Before the ice age, before the flood, before some of the people reading this were even born, the big D&O insurance coverage issue was allocation – that is, the division of loss between covered and non-covered claims or between covered and non-covered parties. After a flurry of judicial decisions in the mid-‘90s, after the addition of entity coverage to the standard D&O insurance policy (also in the mid-‘90s), and after policy allocation language became more or less standardized, litigated allocation disputes became much less frequent. Indeed, the last time I had occasion to write about an allocation coverage decision on this blog was in 2007. (Although, to be sure, allocation is still very much an issue in many D&O insurance claims.) It was with some surprise and interest that I read a recent Delaware Superior Court decision in the long-running Dole Foods insurance coverage dispute dealing with the question of allocating the underlying settlements between covered and non-covered amounts. The decision itself contains some surprises, as discussed below.
A copy of Delaware Superior Court Judge Eric Davis’s January 17, 2020 opinion on the allocation issue can be found here. A January 30, 2020 post on the Wiley law firm’s Executive Summary blog can be found here.
The Underlying Chancery Court Lawsuit
The November 1, 2013 transaction in which David Murdock, Dole Food Company’s Chairman and CEO, acquired Dole shares did not already own was the subject of a breach of fiduciary duty lawsuit filed in Delaware Chancery Court. In 108-page August 27, 2015 post-trial opinion (here), Delaware Court of Chancery Vice Chancellor Travis Laster found that and Murdock and C. Michael Carter, Dole’s COO and General Counsel, had employed “fraud” to drive down the Dole’s share price to lower the amount Murdock and Carter paid in the deal. Laster entered a damages award against Murdock and Carter, jointly and severally, of $148.1 million, as discussed here. On December 7, 2015, Murdock and Dole reached an agreement to pay the shareholders a total (including interest) of $113.5 million, with the remainder of the judgment amount to be paid to the plaintiffs in a separate appraisal action, as discussed here. As part of the settlement, the defendants gave up their right to appeal the Chancery Court rulings and judgment.
The Underlying Securities Class Action Lawsuit
On December 5, 2015, while the approval of the settlement of the Chancery Court action was pending, plaintiff shareholders filed a securities class action lawsuit against Dole and Murdock in the U.S. District Court for the District of Delaware, as discussed here. The plaintiffs in the securities lawsuit alleged that Dole and Murdoch misled investors in connection with the Dole take-private transaction, in violation of the federal securities laws. The parties to the securities class action lawsuit entered mediation. As reflected in the parties’ March 2017 stipulation of settlement, the securities lawsuit ultimately settled for $74 million. The total amount of the two settlements is $222.1 million.
The Insurance Coverage Litigation
Dole maintained a $100 million program of D&O insurance consisting of a layer of primary insurance and eight layers of excess insurance. The primary layer and several of the lower level excess layers were exhausted by defense expense. In January 2016, after the parties had agreed to settle the Chancery Court lawsuit and after the securities lawsuit had been filed, the remaining excess insurers filed an action in Delaware Superior Court seeking a declaratory judgement that there was no coverage under their policies for any portion of the Chancery Court settlement. They also later argued that there was no coverage for the separate securities class action lawsuits.
As discussed here, in a December 21, 2016 decision, Superior Court Judge Davis ruled in the coverage action that because Laster’s findings of fraud were not part of the post-settlement final judgment in the Chancery Court action, the fraud exclusion in Dole’s D&O insurance program did not preclude coverage for the settlement.
As discussed here, in a March 1, 2018 decision, Judge Davis denied the insurers’ summary judgment motions in which the insurers sought to argue that under California law, which the insurers contended applied to the policies, coverage for the under the policy for the settlements is precluded as a matter of public policy. Judge Davis ruled, among other things, that Delaware law rather than California law applied to the policy’s interpretation, and that the Chancery Court’s determination that the individuals had committed fraud did not preclude coverage for the claim as a Delaware public policy.
In two May 2019 rulings, discussed here, Judge Davis ruled on two further motions for summary judgment, the first granting the insurer’s motion for summary judgment on the Dole defendants’ bad faith counterclaim, and the second denying the insurers’ summary judgment motions, among other things, on consent to settlement and cooperation clause issues. In his May 2019 rulings, Judge Davis expressly left open issues relating to subrogation, allocation, and exhaustion.
The Allocation Provision
The parties subsequently filed cross-motions for summary judgment on the allocation issue. The Allocation Provision in the Policy provides that:
If in any Claim, the Insureds who are afforded coverage for such Claim incur Loss jointly with others (including other Insureds) who are not afforded coverage for such Claim, or incur an amount consisting of both Loss covered by this Policy and loss not covered by this Policy because such Claim includes both covered and uncovered matters, then the Insureds and the Insurer agree to use their best efforts to determine a fair and proper allocation of covered Loss. The Insurer’s obligation shall relate only to those sums allocated to matters and Insureds who are afforded coverage. In making such determination, the parties shall take into account the relative legal and financial exposures of the Insureds in connection with the defense and/or settlement of the Claim.
Of significance to the Court’s ultimate ruling on these issues, the Court noted that “the factual record is bereft of any fact that show[s] that the Insurers and/or the Insureds engaged in any efforts to determine any allocation of covered Loss. Moreover, the parties do not discuss any allocation efforts undertaken by anyone in the various motions for summary judgment.”
Historical Background on the Allocation Issue
Some background on D&O insurance allocation issues is pertinent here, and provides important context for the parties’ positions on allocation. Back in the day, D&O insurance policies did not have express allocation provisions. Insurers argued then, in reliance in a 1986 Southern District of New York decision in the Pepsico case, that amounts should be allocated between covered and non-covered amounts, based on the “relative exposure” of the defendants to the covered and non-covered matters.
Policyholders urged that a different rule should apply, in reliance on a 1990 7th Circuit decision in the Continental Bank case, which had first articulated what became known as the “larger settlement rule.” Under the “larger settlement rule” as it ultimately was described by subsequent court decisions, allocation is appropriate “only if, and only to the extent that, the defense or settlement costs of the litigation were, by virtue of the wrongful acts of the uninsured parties, higher than they would have been had only the insured parties been defended or settled.”
Insureds and policyholders duked it out for several years, with insurers urging the “relative exposures” allocation standard based on the Pepsico-line of cases, and policyholders urging the “larger settlement rule” allocation standard in reliance on the Continental Bank case.
Then in 1995 there were a trio of federal appellate cases that came down squarely in favor of the “larger settlement rule” – the Nordstrom and Safeway cases in the Ninth Circuit (which can be found here and here), and the Caterpillar case in the Seventh Circuit. (I have to say, going through all this makes me feel ancient and even a little weary, as if I were hundreds of years old. Yes, there were dinosaurs back then. )
In the wake of the 1995 trio of appellate cases, several things happened in quick succession. First, insurers modified their standard D&O insurance policies to incorporate entity coverage, which eliminated many of the disputes over allocation between covered parties (individual directors and officer) and non-covered parties (before entity coverage, the company itself). Next, insurers modified their policies to expressly include allocation provisions – much like the allocation provision in dispute in the Dole policy – that not only required an allocation but that incorporated the “relative exposures” test. Almost all D&O insurance policies these days contain an allocation provision, and most expressly refer to the “relative exposures” standard.
The Parties’ Positions on Allocation
In their summary judgment motion on the allocation issue, the Dole parties argued that the Court should apply the Larger Settlement Rule, and they argued further than under the Rule, the entire amounts of both underlying settlements are recoverable unless the insurers are able to show that some uncovered liability increased the settlement amounts.
The insurers argued in their summary judgment argued, first, that the Dole parties had the burden to prove allocation between covered and non-covered amounts. The insurers argued further that the allocation provision expressly requires an allocation between covered and non-covered amounts, and that the provision is specific enough that the allocation provision does not apply.
The January 17, 2020 Opinion
In his January 17, 2020 opinion, Judge Davis, applying Delaware law to an issue of first impression in Delaware, held that the Larger Settlement Rule applies with respect to the allocation issue.
In reaching this conclusion, Judge Davis found that while the allocation provision is “unambiguous,” it is “mostly unhelpful under the facts presented here.” The provision, Judge Davis said, speaks only to situations where the insurer and policyholder use their best efforts to arrive at a fair and proper allocation of covered loss. The provision, he said, “does not address the situation where the parties fail to agree.” In the absence of language specifying what is to be done if the parties do not agree, and in light of the policy language, he said, the larger settlement rule applies.
Specifically, Judge Davis said that the larger settlement rule applies in situations where “(i) the settlement resolves, at least in part, insured claims; (ii) the parties cannot agree as to the allocation of covered and uncovered claims; and (iii) the allocation provision does not provide for a specific allocation method (e.g., pro rate or alike.)”
The application of the Larger Settlement Rule here would “protect the economic expectation of the insured – i.e., prevent the deprivation of insurance coverage that was sought and bought.”
Judge Davis said that he found the reasoning underlying the Larger Settlement Rule to be persuasive, as the policy, but its terms, covers all Loss that the Insureds become legally obligated to pay. Any type of “pro rata or relative exposure analysis seems contrary to the language of the Policies.”
The insurers urged the court to note and apply the relative exposure language found in the allocation provision, which Judge Davis rejected, noting that he “does not see how the Allocation Provision establishes a method in the event the parties cannot, using best efforts, agree upon allocation between covered and uncovered claims.” He specifically found that the Allocation Provision is “not drafted in a manner that would provide for a specific allocation manner in the event [the parties] cannot agree to allocation. This is especially true here where the parties did not even attempt to allocate covered and uncovered claims.”
Finally, the court deferred resolution of the factual issues pertaining to the application of the standard and on the burden of proof on allocation issues for later proceedings in the case.
I suspect that for many insurer-side representatives – and indeed for many if not all of the excess insurers directly involved in the case – Judge Davis’s ruling that the larger settlement rule applies may be something of a surprise outcome. (Although maybe not; I am guessing that by now the excess insurers involved in this coverage dispute are getting mighty weary of Judge Davis’s courtroom.)
The reason I say that Judge Davis’s decision that the larger settlement rule applies is surprising is that the allocation provision at issue has the “relative exposures” language. Allocation provisions of this very kind were the exact kind of provisions that the insurers adopted way back in the ‘90s when they wanted to try to circumvent the trio of appellate decisions and instead enshrine the “relative exposures” test directly in the policy.
It seems odd, to say the least, for Judge Davis to say that application of a “relative exposures” analysis here would be “contrary to the language of the policy,” given that the allocation provision – the very provision that he was construing – expressly referred to the “relative exposures” test.
In the end, Judge Davis’s decision to apply the larger settlement rule rather than the relative exposures test does have a sort of matter-of-fact quality about it. He is right that the allocation provision in the Dole policy only addresses what happens if the parties use their best efforts to agree on a fair allocation. The provision does not, in fact, expressly say what should happen if the parties are unable to agree. When he put it this way in his opinion, it seems pretty clear that he is right about what the provision does and doesn’t say.
But just the same, in so many policies out there, insurers have relied and continue to rely on this kind of language in support of an assumption that the “relative exposures” test would govern allocation disputes. (Indeed, in the 2007 blog post in which I last wrote about an litigated allocation dispute, the court had no trouble concluding based on nearly identical language, that the provision required application of the “relative exposures” standard.)
There are some allocation provisions in some policies that do go further than the provision at issue in this case, that contain a provision that usually begins “In the event the parties are unable to agree…” However, these provisions usually only say that the insurer will in that event pay what it agrees it owes while the parties try to sort out the remaining disputed items. These “in the event” provisions usually do not expressly say that the “relative exposure” test will or will not apply to the determination of the allocation of the disputed amounts.
It is worth noting that it was important to Judge Davis that there was no evidence that the parties had tried to agree on a fair allocation. It isn’t clear how it would have affected his decision if they had attempted but failed to agree. However, the fact that this was important to Judge Davis – he repeated it multiple times – does suggest that insurers could be better advantaged for subsequent disputes if they can show that they attempted but failed, using “best efforts,” to come up with an agreed allocation. On the other hand, given that the Dole parties are arguing the entire settlement amounts are covered and the insurers are arguing that there is no coverage at all, conversations about allocation here likely would have been futile.
I wonder if this is the kind of decision that might motivate some insurers to go back and reconsider the language in the allocation provisions, in order to clarify what is supposed to happen if despite their “best efforts” the parties are unable to agree on an allocation. I am not going to make any language suggestions here – that is clearly somebody else’s job – but I will say that it is easy for me to envision language that would, from the insurer’s perspective at least, both address Judge Davis’s concerns and also ensure that the “relative exposures” test rather than the “larger settlement” rule would be applied in the event of an allocation dispute.
A couple of final things about this ongoing coverage dispute. First, it is getting to the point that you could build an entire course about D&O insurance coverage issues based just on this one dispute. Second, I am beginning to understand why I have been hearing from various insurers that they are thinking of incorporating choice of law clauses — or even choice of law and choice of forum clauses — in their policies, in order to ensure that coverage disputes are not decided under Delaware law or even in Delaware courts. I am guessing that by this point the excess insurers involved in this case have had just about as much fun in Delaware as they can stand.
How Should Insurers Respond to the Historically High Levels of Securities Class Action Litigation?: As has been documented in several recent posts on site (most recently here), the rate of securities class action lawsuit filings is at all time highs. It is likelier now for a company to get hit with a securities class action lawsuit than it has ever been. This trend has had a significant impact on the D&O insurance marketplace. Insurance buyers face a significantly disrupted insurance arena.
We already know part of the answer to the question of what insurers are going to do in response to these securities litigation trends — they are all trying to raise rates, and many are increasing retentions or cutting capacity.
There are other things insurers can do to try to address these issues, at least according to a January 30, 2020 meme from John McCarrick and Andrew Lipton of the White and Williams law firm (here). In their memo, John and Andrew propose a number of steps insurers can take in light of the current litigation environment. Most of their suggestions are with respect to claims handling and resolution, rather than with respect to underwriting, risk selection, or limits management. Readers primarily involved on the claims side will find John and Andrew’s memo interesting and helpful.