A federal district court has held that because of an insured company’s application misrepresentation about possible M&A activity, a D&O insurance policy’s Warranty Exclusion precludes coverage for the policyholder’s costs incurred in defending claims arising out of the insured company’s acquisition. The court’s opinion raises interesting questions about how the meaning of application questions is to be determined. Central District of California Judge Phillip Gutierrez’s February 4, 2019 opinion in the case can be found here. An April 15, 2019 post on the Wiley Rein law firm’s Executive Summary Blog can be found here.
Background
ServiceMesh was a start-up technology company providing cloud computing services. As early as January 2013, ServiceMesh’s Chief Technology Officer, at the request of the company’s CEO, reached out to several business partners, including Computer Sciences, in communications that involved at least in part the discussion of a possible acquisition of ServiceMesh. In the subsequent insurance coverage litigation, the company argued that in all of the various conversations in which a possible acquisition was discussed, a variety of alternative business arrangements were also discussed, including a licensing arrangement or other forms of business partnership.
In February 2013, Computer Sciences and ServiceMesh began conducting due diligence. In late February, a Computer Sciences representative sent ServiceMesh an email to set up a meeting, the purpose of which was, among other things, “exploring the possibility and setting the stage for a potential acquisition.” In an email after the subsequent meeting, ServiceMesh’s CEO sent a Computer Sciences representative looking forward to further discussions “on both partnership and M&A potential.” At a March 2013 meeting in Las Vegas, a Computer Sciences representative told Service Mesh representatives “We want to acquire you.” After that meeting, the two companies had a number of communications surrounding the exchange of information in support of a possible acquisition or other business arrangement.
On June 26, 2013, Tamara Brandt, the company’s General Counsel, completed a D&O insurance application. Among other things, the application asked in Question 8 “Does the Company contemplate transacting any mergers or acquisitions in the next 12 months where such merger or acquisition would involve more than 50% of the total assets of the company?” Brandt answered the question “No.” The insurer subsequently issued a policy to ServiceMesh for the policy period August 24, 2013 to August 24, 2013.
In July 2013, there were further communications between ServiceMesh and Computer Sciences relating to the exchange of information, as well as communications within ServiceMesh about the need for a term sheet from Computer Sciences. On September 9, 2013, Computer Sciences provided ServiceMesh a written term sheet. The deal closed in November 2013 and ServiceMesh became a unit of Computer Sciences known as CSC Agility Platform.
In May 2015, Computer Sciences sued ServiceMesh’s former CEO in Delaware Chancery Court, alleging that the former CEO had intentionally made misrepresentations to induce Computer Sciences to acquire ServiceMesh. The U.S. Department of Justice and the SEC also because investigating the CEO in connection with the merger.
CSC Agility Platform submitted the Delaware lawsuit and the government investigations to ServiceMesh’s D&O insurer (whose policy went into runoff after the acquisition). The insurer advanced defense expenses under a reservation of rights. The insurer wound up paying its entire $5 million limit. The insurer then filed an action against CSC Agility Platform and related entities to recoup the amounts it had advanced, contending that the Warranty Exclusion precluded coverage under the policy because, the insurer contended, there had been a misrepresentation in the insurance application in response to the question about merger activity. The parties filed cross-motions for summary judgment.
The Warranty Exclusion
The Policy’s Warranty Exclusion provides as follows:
By acceptance of this policy, the Insureds agree that:
- the statements in the Application are their representations, that such representation shall be deemed material to the acceptance of the risk or the hazard assumed by Insurer under this Policy, and that this Policy and each Coverage Section are issued in reliance upon the truth of such representations; and
- in the event the Application, including materials submitted or required to be submitted therewith, contains any misrepresentation or omission made with the intent to deceive, or contains any misrepresentation or omission which materially affects either the acceptance of the risk or the hazard assumed by Insurer under this Policy, this Policy, including each and all Coverage Sections, shall be void ab initio with respect to any Insureds who had knowledge of such misrepresentation or omission.
Application Question 8, to which ServiceMesh answered “No,” asked “Does the company contemplate transacting any merger or acquisitions in the next 12 months, where such merger would involve more than 50% of the total assets of the company?”
The February 4, 2019 Opinion
In a February 4, 2019 opinion, Judge Gutierrez, applying California law, granted the insurer’s motion for summary judgment, holding that the warranty exclusion operated to preclude coverage based on the answer in the insurance application to Question 8.
In order to reach his decision, Judge Gutierrez had to determine the meaning of Question 8, a question about which the parties disagreed. The insurer contended, in reliance on the dictionary definition of the term, that the word “contemplate” means to think about or to have in view as a possible intention. The defendants in the case argued that Question 8 could only be interpreted as referring to a formal acquisition offer. Under this definition, the answer “No” was not a misrepresentation because the company was not at the time of the insurance application considering a formal offer from Computer Science.
Judge Gutierrez determined that the “ordinary meaning of ‘contemplate’ suggests something more considered and intentional than a stray thought but nonetheless can encompass thinking about something that has not yet been formed into a definite plan.” This “plain-meaning definition,” Judge Gutierrez said, “clearly encompasses ServiceMesh’s actions with regard to a potential acquisition by Computer Sciences.”
Judge Gutierrez rejected extrinsic evidence on which the defendants had sought to rely to argue that the term was ambiguous. Among other evidence he rejected was statements in the declaration of Tamara Brandt, the person who completed the insurance application for ServiceMesh, about what she thought the application question meant.
Brandt stated that she understood Question 8 as asking “whether an offer of a merger or acquisition was being considered by ServiceMesh’s Board of Directors.” Judge Gutierrez said this interpretation represented “merely her own subjective reading of the contract’s language. The mere fact that parties read a contract differently does not create ambiguity.” Brandt’s declaration “does nothing more than show Defendants interpreted the contract differently” than the insurer. Accordingly, Judge Gutierrez said, it has “little relevance to the question before the Court.”
The question before the court, Judge Gutierrez said, is whether the language in Question 8 is “reasonably susceptible of the meaning Defendants seek to ascribe to it.” After considering, among other things, the declaration of the defendants’ expert witness about the application question, Judge Gutierrez concluded that it was not. “The Court,” Judge Gutierrez said, “can see no reason why [the insurer] would only care about a final offer but not about serious discussions that meaningfully increased ServiceMesh’s takeover risk.” Ultimately, he concluded that the defendants had not “convinced the Court” that its interpretation of Question 8 is reasonable. Rather, he concluded that Question 8 “clearly contemplated being acquired by Computer Sciences,” and therefore the answer to Question 8 was inaccurate.
Judge Gutierrez also determined that the insurer had not waived its right to rely on the Warranty Exclusion and that the insurer was not estopped from relying on the Exclusion.
Discussion
At one level, the outcome of this case arguably is no surprise. The company had been in discussions about a possible acquisition by Computer Sciences for months before the insurance application was completed; the discussions continued after the application was completed; and shortly thereafter the discussions resulted in an acquisition. There is the definite sense that ServiceMesh was in the middle of the process that led to its acquisition when the application was completed.
And yet, there is still something about the entry of summary judgment for the insurer here that troubles me. For starters, I have a lingering sense that the Court’s interpretation of the meaning of Question 8 relies on the Court’s silent substitution of an alternative wording for the Question’s actual wording.
Question 8 asked “Does the company contemplate transacting,” not, as the Court’s interpretation seems to suggest, “Is the company contemplating transacting….” Even though these two formulations both use a form of the word “contemplate,” the meaning of the word as used shifts slightly between the two formulations. The actual wording of Question 8 could, and I think arguably does, represent an inquiry about a formed, actual, current existing intent, rather than the consideration of a contingent future possibility. It is the difference between “planning on” (which is what Question 8 asked) and “thinking about” (which is the interpretation the Court gave Question 8).
Viewed in this light, the interpretation of Question 8 by Tamara Brandt, the person that actually completed the application, is easier to understand. If, as I think it can reasonably be argued, Question 8 asks about a formed, current, and actual intent, she arguably was justified in interpreting the question as asking about the consideration of an actual present offer, and not about a possible future offer.
Viewed in this light, it is not accurate to say that Question 8 is only susceptible to one meaning. Viewed in this light, there is a legitimate argument that Question 8 is ambiguous, and therefore that the question of whether or not the company’s answer to the application question was a misrepresentation should have been left to the jury after trial and not decided by the court on summary judgment.
There is another thing about the Court’s rejection of Brandt’s understanding of the meaning of the question that bothers me. Assume that what she said about her interpretation of the meaning of the question is a truthful and accurate statement of what she actually believed the question meant. After all, the only thing anyone filling out an application can do is to try to answer the questions as they understand them. The Court’s brusque declaration that her statement of what she thought the question meant is irrelevant to understanding the question’s meaning would be an alarming suggestion to anyone charged with the responsibility for completing an insurance application. If you can’t rely on what you think the questions mean, how in the world are you supposed to answer the questions at all?
All of that said, there is no doubt that at the time Brandt completed the insurance application for ServiceMesh, the company had for several months been in discussions with Computer Science about a possible acquisition. Did the company mislead the insurer by failing to disclose these discussions? That depends on how you interpret Question 8. It may well be, as the Court concluded, that the information about the acquisition discussions should have been communicated to the insurer. However, in my view, the question of whether or not Question 8 called for the provision of information about the acquisition discussions is an issue that should be decided by a jury, rather than by the Court.
If nothing else, this case represents a sharp, and indeed arguably harsh, reminder of the importance of care in completing an insurance application. Making a mistaken assumption about what an application question means can create potential future coverage problems. It is important for companies’ insurance advisers to make sure they are well aware of these kinds of potential pitfalls, and it is also important that the advisers go through the applications with their clients to try to ensure to the greatest extent possible that the applicant has not inadvertently failed to answer the questions that were actually being asked.