Most public company D&O insurance policies provide coverage for the corporate entity only for “Securities Claims.” But what constitutes a “Securities Claim”? That is the question the Delaware Supreme Court addressed in a recent appeal of an insurance coverage dispute in which a bankruptcy trustee had sued Verizon for breach of fiduciary duty, unlawful payment of a dividend, and violation of the uniform fraudulent transfer act. The trial court had entered summary judgment for Verizon, ruling that the bankruptcy trustee’s claims represented “Securities Claims” within the meaning of the policy. In an October 31, 2019 decision (here), the Delaware Supreme Court reversed the lower court, ruling that the bankruptcy trustee’s claims were not Securities Claims within the meaning of the policy. As discussed below, the decision raises some interesting issues.
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, $7.1 billion in Idearc debt, and $2.5 billion in cash. Verizon distributed the common stock to Verizon shareholders.
In 2009, Idearc filed for Chapter 11 bankruptcy. U.S. Bank, the Litigation Trustee in the bankruptcy filed a lawsuit against Verizon. 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) 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.
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. During the course of the trial and subsequent appeal, Verizon and Diercksen incurred defense cost of over $48 million.
The Insurance Issues
At the time of the spinoff, Verizon and Idearc purchased a D&O insurance program, consisting of a primary policy and three excess policies. 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 said that Verizon’s defense costs would not be paid because the primary policy provided coverage for the entity only for “Securities Claims” and the U.S. Bank complaint does not constitute a “Securities Claim” within the meaning of the primary policy.
The primary policy defines the term “Securities Claim” to mean a Claim against an insured:
(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;
In 2014 Verizon filed an action in Delaware Superior Court seeking coverage for the defense expenses incurred in the U.S. Bank action. The parties filed cross-motions for summary judgment.
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.
The Superior Court Ruling
As discussed here, in March 2017, Judge William C. Carpenter, Jr. 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 ruling in Verizon’s favor, Judge Carpenter noted that each side had offered reasonable but conflicting interpretations of the term “Securities Claim.” Based on the rule of contra proferentum, Judge Carpenter interpreted “any … regulation, rule, or statute regulating securities” as “pertaining to the laws that one must follow when engaging in securities transaction.” He also found that the definition is so broad that it would “simply be inappropriate” to find that the underlying claims did not either allege, arise from, or were based on or attributable to the purchase or sale of securities.
The insurers appealed.
The October 31, 2019 Decision
In an October 31, 2019 opinion written for a unanimous three-judge panel by Justice Collins J. Seitz, Jr. , the Delaware Supreme Court reversed the lower court’s decision, holding that the U.S Bank action did not involve a “Securities Claim” within the meaning of the policies, and therefore that Verizon is not entitled to recover its defense expenses from the insurers.
In interpreting the definition of the term “Securities Claim,” the Court started with “the basic understanding” that the provision is “aimed at a particular area of the law, securities law, and not of general application to other areas of the law.” The regulations, rules, and statutes referenced in the provision must be those that “regulate securities” and therefore are not addressed to “common law or statutory laws outside the securities regulation area.” In addition, because the term “separately establishes a connection to a securities transaction, then regulations, rules, or statutes must be directed specifically towards securities laws for ‘regulating securities’ to have meaning in this definition.”
With these conclusions as the starting point for its analysis, the Court then looked that the three substantive areas alleged in the underlying U.S. Bank complaint.
First, with respect to the breach of fiduciary duty claims, the Supreme Court said that “these claims are not reasonably characterized as regulations, rules, or statutes. Instead they involve a common law duty that if breached, leads to liability.”
Next, the allegation of unlawful distribution of dividends involves statutory claims, but the statutes, the Court said, regulate dividends, not securities. “While it is possible to issue securities as a dividend, the fact that stock might be involved is incidental to the regulatory purpose of the statue,” which is to make sure that the issuance of dividends does not render the corporation insolvent. The relevant statutes “are not statutes ‘regulating securities.’”
Finally, the trustee’s fraudulent transfer claims, while based on statutes, were not statutes “specific to transfers involving securities.” The fraudulent transfer claims “are not specific to securities regulation, and do not fall within the definition of a Securities Claim under the policy.”
The Supreme Court’s reversal of the Superior Court’s ruling is obviously a big win for the insurers. It is also a big loss for Verizon, which went from a position where its defense fees would be reimbursed by the insurers to a position where there is no insurance available at all.
As is always the case in insurance coverage disputes but as was particularly the case here, policy wording matters. In that regard, it was critical that the policy definition of “Securities Claim” did not contain language found in many policies to include within the definition claims alleging violation of “any law, regulation or rule, whether statutory or common law.” (It was in fact a point mentioned by the Superior Court level that the primary insurer whose policy was being interpreted had included this “common law” language in a prior version of its policy form).
Whether or not the language would have resulted in a different outcome here, 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 the Court did here.
There are other recurring issues that frequently arise under varying definitions of the Securities Claim. These other issues can involve which company’s securities are referenced, and even who the claimant is. I discussed these issues in detail in my blog post about the lower court ruling. Because these issues are not relevant to the Supreme Court’s decision, I do not review these issues again here, but instead refer readers to the discussion section of the blog post analyzing the lower court’s decision.