As the number of shareholder appraisal lawsuits increased a few years ago, a recurring question has been whether or not a company’s D&O insurance covers the company’s costs incurred in defending an appraisal action. In a recent decision, a Delaware Superior Court judge rejected a number of the recurring coverage defenses on which insurers rely in disputing coverage for appraisal action costs and expenses. The Court’s opinion in the Solera Holdings case contains several very interesting rulings, some of which could be relevant even outside of the appraisal action context. A copy of the Delaware Superior Court’s July 31, 2019 opinion can be found here.
Background Regarding Appraisal Actions Generally
In an effort to protect minority shareholders who may feel they are being compelled to give up their shares without their consent, various states, including in particular, Delaware, have created a remedy for “dissenting shareholders,” allowing them to seek a judicial appraisal of the fair value of their shares. Under Delaware General Corporations Code Section 262, subject to certain conditions and qualifications, any shareholder voting against a merger on the grounds that the consideration is inadequate “shall be entitled to an appraisal by the Court of Chancery of the fair value of the stockholder’s shares of stock.”
Background Regarding the Solera Appraisal Action
Solera was a publicly traded company until it was acquired by a private company in March 2016. Solera first announced the transaction in September 2016. At the time of the announcement, several shareholders filed a merger objection lawsuit alleging breach of fiduciary duty. That lawsuit was dismissed by the Delaware Chancery Court for failure to state a claim.
Just before the March deal closing, several Solera shareholders filed a Delaware appraisal action, seeking fair value for their shares. The petitioners contended that their shares were worth $84.65 a share. The appraisal action went to trial in June 2017. In July 2018, the Court determined that the fair value of the petitioners’ shares was $53.95 per share, an amount less than the merger price. The court ordered the company to pay the petitioners $53.95 per share, plus $38.3 million in prejudgment interest. Solera incurred $13 million in defending the appraisal action.
Background Regarding the Insurance Dispute
At the time the appraisal action was filed, Solera had a program of D&O insurance consisting of a primary layer of $10 million and several excess layers of insurance totaling $45 million in excess of the primary $10 million. Solera notified its insurers of the appraisal action in January 2018 (that is, after the appraisal action trial but before the verdict was announced). The primary insurer denied coverage for the appraisal action, and Solera filed an action for breach of contract and declaratory judgment, seeking coverage for the pre-judgment interest and defense fees it incurred in the appraisal action. Several of the excess insurers filed a motion for summary judgment on several of the coverage issues, and Solera cross-moved for summary judgment as well. (While the motions were pending, Solera and the primary insurer reached a settlement.)
The July 31, 2019 Opinion
In a July 31, 2019 opinion, Delaware Superior Court Judge Abigail LeGrow, applying Delaware law, denied both the insurers’ summary judgment motion and Solera’s cross-motion as well.
In her Opinion, she addressed three issues: whether an appraisal action is a “Securities Claim” as defined by the primary policy; whether the pre-judgment interest award can represent Loss within the meaning of the policy, even if the amount of the fair value payment is not covered loss; and whether or not coverage is precluded for the defense fees Solera incurred before providing the insurers with notice of the claim and obtaining consent to Solera’s counsel.
With respect to the issue whether an appraisal action is a “Securities Claim,” the insurers relied on the portion of the definition specifying that a “Securities Claim” is a claim for a “violation” of any federal, state or local statute, regulation, or rule relating to securities. The insurers argued that because an appraisal action does not require a petitioner to prove any wrongdoing, an appraisal action is not a claim for a “violation” of law.
Judge LeGrow rejected this argument, saying that nothing in the policy’s use of the word “violation” limits coverage only to claims containing allegations of wrongdoing; a “violation,” she said, simply means a breach of the law or the contravention of a right or duty. The choice of a broader word like violation “must be given effect by the Court.” An appraisal action “necessarily alleges a violation of law or rule”; by its very nature, Judge LeGrow said “a demand for appraisal is an allegation that the company contravened [the right to ‘fair value’] by not paying shareholders the fair value to which they were entitled.” She concluded that an appraisal action is a claim against the company for a violation of the law, and therefore it is a Securities Claim within the meaning of the policy.
In contending that the policy does not cover the amount of the pre-judgment interest award, the insurers argued that because, as the parties agree, the amount of the fair value payment is not covered Loss “it follows” that the pre-judgment interest on the fair value amount is not a covered Loss.
Judge LeGrow said that this argument is “untethered to the Policy.” The policy itself is “unambiguous,” and “nothing in the policy limits coverage for an interest award to interest on a covered judgment.” Had the insurers intended to limit coverage in that manner, “the Policy language easily could have reflected that limitation.” The Court, she said, “will not now insert more favorable language than the language Defendants chose during drafting.” However, she also said that there were other factual and legal issues in dispute about whether or not the policy covers pre-judgment interest, so she denied the cross-motions for summary judgment on the pre-judgment interest issue
Finally, with respect to the insurers’ argument that there was no coverage under the Policy for the pre-notice defense expenses because Solera incurred those costs without the insurers’ consent, Judge LeGrow first determined that Delaware law implies a prejudice requirement in consent clauses in insurance policies. Judge LeGrow specifically found that the implied prejudice requirement applies to the consent to counsel provision. Implying the prejudice requirement, she said, “protects an insured who has breached a consent provision from the harsh result of forfeiture, but only if the insured can prove by competent evidence a lack of prejudice to the insurer.” Because factual disputes remain regarding the prejudicial effect of the lack of consent to counsel, Judge LeGrow denied summary judgment on the consent to counsel issue.
Judge LeGrow’s ruling that an appraisal action is a “Securities Claim” within the meaning of the primary policy is significant. Indeed, according to a July 31, 2019 Law 360 article about the decision (here), Judge LeGrow’s decision on the issue is a ruling of “national first impression.”
The “Securities Claim” issue is important in connection with the question of D&O coverage for an appraisal action. Appraisal actions tend to be filed only against the corporate entity, not against any individual directors and officers. So it is usually an entity claim only The typical public company D&O insurance policy provides entity coverage only for “Securities Claims.” If an appraisal action is not a “Securities Claim,” the appraisal action does not trigger the only relevant insuring agreement. So the court’s determination that the appraisal action here represented a “Securities Claim” within the meaning of the policy is a significant ruling, establishing the possibility that an appraisal action does (or at least can) trigger the insuring agreement.
However, this ruling that an appraisal action represents a “Securities Claim” may not be as significant an issue in the future as it might have been in the recent past. As detailed here, during the period from 2010 to 2016, the number of appraisal actions filed in Delaware increased every year; but in 2017 and again in 2018, the number of appraisal actions declined significantly. The decline is the result of recent Delaware Supreme Court decisions in which the court reversed lower court rulings holding that the fair value exceeded the deal price and instead indicated that the deal price should be given substantial weight, at least where the sales process was “robust.” The upshot is that there are likely to be far fewer Delaware appraisal actions that there were just a few years ago.
But with respect to the question of insurance coverage for those appraisal actions that are filed, Judge LeGrow’s ruling that an appraisal action is a “Securities Claim” within the meaning of this policy potentially could be very significant.
With respect to the prejudgment interest issue, I am sure it will come as a surprise to many insurer side advocates that the policy might cover interest on an amount that was itself not covered under the policy. However, as Judge LeGrow noted in her opinion, there are some D&O insurance policies that expressly provide that the policy provides coverage for pre- and post-judgment interest only on “covered judgments.” The definition of Loss in this policy did not contain any suggestion that the policy’s coverage of interest applied only to interest on covered judgments. This wording distinction was critical in Judge LeGrow’s decision. Her ruling highlights the importance of this wording distinction. So, if insurers’ representatives are surprised that the policy can provide pre-judgment interest on non-covered amounts, there are some specific policy language-related lessons.
Judge LeGrow’s analysis of the consent to counsel is particularly interesting to me, especially her conclusion that Delaware’s implied material prejudice requirement applies to the consent provision. The question of a requirement for a showing of prejudice usually comes up in the context of late notice – the policyholder will argue that even if the notice was late, the late notice did not prejudice the insurer, and therefore coverage should not be precluded.
Judge LeGrow’s conclusion that the prejudice requirement applies to the consent to counsel provision is also noteworthy; I am not aware of any other courts that have previously reached this conclusion. Moreover, there is nothing about her ruling that limits its relevance to the appraisal action context. Her ruling could be helpful to insureds disputing a coverage denial on consent to counsel grounds.
However, the usefulness of her ruling may be limited outside Delaware, as her conclusion was very Delaware-law dependent. Also, policyholder advocates will want to note that her conclusions about the consent to counsel issue did not defeat the carrier’s coverage denial on those grounds. Rather, she held only that under Delaware’s implied prejudice requirement, there is a presumption that the insurers were prejudiced by the breach and that the policyholder may attempt to rebut that presumption. The prejudice issue then becomes very fact-based and case-specific.
I am sure many readers, like me, wondered why the question of whether an appraisal action involves alleged wrongdoing was considered in the context of the definition of the term “Securities Claim.” The question of whether this lawsuit involved alleged wrongdoing would seem to be most relevant in the context of whether or not the appraisal action involves an alleged “Wrongful Act” as the policy requires in order for coverage to be triggered. Indeed, even if the appraisal action involves a “violation” of the law and therefor constitutes a “Securities Claim,” Solera would still have to establish that the appraisal action involved an actual or alleged “Wrongful Act” in order to establish that it is entitled to coverage under the policy.
It puzzles me why this issue was not addressed. A footnote in the opinion suggests Judge LeGrow was puzzled as well. In footnote 2 of the opinion, Judge LeGrow notes that “for reasons that are not clear” the insurers did not argue that the failure to allege a Wrongful Act precluded coverage for the claim. She noted that the insurers only raised arguments based on the meaning of “Securities Claim.” Accordingly, she said, “this opinion does not address or resolve the effect, if any, of the ‘wrongful act’ language.”
It may be that this is the rare case that insurance company counsel chose not to assert an coverage defense arguably is not strong; the typical definition of Wrongful Act is broad (any actual or alleged “act, error, or omission”) and an implied failure to pay fair value arguably meets this standard. Just the same, my expectation would have been that counsel for the insurers would have assert an failure to allege a “Wrongful Act” as an alternative to the absence of a “Securities Claim” argument.
In addition to the Wrongful Act question, I suspect there may be one more issue that troubles some readers. That is, Solera didn’t give notice to its insurers of the appraisal action until nearly two years after the appraisal action was filed – why, some readers might ask, did the insurers not raise late notice of claim as an additional defense to coverage? The answer likely has to do with the earlier merger objection lawsuit in which other shareholders alleged that the company’s board breached their fiduciary duties in connection with the transaction. Solera provided timely notice of this earlier lawsuit to the insurers. The later lawsuit, also relating to the same transaction, was interrelated with the earlier lawsuit and so was deemed under the policy to have been first made at the time of the earlier lawsuit, of which timely notice had been provided.
Special thanks to several loyal readers who called my attention to Judge LeGrow’s opinion.