The First Circuit has overturned a lower court’s decision holding that Genzyme’s D&O insurance policy did not provide coverage for additional amounts paid to claimants who asserted they had not received enough in a share exchange. Though the First Circuit reversed and remanded the case, the First Circuit did not invalidate the so-called bump up exclusion and indeed agreed that the exclusion precluded entity coverage for bump up amounts.
The First Circuit’s October 13, 2010 opinion can be found here.
From 1993 to 2003, Genzyme’s capital structure included "tracking stock" to track the performance of three separate business units within the company. In May 2003, Genzyme’s board decided to eliminate the tracking stocks, and the company announced that it would exchange the business units’ tracking stock for a certain number of the company’s General Division’s shares.
The ensuing exchange was unpopular among many Biosurgery Division shareholders, who subsequently initiated a securities class action lawsuit against Genzyme and certain of its directors and officers. The Biosurgery Division shareholders alleged that the defendants had schemed to depress the Division’s tracking stock so that Genzyme could fold the Biosurgery Division into the General Division at an exchange rate favorable to General Division shareholders. In August 2007, Genzyme agreed to settle the Biosurgery Division shareholders’ claim for $64 million. More detailed background regarding the lawsuit can be found here.
Genzyme sought to recover part of this settlement amount from its D&O insurer. The insurer denied coverage on two grounds: (1) that the settlement did not represent insurable "loss" under the policy; and (2) that coverage was precluded by the policy’s "bump up" exclusion. Genzyme initiated coverage litigation. The D&O insurer moved to dismiss.
As detailed here, in a colorfully written September 2009 opinion, District of Massachusetts Judge Nancy Gertner granted the insurer’s motion to dismiss. Judge Gertner based her decision on two separate grounds.
She concluded first that the settlement amount did not represent insurable loss as a matter of Massachusetts public policy because the settlement benefitted one group of shareholders at the expense of another. She also concluded that coverage for the settlement amount was precluded by the policy’s "bump up" exclusion, which provides that the carrier is not liable for "the actual or proposed payment by any Insured Organization of allegedly inadequate consideration in connection with its purchase of securities issued by any Insured Organization."
In her opinion, Judge Gertner expressly considered and rejected Genzyme’s argument that the "bump up" exclusion was limited by its own terms to the policy’s entity coverage and therefore did not apply to claims against individual directors and officers.
The First Circuit’s opinion
In an October 13, 2010 opinion written by Judge Timothy Dyk, a three judge panel of the First Circuit reversed in part Judge Gertner’s ruling, and remanded the case to the District Court for further proceedings.
As an initial matter, the First Circuit rejected Judge Gertner’s conclusion that coverage for the settlement would violate Massachusetts public policy, noting both that "the public policy rationale articulated by the district court finds no support in Massachusetts statutory or case law." Massachusetts recognizes "only a limited public policy exception" and applicable principles weigh against "creating amorphous public policy limitations on insurance policies."
The First Circuit concluded that not only does it "see no basis in Massachusetts legislation or precedent for concluding that the settlement payment is uninsurable as a matter of public policy," but also that "there are significant reasons why such an exception should not be created as a matter of public policy," noting that such an exception "have the effect of making it impossible to secure coverage for damages awards in routine securities litigation that charges the corporation with unfair or unlawful treatment of a class of securities holders."
The First Circuit then went on to agree with Judge Gertner’s conclusion that the bump up exclusion precluded coverage for the settlement. However, the Court noted that the exclusion by its own terms expressly limited its preclusive effect only to policy’s entity coverage clause. The court held that there was no basis in the policy language or under Massachusetts public policy for applying the bump-up exclusion to the policy’s other insuring clauses.
The First Circuit also referenced the policy’s allocation provisions, which the court found expressly recognized that there might be occasions on which the bump up exclusion operated to bar coverage under the policy’s entity insuring provision but in which the other insuring provisions would still provide coverage.
The court concluded that "we must remand the district court to consider the allocation question," adding that "if part of the Genzyme payment represented indemnification provided to officers and directors," then the payment would fall under the policy’s corporate reimbursement coverage provisions (as opposed to the entity insuring provisions) "and allocation of the total settlement is required under the policy."
With a final wink and a nod, the First Circuit acknowledged that because "the problems involved in allocation may be difficult," this might be a case "where settlement, rather than lengthy and costly litigation, might be worth consideration by the parties."
On the one hand, we might assume that because the First Circuit reversed and remanded this case that insurers would score this as a loss. No doubt, the ruling arguably represents something of a setback for the specific carrier involved in this case. But the news for insurance carriers generally is not all bad here, and looked at from a certain angle, the overall news for the insurers may be relatively good, or at least acceptable.
First of all, the First Circuit affirmed that the bump up exclusion applied to the Genzyme settlement. Sure, the court also concluded that the exclusion only applied to preclude coverage under the Policy’s entity insuring provision, but that limitation is expressly stated in the exclusion itself. It was pretty slick for the insurer to have convinced Judge Gernter that the exclusion applied to other insuring provisions notwithstanding the express limitations in the exclusion, but insurers in general can hardly grumble that exclusions are to be applied according to their express terms.
And though the First Circuit may have taken away Judge Gertner’s public policy determination, I think the circuit court’s conclusion here may not be all bad from the insurer’s perspective.
In thinking about this public policy issue, it is worth drawing a contrast between the colorful prose of Judge Gertner’s district court opinion, which was full of humorous analogies and heavily freighted language, and the straightforward, workmanlike approach of the First Circuit’s opinion.
I noted at the time that not everyone was going to be equally impressed with Judge Gernter’s elaborate hypotheticals and her willingness to dispense with conventional case law formulas. I also noted the problems that that her judicial approach might prsent in the event other less intellectually agile judges were to try reasoning by analogy or from first principles rather than established case law formulas.
Back in the day when I was regularly representing D&O carriers in coverage disputes, I know which way I would have come down on the question whether I would have prefered a judicial decision maker that writes flamboyantly and dispenses with case law formulas, or a judicial decision maker that is unwilling to infer case decisive principles. Over the long haul, this latter approach to the decision making process is likelier to be preferable – in fact, preferable for all litigants, not just insurers.
All of that said, the parties must now go back to this district court to try to sort out the allocation issues, which the First Circuit correctly stated are likely to be difficult. The insurer probably did not appreciate the First Circuit’s friendly suggestion that perhaps settlement is the best approach. As someone who once represented carriers, I know that when a court suggests settlement, what they are really saying is – insurance company, get out your checkbook. I never considered that particularly helpful, actually.
But as I said, though Genzyme’s D&O insurer may not be happy with the way the First Circuit’s opinion impacts this specific case, I don’t think this is necessarily a bad decision overall for the insurers. As was said to me back when I was representing carriers, some days the bear eats you, some days you eat the bear.
I fully recognize that some readers may take strong exception to my interpretation of this decision, and those readers are strongly encourage to post their views to this blog using the site’s comment feature. (I really do wish people would post their thoughts and reactions more often.)
Special thanks to the several loyal readers who send me copies of the First Circuit’s opinion, including Peter Welsh of the Ropes & Grey law firm. The Ropes & Grey law firm represented Genzyme before the First Circuit.