Much has been written about the explosive growth in merger objection litigation in recent years. A less common but increasingly frequent type of merger-related litigation is appraisal rights litigation. In these types of lawsuits an investor exercises his or her statutory right for a judicial determination of the value of his or her stock. These kinds of cases present their own sets of issues and challenges.
Among the recurring issues is the question of whether or not the costs a company incurs in an appraisal proceeding are covered under a D&O insurance policy; traditionally, D&O carriers have argued that appraisal proceedings are not covered under their policies because the request for an appraisal proceeding does not involve an alleged “Wrongful Act.” However, an August 2, 2017 memo by Peter Gillon and Benjamin Tievsky of the Pillsbury law firm (here) argues that in many cases this coverage analysis is inaccurate and that in fact there should be coverage under the D&O policy for the expenses incurred in an appraisal proceeding.
Section 262 of the Delaware General Corporation Law provides that a shareholder “shall be entitled to an appraisal by the Court of Chancery of the fair value of the stockholder’s shares of stock.” If the Chancery Court concludes that the deal price offered is too low, the shareholder is entitled to recover the adjusted amount plus interest. The court may also award the shareholder his or her attorney’s fees and experts’ fees. The basics of a Delaware Appraisal Rights proceeding are described in detail on the Appraisal Rights Litigation Blog (here).
As well-told by Alison Fleming in an August 2, 2017 post on her On the Case blog (here), just this week the Delaware Supreme Court has released a detailed and interesting decision detailing the factors the Chancery Court is to consider in an appraisal proceeding and the weight to be given to the various factors.
In a July 29, 2017 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “The Evolving World of the Delaware Appraisal” (here), attorneys from the Fried Frank firm detail that while Delaware appraisal proceedings remain much less frequent than the more typical merger objection lawsuit, the number of appraisal proceedings filed is increasing. Thus according to the article, there were only 20 appraisal proceedings filed in Delaware in 2014, but in 2016 there were 48 filed.
As the number of appraisal proceedings has increased, so too has the number of disputes regarding coverage for the proceedings under the target company’s D&O insurance policy. As the attorneys from the Pillsbury law firm note in their recent article, many insurers have viewed appraisal proceedings as “as a simple exercise in economics, not an allegation of ‘Wrongful Acts.’” In these attorneys’ view, this analysis is incorrect because it “ignores the reality of appraisal proceedings today, which tend to focus on the adequacy of the process by which the purchase price was determined.”
According to the article’s authors, numerous recent Delaware chancery decisions have reinforced the point that in an appraisal right proceedings the Court must ensure that the process used in arriving at the merger price was fair. Among other things, the Court must consider “whether there was meaningful competition among bidders, whether the seller offered adequate and reliable information, whether there was evidence of collusion or favoritism towards certain bidders, whether the seller sought topping bids during a go-shop period, and whether the Board obtained an independent third-party valuation, among other factors.”
The authors contend that these kinds of allegations are sufficient to meet the typical D&O insurance policy’s definition of Wrongful Act, which, they contend, is broad enough to encompass any corporate act or omission. As a result, they contend, “a Board’s alleged ‘omission’ in failing to follow an adequate sales process may be considered a Wrongful Act under a D&O policy’s broad definition of that term.”
In addition, they note, in many cases, the claimants may “couple their appraisal claim with a breach of fiduciary duty claim, asserting improper self-dealing or other misconduct by a target company’s directors and officers.” The fact that appraisal proceedings “generally delve into the adequacy of the sales process and other ‘relevant factors’ provides a strong basis for coverage under D&O policies,” the authors contend.
In addition to the question of whether or not the assertion of appraisal rights involves a Wrongful Act allegation, another coverage questions has to do with whether or not the assertion of appraisal rights is lodged against the board of directors or against the company itself. Though these types of proceedings may involve allegations of board misconduct, if the action is lodged against the company itself, the insurer may raise another ground on which to dispute coverage, which is that the public company D&O policy’s entity coverage provision applies only to securities claims, and, the insurer will contend, an appraisal rights proceeding is not a securities claim.
The authors note that while an appraisal rights action may not allege a violation of federal or state securities laws, it may nevertheless meet the definition in many D&O insurance policies of the term “Securities Claim.” First, by definition, the claim involves securities of the company. Second, as I discussed in a prior blog post (here), a recent Delaware Superior Court ruling determined that the term Securities Claim in the D&O insurance policy at issue in the case was not limited just to alleged violations of the federal securities laws and state securities laws, but in fact is much broader. Under this broad view of the term Securities Claim as found in many D&O insurance policies, the term is broad enough to encompass an appraisal rights proceeding.
In short, the authors argue, there may be substantial grounds on which to argue that there is coverage under a D&O insurance policy for the cost associated with litigating an appraisal rights proceeding.
I think the Pillsbury attorney’s blog post is interesting and raises some very important questions. I am very interested to know what other readers may think. I invite readers to post their thoughts about the authors’ position, using this site’s comment feature.