A frequent component of derivative litigation resolution is an award to the plaintiffs of the fees and expenses the plaintiffs incurred in pursuing the suit. A contentious, recurring question is whether D&O insurance covers fee awards to derivative litigation plaintiffs. This issue received a through going over in a February 17, 2011 opinion from a five judge panel of the New York Supreme Court, Appellate Division.
In the opinion (here), a three-judge majority held, over the dissent of two judges, that a $8.8 million derivative plaintiffs’ fee award was covered under Loral Space & Communications D&O insurance policy, but all five judges held unanimously that the D&O policy did not cover the separate $10.7 million awarded for plaintiffs’ fees in a related action seeking damages for breach of fiduciary duty.
The coverage suit arises out of litigation filed after Loral agreed to enter a financing transaction with MHR Fund Management. In the transaction, MHR agreed to provide Loral $300 million in exchange for convertible preferred stock Loral was to issue to MHR.
Two lawsuits ensure. First, a BlackRock fund filed a shareholders’ derivative action seeking to rescind the deal. Second, Highland Crusader Offshore Partners filed a damages action. Both actions alleged Loral had breached its fiduciary duty because the value to MHR of the proposed deal allegedly far exceeded $300 million.
The cases were consolidated. Following a trial, the Delaware Chancery Court concluded that the transaction was unfair to Loral, and reformed the deal terms so that MHR would receive nonvoting common stock rather than convertible preferred stock. The court awarded no damages and made no findings of fault.
Concluding that the plaintiffs’ actions had produced a substantial benefit for Loral, and applying the corporate benefit doctrine, the Court entered a fee award to BlackRock of $8.8 million and entered a fee award to Highland of $10.7 million. Loral paid these amounts and then sought coverage under its D&O insurance policy for the payments.
Loral’s D&O insurer denied coverage and commenced an action seeking a judicial declaration that their policy did not cover the plaintiffs’ attorneys’ fee awards. The trial court denied the insurer’s motion for summary judgment and granted summary judgment in Loral’s favor. The insurers appealed.
The February 18 Order
On appeal, the insurers argued that the Highland fee award was not covered because the Highland action for damages was not a "securities claim" and therefore there was no coverage under the policy for any amount related to that action. The insurers argued that the BlackRock fee award was not covered because the BlackRock litigation produced a benefit for Loral and therefore the fee award did not represent covered "Loss since it was a cost the company incurred as part of procuring the benefit.
The five-judge panel unanimously agreed that there was no coverage for the $10.7 million Highland fee award, because the Highland damages action was neither a derivative suit nor did it allege violation of any securities law, and therefore it did not represent a securities claim as was required to bring the claim within the Policy’s coverage.
The panel split badly on the question whether or not the fee award in the BlackRock derivative action was covered under the D&O policy. The three-judge majority concluded that it was. Its reasoning turned it part on the policy’s definition of "Loss," which provides that "Loss" includes "damages, judgments, settlements or other amounts (including punitive or exemplary damages where insurable by law) and Defense Expenses in excess of the Retention that the Insured is legally obligated to pay."
The majority rejected the insurers’ argument that because the derivative suit produced a benefit for Loral, Loral had not suffered a "Loss." The majority perceived this argument as essentially a suggestion that the fee award should be offset against the nonmonetary benefit Loral received as a result of the restructured transaction. The majority found that while Loral received a benefit in that it no longer suffered the detriment that would have followed from the transaction as originally structured "it does not follow that Loral actually made a tangible profit."
The attorneys’ fee award, the majority found, "constitutes damages" and representing "other amounts" that Loral has become "legally obligated to pay" and therefore comes within the Policy’s definition of "Loss." The majority also noted that the Policy expressly covers derivative lawsuits and that "to declare that Loral has no coverage for derivative plaintiffs’ attorneys’ fees would deprive Loral of the coverage for derivative lawsuits that it paid for and expected to receive."
The dissent objected to the majority’s conclusion about the derivative fee award. First, the dissent argued that the "legally obligated to pay" language in the definition of Loss followed and referred to "the Retention," not to "other amounts."
The dissent also argued that in order for the derivative fee award to be covered, it would have to represent "an actual loss, not an expense or the cost of doing business." The dissent reasoned that in this case, Loral "did not sustain a loss but rather benefitted from the judgment."
A fee award a derivative suit, the dissent observed, represents "the equitable entitlement of the successful derivative plaintiff to recover the expenses of his/her attorneys’ fees from all the shareholders of the corporation on whose behalf the suit was brought." The dissent observed that "if not spreading the cost of attorneys’ fees sounds in unjust enrichment, the obvious corollary is that shifting the cost to shareholders as a group cannot be characterized as a loss."
The insurers in this case did not come away empty, as the appellate court unanimously agreed that because there was no coverage under the policy for the Highland damages claim, the $10.7 million Highland fee award was not covered under the Policy.
This holding was not preordained as at least one court has recently held that a fee award can represents damage for which there can be coverage under a D&O policy even if there is no coverage under the policy for the underlying litigation. In a February 9, 2010 ruling (here), the District of Minnesota held that a derivative lawsuit fee award represented "damages" and could be covered under a D&O insurance policy even where the underlying claim itself was not covered under the policy.
With respect to the question of coverage for the BlackRock derivative fee award, the insurers did manage to persuade two of three judges that because of the nature of the outcome of the underlying case and the nature of the derivative fee award, the award did not represent a loss to Loral and therefore is not covered under the policy.
The narrowness of split between the majority and the dissent on this issue suggests that this dispute is far from resolved. Even just in this case, there seems a substantial likelihood for further appellate proceedings in the New York Court of Appeals. And in general, given the close split, the underlying issue is likely to continue to be debated in other cases.
The carriers assert their position on these issues with conviction. Policyholders find the insurers’ rationale on this issue obscure and unpersuasive (those are among the milder adjectives, actually) – although obviously the insurers were able to persuade two judges of the appellate court of their position, so clearly there is something to their position on this issue.
The danger for all involved is that this issue will continue to come up over and over again. A colleague in the industry suggested to me in a note about the Loral case that eventually this issue may have to be addressed in the policy, along the lines of the way the industry developed a policy solution to the contentious issue that Section 11 settlements were not covered under the Policy. The way the industry addressed that issue is that it became standard to include in public company D&O policies language stating that the insurer would not take the position that a settlement of a ’33 Act case was not covered under the Policy. Perhaps, the colleague suggested, the industry will adopt a similar approach on this derivative lawsuit fee award issue.
I am interested in readers’ thoughts on these issues. I hope readers will add their observations to this post, using the blog’s comment feature.
Many thanks to the several readers who sent me a copy of the Loral decision.
I am Word Power: In a column in the February 28, 2011 issue of The New Yorker entitled "Who Am I" (here), Demetri Martin wrote "I am bravery. I am courage. I am valor. I am daring. I am holding a thesaurus."