Settlement is the critical goal in every claim that cannot be resolved otherwise. It terminates the open dispute, it provides the parties with finality, and, perhaps, most importantly, it provides the parties with repose. After a settlement is final, everyone is free to get on with their lives.
Notwithstanding these fundamental settlement values, are there times when a D&O insurer may nevertheless seek to recoup from its own insured the amount the insurer previously paid in settlement of a third-party claim? A November 22, 2010 Eastern District of Virginia decision, applying Kansas law, in a case involving Sprint Nextel Corporation, addressed this issue. The court held that an excess D&O insurer could not, two years after a settlement was final and based upon post-settlement case law developments, recoup from its insured the amount the insurer paid toward settlement.
In February 2004, Sprint Nextel’s board voted to recombine the company’s two separate tracking stocks, leaving a single surviving equity interest. The holders of shares to be retired received, in exchange for their shares, additionally issued shares of the surviving share class.
In March 2004, investors who had held shares of the retired class of stock filed class action lawsuits alleging that the company’s board breached its fiduciary duty by implementing a conversion ratio that undervalued the retired shares.
Sprint Nextel provided notice of claim to its D&O insurers. At the time of the shareholder claims, Sprint Nextel carried a total of $100 million in D&O insurance, which was written over a $25 million self-insured retention. The first three layers of the D&O insurance program consisted of three layers of $15 million each, arranged between a primary layer of $15 million, and two excess layers of $15 million.
In 2007, as a result of mediation, the parties to the shareholder litigation agreed to a $57.5 million settlement. The settlement was to be funded by Sprint Nextel’s payment of the $10 million remaining under the deductible, as well as full $15 million contributions from the primary, first excess and second excess carriers. The fourth level excess carrier contributed the remaining balance.
The second level excess carrier agreed to pay its limit but sought in its letter of consent to "reserve its rights to deny coverage and seek repayment."
The carriers ultimately funded their respective contributions toward the settlement. On December 12, 2007, the court entered final judgment in the shareholder litigation. The second level excess carrier closed its claim file.
However, in December 2009, after the District of Massachusetts issued its opinion, in the Genzyme case, the second level excess carrier filed a complaint against Sprint Nextel in the Eastern District of Virginia against its insured, seeking to recover the $15 million it had paid in the 2007 settlement.
As I discussed in a prior post, here, the district court held in the Genzyme case that under Massachusetts law Genzyme’s D&O insurance did not cover amounts Genzyme paid to settle the claims of individuals who asserted they had received inadequate consideration in an exchange for their tracking shares of an internal Genzyme division.
The second level excess carrier and Sprint Nextel filed cross-motions for summary judgment.
The November 22, 2010 Decision
In seeking to recover its settlement payment, the second level excess carrier argued that the settlement did not represent covered loss under the policy because it represented a delayed payment of a preexisting obligation (in that the company had preserved the Board’s right to decide to recombine the two separate classes of tracking stock into a single class). The second level excess carrier also argued that the settlement represented a mere redistribution of assets among different classes of Sprint shareholders.
In making these arguments, the second level excess carrier relied on the Massachusetts District Court’s September 28, 2009 opinion in the Genzyme case. As I as discussed at length here, the district court’s opinion in Genzyme was overturned by the First Circuit on October 13, 2010.
In rejecting the second level excess carrier’s argument that the settlement merely represented a preexisting obligation, Judge Claude Hilton wrote that "it is no understatement to say that one of the principal reasons for D&O insurance is to cover D&Os when they are alleged to have breached such preexisting obligations. The mere existence of generalized obligations to follow the law and honor one’s fiduciary duty does not render uninsurable a lawsuit alleging that corporate directors failed to do so."
Judge Hilton also rejected the second level excess carrier’s further argument that there is a general public policy against insuring this type of settlement. Judge Hilton also noted that the second level excess carrier only decided to file its recoupment action after the Massachusetts District Court entered its opinion in Genzyme, which the second level excess insurer characterized as "a case of first impression" – which contention, even if true, is inconsistent with the notion that there is a clear and pervasive public policy against payment of these types of settlements.
To the contrary, Judge Hilton found, Kansas public policy "favors enforcement of D&O insurance policies" and the second level excess carrier had not identified any grounds that would justify restitution or recoupment of the settlement payment.
Judge Hilton specifically noted that though the D&O policy allows the reinsurer to seek repayment of defense costs if the costs were not covered, "there is no basis under the policies for an insurer to make a settlement advance and later to seek its return."
Judge Hilton said that he would not allow the second level excess carrier "to retroactively amend its policy by trying to infer a recoupment right or attempt to circumvent the policy’s terms by invoking restitution." Although the carrier may have made its payment "grudgingly," there "can be no question that the payment was made voluntarily." Judge Hilton also found there was no excuse for the second level excess carrier’s delay in brining its action.
I can certainly see the argument that amount paid in the underlying settlement represents nothing more that a payment by or on behalf of the company to make up for the inadequate consideration the company allegedly paid to the holders of the retired shares in the share recombination.
But in the end, I don’t think that Judge Hilton’s grant of summary judgment in favor of Sprint Nextel necessarily depended on the merits of the second level excess carrier’s arguments about the nature of the settlement amount or even on the fortuity that the Genzyme decision was reversed after the second level excess carrier filed this action.
I think the summary judgment ruling is best understood as a reflection of the second level excess carrier’s timing. It might have been one thing if the second level excess carrier had asserted its position and resisted its settlement obligation while the underlying claim was still pending. The simple fact is that the second level excess carrier did not bring its recoupment action until two years after the settlement of the underlying claim was final.
Moreover, as Judge Hilton noted, the grounds on which the second level excess carrier sought to recover the amounts it had paid in settlement was not "fraud, duress or mistake of fact," which might justify setting a prior settlement aside and requiring a restoration of funds. Rather, the second level excess carrier’s bid to recoup funds was based solely on a district court opinion entered two years after the underlying claim was finally settled.
If carriers were able to seek the return of settlement payments years after the fact based on nothing more than post-settlement case decisions, the case resolution process could be seriously compromised. Settlements could become nothing more than a contingent arrangement, a state of affairs which frankly is in no one’s interest.
Whatever else might be said about second level excess carrier’s decision to pursue this belated action, one can only hope that the outcome of this case and the impression it makes might deter other carriers from seeking to recoup settlement payments long after the fact, at least in the absence of fraud or other similar factor.