The D&O Diary

The D&O Diary


Court Holds Professional Liability Insurance Covers Restitutionary Settlement

Posted in D & O Insurance

minnOn July 3, 2014, in an interesting decision that is sure to stir up much discussion and controversy, District of Minnesota Judge Paul Magnuson, applying Delaware law, held that U.S. Bank was entitled to coverage under its professional liability insurance for restitutionary amounts it paid in settlement of an overdraft fee overcharge class action. The Court held that there is no Delaware public policy against insuring restitutionary amounts and that the “after adjudication” requirement of the ill-gotten gains exclusion implies coverage for restitutionary amounts in the absence of an adjudication. A copy of the July 3 Opinion can be found here.



In 2009, U.S. Bank was sued in a series of class action lawsuits in which the claimants alleged that the bank had improperly charged overdraft fees to its customers and that it had misrepresented its overdraft fee policy. The claimants asserted a variety of common law and statutory claims and sought the return of the excess overdraft fees. In 2013, U.S. Bank settled the class actions for $55 million.


U.S. Bank then sought coverage from its professional liability insurers for its defense costs and for settlement amounts in excess of the primary policy’s retention. The insurers denied coverage on the ground that the settlement was restitutionary in nature and that restitution is uninsurable as a matter of law. U.S. Bank filed an action against its insurers in the District of Minnesota alleging breach of contract and seeking a judicial declaration that the settlement and defense costs are covered. The insurers filed a motion for judgment on the pleadings.


The primary policy’s definition of the term “Loss” contained a provision (which the Court called the Uninsurable Provision) that “Loss” does not included “matters which are uninsurable under the law pursuant to which the Policy is construed.” The definition of “Loss” also specified (in a provision that the Court called the Extension-of-Credit Provision) that “Loss” does not include “principal, interest or other monies either paid, accrued or due as a result of any loan, lease or extension of credit” by the bank.


In addition, in an exclusion the Court called the Ill-Gotten Gains Provision, the primary policy precluded from coverage claims “brought about or contributed to in fact by any … profit or remuneration gained by [U.S. Bank] or to which [U.S. Bank] is not legally entitled … as determined by a final  adjudication in the underlying claim.”


The July 3 Opinion

In his July 3 Opinion, Judge Magnuson denied the insurers’ motion for judgment on the pleadings. Judge Magnuson rejected the insurers’ arguments that the restitutionary settlement was precluded from coverage as a matter of law.


First, Judge Maguson rejected the insurers’ argument that the settlement is uninsurable, “because no Delaware authority has held that restitution is uninsurable as a matter of law.” He added that “neither Delaware statute nor case law expressly precludes insurance coverage for settlements constituting restitution.” In response to the insurers’ various arguments about how a Delaware court might rule or might consider rulings from other jurisdictions holding restitution to be uninsurable, Judge Magnuson said that “the Court finds none of these reasons compelling enough to support holding as a matter of first impression that Delaware law prevents parties from contracting to insure settlements constituting restitution.”


Second, Judge Maguson found that “the policies exclude from coverage restitution resulting from a final adjudication and by implication include within coverage restitution stemming from a settlement.” In this case, where the class actions were settled, “there is no final adjudication and the settlement is not excluded from coverage.” The insurers tried to argue that if there hasn’t been an adjudication, that means that the provision is simply irrelevant; it doesn’t mean that the provision implicitly establishes coverage. Judge Magnuson rejected this argument because its logical extension is that there could never be coverage for restitution, by operation not of the exclusion but rather of the Uninsurable Provision. He said that “to interpret the Uninsurable Provision to always preclude coverage for restitution would nullify the Ill-Gotten Gains Provision, which plainly says that only a final adjudication precludes coverage for restitution. The provision must have effect.”


Judge Magnuson also rejected the insurers’ attempt to rely on the “no loss” line of cases. These cases, the first of which was the Seventh Circuit’s 2001 decision in Level 3 Communications, Inc. v. Federal Insurance Co., hold that an insured incurs no loss when it unlawfully takes money or property and is forced to return it, and that to allow insurance for these amounts would bestow an unjustified windfall. Judge Magnuson found that these cases are distinguishable because they involved policies without a specific provision requiring a “final adjudication.” He added that the parties knew about the Level 3 decision when they executed policies and still decided to cover a settlement constituting restitution absent a final adjudication.


Finally, Judge Magnuson rejected the insurers’ argument that the Extension-of-Credit Provision precluded coverage for the settlement amounts because the underlying claim was based on the bank’s improper overdraft fee practices and not on an extension of credit.



I am guessing that the management liability insurance claims departments are buzzing about this decision. For many years, at least since the Seventh Circuit’s Level 3 decision, it has been a basic claims handling assumption that professional liability and management liability insurance policies do not cover restitutionary amounts and that insurance for restitution is against public policy. This decision knocks those assumptions in the head.


To be sure, Judge Magnuson said only that he could find no Delaware law for the proposition that restitutionary amounts are uninsurable as a matter of law in that state. That ruling obviously has no bearing in cases to which other jurisdictions’ law apply and where there is law barring the insurance of restitutionary amounts. Moreover, as a federal trial court decision interpreting a nonforum state’s law, this decision has no precedential authority – yet, at least until a Delaware court says that there is a public policy in Delaware against insuring restitution, it will have an impact just the same.


What makes the case particularly interesting is Judge Magnuson’s interpretation of the Ill-Gotten Gains Provision and his rejection of the “no loss” line of cases. Since the time period when Seventh Circuit ruled in the Level 3 cases, most professional and management liability insurance policies have been modified to incorporate an after adjudication provision in their improper profits exclusion. Judge Maguson’s conclusion that the “no loss” line of cases are distinguishable based upon the exclusion’s after adjudication provision has significant implications for insurers, as most of their policies’ improper profit exclusions  now have an after adjudication requirement. The suggestion that insurers whose policies have this provision by implication insure restitution in the absence of an adjudication and might not be able to rely on the “no loss” line of cases undoubtedly will be disturbing revelations for many insurers.


As unexpected as this case is, I do think there may be a limit to which other courts might be willing to follow it, even without the questions about precedential authority and effect. I think many courts may be (and will continue to be) reluctant to conclude that that restitutionary amounts are insurable. The many cases in which courts have refused to allow restitution to be insured are a reflection of some courts’ fundamental discomfort with allowing insurance for amounts a party has gained improperly and been forced to return.


That said, many insureds undoubtedly will now try to rely on Judge Magnuson’s conclusion that in the absence of an adjudication coverage exists for restitutionary amounts. To the extent other insureds gain traction on this theory, the insurers may have to think about expressly providing in their policies that “Loss” does not include amounts paid in restitution.


Many thanks to a loyal reader for providing me with a copy of Judge Magnuson’s opinion.


PLUS Webinar on the Halliburton Decision: On Monday July 14, 2014, at 12:30 pm EDT, the Professional Liability Underwriting Society will be hosting a free webinar on the U.S. Supreme Court’s recent Halliburton decision and its implications for publicly traded companies and for their D&O insurers. This 45-minute webinar will feature Jordan Eth of the Morrison Foerster law firm, Mike Dowd of the Robbins Geller law firm, and Michael Nicholai of Berkley Professional. Registration information about the webinar can be found here.


Time for Nominations to the ABA Journal’s Annual Blawg 100: It is once again time for nominations to the ABA Journal’s annual list of the top 100 law blogs. Everyone should take a moment to nominate their favorite law blogs for inclusion in the list. I would be humbled if any reader would be willing to nominate my blog for inclusion. Nominations can be made here. Don’t delay, nominations are due by 5:00 pm EDT on Friday August 8, 2014.


More About Stories We’re Following

Posted in Cyber Liability, Director and Officer Liability

newspaperCybersecurity as a D&O Liability Issue: I have noted in prior posts on this site (refer for example here) that cybersecurity represents, among other things, a D&O liability exposure. The recent lawsuits filed against Target (refer here) and Wyndham Worldwide (refer here) underscore this point. In addition, at least according to a July 7, 2014 Bloomberg article entitled “Hacked Companies Face SEC Scrutiny Over Disclosure” (here), several companies are now facing SEC investigative action related to cybersecurity issues.


According to the article, which cites undisclosed sources, the agency is investigating whether the companies “properly handled and disclosed a growing number of cyberattacks.” The investigations are “focused on whether the companies adequately guarded data and informed investors about the impact of the breaches.” The SEC is “also investigating companies’ internal controls in cases where the value of assets could have been affected by a breach.”


The article says that the prospect of enforcement activity focused on the cyberattack targets “marks a new front in the agency’s efforts to combat the rising threat hackers pose to public companies.” Previously the SEC had focused more on providing guidance to public companies about how to disclose its cybersecurity risks.


Other than Target Corp., which previously disclosed in public filings that it was the subject of an SEC investigation, as well as of investigations by the Federal Trade Commission and states’ attorneys general, the article does not identify other companies that are the subject of SEC scrutiny.


This news about SEC investigative activity follows after the June 10, 2014 speech of SEC Commissioner Luis Aguilar (about which refer here), in which Aguilar said “ensuring the adequacy of a company’s cybersecurity measures needs to be a part of a board of director’s risk oversight responsibilities”  and that “boards that choose to ignore, or minimize the importance of cybersecurity oversight responsibility, do so at their own peril.”


The possibility of SEC enforcement activity related to cybersecurity seems increasingly likely, which reinforces the conclusion that cybersecurity represents a D&O liability exposure.


Companies Adopting Fee-Shifting Bylaws: In May, when the Delaware Supreme Court upheld the validity of a fee-shifting bylaw, the possibility arose that companies might be able to adopt these kinds of bylaws as a way to try to deter abusive shareholder litigation, as discussed here. The bylaws shift attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation. The opportunity to adopt this type of bylaw quickly seemed to be short-lived, as the Delaware legislature got active and took up a measure that would have limited the Supreme Court’s ruling to non-stock companies, meaning that most Delaware corporations would be unable to take advantage of a fee-shifting bylaw. However, as discussed here, the Delaware legislature has now tabled the measure until 2015, leaving the status of this type of bylaw in an uncertain state.


Despite the uncertainty, at least some companies are going ahead and adopting fee-shifting bylaws. According to a July 7, 2014 Reuters article by Tom Hals entitled “US Companies Adopt Bylaws that could Quash Some Investor Lawsuits” (here), “a handful of mostly tiny U.S. companies have become the first to adopt controversial by laws that would shift legal fees to investors who sue and lose.” Six companies have adopted the bylaws in recent weeks. At least two of the companies adopting the bylaws were sued earlier this year about the make-up of their boards. All but one of the companies are planning or recently completed initial public offerings.


The article quotes one commentator as saying that “I think it’s notable that we’re not seeing the well-established, large-cap companies” adopt the bylaws, adding that most companies “are probably reluctant to adopt the bylaw because of the potential harm to investor relations.”


It also seems likely that the uncertain state of play in Delaware also is discouraging some companies from acting. The Delaware legislature could act next year to undercut the validity of fee-shifting bylaws for stock corporations. Until the Delaware legislature’s action, if any, becomes clear, some companies may be reluctant to adopt the bylaws. However, as the Reuters article makes clear, at least some companies are going ahead, in a self-help version of litigation reform.


D&O Diary Discount for the ACI D&O Liability Conference: On September 30 and October 1, 2014, the American Conference Institute will be hosting its Eighteenth Forum on D&O Liability in New York. The event features a stellar line up of speakers and will be co-chaired by my good friends Carol Zacharias of ACE North American and Doug Greene of the Lane Powell law firm. Information about the event can be found here.


Through this Thursday, July 10, 2014, readers of the D&O Diary can obtain a $200 discount on the event registration fee, by using the code DOD200. I hope as many readers as possible will take advantage of this discounted rate.

Guest Post: Class Certification Timing and the IndyMac MBS Case in the Supreme Court

Posted in Securities Litigation

engstrom-davidAs I discussed in a prior post (here), in March 2014 the U.S. Supreme Court agreed to take up the IndyMac case in order to consider whether the filing of a class action lawsuit tolls the statute of repose under the Securities Act (by operation of so-called “American Pipe” tolling) or whether the statute of repose operates as an absolute bar that cannot be tolled. The case will be heard during the next Supreme Court term. In the following guest post, Stanford Law School Professor David Engstrom, who filed an amicus brief in the case, takes a look at the IndyMac case and its implications for class action securities litigation.  

I would like to thank Professor Engstrom for his willingness to publish his article on this site. I welcome guest post contributions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you would like to submit a guest post. Here is Professor Engstrom’s guest post:  


The Supreme Court has granted certiorari in Public Employees’ Retirement System of Mississippi v. IndyMac MBS, Inc., a case that has significant implications for securities class actions and the efficient operation of the federal courts.  I recently filed an amicus brief in the case with eleven academic colleagues (found here)[1] using data from Stanford Securities Litigation Analytics.[2]  The brief assists the Court by showing that, if the Second Circuit’s decision below were to stand, class members in a large number of securities class actions would have to make wasteful “protective filings”  in order to maintain their right to proceed independently and avoid being time-barred if class certification was subsequently denied.  These filings would drain judicial resources and impose costs on putative class members without any countervailing benefit.

In American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), the Supreme Court held that the filing of a class action complaint “suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.”  Id. at 554. A contrary rule, the Court warned, would impair the “efficiency and economy of litigation.”  Id. at 553.  In its IndyMac decision below, the Second Circuit broke with this proposition, refusing to apply American Pipe’s tolling rule to the three-year limitations period in Section 13 of the Securities Act in a case brought under Sections 11 and 12 of the Securities Act, which address misstatements and omissions of material information related to a public offering.  Under the Second Circuit’s rule, a putative class member must thus file a protective action—either intervening in the class action or filing entirely separate suits—on the eve of expiration of Section 13’s three-year limitations period in order to preserve the right to proceed independently if class certification is later denied.

An important question in this case, as the Second Circuit noted, is the quantity of protective filings that can be expected if American Pipe does not apply to Section 13’s three-year limitations period in Section 11 and 12 cases.  A related question not addressed in this case, but clearly implicated, is the number of protective filings we can expect if the Second Circuit’s holding is extended to the similar five-year statute of limitations applicable to the much larger number of securities class actions brought under Section 10(b) of the Securities Exchange Act.

Data on class actions filed during 2002-2009 helped answer these questions.  We first estimated the proportion of cases asserting only Section 11 and 12 claims in which a class certification order occurred after Section 13’s three-year limitations period had expired.  More specifically, we calculated the number of days between the first day of the class period and either:  (i) the date of the district court’s order on a motion for certification (or, in multi-certification-order cases, the last certification order); or (ii) the date of the district court’s order preliminarily certifying a class for purposes of settlement.[3]  The results of these calculations are presented in Figure 1’s scatterplot. 

Figure 1. Time from the Start of the Class Period to a Certification Decision or a Dismissal Without Certification in Cases Asserting Only § 11 or 12 Claims, 2002-2009

fig1_color updated

The results are striking:  Section 13’s three-year limitations period, denoted in Figure 1 as a horizontal dashed line, would have expired prior to a certification decision in 73 percent (38 of 52) of cases that reached a certification decision, and prior to a certification decision in 44 percent (38 of 86) of all filed cases.   To provide more detail on the 52 cases depicted in Figure 1 that reached a certification decision, the three-year limitations period would have expired before an order on a free-standing motion for class certification in 11 of 12 cases reaching such an order.  And that period would have expired in 29 of the 42 cases that reached certification as part of the court’s preliminary approval of a settlement.[4]

Figure 2 presents the results of the same analysis for cases brought under Section 10(b) of the Securities Exchange Act, which is governed by a five-year limitations period.[5]  Data on these cases is taken from a random sample of 500 cases drawn from roughly 1,200 securities class actions filed between 2002 and 2009.[6] The results are again striking: The five-year limitations period that applies to § 10(b) claims would have expired prior to a certification decision in 44 percent (135 out of 307) of cases that reached a certification decision and prior to a certification decision in 27 percent (135 out of 500) of all cases in the sample.[7] 

Figure 2. Time from the Start of the Class Period to a Certification Decision or a Dismissal Without Certification in Cases Asserting § 10(b) Claims, 2002-2009

fig2_color updated


Among the 307 cases in which class certification occurred, 227 classes were certified for the purposes of settlement, and 86 classes were certified in response to free-standing motions to certify. Of the 227 cases certified for settlement purposes, 97 came after the five-year limitations period; of the 86 cases producing an order upon a free-standing motion for certification, 42 came after the limitations period.[8]

Using the above estimates and extrapolating to the roughly 3,200 securities class actions filed since 1997 alleging either Section 11, 12 or 10(b) violations, plaintiffs seeking to preserve their rights without American Pipe’s protective rule would have had to make protective filings in as many as 850 cases.[1][9]  Had even a handful of potential class members in each case done so as the end of the relevant three- or five-year limitations period approached, total filings would have easily numbered in the thousands.

Moreover, as we explained in our brief, these calculations may even underestimate the effect of the Second Circuit’s ruling.  First, a significant number of cases are dismissed without certification after the limitations period expires.  These cases—denoted as dots falling above the dashed line in Figures 1 and 2—could generate protective filings but are not included in the above estimates.  Second, a potential class member’s rights can be cut off by the limitations period because of any defect that is fatal to a class claim, not just denial of certification. Without American Pipe’s protective rule, class members who lack confidence that the lead counsel has cleared all legal hurdles to recovery may make protective filings even after class certification has been granted. Third, if American Pipe’s protective rule does not apply, both lead counsel and defendants will have incentives to drag their heels in the course of pre-trial proceedings in order to cut off potential class members’ opt-out rights.  Finally, the Court’s June 23rd decision in Halliburton strongly suggests that class certification proceedings will likely take longer going forward.  This is because at least some cases will involve dueling expert opinions (including “event studies” using multiple-regression to measure stock-price movement at the time of a false or misleading statement) in order to determine whether the presumption of reliance on which federal securities law rests can be rebutted.  Additional pre-certification proceedings of this sort will likely push more cases above the horizontal dashed lines in Figures 1 and 2, thus increasing the proportion of cases that could generate wasteful protective filings.

Procedure cases often entail difficult trade-offs – for instance, between speed and accuracy in weighing the merits of a case.  In this case, however, there is no benefit to requiring potentially thousands of protective filings in securities class actions. 


[1] Signatories other than me include:  Janet Alexander, Stanford Law School; Stephen Burbank, Penn Law School; Kevin Clermont, Cornell Law School; John Coffee, Columbia Law School; James Cox, Duke Law School; Scott Dodson, Hastings Law School; Jonah Gelbach, Penn Law School; Alexandra Lahav, Connecticut Law School; David Marcus, University of Arizona Law School; Norman Spaulding, Stanford Law School; and Benjamin Spencer, Washington & Lee Law School.


[2]Stanford Securities Litigation Analytics, co-founded by Professor Michael Klausner and Jason Hegland, is a practitioner-focused research group with extensive databases covering securities class actions and SEC enforcement actions.  They are launching a new web tool for practitioners that will allow detailed queries of the database, aggregated statistics based on search results and interactive data visualizations.


[3] Keying this calculation to the start of the class period is consistent with § 13’s language, which states that the limitations period begins to run when the security was “bona fide offered to the public” (§§ 11 and 12(a)(1) claims) or upon the security’s “sale” (§ 12(a)(2) claims). 


[4] Two of the cases in the sample of §§ 11 and 12 cases produced both an order on a motion for certification and a preliminary order approving a class settlement beyond the three-year limitations period, which explains why the numbers reported for cases falling into each category sum to 40 (11 + 29) rather than 38. 


[5] See 28 U.S.C. § 1658(b) (requiring securities fraud cases brought under § 10(b) and Rule 10b-5 to be brought within “5 years after such violation”).


[6] As with the prior analysis, keying the calculation of elapsed time to the start of the class period is consistent with the weight of authority among lower courts that § 1658(b)’s five-year limitations period is subject to an event-accrual rule – i.e., the date of the misrepresentation or the completion of (or commitment to complete) the purchase or sale of the security. See, e.g., McCann v. Hy-Vee, Inc., 663 F.3d 926, 932 (7th Cir. 2011) (holding that the five-year limitations period starts upon misrepresentation); In re Exxon Mobil Corp. Sec. Litig., 500 F.3d 189, 200 (3d Cir. 2007) (same); see also Arnold v. KPMG LLP, 334 Fed. App’x 349, 351 (2d Cir. 2009) (explaining that the limitations period starts when parties commit to purchase or sell).  


[7] The margin of error for these estimates, calculated at the standard 95 percent confidence level, is ±5.5 percent for the first and ±3.9 for the second. In other words, we can be 95 percent confident that the actual proportions lie somewhere between roughly 38 and 50 percent for the first estimate and between 23 and 31 percent for the second.


[8] Four of the cases in the sample of § 10(b) cases produced both an order on a motion for certification and a preliminary order approving a class settlement beyond the five-year limitations period, which explains why the numbers reported for cases falling into each category sum to 139 (42 + 97) rather than 135.



[9] See Alexander Aganin, Cornerstone Research, Securities Class Action Filings: 2013 Year in Review 3 fig.2 (2014), available at (reporting more than 3,200 securities class action lawsuits between 1997 and 2013, an average of nearly 200 per year). The “850 cases” figure was derived by multiplying the 3,200 cases filed since 1997 by the above-reported 27 percent estimate of the proportion of cases in the 500-case sample that reached a certification order after the five-year limitations period.

D&O Insurance: Excess Insurance Not Triggered Due to Insolvency of Underlying Insurer and Due to Insufficient Loss

Posted in D & O Insurance

paIn a long and convoluted opinion befitting the long and convoluted case in which it was entered, Judge David Grine of the Pennsylvania (Centre Country) Court of Common Pleas, applying Pennsylvania law, entered summary judgment for an excess D&O insurer, holding that the excess insurer’s payment obligation had not been triggered due to the insolvency of an underlying excess insurer and because covered defense expenses and settlement amounts were less than the amount of the underlying insurance.


In a nearly two-decade saga growing out of a specialty medical service provider’s alleged over-billing, the Court rejected the plaintiff directors and officers’ argument that settlement amounts funded by the sale of related medical practices — that were neither subsidiaries of the named insured nor additional named insureds under the policy — should be taken into account in determining whether the amount of the plaintiffs’ loss reached the excess insurer’s limit.


A copy of the Court’s June 30, 2014 opinion can be found here.



EquiMed was a specialty medical services company providing services to radiation oncologists. In 1996, EquiMed was named for the first time as a defendant in an existing qui tam action that had first begun in 1995. There were numerous other defendants in the action, which involved alleged over-billing. In 1998, the U.S. government intervened in the qui tam action. In late 1999 and early 2000, the various defendants reached an agreement to settle the qui tam action, but in February 2000, an involuntary bankruptcy petition was filed against EquiMed. Further settlement negotiations ensued. The ultimate settlement of the qui tam action involved a series of payments by or on behalf of a number of different parties, including a number of medical practice groups that were neither subsidiaries of EquiMed nor additional named insureds under the relevant D&O insurance program.


At the time that the qui tam action was amended to include EquiMed as an additional defendant, EquiMed had a program of D&O insurance that consisted of a $5 million layer of primary insurance, a $5 million first layer of excess insurance, and a $10 million second layer of excess insurance. The first excess layer was provided by Reliance National, which was declared insolvent and went into liquidation on October 3, 2001.


EquiMed submitted the qui tam action to its D&O insurers as a claim. The D&O insurers denied coverage for the claim based on their policies’ respective prior and pending litigation exclusions, in reliance on the fact that the qui tam action had initially been filed before the prior and pending litigation date.  In May 1999, EquiMed filed a coverage lawsuit against the primary insurer and against Reliance National seeking an injunction to force the insurers to pay its defense cost in the qui tam litigation. The second level excess insurer was not a party to this prior coverage lawsuit. The court in the prior coverage lawsuit held that the primary insurer’s prior and pending litigation exclusion did not preclude coverage for the defense costs incurred in the qui tam action.


Three former directors and officers of EquiMed subsequently filed a separate insurance coverage action against the second level excess insurer, seeking reimbursement for the defense expenses and settlement amounts that had not been paid by the primary insurer. The plaintiffs asserted claims for breach of contract and for bad faith. The parties moved for summary judgment.


The second level excess insurer’s policy specified that coverage under its policy did not attach until all of the underlying insurance “has been exhausted solely as a result of actual payment or payment in fact of losses of all applicable Underlying Insurance limits.”


The June 30 Opinion 

In arguing that its payment obligation had not been triggered, the second level excess insurer (hereafter the excess insurer) made two arguments: first, the excess insurer argued that due to Reliance National’s insolvency, the underlying limits had not been exhausted by payment of loss; and second, and in any event, that the amounts the insureds incurred by way of defense and settlement were less than the $10 million, the amount of the underlying insurance.  The Court agreed with both of these arguments.


First, based on the Second Circuit’s June 2013 opinion in Ali v. Federal Insurance Company (about which refer here), the facts of which the Court said were “almost identical to the case at bar,” the Court agreed that, due to Reliance National’s insolvency,  the excess insurer’s payment obligation had not been triggered. In Ali, the Second Circuit held that excess D&O insurance is not triggered even if losses exceed the amount of the underlying insurance, where the underlying amounts have not been paid due to the insolvency of underlying insurers. The Court said that it is “persuaded that the holding in Ali should apply to the case at bar.”


The Court also agreed with the excess insurer that the plaintiffs “are unable to show the required $10 million actual loss, and as a result, Defendants’ duty to indemnify on the claim was never triggered.” The record showed that the primary insurer had paid a total of $4.4 million in defense and indemnity. The excess insurer argued that this amount was the extent of the plaintiffs’ total loss. The plaintiffs, in turn, argued that various other amounts contributed to the qui tam action settlement should be attributed to the plaintiffs for purposes of calculating their actual loss.


The Court rejected the plaintiffs’ arguments to incorporate these additional amounts. First, the Court, citing with approval an opinion from a New York appellate court, held that the payment of a settlement amount in a qui tam action “established unjust enrichment for the purposes of the public policy against insuring against the risk of being ordered to return money or property that has been wrongfully acquired.”


Second, the Court rejected the plaintiffs’ argument that their total loss included amounts contributed toward the qui tam settlements based on the sale of various medical practices that were 100% owned by one of the plaintiffs, Dr. Douglass Colkit. These medical practices were not subsidiaries of EquiMed and were not named insureds in the D&O insurance policies. However, the various medical practices had been defendants in their own name in the qui tam action.  Dr. Colkit had argued that he had been forced to sell the practices in order to fund the settlement. However, the Court ruled that the “payment of funds resulting from their liquidation to the qui tam settlement should be attributed to themselves as defendants, not to the Plaintiffs.”


Third, the Court rejected the argument that amounts of government medical payments the U.S. government had withheld as part of the qui tam settlement were attributable to the plaintiffs. These amounts were “owed to the medical practices, which were themselves defendants in the qui tam action and subsequent settlement,” and are therefore “rightfully attributed to the entities themselves.”


Even certain additional unreimbursed defense expenses, even if taken into account and combined with the $4.4 million paid by the primary insurer “falls short, by almost half, of the amount required to trigger a duty for Defendants to indemnify plaintiffs under the Policy.”


The Court also found that, while certain of the plaintiffs’ allegations stated a claim for bad faith, the plaintiffs’ bad faith claims were time-barred.



It is astonishing to me that there are still cases out there working their way through the system that are affected by the insolvency and liquidation of Reliance National, which went bust in 2001. The Reliance insolvency seems like so much ancient history. If nothing else, this case is a reminder that the most important criterion in choosing an insurer is financial solvency. When an insurer becomes insolvent and goes into liquidation, the mess can be enormous and it can take years to clean up, as this case shows.  


The Court’s holding that the due to the insolvency of the underlying insurer the excess insurer’s payment obligations were not triggered is consistent with the Second Circuit’s holding in the Ali case, which also involved a gap in coverage created by the insolvency of Reliance. In light of the Court’s adoption of the Second Circuit’s holding in Ali, the other parts of the Court’s analysis that the excess insurer’s payment obligations had not been triggered arguably are superfluous. But the Court’s conclusion that the plaintiffs’ losses did not amount to $10 million has some interesting components.


The Court’s holding, made in reliance on a prior New York case, that the settlement of a qui tam action represents the disgorgement of an ill-gotten gain of which it would be against public policy to insure is interesting. The plaintiffs had argued, understandably enough, that because the qui tam action had been settled, there had been no findings of fact that the gains were ill-gotten or improper. The Court cited the New York case for the proposition that the settlement “was essentially equivalent to a determination, reached through agreement of the parties, that the plaintiffs had been unjustly enriched” and that the plaintiffs “made restitution by way of settlement.”


I am sure I am not the only one that finds this not entirely convincing. Parties settle cases for all kinds reasons – for example, a party might settle a qui tam action because one of its excess D&O insurers went insolvent and the other excess insurer was denying coverage and the only way for the party to avoid ruinous defense expenses was to settle the case. Settlements typically represent only the compromise of disputed claims. In the absence of express admissions, the Court’s conclusion that the settlement is “essentially equivalent to a determination” and that the amounts paid in settlement represented “restitution” seems to me to be speculative.


I can certainly see how the Court concluded that the amounts paid in settlement upon sale of the unrelated medical practices represented a settlement of those separate medical practices’ potential liabilities in the qui tam action. However, I can also see Dr. Colkit’s argument that he sold the medical practices, as he might sell any other asset, in order to realize sufficient funds to settle his own potential liability. There may have been more in the record in this case, but I couldn’t find anything in the Court’s opinion to substantiate conclusively that the proceeds of the medical practices’ sale were paid in settlement of the medical practices’ potential liabilities and not paid in settlement of Dr. Colkit’s potential liabilities, other than the Court’s observation that the medical practices had been named as defendants in the qui tam action.


In any event, it may be that this long-running story has finally reached its end. However, the plaintiffs have the option of appealing. Given the history of this case, the possibility that there may yet be further proceedings in this case seems likely.


Special thanks to a loyal reader for sending me a copy of this opinion.  


Guest Post: Protecting Aunt Sally: When Hackee becomes Hacker-in-Pursuit

Posted in Cyber Liability

alansmall[1]In the following guest post, Alan Borst of Willie Borst ADR takes a look at the new and perhaps unappreciated exposures and risks posed by cyber counter-measures. Alan also explores the potential insurance issues related to these activities. 

I would like to thank Alan for his willingness to publish his post on this site. I welcome guest post contributions from responsible authors on topics of interest to readers of this blog. Anyone interested in publishing a guest post should contact me directly. Here is Alan’s guest post: 


Practitioners of the roughly ten-year old and rapidly expanding area of cyber liability insurance coverage should be startled at the recent surge in activity both in new offerings –a leading national carrier’s inclusion of bodily injury and property damage coverage — growing penetration of the market[i], and well publicized “events”.  The events get the most public press, of course, and as such have the biggest impact on the insurance industry. 


Cyber victims take the offense – Up to now the scholarly reporting and insurance discussion has focused on the victims of data security and privacy events, but recently the focus has shifted to law enforcement, and to the role of private security firms in developing increasingly sophisticated countermeasures.  Just as the well-publicized pre-holiday hacking of the retail industry put a damper on an otherwise growing business in 2013, we should all take heart that our Justice Department has not been completely asleep and has scored a moral if not final victory over the Grinch-like community of hackers by “killing” at least one ransomware program, “Cryptolocker” in June of 2014.  Here[ii].   The cited New York Times article takes a cautionary look at the emergence of cyber vigilantism in the lutte internationalle against cyber-terrorism, of which cyber extortion is only the most conspicuous form.  The author, Ian Urbana, posits:


In response, more companies are resorting to countermeasures like planting false information on their own servers to mislead data thieves, patrolling online forums to watch for stolen information and creating “honey pot” servers that gather information about the intruders.  Last year, companies also spent roughly $1.3 billion on insurance to help cover expenses associated with data theft.  (emphasis supplied)


If we are now in the Wild West of cyber warfare it seems to be generally accepted that victims of data theft can and do follow and retrieve stolen data wherever it leads them.  Acting through their forensic teams, and in collaboration with law enforcement agencies, Federal law may even protect such counter-hacking activity.  The law is apparently not clear, in this regard however,[iii]  so at least in theory innocent third parties may be at risk of being hacked by a victim whether or not they have participated in the original hacking event, whether they are in possession of stolen data, or indeed whether a hacking event has occurred at all.   Cyber insureds who believe they have been attacked generally have a year to conduct an investigation into a reported data security or privacy event and cyber policies do not specifically provide coverage for intentional hacking of third party servers (nor do they exclude it).  Insureds who conduct such countermeasures may themselves be in violation of the Computer Fraud and Abuse Act or other state and federal regulations.


Insurance implications – Will the current group of insurance policy forms protect the insured – as sometimes expanded to include “information holders”– in this new offensive role as a “hacker-in-pursuit”, or only in the defensive role of “hackee”/ victim?   The cited article refers to a law school professor’s paradigm of protecting innocent third parties –“Aunt Sally[iv]”– from possible loss and uncertainty as the result of the reckless pursuit of hackers and their methods.  In the case of “Aunt Sally v. Your Insured” is there coverage under your cyber policy?  Is Aunt Sally an insured (if so, the Insured v. Insured exclusion may apply)?   And is there an Aunt Sally exclusion?  Probably not.  The answer to these questions is: consult your insurance broker or qualified independent risk management consultant, read your policy provisions, then go back to the broker/consultant, again.  You may decide that the risk of third party liability from the pursuit of the cyber suspects outweighs the potential reward of finding the source of any given hacking event.  Keep in mind that first party cyber coverage is triggered by an actual occurrence or the reasonable belief by the insured and insurer that a breach has occurred.  The carrier should clearly be on board with the decision to go after hackers or to knowingly transmitting malware.


Any coverage for affirmative hacking activity would have to fall within the definition of “Loss”, but the categories are quite broad and include crisis management with the goal of minimizing harm and restoring public confidence in the insured.  Coverage is generally afforded for both the receipt and the transmission of malicious code.  At least one policy from a major carrier provides coverage for “any other services approved by the Insurer at the Insurer’s sole discretion”[v].   If the policy would cover the insured’s expenses from an inadvertent transmission of the malware, why would it not cover deliberate transmission of malware designed to stop future attacks or mitigate their impact.   Depending on the particular attack and role of the insured in potential future attacks, I would think that various “sting” operations could be approved or maybe even encouraged by sophisticated carriers with a long term view of the exposure.  Ultimately, insurance carriers and their accumulation / clash reinsurers have an interest in the systemic risk component of almost all modern forms of cyber security.  That means catching the bad guys, if that is what it takes to restore public confidence in the insured.


What if the insured gets caught up on the wrong side of a lawsuit alleging deliberate hacking or other counter-measure?  As a first cut of the issue, I submit that most policy forms I have reviewed exclude coverage for intentional and criminal acts, and (more broadly) for loss “arising, based upon, or attributable” to such acts.  Wisely, the policies have carve-backs of coverage for claim expenses up to the point of an adverse adjudication, arbitral award, etc. adverse to the insured.  So if the insured company has negligently caused harm to a third party as the result of countermeasures from a reported hacking attack, the third party cyber coverage should respond.  Nevertheless, if the counter-hacking is sufficiently unrelated to a reported hacking event, and not sanctioned by the authorities or consented to by the carrier, one could easily see a situation where the alleged victim is in fact a perpetrator, with the consequent forfeiture of coverage (including the advanced expenses).  First party cyber insurance covers loss to the insured itself as the result of a data breach.  That coverage essentially protects the insured’s data residing on its own servers, or those of independent contractors.  But this protection would not extend to third parties whose data and systems might be harmed.  Cyber coverage may further expand to anticipate this exposure more directly.  In the meantime, the current policies do exclude coverage for seizure, confiscation, nationalization or destruction of a computer system by order of a government or public authority, so it is clearly advisable for insured’s not to take the law into their own hands.


Protecting Aunt Sally – Of the particular acts of counter-hacking it seems to me the one with the biggest threat to insurance coverage and public safety is the deliberate planting of false information in order to catch a thief or thwart attempts at hacking.  Using lawyers and outside information holders as accomplices in this subterfuge adds another layer of complexity and uncertainty to this questionably prudent practice.  If an innocent third party relies on or executes a deliberately falsified construction or manufacturing plan, resulting in property damage or bodily injury, it may not be an argument for coverage or defense to the suit itself that the insured was trying to catch a bad guy.  (Or bad gal).  Risk managers and their insurers may be faced with ethical issues in the course of investigating and reporting both routine and unusual cyber threats and creating resilient defenses.


As indicated by a previous post and in the Wall Street Journal here[vi], medical records have apparently become the hackers preferred booty in the data piracy sea.  If the counter-measure to catch medical record pirates is to plant false medical records on health industry servers, it is not hard to see where serious medical liability exposure might result.  Assume the original act of medical record hacking is covered by cyber coverage; will the forensic or other coverage parts extend to such counter-measures?  Could insurers who sanction such measures become exposed to the consequences?  I am not sure that insurers will necessarily be leading the attack in these murky waters, but neither will they be putting up coverage obstacles to legitimate countermeasures which are sufficiently related to a reported, covered hacking event.  Ultimately, it will be the tech community in close cooperation with insurers, government agencies (the FBI and state and local law enforcement) and the insured who should be make this call when and by what means to take the offensive. 


We have clearly reached the point where privacy liability and network security insurance is an indispensable part or every organization’s enterprise risk management.  The insurance is as valuable for the continual assessment and re-assessment of vulnerabilities, and access to independent forensics, as it is for regulatory and civil liability expense reduction.  What is more, applying advanced metrics to the flow of data security breaches helps to differentiate and prioritize them.  Hackers have become sophisticated about covering their tracks, using “watering hole” techniques to troll unsuspecting third parties for data over a period of time until they find something of substantial value.  Russian hackers have apparently infected websites that their targets visit often – like an on-line Chinese restaurant—with malicious software and have broken into networks of industrial control software, or I.C.S, so that when users download the latest version of the software, they also download the hacker’s malware as well.  The Chinese Army that stole data from military contractors often hid their attack software in e-mailed invitations to golfing events.  When hackers use these techniques they are exploiting the relatively weak defenses of the Aunt Sallys to penetrate the otherwise robust defenses of their intended targets.  The harm to the occasional Aunt Sally server –the Chinese restaurant or golfing event –seems an inevitable social cost of maintaining network security. So reporting minor system breaches both to law enforcement and insurers serves a useful purpose in preventing and mitigating the cost of more serious breaches.  The data thus obtained can be used by cyber defenders and governments to develop permanently improved and standardized methods.  It is all part of the world wide effort to avoid “cybergeddon” – a systemic risk of internet failure.  The World Economic Forum has studied the risk in detail as well as insurers’ role in the measurement of global cyber risks here[vii].


By counterattacking –setting up “honeypot” servers, bogus data banks, or a Maze[viii]—cyber-insured companies and their employees, directors and officers may at best slow down the hackers and make their work more costly, but may also face the potential risk of themselves violating the CFAA and, if so adjudicated, losing their valuable cyber coverage for economic loss, including bodily injury or property damage.


It has been said that “War is hell” and cyber war should be no different, I suppose.   To prevent crime and loss of internet utility, our insureds have to adopt strong countermeasures and robust security, but insurers and risk managers will need to help define where the line is to be drawn between protecting data and systems, and deliberately breaching or corrupting them in an effort to identify hackers.



Alan is an attorney at law in New York, providing professional liability claims advocacy and mediation services at Willie Borst ADR.  He has over 20 years’ experience in D&O as Vice President, Sr. Account Manager of XL Reinsurance America, a Director Complex claims AIG Domestic Claims, and most recently as a consultant with Corporate Risk Solutions, LLC. (   



[i]Business Insurance, “Purchase of cyber insurance policies on the rise: Marsh”, March 31, 2014.

[ii] “Hacker Tactic: Holding Data Hostage,” NYT 6/22/2014, pg. D4).

[iii] 18 U.S.C. § 1030(f) – Fraud and related activity in connection with computers provides:

 (f) This section does not prohibit any lawfully authorized investigative, protective, or intelligence activity of a law enforcement agency of the United States, a State, or a political subdivision of a State, or of an intelligence agency of the United States.

There is no statutory immunity for civilians under the act, but one would assume that if the original hacking event was reported to the state or federal authorities, any countermeasures taken in connection with “investigative, protective, or intelligence activity” should be immune from federal prosecution under the CFAA.  While management may be protected from criminal prosecution in its anti-hacking activity, this may not protect it from civil liability or derivative exposure from an anti-hacking event.  See In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996).  If directors know of an illegal anti-hacking measure, fail to prevent it, and the counter measure proximately causes damage to the company, they could arguably face liability under Caremark.

[iv] As described by professor Orin S. Kerr from George Washington Law School, ”it is like a blindfolded partygoer trying to hit a piñata with a baseball bat.  He might hit Aunt Sally who happens to be nearby.”

[v] Security Failure/Privacy Event Management Insurance, Definition (h) “Loss” Chartis 101018 (11/09).

[vi] What Are the Bad Guys Up to Now?  Hacking Health Care Records, Apparently (D and O diary 2/19/2014).

[vii] World Economic Forum, Global Risks 2014 at section 2.4.

[viii] CloudFlare has developed a service called Maze which is “a virtual labyrinth of gibberish and gobbledygook”.


First Half Securities Lawsuit Filings Consistent with Recent Years’ Filing Levels

Posted in Securities Litigation


The number of securities class action lawsuit filings during the first half of 2014 was slightly above the number of filings in the first half of 2013. On an annualized basis this year’s filings are consistent with the full year filing figures for 2012 and 2013, though well below longer term historical averages.


During the first half of 2014, there were 78 new securities class action lawsuit filings, compared to 74 in the first half of 2013. The 78 filings in this year’s first half annualizes to a full year number of filings of 156. This annualized figure is slightly below the 2013  year-end total of 166, but is slightly above the 2012 year-end total of 152. However, the projected 2014 year end total of 156 would be well below the annual average number of filings of 192 during the period 1997 to 2012.


The relatively lower number of filings in recent years compared to longer term averages has led some commentators to suggest that securities class action lawsuit filings are down. There is no doubt that in terms of absolute numbers of lawsuit filings, the numbers of filings are down. The 156 projected number of filings for 2014 would be about 18% below the 1997 to 2012 average number of filings, and about 31% below the number of filings in 2004, when there were 228 securities class action lawsuit filings.


But while the number of lawsuit filings unquestionably is down, the rate of lawsuit filings relative to the number of publicly traded companies is more or less unchanged. Thus, for example, in 2004, while there were 228 securities class action lawsuit filings, there were also 6,097 publicly traded companies at year’s end, implying an overall securities suit filing rate of 3.74%. At the end of 2013 there were only 4,972 publicly traded companies. I don’t have the updated figure for 2014, but the 2013 year end number of publicly traded companies and the projected number of 2014 filings, the projected filing rate is about 3.17%.


According to Cornerstone Research, the 1997-2012 average annual filing rate was about 2.85%.In other words, while the absolute number of lawsuit filings is down compared to long term annual filing averages, the current rate of securities class action lawsuit filings relative to the number of publicly traded companies is actually up compared to longer term filing rates. Please keep this in mind when you see reports in the mainstream media based only on the absolute numbers of filings suggesting that securities suits are down.


The securities lawsuits filed in the year’s first half involved companies in a broad variety of industries. The companies named as defendants in the lawsuits represented 51 different SIC Code categories. The largest number of first half filings involved companies in the life sciences industries. There were a total of 14 lawsuits against companies in Industry Group 283 (Drugs) and Industry Group 384 (Surgical, Medical and Dental Instruments), representing about 18% of all first half filings. There were also a total of seven lawsuits against companies in Industry Group 737 (Computer Programming and Data Processing), representing about 9% of securities suit filings in the year’s first six months.


The securities lawsuits in the first half of 2014 were filed in a total of 28 different federal district courts, but many of the filings were concentrated in just a few courts. There were 22 securities lawsuit filings in the S.D.N.Y., representing about more than a third (35%) of all first half filings. There were also nine filings in the N.D. Cal., representing another 11.5% of first half filings. Other district courts with a larger number of filings included D.N.J, which had five, and the S.D. Tex., which had four.


One feature of securities class action litigation in recent years has been the number of securities suit filings involving companies domiciled outside the United States. During the first half of 2014, there were a total of nine lawsuit filings involving non-U.S. companies, representing about 11.5% of all first half filings. (Please note that I included the “Flash Boys”/High Frequency Trading securities lawsuit in this tally, as many – though not all – of the defendants in the lawsuit are based outside the U.S.). By way of comparison, in 2013, about 15% of all securities suit filings involved non-U.S. companies. Non-U.S. companies represented about 16% of all companies listed on U.S. exchanges.


Another significant feature of corporate and securities litigation in recent years has been the growing numbers of lawsuits arising out of mergers and acquisitions activity. Most of these lawsuits are filed in state courts. However, during the first half of 2014 there were a number of these lawsuits filed in federal courts, generally alleging that the merger-related proxy disclosures were deficient in violation of Section 14 or other provisions of the federal securities laws. In the year’s first half, there were nine merger-related lawsuit filings, representing about 11.5% of the filings during that period.


Two other aspects of securities lawsuit filings that I have previously noted are the number of filings involving IPO companies and the number of lawsuits filed in the wake of regulatory investigations. Five of the first half securities suit filings (about 6.4%) involved allegations of misrepresentations in connection with the defendant companies’ initial public offerings. Eleven of the first half filings (or about 14%) involved companies that had announced that they were the subject of regulatory investigations.


One interesting note about the first half filings is that there were at least three new lawsuits in which the defendant company had been using the services of a public relations firm known as the Dream Team. The three lawsuit involved Galena Biopharma (here); Cytrx Corporation (here); and InterCloud Systems (here). The allegations in the three cases are similar. For example, the CytRx and Galena cases refer to a March 15, 2014 Barron’s article discussing the two companies and stating that Seeking Alpha and other publications removed from their sites articles about CytRx and Galena that had been submitted by The Dream Team. The Barron’s article states that The Dream Team had not disclosed its paid affiliations in submitting supposedly free-lance copy. The Barron’s article (and the Seeking Alpha article to which it refers) makes for interesting reading. The lawsuit against Galena alleges that articles submitted by the Dream Team to various publications (including Seeking Alpha) had driven up the company’s share price, after which its CEO allegedly sold $3.8 million of his company shares.


The other important securities litigation development in the year’s first half is something that did not happen. That is, the U.S. Supreme Court did not throw out the fraud-on-the-market theory in the Halliburton case.  Had the Supreme Court tossed the presumption of reliance in class action securities suits, which is based on the theory, it seems likely that the litigation environment for Section 10(b) securities cases would have been changed dramatically. Reports like this one examining securities suit filings trends would have looked very different in the future.


Even though the Court did rule that defendants should have the opportunity at the class action stage to try to rebut the presumption of reliance by showing that the alleged misrepresentation did not impact the defendant company’s share price, that defense-oriented alteration to the class certification procedures seems unlikely to have a dramatic impact on the number of securities class action lawsuit filings.


In other words, readers can continue to look forward to period analyses, like this one, of securities class action lawsuit filing trends.


D&O Insurance: Liberalization Endorsement Allows Insureds to Rely on New Policy Form’s Enhanced Insured vs. Insured Exclusion Carve-Back

Posted in D & O Insurance

nystate3On June 19, 2014, in a case involving so many unusual coverage issues that it seems more like a law school exam question than an actual coverage dispute, New York (New York County) Supreme Court Judge Melvin Schweitzer, applying New York law, granted summary judgment for the former directors of the bankrupt Lyondell Chemical Company who sought coverage from their company’s excess D&O insurers for their costs of defending themselves in an adversary action in the bankruptcy proceeding. A copy of the June 19 opinion can be found here.


The follow-form excess insurers had denied coverage for the defense fees based on the primary policy’s Insured vs. Insured exclusion. The directors argued they were entitled to have their defense expenses paid based on a coverage carve-back in the exclusion – not a carve-back to the exclusion in the primary policy, but rather a carve-back to the exclusion in a new policy form the primary insurer had launched eighteen months after the expiration of the initial primary policy. In reliance on the Liberalization Endorsement in the primary policy, the directors argued that the language in the new policy form governed, rather than the language in the primary policy that had been issued to Lyondell. Judge Schweitzer agreed with the directors and concluded that the enhanced wording in the new policy form did not preclude coverage for the directors’ defense costs.



In December 2007, Basell AF S.C.A. acquired Lyondell Chemical Company and the combined companies became known as Lyondell-Basel Industries. In August 2007, prior to the merger, a shareholder filed an action in Delaware Chancery Court against the Lyondell board (the Ryan Litigation) alleging that the directors had breached their fiduciary duties because the merger consideration was “grossly insufficient.” (Judge Schweitzer’s opinion in the coverage lawsuit does not mention the outcome of the Ryan Lawsuit.)


The merged company went bankrupt in January 2009. Later in 2009, a creditors committee filed an adversary lawsuit in the bankruptcy proceeding (the Adversary Proceeding) against the former directors of Lyondell, alleging that the financing for the merger transaction had over-leveraged the company and forced it into bankruptcy. The creditors committee assigned the Adversary Proceeding to a litigation trust, which continued to pursue the Adversary Proceeding against the former directors.


The directors sought to have their costs of defending the Adversary Proceeding paid by Lyondell’s D&O insurers. For purposes of this coverage dispute, there are two relevant insurance programs, each arranged with a primary insurance policy and several layers of excess insurance. The policy period of the two towers were, respectively, 2006-2007 and 2007-2013. The primary carrier paid its full policy limit in payment of defense costs (Judge Schweitzer’s opinion does not say under which policy the primary carrier paid these costs). The directors sought to have the excess insurers pay  their continuing costs of litigation defense. The excess insurers’ policies provided follow form coverage, meaning that the terms and conditions of the primary policy determined whether or not there was coverage under the excess policies


The excess insurers denied coverage in reliance on the Insured vs. Insured exclusion in the primary policies and filed an action in New York state court seeking a judicial declaration that there was no coverage under their policies. The parties cross-moved for summary judgment.


Both the 2006-2007 primary policy and the 2007-2013 primary policy contain an exclusion (the Insured vs. Insured exclusion) precluding coverage for Loss arising from a claim “brought or maintained by or on behalf of the Company.”  The excess carriers contended that this exclusion precluded coverage for the directors’ defense expenses. 


Both the 2006-2007 primary policy and the 2007-2013 primary policy contained a Liberalization Endorsement, which provides that if the primary carrier issues a new policy form or a new standard endorsement then “the Company shall have the right to such new policy or such new coverage enhancement endorsement,” except that “any existing claims will be controlled by the existing policy form the claim was reported under.”


In April 2009, the primary carrier launched a new standard endorsement form (the Select Form). The Select Form provides a broad bankruptcy exception to the Insured vs. Insured Exclusion. The exception to the exclusion preserves coverage for Loss arising out of a claim “brought or maintained by or on behalf of a bankruptcy or insolvency trustee, examiner, receiver, similar official or creditors committee for such company, or assignee of such trustee, examiner, receiver or similar official or creditors committee.” The directors contended that by operation of the Liberalization Endorsement in the primary policies, this coverage carve back in the Insured vs. Insured exclusion in the Select Form controlled the question of coverage and preserved coverage for their defense expenses.


Both the 2006-2007 primary policy and the 2007-2013 primary policy include an Interrelated Wrongful Acts Provision, which stated that “all Loss arising out of the same Wrongful Acts and Interrelated Wrongful Acts of Insured Persons shall be deemed one Loss, and each Loss shall be deemed to have originated in the earliest Policy Period in which a Claim is first made against an Insured Person alleging any such Wrongful Act or Interrelated Wrongful Act.” Both of the primary policies defined the term “Interrelated Wrongful Acts to mean “all Wrongful Acts that have as a common nexus any fact, circumstance, situation, event, cause or series of causally connected facts, circumstances, situations, events, transactions or causes.”


The Court’s Opinion

The Court granted summary judgment for the directors based on its determination that by operation of the Liberalization Endorsement in the primary policies the enhanced bankruptcy coverage carve-back in the Select Form applied to preserve coverage for the directors’ defense expenses.


The insurers had tried to argue that the language in the Select Form did not apply because the Liberalization Endorsement specifies that it does not apply the language in new forms to “existing claims.” The carriers argued that because the Ryan Litigation and the Adversary Proceeding both alleged wrongdoing against the directors in connection with the Basell merger, the two claims were interrelated and therefore that they constitute one claim that was an “existing claim” at the time the Select Form was launched.


The Court rejected this argument, noting that the Interrelated Wrongful Act provision in the primary policy referred to “Loss,” not “Claims,” and provided only that all Loss from Interrelated Claims is “treated as ‘one Loss,’ triggering only one set of policy limits instead of two. It does not affect the separateness of the Claims.” The Court noted that the provision’s reference to “Loss” rather than to “Claims” differed from language found in Interrelated Wrongful Act provisions found in other D&O insurance policies. The language in the primary policies “treat related claims as ‘one Loss,’ not ‘one Claim,’” and therefore “although the Ryan Litigation and the Adversary Proceeding may be Interrelated Wrongful Acts, and therefore one Loss, they remain separate claims commenced on separate dates.”


The Court also said it didn’t matter that the Select Form had not been launched until 18 months after the end of the 2006-2007 policy period because (by contrast to language found in Liberalization Endorsement in other policies) “there is nothing in the plain language of the Liberalization Endorsement that prohibits liberalization by a form announced after the expiration of the policy period.”


Finally, the Court rejected the arguments of one of the excess carriers whose 2006-2007 policy did not include a liberalization provision. This excess carrier argued that because the Adversary Proceeding was Interrelated with the Ryan Litigation, the Adversary Proceeding would be deemed made in the 2006-2007 policy period in which its policy had no Liberalization Endorsement, and therefore that the enhanced wording in the Select Form did not apply to preserve coverage under its policy. The insurer argued that the two lawsuits were interrelated because they both related to the merger transaction.


The Court said “such a broad reading of Interrelated Wrongful Acts would encompass any Claim that is connected to the merger.” The Court found that in fact the two cases were “fundamentally inconsistent” with each other, that in the Adversary Proceeding the claimants alleged that the company had overleveraged itself to complete the transaction whereas the claimant in the Ryan litigation alleged that the company was getting inadequate consideration.



The outcome of this case depended on a couple of unusual features of the primary policy. Whereas the Interrelated Wrongful Acts provision in most policies provide for the interrelatedness of “Claims,” the Interrelated Wrongful Acts provision in these policies referred to and defined the interrelatedness of “Loss.” By the same token, again by contrast to the provisions found in many other D&O insurance policies, the Liberalization Endorsement in the primary policies had no time limitation on its applicability, and so the enhancements in a new policy form apply to the primary policy regardless of when the new form is released, even if it is released after the policy period of the policy.


The case does involve the rather unusual circumstances that a policy’s Liberalization Endorsement operated to define the availability of coverage. It is fairly standard for D&O insurance policies to include a Liberalization Endorsement, but at least in my experience it is relatively rare for the Liberalization Endorsement to actually affect the coverage analysis.  (Perhaps one reason it is relatively unusual for the Endorsement to be relevant is that most policies’ Endorsements, unlike the Endorsement here, specify that the liberalization applies only to new policy forms introduced during the policy period.) This case does underscore how the Liberalization Endorsement could be important for maximizing the availability of insurance for policyholders.


The purpose of a Liberalization Endorsement is to make sure that if the insurer launches a new form after it has issued a policy to a policyholder that the policyholder gets to the benefit of any coverage enhancements in the new form. It operates as a kind of fairness mechanism, by ensuring that the policyholder doesn’t have to do without the enhancement just because its policy was issued before the new form came out. It is fair to the insurer too, since the insurer is willing to offer the enhancement at all, it ought to provide the enhancement to present policyholders as well as future policyholders. This element of fairness to the insurer breaks down a little bit in this case, since the excess insurers that are being forced to honor the provisions of the new policy form are not the ones that issued the new policy form. Basically, by operation of the Liberalization Endorsement, the excess insurers must provide coverage for defense expenses that arguably would not have been covered under their policies, because the primary insurer – that wasn’t even a party to this coverage action – issued a new policy form after the excess insurers had agreed to provide follow form excess over the primary insurer’s former policy. The excess insurers may feel aggrieved by this, but they did agree to provide excess insurance over a primary policy that contained a Liberalization Endorsement, so there was always the risk that something like this might happen.


The case also highlights the importance of the wording of the bankruptcy carve-back in the Insured vs. Insured exclusion. Several specific features of the carve-back in the Select Form proved to be particularly important here. The carve-back preserved coverage for claims “brought or maintained” by the “creditors committee.” Not all carve-backs expressly refer to the “creditors committee.” Also the carve-back language in the Select form also referred to “any assignee of such trustee, examiner, receiver, or similar official or creditors committee.” Not all carve-backs expressly refer to an “assignee.” This reference was important here because the initial claimant against the Lyondell directors, the creditors committee, had assigned its claim to a litigation trust that continued to pursue the claim. Practitioners may want to note these coverage features and take them into account when reviewing policy wordings.


This case does present yet another instance of the elusiveness of Interrelated Wrongful Act provision interpretations. As I have noted before, the cases interpreting these provisions are all over the map. In my view, the Court’s conclusion on the interrelatedness question here is less than satisfying. Judge Schweitzer held that even though the Ryan Litigation and the Adversary Proceeding both related to alleged wrongful conduct by the directors in connection with the merger, the two claims were not related because in the Ryan Litigation the allegation was that the merger price was too low and in the Adversary Proceeding the directors had bankrupted the company by paying too much.


However, the definition of the term Interrelated Wrongful Acts in the primary policy refers only to “all Wrongful Acts that have as a common nexus any fact, situation, event, [or] transaction.” The definition does not add an additional requirement that the various Wrongful Acts must involve the same theory of wrongdoing or theory damages. The definition only requires that the various Wrongful Facts have a “common nexus” of “any transaction.”


Judge Schweitzer rejected the idea that because the two lawsuits related to the merger that they were interrelated because, he said, that would mean that any claim related to the merger would be interrelated. To which I say, well, yes, if the definition says that alleged wrongful acts that have as a common nexus any transaction are interrelated wrongful acts, then any wrongful acts related to the merger (which is, after all, a transaction) are interrelated.


I don’t know what the problem is with the interrelatedness question. It is not just the cases are all over the map, it is that so often courts’ analyses of interrelatedness issues are so unsatisfying.  (For a recent post in which I discuss another court’s unsatisfying interpretation of interrelatedness issues, refer here.)


There are also some details in the opinion that seem incomplete or that don’t add up. First, to me, it matters under which policy the primary insurer paid out its limit, as that will determine whether or not the underlying insurance has been exhausted.


Second, if the excess insurer paid its limit out under the 2006-2007 policy, it would likely have done so because it concluded that the Adversary Proceeding was interrelated to the Ryan Litigation. That seems like a relevant detail to me.


Third, Judge Schweitzer didn’t decide under which of the two programs the excess insurers’ obligations to pay defense expenses arose. That seems like an important detail to me. But instead, he prefaced his conclusion that the carve-back in the Liberalization Endorsement controlled the determination of the coverage issue by saying “Regardless of which policy (2006-2007 or 2007-2013) applies to the Adversary Proceeding, the Select Form’s terms apply.”


Fourth, I am confused by Judge Schweitzer’s conclusion that the Ryan Litigation and the Adversary Proceeding are not interrelated. In light of his earlier comments about the Interrelated Wrongful Acts provision in the primary policy, does his conclusion that the two lawsuits are not interrelated mean that they represent two losses rather than a single loss? That would seem to imply that each of the two insurance programs was triggered — the first by the Ryan Litigation and the second by the Adversary Proceeding.


As a final comment, I note that that this is yet another instance where insureds were forced to litigate with their excess insurers after the primary insurer had paid its limits in full. As I have noted elsewhere, the whole point of follow form excess insurance is so that every layer in the insurance program responds the same way to the same set of losses.


When the different insurers on the different layers of an insurance program respond differently to the same set of circumstances, the intent of the insurance acquisition process is frustrated. More to the point, no insured expects to have to fight their way through the various layers of the insurance program. The prospect of compulsory separate fights with separate carriers represents an undesirable burden and vexation for the policyholder – a burden that all too many insureds must face as fights with excess insurers become all too common. (For more on this theme, refer here.)

The Latest Assortment of Mug Shots

Posted in Blogging, Mug Shots

031aIt has been a while since I have published a mug shot gallery. The pictures have continued to arrive from far and near and now the time has arrived to post another round.


Readers will recall that over a year ago, I offered to send out a D&O Diary coffee mug to anyone who requested one – for free – but only if the recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In previous posts (here, here, here, here, here, here, here, here , here, here, here, here, here, here, here, and here), I published prior rounds of readers’ pictures. I have posted the latest round of readers’ pictures below.


It wouldn’t be a proper D&O Diary mug shot gallery without at least one picture from overseas, and in this collection we have two. The first comes to us from Sydney, Australia. Chris Smith of the Lee and Lyons law firm sent us this picture taken from his office on Macquarie Street in Sydney. Chris reports that across the road from his office is the Royal Botanic Gardens, beyond which lies Sydney Harbour.








Our next mug shot comes to us from Bermuda, and depicts Josh Schwartz of ACE Bermuda Insurance, in Hamilton, Bermuda. I wonder how many years of wearing Bermuda shorts it takes to be able to wear the shorts  as nonchalantly as Josh.













The next mug shot was sent in from Atlanta, but nevertheless is in keeping with the theme of The D&O Diary mug as a global phenomenon. The picture was sent in by Dave Leonard of the Carlton Fields Jorden Burt law firm and it shows the view to the north from Dave’s midtown Atlanta office.









The next picture was sent in by new friends Rebecca Wolinsky and Sarah Voutyras of the Boundas Skarzynski law firm in New York. I recently had the pleasure of meeting Rebecca and Sarah at an industry event near Wall Street. They sent in this colorful picture from the Jefferson Market Garden, which they described as a “beautiful park in the west village.”










The final picture in this collection was sent in by Andy Hamilton, who is the risk manager for Spectra Energy. Andy provided this description of his picture: “I attended the Zurich Classic this weekend in New Orleans and participated in a home rebuilding project in the St. Bernard Parish sponsored by Zurich. Here is a mug shot from the project site.”










It is always such a pleasure to receive readers’ mug shot and to see the places they have taken their pictures. I know that other readers want to get in on the action but I am afraid I can’t fulfill any more mug orders, as my mug supplies are exhausted. Readers who would still want to contribute a picture can send in a photo of their own firm’s mugs, which I would be happy to publish.


In any event, many thanks to everyone who has sent in a picture. All of the mug shots are great and it has been a lot of fun sharing them with the other readers.


To make it easier to view past picture gallaries, I have added a new Mug Shots category to the Topics index in the right hand column.


Guest Post: Halliburton: Procedures and Percentages Part II—Should We Expect Any Changes Following the Supreme Court’s Ruling?

Posted in Securities Litigation

skaddenFollowing the U.S. Supreme Court’s ruling earlier this week in the Halliburton case, questions have continued to swirl about the implications of the court’s decision. In the following guest post, Jennifer Spaziano of the Skadden law firm, takes a look at the impact the Halliburton decision will have on securities class action procedures, outcomes and filings. This article follows an earlier guest post Jen posted on this site (which can be found here) following oral argument in the Halliburton case but before the Supreme Court  ruled. My own take on the Halliburton decision can be found here 

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


During oral argument in Halliburton v. Erica P. John Fund, No. 13-317, much of the discussion focused on the practical realities of securities litigation, including (i) the procedures available to defendants to rebut the presumption of classwide reliance established in Basic Inc. v. Levinson, 485 U.S. 224 (1988) and (ii) the percentage of cases that make it to summary judgment and trial.  The upshot of this discussion—at least to some—was that if Basic’s presumption of classwide reliance survived, something needed to be done to ensure that its equally strong mandate regarding the presumption’s rebuttability is given effect.  

On June 23, 2014, the Supreme Court issued its ruling in Halliburton.  The ruling was consistent with the expectations of many commentators following oral argument:

First, despite recognition that the “efficient capital markets hypothesis” underlying Basic is not perfect, the Court did not overrule or modify Basic, finding no “special justification” to do so.  (Slip op. at 7; see also slip op. at 8-12.)

Second, the Court held that “defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”  (Slip op. at 23.)

The Court thus adopted a middle ground approach that left Basic’s presumption of classwide reliance intact but gave practical meaning to Basic’s plain recognition that the presumption is rebuttable.  See Basic, 485 U.S. at 248 (“Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.”).

The Court’s ruling answers several important questions:

Can a plaintiff still rely on Basic’s presumption of reliance?  

Yes.  A plaintiff can “satisfy the reliance element of the Rule 10b-5 cause of action by invoking a presumption that a public, material misrepresentation will distort the price of stock traded in an efficient market, and that anyone who purchases the stock at the market price may be considered to have done so in reliance on the misrepresentation.”  (Slip op. at 23.)

What must a plaintiff prove to invoke the presumption of reliance?  

To invoke the presumption, a plaintiff must make the following showings:  “(1) that the alleged misrepresentations were publicly known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time the misrepresentations were made and when the truth was revealed.”  (Slip op. at 6-7.)

Is the presumption of reliance rebuttable?  

Yes.  “[T]he presumption of reliance [is] rebuttable rather than conclusive.”  (Slip op. at 7.)  “[A] defendant [can] rebut this presumption in a number of ways, including by showing that the alleged misrepresentation did not actually affect the stock’s price—that is, that the misrepresentation had no ‘price impact.’”  (Slip op. at 1.)

Can a defendant attempt to rebut the presumption before class certification?  

Yes.  “[T]o maintain the consistency of the presumption of reliance with the class certification requirements of Federal Rule of Civil Procedure 23, defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”  (Slip op. at 23.)

If a defendant rebuts the presumption of reliance by showing that the alleged misrepresentation did not actually affect the stock’s price, can the plaintiff still rely on the presumption?  

No.  “If a defendant could show that the alleged misrepresentation did not, for whatever reason, actually affect the market price . . . a plaintiff would have to prove that he directly relied on the defendant’s misrepresentation in buying or selling the stock.”  (Slip op. at 7.)

Although the Court’s ruling provides some clarity with respect to the prerequisites for invoking the presumption of reliance and the procedural point at which a defendant can attempt to rebut the presumption, the public reaction to the Court’s ruling to date suggests that it leaves open a number of questions that will only be answered as pending and future cases play out.  These questions include:

What percentage of defendants will seek to rebut the presumption of reliance at the class certification stage? 

The Court’s ruling permits, but does not require, a defendant to attempt to defeat the presumption at the class certification stage.  Numerous considerations—including the jurisdiction in which the case is proceeding, the weakness of plaintiffs’ required showings and the strength of other defenses—might lead a defendant to refrain from raising the lack of price impact at the class certification stage. 

Will class certification decisions be made at a later point in the life cycle of a case?  

Federal Rule of Civil Procedure 23(c)(1)(A) states: “[a]t an early practicable time after a person sues or is sued as a class representative, the court must determine by order whether to certify the action as a class action.”  Justice Ginsburg noted in her concurring opinion in Halliburton that “[a]dvancing price impact consideration from the merits stage to the certification stage may broaden the scope of discovery available at certification.”  It remains to be seen how courts will balance their obligation to consider class certification at “an early practicable time” with the need to conduct appropriate discovery in assessing the applicability of the presumption at class certification.

Will the percentage of class certification motions that are granted decrease?  

According to Halliburton’s counsel, “[t]he most recent studies by NERA and Stanford show that 75 percent of class certification motions are granted in securities cases; and that number is much, much higher with respect to New York Stock Exchange companies that essentially have no way to dispute market efficiency.”  (03/05/2014 Hearing Tr. (“Tr.”) at 50:17-22.)  Allowing defendants to challenge the presumption of reliance at class certification should result in a decrease in the percentage of classes that are certified.  The magnitude of that decrease, however, remains unknown.

Will the percentage of cases that settle following class certification increase?  

As Halliburton’s counsel noted at oral argument “only 7 percent” of securities fraud class actions make it to the summary judgment stage, “because once the case gets past class certification . . .  there is an in terrorem effect that requires defendants to settle even meritless claims.”  (Tr. at 51:5-9.)  The rate is even lower with respect to trial:  “less than one third of one percent actually go to a verdict.”  (Tr. at 23:8-9.)  These numbers are already very low and it is hard to imagine them getting any lower.    

Will there be a decrease in the number of securities fraud class actions that are filed?    

The Court’s ruling places an additional hurdle before a plaintiff seeking to pursue a securities fraud class action.  In addition to satisfying the requirements of the Private Securities Litigation Reform Act and establishing the prerequisites for invoking the presumption of classwide reliance, a plaintiff also may face a price impact challenge from the defendant before a class is certified.  This additional hurdle likely will be considered by plaintiffs and their counsel in deciding whether to file an action.   

To sum up:

  • ·        The Court’s ruling leaves intact Basic’s presumption of classwide reliance but gives effect to Basic’s directives regarding ways in which the presumption can be rebutted.
  • ·        Now, a defendant will have the opportunity to test Basic’s presumption prior to class certification with evidence of a lack of price impact.
  • ·        What this means as a practical matter remains to be seen.

Halliburton does not appear to represent the sea change some had anticipated.  That said, it may lead to fewer certified classes and, ultimately, fewer filed cases.  Time will tell.  At a minimum, the Court’s ruling addresses the practical realities of securities litigation that were a focus of oral argument by providing defendants a meaningful opportunity—one they previously did not have in many jurisdictions—to rebut the presumption of classwide reliance.  

—By Jen Spaziano, Skadden, Arps, Slate, Meagher & Flom LLP

Jen Spaziano is a partner at Skadden, Arps, Slate Meagher & Flom LLP’s Washington, DC office.

The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.