A lot has happened since early March, when I first wrote about the possibility that the coronavirus outbreak could lead to D&O claims. At that time, there were only 43 confirmed cases of COVID-19 in the United States and six deaths. Now, three months later, there have been over 2 million confirmed cases in the U.S. and over 115,000 deaths. Along with the public health crisis, a dramatic business downturn has unfolded over the last three months as well, one that likely will continue to effect the economy for months to come. Among other things, in the wake of these dramatic events, a number of disputes have developed, including litigation affecting corporate directors and officers. In this latest installment in my continuing series of monthly reports about the D&O consequences arising from the coronavirus outbreak, I have provided an overview of the developing claims trends, as well as the impact both the circumstances and the claims trends have had on the D&O insurance marketplace.
Claims Trends
Securities Class Action Lawsuits: The most significant D&O claims trend that has emerged over the past three months with respect to the coronavirus outbreak has been the rise of a number of COVID-19-related securities class action lawsuits. The current count of COVID-19 securities suits stands at 11 total lawsuits to date, up from five at the time of my May update. In the larger context of litigiousness in the U.S., eleven securities suits over the course of three months hardly qualifies as a “wave” of litigation. (By way of contrast, there were eleven securities suits filed against a number of cyptocurrency firms in a single day in April, as discussed here.)
Here are the links to my posts about the eleven lawsuits: Norwegian Cruise Lines (here); Inovio Pharmaceuticals (here); iAnthus Capital Holdings (here); Zoom Video Telecommunications (here); Phoenix Tree Holding Ltd. (here); SCWorx (here); Elanco Animal Health (here); Sorrento Therapeutics (here); Carnival Corporation (here); Wells Fargo & Company (here); and Forescout Technologies (here).
Though the number of coronavirus-related securities suits so far is relatively modest, a number of patterns have emerged. There have been two securities suits filed against cruise ship lines, hardly a surprise in the context of the evolving coronavirus story. There have also been three lawsuits based on company statements relating to the companies’ ability to produce coronavirus-related therapies or testing materials (Inovio, SC Worx, and Sorrento Therapeutics). Two of the eleven lawsuits involve U.S.-listed companies domiciled or based outside the United States (Phoenix Tree Holdings Ltd. and iAnthus Holdings).
At least three of the lawsuits involve allegations pertaining to the business impact of the coronavirus outbreak on the companies’ financial performance or business operations. For example, the iAnthus Capital Holdings securities suits raises allegations pertaining to the company’s failure to make scheduled interest payments at the end of the first quarter. The case filed against Elanco Animal Health raises allegations having to do with the revenue impact on the company based on the inability of the company’s distribution partners to sell-through the company’s animal health care product. The lawsuit against Forescout Technologies is based on allegations that the company failed to update proxy materials to report a COVID-19 caused downturn in its business revenue.
As the pandemic moves from the public health crisis phase to the economic impact phase, there may well be more lawsuits along these lines, raising allegations pertaining to the disruption on companies’ financial performance or business operations arising from the pandemic.
It is also worth noting that the securities class action lawsuit filed against Zoom arose out of underlying privacy concerns, an issue that could recur in the context of the coronavirus outbreak and concerns regarding health information privacy and biometric information data security.
With respect to possible future securities suits, it is entirely possible that the company statements that wind up serving as the basis of future securities class action lawsuits have not yet been made. As companies open back up as stay at home orders expire, companies will be making many statements about their financial condition, their operating readiness and capabilities, about their supply chain; about their cash, ability to service debt or availability of credit, collectability of receivables, and levels of customer or product demand. Many of these statement may project optimism. However, if the companies making these statements later stumble, they could find themselves facing litigation based on the prior optimistic statements.
Shareholder Derivative Lawsuits: In addition to the eleven coronavirus-related securities class action lawsuits, there have been two COVID-19-related shareholder derivative lawsuits filed. Both of the derivative lawsuits were filed against boards of companies that were also separately named as defendants in prior securities class action lawsuits, Inovio (here) and Zoom (here).
The type of lawsuit we have not yet seen but about which there has been a great deal of speculation is a lawsuit (filed either derivatively or directly) alleging breach of the duty of oversight. There has been significant conjecture (for example, here) that the impact of the pandemic on businesses could lead to a claimant asserting a claim based an alleged breach of the directors’ duty of oversight, or what is often referred to as a Caremark claim. These observations are based on the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill, in which the court held that the plaintiff had sufficiently stated a Caremark claim against the board of an ice cream manufacturer, Blue Bell Creamery, that had suffered a listeria outbreak leading to three deaths. Commentators have suggested that boards of some companies could be susceptible to Caremark claim based on coronavirus outbreak-related health issues, along the lines of the claims asserted against the Blue Bell Creamery board. So far at least to my knowledge, there have as yet been no pandemic-related claims asserting a breach of the duty of oversight.
SEC Enforcement Actions: In addition to the eleven securities class action lawsuits and two shareholder derivative lawsuits filed so far, there have also been a total of four coronavirus-related SEC enforcement actions filed as well, up from only one at the time of my prior update in May. In each of the now four SEC enforcement actions, the SEC alleged misrepresentations by or about companies pertaining to COVID-19 safety equipment and prevention products (including, for example, face masks, thermal scanners, test kits, hand sanitizer, and the like). The common thread among the actions is that in each case the enforcement action defendant misleadingly tried to convince investors that the company involved was positioned in some way to be able to profit from the pandemic.
Here are the links to my posts describing the four coronavirus outbreak-related SEC enforcement actions: Praxsyn Corporation (here); Applied Biosciences Corp. (here); Turbo Global Partners (here); Nielsen/Arrayit Corporation (here).
There likely will be more SEC enforcement activity to follow. In a series of statements and actions, the agency has shown its intent actively monitor the markets for “frauds, illicit schemes and other misconduct relating to COVID-19.” Among other things, the agency’s Enforcement Division has formed a Coronavirus Steering Committee to focus on fraud, insider trading, disclosure improprieties, and market-moving pronouncements relating to the pandemic. The likelihood is that there will be further SEC enforcement actions in the weeks and months ahead.
Bankruptcy and D&O Claims: Another area in which I expect to see more coronavirus-related claims is the bankruptcy context. There is widespread speculation that a substantial number of companies could wind up seeking the protection of the bankruptcy court. Indeed, a May 28, 2020 Harvard Business Review article (here), suggests that there could even be a “bankruptcy pandemic” – an “explosion” of bankruptcy proceedings that could “overwhelm” the bankruptcy courts. A number of companies have already filed for bankruptcy, and there undoubtedly will be more to come.
If this surge in bankruptcy filings does materialize, one likely side-effect will be a wave of D&O claims filed against the directors and officers of the bankrupt company by creditors or bankruptcy trustees. As I have frequently noted on this blog (most recently here), in a number of ways bankruptcy presents multiple D&O insurance coverage complications.
Private Company-Related Claims Concerns: One question I often get when I review the kind of statistics outlined above is – what about private companies? It is true that each of the above D&O claims examples involve publicly traded companies. I am not aware of any coronavirus-related D&O claims filed so far against private companies; there could be claims out there that I am not aware of, of course, but so far none have come to my attention.
From my perspective, the likeliest area where we may see private company coronavirus-related D&O claims is in the bankruptcy context. The possibility of winding up in bankruptcy is certainly not limited to publicly traded companies alone; many private companies may wind up filing for bankruptcy as well. Claims against the former directors and officers of the bankrupt companies may well follow.
One other observation relevant to potential future claims against private companies is that Blue Bell Creamery, the company involved in the Marchand v. Barnhill case noted above, is a privately held company. Private company directors have the same legal duties their company and its shareholders and the same potential liabilities; indeed, as I have noted numerous times on this blog (most recently here), the federal securities laws do not apply only to public companies – the securities laws apply to private companies as well.
D&O Underwriting Issues
Even before the pandemic-related public health crisis began to unfold earlier this year, the D&O insurance marketplace was already in a “hard market,” with insurers increasing their pricing, reducing their limits, restricting their exposures to certain classes of business, and tightening terms and conditions.
The outbreak of the coronavirus exacerbated all of these trends. But while the factors that led to the ongoing hard market, on the one hand, and the coronavirus outbreak, on the other hand, combined to create a disrupted insurance market, the current economic recession (which the National Bureau of Economic Research says began in February) has aggravated matters still further and has shaped and will continue to shape the D&O insurance underwriters’ response.
Public Company D&O Insurance: For public company D&O insurers, these various factors have translated into significantly increased underwriting requirements. Most D&O insurers have introduced written questionnaires they require applicants to complete as a now critical part of the application process. The questionnaires are detailed, and not only inquire into the ways that the coronavirus has impacted the applicant’s business operations, work force, and supply chain, but also go into detail about the applicant’s financial condition, including liquidity and cash flow; credit availability, debt levels, and debt covenants; and reserves and collectability of receivables.
The increasing public company D&O insurance pricing trends that were already in effect before the pandemic have now accelerated, to the point that many public company D&O insurance buyers can expect pricing increases of as much as 30% to 50% on their primary D&O insurance, and potentially even higher on excess insurance – and upper level excess insurance may be priced at the same levels as the underlying layer.
On many accounts, insurers are managing their capacity, both by reducing their limits exposed and by increasing the self-insured retention. Both of these trends were already in play prior to the pandemic, but the COVID-19 outbreak accelerated these trends. As a consequence, primary insurers that may have provided, for example, a $5 million limit may offer renewal terms that include, say, only a $2 million limit of liability. In addition, there may be no difference between the non-securities retention and the securities retention. As a result of the reduction of the limits offered, filling out a renewal program with equivalent limits of liability in some cases may be a challenging, time-consuming, and labor intensive process.
Some carriers on some accounts have attempted to add COVID-19 or communicable disease exclusions, but these types of exclusions have not become widespread, at least in the public company D&O space. (These exclusions are more widespread in other lines, particularly certain E&O classes; also, these types of exclusions may be more frequent among the London market underwriters). Certain carriers on certain accounts have attempted to add bankruptcy or creditor claims exclusions. For some carriers, the inclusion of a bankruptcy or credit claim exclusion is the default response for applicant that are slow in providing coronavirus-related underwriting information, even if the applicant is not a bankruptcy risk.
Private Company D&O: The marketplace disruption is not limited just to public company D&O; the private company D&O insurance marketplace is also roiled. Many private company D&O insurers are focused on their existing book of business and for now are unwilling to provide quotes for new business; as a result it has become more difficult to secure competitive alternative quotes.
The private company D&O insurers have also introduced underwriting processes seeking to elicit information about the impact on the applicant company from the coronavirus outbreak and resulting economic downturn. Private company D&O insurers are also seeking pricing increases, although not as steep as for public company applicants. The rate increases in the private company space for most buyers is in the 10-15% range. The private company insurers are also seeking to reduce their limits exposed and to increase retentions.
In many instances, the private company D&O insurers are reducing the scope of coverage afforded, both by eliminating enhancements that had become standard in recent years and by adding restrictive terms. For example, with respect to enhancements, some insurers are eliminating Wage & Hour sublimits on the EPL coverage part, or eliminating the added layer of Side A protection often offered on some private company D&O policies. The restrictive terms added include, among other things, the addition of antitrust exclusions, communicable disease exclusions, and creditor claim or bankruptcy exclusions.
Some private company insurers are moving to try to restrict their exposure to certain industries, including for instance hospitality, gaming, oil and gas exploration and development, life sciences, and adult living services companies. In some instances, some insurers are non-renewing their accounts in these industries.
Discussion
As I noted in my prior update, the current D&O insurance marketplace is the most disrupted I have seen during the 38 years I have been involved (one way or the other) in the business. For buyers, the message is not just that your D&O insurance is going to cost more than it has in the past. The message is also that the D&O insurance buying process is going to be very different than in the past, as well. The process will be more time-consuming and more labor-intensive, and much more unpredictable.
As a result of these developments, the behavior of many buyers has changed as well. When confronted with significantly increased D&O insurance premiums, some buyers want to consider alternatives. Some buyers may chose simply to buy less insurance, or consider whether alternative insurance structures may be less costly. (The extreme example of this type of reaction is the automobile company, Tesla; when confronted with a significantly increased cost for their D&O insurance, the company’s board agreed to accept a personal guarantee from the company’s CEO Elon Musk in lieu of D&O insurance).
While I certainly understand how dramatically increased pricing might cause buyers to want to consider an alternative approach, I think companies generally should move very cautiously in reducing or eliminating insurance protections in the current environment. For most companies, this would be a particularly dangerous time to be underinsured.
That said, there is no single right answer to the question of what amount of insurance that is the right amount of insurance, and different companies will answer the question differently. In a time of rapidly escalating insurance prices, it certainly is appropriate to reconsider the limits sufficiency issue.
My crystal ball is no better than anyone else’s but I continue to believe we are likely to be in a hard market for D&O insurance for some time to come, almost certainly well into 2021. In making this projection, I am not only thinking of the current challenging economic circumstances that are likely to continue well into the future, but also of the absence so far of fresh capital seeking to exploit a disrupted insurance marketplace. To be sure, a number of insurers have in recent weeks turned to the capital markets to raise funds, but by and large these financings are balance sheet shoring-up efforts, rather than fundraising for new initiatives and opportunistic enterprises.
And on top of everything else, there is the unpredictability of the coronavirus outbreak itself. We all hope that the worst is past and the re-opening process can continue. However, in some U.S. localities, there are worrisome signs of infection spikes and increased numbers of confirmed cases. There also the lurking danger of a renewed outbreak in the fall, as happened in 1918 with the Spanish flu. Worrisome issues like these may weigh on the economy for months to come – these and many other concerns may delay any return to normal, in the economy generally, and in the D&O insurance marketplace in particular.