The D&O insurance coverage decisions are coming out of the Delaware courts so fast and furious these days that it is getting hard to keep up. Just days before the Delaware Supreme Court issued its high-profile opinion in the Dole Foods case (which I discussed in yesterday’s post), the Delaware Superior Court issued an opinion in the Sycamore Partners case. As may come as no surprise to many industry observers, is favorable to policyholders. The Superior Court held in the Sycamore Partners case that Delaware law applies to the question whether disgorgement or restitution of ill-gotten gains is uninsurable, and held further that as Delaware has no public policy that would prohibit the insurance, the so-called uninsurability defense does not preclude coverage for the amounts. While I have been critical of several recent Delaware court insurance coverage decisions, I have fewer concerns about the Sycamore Partners decision, as discussed below. A copy of the Superior Court’s February 26, 2021 decision can be found here.
In 2014, Sycamore purchased the Jones Group, a fashion brands holding company, through a leveraged buyout. The Jones Group was renamed as Nine West. Nine West then sold certain high-performing assets to Sycamore from which Sycamore extracted significant dividends. Sycamore then sold the assets on the secondary market for substantial profits. Nine West, in the meantime, was left saddled with debt and ultimately filed for Chapter 11 bankruptcy.
In the bankruptcy proceedings, Nine West’s estate sued Sycamore and related entities and individuals alleging fraudulent transfers, breaches of fiduciary duty, and related business torts. Sycamore ultimately settled the claims for an agreement to pay Nine West’s estate $120 million.
The Insurance Issues
At relevant times, Sycamore maintained a program of D&O and E&O insurance consisting of a layer of primary insurance and several layers of follow form excess insurance. Sycamore sought to have its insurers pay the Nine West settlement amount as well as the costs incurred in defending the Nine West action. The insurers denied coverage for the amounts in reliance on the “uninsurability defense” (described further below). Sycamore initiated insurance coverage litigation against the insurers in Delaware Superior Court. Sycamore then filed a motion for partial judgment on the pleadings with respect to the uninsurability defense issue.
The Relevant Policy Language
The policy’s definition of Loss includes “settlements,” “judgments,” “damages,” and defense expense, but excludes “amounts which are uninsurable under the law most favorable to … insurability.” As the Superior Court later put it, under this provision, the policy bars coverage for expenses that are “uninsurable” in a jurisdiction that would be most likely to construe the Loss as insurable.
The insurers argued that the settlement amount is uninsurable as a matter of public policy because it represents disgorgement of or restitution for ill-gotten gain. Sycamore, organized under the laws of Delaware, argued that the “law most favorable” to the insurability issue is the law of Delaware, which has no public policy against insurability of disgorgement or restitution amounts. The insurers argued that because Sycamore is based in New York and because the policies were negotiated and delivered in New York, New York law should apply, and, further that New York does have a public policy against insurability of disgorgement and restitution amounts.
The February 26, 2021 Opinion
In a February 26, 2021 opinion, Delaware Superior Court Judge Abigail Legrow granted Sycamore’s motion and entered judgment in Sycamore’s favor with respect to the insurability issue.
In addressing the parties’ positions, Judge Legrow held that the “law most favorable” provision “unambiguously” is an enforceable choice of law clause that allows Sycamore to select a forum for determining whether a Loss is uninsurable. Because Sycamore is organized under the laws of Delaware, and because Sycamore’s choice of Delaware law is therefore a reasonable choice, Delaware law and public policy govern the uninsurability issue. In Delaware, Judge Legrow said, public policies against insurability must be pronounced by statute. Because the Delaware legislature has not enacted a law rendering restitution or disgorgement uninsurable, the insurer’s uninsurabiltiy defense therefore fails.
In reaching these conclusions, Judge Legrow rejected the insurers’ various counterarguments, noting that the insurers “fault the wording they voluntarily accepted,” including their argument that the clause is not a choice of law clause because it fails to specify the “law most favorable.” Judge Legrow also rejected the insurer’s argument that the clause is unenforceable because it would negate an important public policy of New York, the state whose law would apply in the absence of the provision. Judge Legrow rejected the argument that New York would apply in the absence of the provision, concluding rather that Delaware law would apply even in the absence of the provision, citing for this proposition Delaware’s “superseding interest in the merits of disputes involving insurance coverage for fiduciary mismanagement of Delaware organizations.”
Regular readers know that I have been drawing attention to the Delaware courts’ apparently policyholder-friendly approach to D&O Insurance coverage issues. Some observers might say that this Sycamore decision is just the latest evidence of Delaware courts’ approach; to be sure, Judge Legrow’s ruled in policyholders’ favor and rejected the insurers’ arguments. However, some industry observers have expressed concerns about the Delaware courts’ apparent policyholder inclination in other instances, I think there is a good argument that in this case the court got it right, at least with respect to the “law most favorable” issue.
The whole point of the “law most favorable” language is so that the policyholder can choose which jurisdiction’s law should govern the question of insurability. Given the role of this language in the policy and the way the policy is intended to work, Sycamore was entirely within its rights to choose Delaware law as applicable to the insurability issue – indeed, that is exactly the way this standard policy language is supposed to work.
The insurers here may be correct that the Nine West settlement represented disgorgement or restitution of ill-gotten gains, and they may be entirely correct that New York law would have barred the insurance of the settlement, but does not change the fact that the policy language expressly gives the policyholder the right to choose which jurisdiction’s law applies to the insurability issue.
In my opinion, Judge Legrow was correct in rejecting the insurer’s arguments against Sycamore’s choice of law. Indeed, I will go further than that – I seriously do not see how the insurers believed that they had any right to object to the policyholder’s choice of law. Of course, I understand that the insurers were offended by the fact that they were being asked to insurer the policyholder for its return of amounts to which it was not legally entitled. But just the same, it was not a good look for the insurers to be in the position, as Judge Legrow put it, of trying to find fault with the policy wording to which they had agreed (and that is in fact industry standard language).
For the D&O insurers keeping score back in their offices, the outcome of this case – that is, that the insurers have to pony up to reimburse Sycamore for its return of amounts to which it was not legally entitled – will be one more gripe in their growing list of grievances with the Delaware courts. And even though I generally think that Judge Legrow got the “law most favorable” issue right, I am nevertheless troubled by her conclusion that even in the absence of the “law most favorable” clause that Delaware and not New York law would govern interpretation of the uninsurability defense. As I made clear in my recent post discussing the Delaware Supreme Court’s recent Dole Foods decision, I have a real problem with the Delaware courts’ conviction that merely because a firm is organized under Delaware’s law that Delaware law should control D&O insurance policy interpretation issues.
So even though I think Judge Legrow got the “law most favorable” issue right in this case, I still think her decision is likely to add that much more fuel to the issue on the question of whether D&O insurers should consider adding either choice of forum or choice of law provisions (or both) to their policies. However, even if insurers do come around to the conclusion that it is time to add choice of forum or choice of law provisions to their policies, this case shows that the insurers are going to have to consider other existing provisions in their policies as well. In that regard, I am skeptical that the D&O insurance marketplace would easily give up on the “law most favorable” wording. It is standard language, it has been there a long time, and it is there to address some very important concerns.
All of that said, there is one thing I will say for sure about the recent rash of coverage decisions that have been coming out of Delaware’s courts, and that is the D&O insurance industry is being challenged in fundamental ways that is basically forcing everyone in the industry to confront some very basic things about the D&O insurance policy, including things that have long seemed settled.