Public company D&O insurance policies typically provide coverage for the corporate entity only for “Securities Claims.” A recent case in the Delaware Superior Court involved the question of whether a bankruptcy trustee’s claim related to Verizon’s multi-billion dollar spinoff of its electronic directories business was a “Securities Claim.” In an interesting and detailed opinion dated March 2, 2017 and released March 15, 2017 (here), Judge William C. Carpenter, Jr. ruled that the bankruptcy trustee’s claim was a “Securities Claim” within the meaning of the Verizon’s D&O insurance policy and therefore that Verizon’s insurers were liable of the costs incurred in defending against the trustee’s claim. The opinion makes for interesting reading for anyone interested in how these kinds of disputes can arise, and also has some important practical lessons.
The Underlying Claim
This insurance dispute arises out of Verizon’s 2006 spin-off of its electronic directories business into a standalone company called Idearc. Verizon transferred the directories business to Idearc in exchange for 146 million shares of Idearc common stock, $2.85 billion in promissory notes, and a portion of a secured loan facility. Verizon distributed the shares to Verizon shareholders and transferred the notes and debt to certain investment banks in exchange for Verizon debt the banks held.
In 2009, Idearc filed for Chapter 11 bankruptcy. A number of lawsuits were filed against Verizon and others alleging liability in connection with the spinoff. Of relevance here, one of the lawsuits was filed by U.S. Bank, the Litigation Trustee in the bankruptcy. U.S. Bank sought damages of approximately $14 billion from Verizon and related entities, as well from John Diercksen, a Verizon executive and Idearc’s sole director at the time of the spinoff. U.S Bank asserted three substantive claims: (1) promoter liability and breach of fiduciary duty; (2) payment of an unlawful dividend in violation of the Delaware Code; and (3) fraudulent transfer under the U.S. bankruptcy code and the Texas Uniform Fraudulent Transfer Act.
In its lawsuit, U.S. Bank alleged that the spin-off transaction involved “fraudulent consideration” to Verizon because it received much greater value than Idearc received. U.S. Bank further alleged that Verizon “took advantage of a distorted capital market to shift billions in debt obligations from itself to Idearc and Idearc’s creditors.” Verizon was alleged to have disguised the spin-off as a legitimate business transaction in order to generate financial market interest, and structured the transaction so that it only had to file a Form 10 under the 1934 Securities Act, supposedly “easing the path for private placement of Idearc’s highly questionable Unsecured Notes.” Verizon also allegedly manipulated financial information in the Form 10 and advertising materials to make Idearc appear like a growing, profitable business.
Verizon and the other defendants defended the U.S. Bank lawsuit for five years. The case ultimately was dismissed following a bench trial. The dismissal was affirmed on appeal. Among other defenses that the defendants raised in the lawsuit, the defendants argued under Bankruptcy Code Section 546(e), which under certain circumstances provides a “safe harbor” against liability for settlement payments made to complete a “securities transaction.” The court in the U.S. bank lawsuit found that the safe harbor provision applied since the case involved a “securities transaction, because the Idearc stock and Idearc debt are all securities.”
The D&O Insurance Dispute
At the time of the spinoff, Verizon and Idearc purchased a D&O insurance program, consisting of a primary policy and three excess policies. As Judge Carpenter stated in his coverage opinion, the purpose of the program (which he described as a run-off program) was to “insure against litigation risks and potential liabilities arising from the transactions.” The insurance program provide coverage for “Organizations,” which included Idearc, Verizon, and their subsidiaries, as well as for “Insured Persons,” defined as certain executives and employees of the Organizations.
Verizon provided notice of the U.S. Bank lawsuit to the primary insurer on the D&O insurance program. The insurer acknowledged that Dierckson’s defense costs would be covered (subject to the policy’s self-insured retention) but that Verizon’s defense costs would not be paid because, the insurer said, the U.S. Bank complaint does not constitute a “Securities Claim.”
Following the dismissal of the U.S. Bank action, Verizon and its related entities sued the insurers in the D&O insurance program seeking to recover the $48 million in expenses incurred in defending the U.S. Bank lawsuit. The parties filed cross motions for summary judgment.
The primary policy defined the term “Securities Claim” as a “Claim made against any Insured Person:”
(1) alleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities (including, but not limited to, the purchase or sale or offer or solicitation of an offer to purchase or sell securities) which is:
(a) brought by any person or entity alleging, arising out of, based upon or attributable to the purchase or sale or offer or solicitation of an offer to purchase or sell any securities of an Organization; (b) brought by a security holder of an Organization with respect to such security holder’s interest in securities of such Organization; or
(2) brought derivatively on behalf of an Organization by a security holder of such Organization, relating to a Securities Claim as defined in subparagraph (1) above.
Judge Carpenter’s Opinion
In his ruling decided March 2, 2017, Judge Carpenter granted the Verizon parties’ motion for summary judgment motion and denied the insurers’ summary judgment motion, ruling that the U.S. Bank lawsuit was a “Securities Claim” within the meaning of the primary policy’s definition, and therefore that the insurers’ are liable for the amounts Verizon incurred in defending the U.S. Bank lawsuit.
In framing the issues, Judge Carpenter said that the parties’ cross-motions required him to determining with the U.S. Bank lawsuit alleged “a violation of any … regulation, rule or statute regulating securities” and whether U.S. Bank, as litigation trustee, qualified as a proper “Securities Claim” plaintiff.
On the question of whether the U.S. Bank lawsuit was a “Securities Claim,” Verizon argued that the court should interpret the word “rule” in the definition of the term to include judicial rules of law or common law rules, such as those governing the conduct of fiduciaries, arguing that if a law “regulates securities” in that it much be followed to properly engage in a securities transaction, then any alleged violation of the law constituted a “Securities Claim.”
The insurers argued that “rules” and “regulations” referenced in the definition should be understood in the securities context to include only those laws issued by an administrative action of a legislative or regulatory body. Basically, Judge Carpenter said, the insurers were arguing that the term “Securities Claim” is expressly limited to alleged violations of federal securities and state Blue Sky laws.
Judge Carpenter noted that Black’s Law Dictionary defines “rule” as “an established and authoritative standard or principle,” and includes “a judicial notice, order, decree or direction; ruling.” To “regulate” according to the Dictionary is “to control (an activity or process) esp. through the implementation of rules.” He also noted that nothing in the definition of “Securities Claim” excluded common law rules or limited coverage to only those claims alleging violations of state or federal securities statutes or regulations, adding that if the insurers sought to exclude claims alleging violations of common law rules, the policy language should have reflected this distinction.
Judge Carpenter also noted that an earlier 1995 version of the primary insurer’s policy contained a definition of the term “Securities Claim” that reflected the narrow construction the insurers urged here; that is, it limited the term to claims asserting violations of rules and regulations promulgated under the 1933 and 1934 Securities Acts and state or foreign securities laws. Interestingly, an intervening 1998 version of the primary insurer’s policy defined “Securities Claim” to include claims alleging violation of “any law, regulation or rule, whether statutory or common law.”
The insurers sought to argue that the removal of the reference to “common law” from the term as defined in the policy at issue substantiated their argument that the U.S. Bank lawsuit did not meet the policy’s definition of “Securities Claim,” but Judge Carpenter said that the insurers “are unable to provide a reasonable explanation as to why the insurers went from a clear unequivocal phrase limiting coverage in both the 1995 and 1998 form to the present language,” adding that “no one has asserted that the change in language was intended to further limit coverage.” Whatever the reason for the change, Judge Carpenter could not conclude that the version of the language was intended only to provide the limited coverage provided by the 1995 form, which, he said, was what the insurers were trying to argue.
Judge Carpenter also noted that the primary insurer’s own prior coverage position involving a prior claim under Verizon’s policy was inconsistent with the position it was trying to take in this case. In 2009 in an action brought by shareholders of a subsidiary of Verizon, in which the shareholders challenged the adequacy of consideration they had received as a result of the merger of the subsidiary and alleged breaches of fiduciary duties of loyalty and disclosure, the primary insurer had, in a coverage letter, stated that the prior complaint “appeared to meet the Policy’s definition of Securities Claim.” Judge Carpenter noted that this “undercuts [the insurers’] contention that Securities Claim was intended to cover only alleged violations of statutes or laws specifically and exclusively enacted to govern securities.”
Judge Carpenter concluded that the plaintiffs’ interpretation of the term “Securities Claim” was “reasonable.” He added that he “cannot read the words ‘regulating securities’ as limiting Securities Claims under the Policies to those based on alleged violations of statutes, rules or regulations specifically promulgated with the singular focus and effect of regulating securities, and securities alone.” Rather, he said, he would “interpret those terms as pertaining to laws that one must follow when engaging in securities transactions.”
Finally, Judge Carpenter concluded that U.S. Bank met the policy’s requirement as a Securities Claim plaintiff. He specifically noted that the definition’s requirement that the claim be brought by a “person or entity alleging, arising out of, based upon or attributable to the purchase or sale or offer or solicitation of an offer to purchase or sell any securities of the Organization” is “so broad it would simply be inappropriate to find that U.S. Bank’s claims did not either allege, arise from, or were based upon or attributable to ‘the purchase or sale or offer or solicitation of an offer to purchase or sell any securities of an Organization.”
I think that any of us that live with and work with D&O insurance policies will recognize that the questions involved here were complicated. Indeed, in his concluding paragraph, Judge Carpenter specifically noted that “this was not an easy decision,” adding that “all parties presented effective arguments and served as outstanding advocates for their clients.”
I suspect that the insurers are surprised and more than a little disappointed that Judge Carpenter wasn’t persuaded by the elimination from the version of the definition of the term “Securities Claim” in Verizon’s policy of the reference to the common law that had been in the prior version (the 1998 version) of the definition. You can almost hear them saying, we removed the reference to the common law from the definition, how can a common law claim be a securities claim?
But the issue Judge Carpenter was trying to decide was the meaning of the terms “rule” and “regulation” within the definition. The 1995 version of the definition had specifically limited those terms to rules and regulations promulgated under the 1933 and 1934 Securities Acts or state or foreign law. The version of the definition in Verizon’s policy did not have this limiting language; if the removal of language is supposed to give meaning to the current version of the definition, then the removal of the “promulgated under” language seems to suggest that the terms “rule” and “regulation” are not so limited, but instead have a broader meaning and therefore should be interpreted expansively — and “rule” could mean a rule under the common law, even if the definition itself does not expressly refer to the common law.
In the end, the prior history of the definition of securities claim points in different directions and therefore really doesn’t help solve the meaning of the current definition. The primary insurer’s concession in the prior claim involving the Verizon subsidiary that a breach of fiduciary duty claim could be a Securities Claim obviously had an impact on Judge Carpenter’s analysis.
Judge Carpenter interpreted the definition of the term “Securities Claim” to encompass claims based on alleged violations of the common law. But as his review of the prior version of the definition demonstrated, there are versions of the definition that expressly refer to the common law. Though Verizon was able to secure coverage for the costs it incurred in defending the U.S. Bank lawsuit despite the absence in the definition of a reference to claims under the “common law,” it is in the best interests of policyholders for the term to be amended to include an express reference to claims asserted under common law. I want to emphasize that I am not suggesting anything about the policy language at issue in this case. D&O insurance policy language is almost always the subject of extensive negotiations, and wording available in one situation may not be available in another. That said, the preferred approach would be to have the definition of Securities Claim amended to include an express reference to claims under the “common law,” where that amendment is available, rather than to depend on a Court interpreting language without that reference in the way Judge Carpenter did here.
One problem that can arise in connection with questions of whether or not a particular claim is a “Securities Claim” did not arise here, because both Idearc and Verizon were both included with the definition of an “Organization.” The entity identified as the “Organization” can matter in determining whether or not a claim is a “Securities Claim” because many definitions of the term “Securities Claim” limit the definition to claims arising from transactions involved securities of the “Organization.” Indeed, the definition here referred to the securities of the Organization (which just happened to include both Idearc and Verizon).
In the typical scenario, a company’s D&O insurance policy will define the Organization as the company itself. If a company insured under a policy with this more standard definition were to spin out assets into a standalone company in exchange for the spun out company’s shares, a subsequent claim relating to the transaction arguably would not involve the securities of the insured parent company, and thus the insurer would try to argue that the claim is not a securities claim.
As this example shows, problems can arise can arise when a company is hauled into a lawsuit alleging violations of the securities laws when the specific securities are not be those of the insured company. For that reason, I prefer definitions of the term “Securities Claim” that extends coverage to any claim alleging a violation of the federal securities laws or state or local equivalents, where that formulation of the definition is available.
One aspect of Judge Carpenter’s opinion involved an issue that may not always be taken into account in considering the meaning of the term “Securities Claim,” and that is the fact that who the claimant is can affect whether or not there is coverage. While Judge Carpenter was able to conclude that U.S. Bank was a Securities Claim plaintiff sufficient to satisfy the policy’s requirements, it is not hard to imagine alternative scenarios where the claimant does not meet these requirements — in which case the claim would not meet the policy’s definition even if the claimant was expressly asserting a violation of the securities laws.
This aspect of Judge Carpenter’s underscores that in considering the scope of the definition of “Securities Claim” in a particular policy, it is important to consider not just how the kinds of claims are described, but also how the claimants are described. (I do kind of wonder why the identity of the claimants should matter; it seems to me that if a claim in all other respects constitutes a securities claim, the identity or nature of the claimant should be irrelevant.)
As I noted above, policy wording matters. The importance of policy wording issues underscores a point that I have made frequently on this blog, which is that because the subtle differences in wording can make such a huge difference when claims arise, it is critically important for D&O insurance buyers to enlist the assistance of an experienced and knowledgeable adviser in the insurance acquisition process.
Special thanks to a loyal reader for sending me a copy of Judge Carpenter’s opinion.