In prior posts (refer here), I have observed that the D&O insurer’s consent to settlement really is required. An August 10, 2009 decision by the Delaware Supreme Court (here) confirms that not only is the insurer’s consent required, but the D&O insurer may under certain circumstances reasonably withhold its consent to settlement. The Court, applying Missouri law and observing that the excess carrier in the case had been "cut out" of the settlement process, affirmed the jury’s verdict that the excess carrier had not unreasonably withheld its consent.

 

Special thanks to Francis Pileggi of the Delaware Corporate and Commercial Litigation Blog (here) for providing me with a link to the opinion. Pileggi’s blog post on the opinion can be found here.

 

Background

Payless Cashways was insured under three different layers of insurance from three different carriers, a primary carrier and two excess carriers. The first level excess insurer is referred to in this post as the excess insurer.

 

In 2003, Hilco Capital and another entity sued Payless’s directors and officers alleging that in connection with certain loans Hilco made to Payless the defendants had misrepresented the value of Payless’s inventory.

 

Prior to trial, the parties scheduled a mediation session. The primary carrier’s representative attended the mediation, but because the defense counsel (Shay) and the primary carrier valued the case within the primary insurer’s $10 million limit, and because Shay told the excess carrier’s representative that he would rather try the case than settle for more than the the primary limit, all parties agreed that the excess carrier’s representative should not attend the mediation, but rather  be available by telephone.

 

After the mediation’s first day, the mediator proposed mediation of a single issue – whether the defendants were aware that a Payless employee had falsified the company’s inventory numbers. He further proposed a "high-low" outcome, whereby the primary insurer would pay Hilco $5 million immediately, and then if Hilco lost the single issue mediation, it would keep the $5 million, but if it won the mediation, it was also get the remaining limits of the primary policy (about $3.7 million) — and in addition approximately $7 million under the excess insurer’s policy.

 

Unfortunately, it was 10:00 P.M. by the time the mediation parties agreed to this proposal, and they couldn’t get the excess insurer’s representative on the phone. As the Delaware Supreme Court later put it, "rather than wait until the next morning," the parties finished the deal that night by agreeing that the individual defendants would not be liable for the settlement and would assign their rights under the excess policy to Hilco.

 

Upon reviewing the memorandum of understanding (MOU), the excess insurer’s representative rejected the proposed settlement, among other grounds on that a "straight" settlement would be lower than the high-end number in the high-low settlement.

 

The excess carrier asked the mediation parties to withhold finalizing the MOU until after a January 5, 2005 settlement conference, but they did not. The mediation parties later mediated the single issue, and Hilco prevailed. The primary insurer paid its remaining limit. The excess insurer denied coverage for the settlement, asserting a breach of the policy’s consent to settlement requirement.

 

Coverage litigation ensued. The trial court granted summary judgment for the excess insurer on certain legal issues, and the coverage action then went to trial. The jury found for the excess insurer on three issues: that the individual insureds had breached the policy before the excess insurer withheld consent; that the excess insurer did not unreasonably withhold its consent; and that the excess insurer was not permitted to reasonably associate in the negotiation. Hilco appealed.

 

The Delware Supreme Court’s Opinion

One of the issues on which the trial court had granted summary judgment was whether or not the excess insurer had breached the covenant of good faith and fair dealing under Missouri law. The Court affirmed the trial court’s ruling but on alternative grounds, holding that even viewing the record in the light most favorable to Hilco, the excess insurer was entitled to judgment as a matter of law.

 

In reaching this conclusion, the Court noted that "all agreed" that the excess carrier’s representative should not attend the mediation because it would "send the wrong message," so, the Court concluded, there was no breach in the excess carriers’ failure to attend the mediation. And, the Court noted, it was the mediation participants "who refused to wait until the next day to discuss the proposal" but instead "effectively cut [the excess carrier] out of the process by agreeing that the Insureds would assign their rights to Hilco."

 

Hilco argued that while the MOU was being negotiated, the excess insurer "was willing to negotiate" but that the "straight settlement" it sought required the primary insurer to tender its limits. The Supreme Court noted that the primary insurer refused to tender its limits "because the MOU gave it a better deal," under which, at worst it would pay its limits, but "at best "it would save approximately $3.5 million.

 

The excess insurer’s "only recourse" under the circumstances was to object to the settlement at the January 5 settlement hearing, but the "mediation participants mooted that effort by executing a definitive settlement agreement the day before the conference." Thus, the Court said based on these circumstances, "in sum, there is no record of a breach of good faith claim against [the excess insurer]."

 

The Court also ruled in the excess carrier’s favor on other legal grounds and held as well that even if the trial court erred in excluding certain evidence at trial, it "did not deny Hilco a fair trial."

 

Among Hilco’s evidentiary objections was that the trial court had allowed Shay to testify that the excess carrier "had a reasonable basis to withhold settlement." The Court noted that Shay testified that "he believed it was more likely than not that the Insured would win if the case went to trial and that Hilco had grossly overstated its damages." Shay also testified that he "believed a ‘straight’ settlement could have been negotiated for less than the ‘high’ end …of the high-low agreement."

 

The Court found that given his testimony "it was obvious" that Shay thought the excess insurer "had a reasonable basis to withhold its consent," so his testimony on that question "did not deny Hilco a fair trial."

 

The Court reached similar conclusions regarding Hilco’s other evidentiary objections and concluded that because the jury found the excess carrier had "a reasonable basis to withhold its consent," it did not need to reach the jury’s other rulings, and affirmed the jury’s verdict.

 

Discussion

There are two sides to every story, and there may well be a side to this story that does not appear from the face of the Court’s opinion. Perhaps the information in the excluded evidence paints a different picture.

 

All of that said, though, the only surprising thing to me about this case is that it went all the way to the Delaware Supreme Court. Pretty clearly, the settlement looked like a set up deal to the jury, and that seems to be the way the Supreme Court saw it too.

 

Whatever else might be said in defense of the settlement process, it is undeniable that the mediation participants’ actions managed to eliminate any possibility that the process would later appear to have been fair to the excess insurer. Their repeated actions to, as the Supreme Court put it, to "cut out" the excess insurer, make it appear as if their goal was to keep the excess insurer from upsetting a settlement that they clearly found advantageous for themselves, even if objectionable – for obvious reasons – to the excess insurer.

 

The details of the settlement that the Supreme Court chose to emphasize in its opinion are telling. The Supreme Court twice noted that at the mediation (a mediation "all agreed" the excess carrier’s representative should not attend to avoid "sending the wrong message"), the mediation participants decided not to wait until the following morning to discuss the proposed settlement. Instead, the Court observed, they cut the excess insurer out of the deal, with the assignment of rights and the agreement that the inidividuals would not be liable.

 

The Court also noted that the mediation participants, having refused even to wait until the next morning to discuss the deal with the excess insurer,  refused to forebear from finalizing the settlement until after the January 5 hearing, depriving the excess insurer of its only means of objecting to the settlement.

 

In addition to the obvious question of fairness of a process that appears to have been calculated to cut out the excess insurer but that nonetheless exposed its interests, there are the further questions of the fairness of the amount of the settlement and the burden it imposed on the excess insurer, given Shay’s trial testimony about the trial prospects of the underlying case and the appropriate settlement valuations at the high end.

 

The interesting thing about the outcome of this case is its suggestion that absent a reasonable opportunity to consider a settlement, a D&O insurer may reasonably withhold its settlement consent. The further implication is that a set up deal that deprives a D&O insurer of a reasonable opportunity to consider a proposed settlement may represent a sufficient basis for the insurer to withhold its consent. Perhaps with an awareness of this possibility, other settlement participants might think twice about taking steps that later could be portrayed as cutting an insurer out of the process.

 

About Those Late Night Settlement Demands: 10 P.M. seems to be a popular time to send D&O insurers unexpected settlement demands. As I noted in a prior post (here), former Globalstar CEO Bernard Schwarz sought his company’s D&O carriers’ consent to a $20 million at 10 P.M. on a Sunday night before his Monday morning trial testimony.

 

In that case, by contrast to the one discussed above, the Second Circuit held that the insurers’ did not reasonably withhold consent to Schwarz’s settlement. However, the critical difference between that case and the case discussed above is that in connection with his settlement, Schwarz accepted personal liability and in fact funded the settlement out of his own assets while seeking coverage from the carriers. This willingness to assume responsibility for the settlement deprived the carriers of the ability to argue that the amount of the settlement was unreasonable and by extension that their action in withholding consent reasonable.

 

In other words, the difference between the two cases is that in the case discussed above the deal looked like a set up. That seems to be how the jury saw it and how the Delaware Supreme Court saw it. That is why I say I am surprised the case went all the way to the Supreme Court. It is hard to argue that someone else wasn’t reasonable when your own conduct can be portrayed as unreasonable.