It is not uncommon for coverage disputes to arise in connection with D&O insurance claims, but every now and then there is a coverage dispute so broad that it constitutes a veritable D&O insurance coverage curriculum. That was certainly the case in what a Delaware Superior Court judge called the “sprawling insurance coverage dispute” between a unit of Northrup Grumman and its predecessors-in-interest’s D&O insurers. The coverage dispute arose out of underlying claims relating to the 2015 merger of Alliant Techsystems, Inc and Orbital Sciences Corporation to form Orbital ATK, Inc. The court’s lengthy opinion on the parties’ cross-motions for summary judgment and for judgment on the pleadings covers a wide variety of recurring D&O insurance coverage issues and makes for interesting reading for anyone involved with D&O insurance. The Delaware Superior Court’s February 2, 2021 opinion in the Northrup Grumman case can be found here.
On April 29, 2014, Alliant and Orbital Systems announced their proposed merger plan. The merger transaction closed on February 9, 2015. The transaction resulted in the formation of Orbital ATK (OATK). Pursuant to the terms of the merger agreement, Orbital’s stock was converted into a right to receive Alliant stock. The stock swap resulted in an ownership split consisting of a 53.8% stake for Alliant shareholders and a 46.2% stake for Orbital Sciences shareholders. Alliant was then renamed OATK and the stock was converted accordingly. Northrup later acquired OATK.
Prior to the merger that formed OATK, David Thompson was the Chairman of the Board, CEO, and President of Orbital Sciences; Garrett Pierce was the Vice Chairman of the Board and CFO of Orbital Sciences; and Mark DeYoung was the CEO and President of Alliant. Following the merger, Thompson became OATK’s President and CEO and Pierce became OATK’s CFO. DeYoung served as an OATK director following the merger until March 2016.
The Underlying Litigation
On August 12, 2016, a plaintiff shareholder (Knurr) filed a securities class action lawsuit in the Eastern District of Virginia against OATK and certain of its directors and officers. The lawsuit related to OATK’s August 2016 announcement that it would have to restate its financials to reflect losses on a 2013 contract to manufacture bullets for the U.S. military at a U.S. government facility. Following further investigations, OATK disclosed that the statements would go back to 2013 and would amount to approximately $400 million in adjustments.
On April 24, 2017, the lead plaintiff in the Knurr action filed an amended complaint in the Knurr litigation. The amended complaint was filed on behalf of two plaintiff classes: a class alleging violations of Section 10 (b) and consisting of investors who purchased OATK securities between May 28, 2015 and August 9, 2016; and a class alleging violations of Section 14(a) of the Securities Exchange Act and consisting of investors who exchanged shares of Orbital Sciences common stock for shares of Orbital ATK common stock on or around February 9, 2015.
The amended complaint included as defendants not only OATK, but also, among others, Thompson and Pierce, who prior to the merger were both executives at Orbital Sciences; and DeYoung, who prior to the merger was an executive at Alliant.
In the Section 10(b) claim, the class alleged that OATK distributed false post-merger data about OATK’s financial health. In the Section 14(a) claim, the class alleged that DeYoung, Thompson, and Pierce, in their former roles, were responsible for false or misleading statements in the proxy statement and other materials distributed in advance of the merger transaction. The allegedly false statements prior to the merger “caused Alliant to be overvalued” and impacted the OATK ownership split, which, in turn, deprived them of “their right to a fully informed vote and induced them to vote their shares and accept inadequate consideration.”
The parties to the Knurr litigation ultimately agreed to settle the Section 10(b) claims for approximately $62.4 million and the Section 14(a) claims for $45.6 million.
The Insurance Coverage Dispute
The insurance coverage dispute involved three separate towers of insurance, one each for OATK; Alliant; and Orbital Sciences. Northrup sought coverage from each of the three towers. For varying reasons, each of the three towers denied coverage. Northrup launched a coverage lawsuit against the insurers. Northrup and each of the three insurers filed various cross-motions for summary judgment or judgment on the pleadings.
The February 2, 2021 Opinion
In his 60-page February 2, 2021 opinion, Delaware Superior Court Judge Paul R. Wallace held that the policy provisions on which the OATK and Alliant insurers relied did not preclude coverage as the insurers contended and he left for trial the question of whether or not coverage under the Orbital Sciences insurers’ policies was precluded by Northup’s late provision of notice of claim.
The OATK insurers
The OATK insurers contended that coverage for the Section 10(b) claim was precluded by their policies’ Prior Acts Exclusion. The Exclusion provides that the insurers “shall not be liable to make any payment for Loss in connection with any Claim made against [OATK and its directors and officers] occurring prior to February 9, 2015 …. Loss arising out of the same or related Wrongful Act shall be deemed to arise from the first such same or related Wrongful Acts.” As Judge Wallace restated it, “the Prior Acts exclusion strips coverage from an otherwise covered Wrongful Act if the latter is infected by a Wrongful Act that occurred before the coverage period commenced.”
After concluding that Delaware law applied to the contractual law issues on which the OATK insurers relied, Judge Wallace then addressed the OATK insurers contention that the Prior Acts Exclusion bars coverage for the Section 10(b) claim because the 10(b) claim is related to the Section 14(a) claim that occurred before the Policy Period of the OATK policies. In rejecting this argument, Judge Wallace noted that the 14(a) claim was brought against Alliant and Orbital Sciences personnel in their capacities as directors and executives of those firms – it was not brought against OATK or its executives, and, indeed, as Judge Wallace noted, it couldn’t have been as the alleged Section 14(a) wrongdoing took place before OATK was created. The Section 10(b) claim, Judge Wallace noted, “alleged wrongdoing by OATK and its management squarely within the Policies’ period and purpose.” The Prior Notice Exclusion, Judge Wallace said, “unambiguously … does not reach the 14(a) Claim” and therefore “coverage for the 10(b) Claim in unaffected by the 14(a) Claim.”
The OATK insurers tried to circumvent this distinction by arguing that OATK and Alliance are really just the same firm because Alliant merely changed its name to OATK. Judge Wallace noted that the polices “unambiguously were issued to OATK – a legally distinct entity, regardless of the effect a name change might have.” The Prior Acts Exclusion in the OATK policies, Judge Wallace said, “simply doesn’t concern Alliant’s Wrongful Acts. And why would it? Alliant had its own Policies and OATK reasonably expected that it was purchasing separate insurance for its separate liabilities.”
This interpretation, Judge Wallace said, did not, as the OATK insurers contended, render the exclusion superfluous, because the exclusion might apply “if the insured’s management were sued for misconduct arising prior to and during the policy period but attributable to an overlap in their pre-period and in-period roles.” As he noted, “just because OATK’s manager were sued in unconnected capacities for wrongdoing with different aims engaged at different firms doesn’t mean the Exclusion is inconsequential. It simply means the Exclusion is of no consequence under these facts – and that OATK’s Policies cover the Section 10(b) Claim.”
Finally, Judge Wallace addressed the OATK insurers’ argument that certain investigatory costs OATK had incurred were not covered Defense Costs within the meaning of the policy. The OATK insurers contended that the challenged fees were incurred prior to the Knurr litigation and thus were charged before a Claim existed. Judge Wallace noted that Delaware law “takes an expansive view of Defense Costs.” He noted that there was opposing testimony about whether defense counsel use pre-litigation insights to defend the litigation once it was filed. Judge Wallace found that there was an issue for trial on the question whether the disputed investigatory costs were reasonably necessary in minimizing litigation expenses and developing defense strategies. Judge Wallace noted that the costs, though incurred pre-litigation, may have been incurred during discovery anyway. Even if the costs were “ancillary,” that does not, Judge Wallace said, render them Non-Defense Costs, adding that the OATK insurers can fight the bill at trial.
The Orbital Sciences Policies
The Orbital Sciences insurers argued that coverage was precluded under their policies because of Northrup’s late provision of notice of claim. (The opinion does not detail the specifics of the Orbital Sciences insurers’ late notice defense, but one of the opinion’s footnotes notes that the insurers contend that Grumman “waited 438 days” to provide notice. Northrup apparently argued that facts in dispute showed that the insurers were “directly or indirectly” notified of the claim)
The Orbital Sciences policies provide that
As a condition precedent to their rights under this Policy, the Insureds shall give the Underwriter written notice of any Claim made against the Insureds as soon as practicable after the Company’s risk manager or general counsel first learns of such Claim, but in no event later than (i) ninety (90) days after expiration of the Policy Period or (ii) expiration of the Extended Reporting Period or Run-Off Coverage Period, if exercised.
In assessing this argument, Judge Wallace applied Delaware choice-of-law principles to determine which jurisdiction’s law governed the Orbital Sciences insurers’ late notice defense. (The Orbital Sciences insurers argued that Virginia law should apply as that is where the company had its headquarters.) Delaware law, he determined, had the most significant relationship to the dispute, because Delaware’s courts have “held consistently that, in the D&O insurance context, Delaware takes an overriding interest in disputes involving coverage for fiduciary mismanagement of Delaware organizations.” Having determined that Delaware law governed the issue, Judge Wallace then denied the Orbital Sciences insurers’ motion for summary judgment on the late notice issue, on the grounds that under Delaware law late notice cannot be resolved on summary judgment, as the insurers must establish that they were prejudiced by the late notice.
The Alliant Policies
The Alliant insurers sought to deny coverage for the Section 14(a) claim in reliance on their policies “Bump Up” Provision. This provision provides that
In the event of a Claim alleging that the price or consideration paid for the acquisition or completion of the acquisition of all or substantially all the ownership interest or assets in an entity is inadequate, Loss with respect to such Claim shall not include any amount of any judgment or settlement representing the amount by which such price is effectively increased …; provided, however, that this paragraph shall not apply to Defense Costs or to any Non-Indemnifiable Loss in connection therewith.
Judge Wallace held that though this provision was found in the policy’s definition of Loss, it was effectively an exclusion. He concluded that the provision does not operate to preclude coverage for the Section 14(a) claim, in reliance on three ground.
First, he said, the provision precludes coverage in connection with claims that allege only that the consideration exchanged as part of a control transaction was inadequate. The Section 14(a) claim, he said, was not exclusively about the Orbital Sciences’ shareholders’ inadequate consideration. The 14(a) claim, Judge Wallace said, was about the Orbital Sciences officials’ dissemination of an allegedly false proxy statement. The officials’ misstatements not only “coerced” Orbital Sciences shareholders to “accept inadequate consideration,” but also “induced them to vote their shares” when they otherwise wouldn’t have. A “federal securities class action about fabricated proxy forms is not the narrowly tailored fit this Exclusion imagined.”
Second, the provision applies solely to “a special type of transaction” – that is, “an acquisition of all or substantially all of an entity’s assets or ownership.” However, the Section 14(a) allegations were based on a merger, not an acquisition. The Alliant insurers tried to argue that the specifics of the transaction effectively made it an acquisition, but Judge Wallace rejected this argument on the grounds that what the transaction accomplished was a stock-for-stock merger. Moreover, he concluded, Alliant did not, as would be required in order for the Bump Up provision to apply, acquired all or substantially all of the ownership of Orbital Sciences; the Alliant and Orbital Sciences shareholders shared 53.8% and 46.2% (respectively) in OATK once the transaction closed.
Finally, Judge Wallace said, the Alliant insurers can’t show that the settlement of the Section 14(a) claims “represent(s)” an “effective increase” of the supposed “inadequate consideration” of which the Orbital Sciences stockholders complained. The Orbital Sciences shareholders didn’t seek an appraisal, he said, they sought unelaborated compensatory damages for the overvalued Alliant stock “extracted through falsified proxy forms.”
Judge Wallace’s lengthy opinion covers a lot of ground. I have tried to summarize his rulings above but in condensing I necessarily omitted details, some of which may be material. In addition, his opinion addresses still other issues that I was not able to include in my summary. Students of D&O insurance coverage issues will want to read the entire opinion rather than just relying on my summary.
While Judge Wallace’s opinion covers a lot of ground, there is one generalization that can be applied to the opinion as a whole, and that is that it is generally favorable to the policyholder and generally unfavorable to the insurers. In that respect, this opinion is generally consistent with other recent D&O insurance coverage opinions coming out of Delaware’s courts. Although it is not a universally valid proposition, it is generally true that on balance policyholders will want to have their D&O insurance coverage disputes resolved in Delaware courts. Insurers? Not so much.
Although there are several parts of Judge Wallace’s opinion I could reference in support of the proposition that Delaware is a policyholder-favorable forum, I think the most telling is Judge Wallace’s choice of law analysis, made in reliance on Delaware choice of law principles. Though the principles refer to the generally accepted “most significant relationship” test, the Delaware principles as applied give little weight to typical considerations such as where the contract was delivered or where the underlying conduct took place, and instead give virtually preclusive effect to the policyholder’s state of incorporation. And why is this consideration given predominant weight? Because – to cut to the chase on what it is really going on here – Delaware clearly thinks it has an interest in seeing that D&O insurers pay the claims of corporations incorporated under the laws of the state.
In reading this opinion, I wondered – not for the first time – how long it will be before choice of law or choice of forum provisions start to become standard features of D&O insurance policies. There are a lot of insurers who are parties to this coverage dispute and who when they got done reading Judge Wallace’s opinion decided that in the future they would prefer to litigate their issues somewhere other than Delaware.
Which is not to say that I am prepared to defend the insurers here. For those of us who are routinely involved in D&O claims situations, there is something basic about this situation that might be easy to overlook. That is, all of the insurers – three towers worth – denied coverage for this claim. (To be sure one of the insurers on one of the towers did separately settle with Northrup.) The underlying litigation is exactly the kind of circumstance for which companies buy this kind of insurance. The insurers’ response was uniform – “Not me.”
All of that said, there are parts of this opinion that are worth further contemplation. The purpose and effect of both the Prior Acts exclusion in the OATK policies and the Bump Up Provision in the Alliant policies in the context of a merger transaction are worth thinking about. I will say this about the Bump Up provision and that is that in general in the D&O insurance industry there is a lot of not very careful thinking about the Bump Up exclusion and what it is there for. For example, I regularly hear D&O insurance professionals refer generically to merger objection claims as bump up claims, even when there is no inadequate consideration component of the merger objection lawsuits. Most merger objection lawsuits these days are inadequate disclosure claims not inadequate consideration claims, yet you will still hear some people refer to all merger objection suits as bump up claims. Whatever else might be said about the merits of the Alliant insurers’ position regarding the bump up claims provision, the specifics of merger objection lawsuits matter, and many merger objection lawsuits do not involve bump up claims.
One particular aspect of Judge Wallace’s decision that is particularly interesting for those of us on the policyholder side of the aisle, and that is the part where he reserved for trial the question of whether the investigative costs incurred before the litigation constitute covered defense expense. This aspect of Judge Wallace’s opinion is noteworthy because there is a perennial D&O insurance claims issue about whether pre-claim costs can count as defense expense. In holding this issue over for trial, Judge Wallace considered, and gave weight to, many of the arguments that usually come up, such as that the work was vital to the later defense, or that the amounts would have been spent later anyway. Policyholder-side advocates may take heart from this portion of Judge Wallace’s opinion.
One final note: this dispute could still have a long way to go yet. If the parties are not able to reach a compromise, there are a number of issues that are going to go to trial. There could be appeals beyond that. There is a long road ahead before the parties’ disputes are resolved.
Special thanks to the several loyal readers who send me a copy of Judge Wallace’s opinion.