits are adequate though.  Buying and selling companies should also consider Representations and Warranties Insurance policies to cover any resulting losses.


D&O policies should cover any shareholder claims for breach of fiduciary duty by a company’s directors and officers.


The FTC has proved to be a very active enforcer of privacy rights.  If the FTC and private plaintiffs are focused on an issue, companies do well to pay attention.  An ounce of prevention now in the form of a well-crafted privacy policy and an equally well-crafted insurance program may save companies a very expensive pound of cure later.




Guest Post: Texas Supreme Court Guts Minority Shareholder Oppression Claims

Posted in Director and Officer Liability

Kara_Altenbaumer-price1[1]On June 20, 2014, the Texas Supreme Court issued its opinion in Ritchie v. Rupe, in which the Court addressed the rights and remedies of minority shareholders of Texas companies. In the following guest post Kara Altenbaumer-Price, Vice President, Management & Professional Liability Counsel for USI Southwest / USI Northwest, takes a look at the decision and analyzes its implications.


I would like to thank Kara for her willingness to publish her post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. If you would like to submit a guest post, please contact me directly. Here is Kara’s guest post:


The Texas Supreme Court ruled in late June that minority shareholders in private companies in Texas cannot sue for shareholder oppression, even when majority shareholders attempt push them out of the business, dilute their shares, or otherwise act to lower the value of their investment.  While some have heralded the decision as pro-business and an effort to keep the courts out of Texas boardrooms, others suggest that the case will discourage investment in Texas companies.

The ruling in Ritchie v. Rupe, which applies to businesses incorporated in Texas, held that not only does the Texas Business Organizations Code not prohibit oppression of minority shareholders, there is no common-law cause of action for minority shareholder oppression in Texas.  Intermediate appellate courts in Texas had allowed such claims to be brought, but this was the first time the question had been addressed by the Texas Supreme Court.  The Court’s ruling means that except in very narrow circumstances—addressed below—minority shareholders cannot sue unless they can allege that the complained-of actions were fraudulent, a breach of fiduciary duty, or another cause of action other than shareholder oppression.  

The facts in Ritchie v. Rupe involved a minority shareholder who inherited 18 percent of private company stock following the death of her husband.  The majority shareholders had offered to purchase the shares for $1 million, but because the company had sales in excess of $150 million and assets in excess of $50 million, her attorney encouraged her to decline the “absurd” offer.  Although the offer was ultimately raised to $1.7 million through negotiations, the minority shareholder continued to refuse what she believed was a too-low offer.  She then found a third-party buyer to whom she wanted to sell the stock, but the majority shareholders objected and refused to meet with the potential third-party buyer for fear it would put the company at risk for securities fraud.  This left the minority shareholder unable to market or monetize her shares.  She sued, alleging that the majority shareholders engaged in “oppressive” conduct toward her.  At trial, the company was ordered to purchase her shares at a jury-determined fair market value of $7.3 million.  The majority shareholders appealed. 

The Texas Supreme Court ruled that her claims were not valid under Texas common law or the Texas Business Organizations Code.  Instead, the Court held that the only time a shareholder oppression claim could be brought against a private company in Texas is when a rehabilitative receiver has been appointed.  Even within this narrow context of receivership, the standard for proving a shareholder oppression claim would be extremely high; a shareholder would have to show that he or she was intentionally harmed by officers and directors.  As a practical matter, it is unlikely that forcing the company into rehabilitative receivership would benefit the minority shareholder seeking to get greater value for his or her shares.  As a result, this is a hollow consolation at best.

As one Texas appellate lawyer described it, this ruling puts Texas “on an island.”  Most states either overtly allow suits for minority shareholders oppression or don’t prohibit them.  From a litigation perspective, the ruling is certainly positive for private companies in that it will very likely reduce the amount of shareholder litigation against them, or at the very least, make them more likely to prevail on suits that are filed on other grounds.  While there are still avenues for minority shareholders to sue, as noted above, it may not make logical sense for them to sue for fear of even further reducing the value of their investment by pushing for rehabilitative receivership or because claims like fraud or breach of fiduciary duty are difficult to prevail on.

This ruling should not, however, cause private companies to abandon their D&O insurance for a number of reasons.  First, as noted above, minority shareholders can still sue Texas companies; they just won’t be able to bring this relatively common cause of action unless they also seek to place the company into rehabilitative receivership.  Plaintiffs lawyers are resourceful, and private companies will still need to defend themselves from disgruntled shareholders.  Second, sophisticated investors—even if minority investors—will be likely to add minority shareholder protections contractually into their investor agreements as prerequisite to investing in a Texas corporation.  They would be able to sue pursuant to these contractual provisions.   Third, the Texas Legislature meets in a little less than six months and has the ability to change the Business Organizations Code to overrule the Court’s decision by statute.  Finally—and most importantly—unlike public company D&O insurance, the coverage afforded under private company D&O insurance is very broad and can cover many non-investor claims, including those arising from vendors, business partners, lenders, and other third parties.  It would be wise, however, for Texas private companies to use this reduced threat of shareholder litigation as leverage in renewal negotiations with carriers to push for improved terms and conditions or pricing.