Readers may have seen the news this past week that WTW has filed an appeal to the Fourth Circuit of the district court’s holding that the bump-up exclusion in its D&O insurance policy precludes coverage for the settlement of the post-closing lawsuit filed  the company’s merger with Towers Watson. This appeal is in fact the second time this coverage lawsuit has made its way to the Fourth Circuit. This appeal will be closely watched not only because of the parties involved, but also because, as discussed in a recent memo from the Cooley law firm, issues surrounding the bump-up exclusion increasingly have been the source of litigated coverage disputes, and indeed questions concerning the exclusion are increasingly common. For reasons discussed below, I think there are important issues about this exclusion that the D&O insurance industry should be discussing.

The Cooley law firm’s July 11, 2024, memo entitled “Will A Bump-Up Exclusion Bar Coverage of an M&A Settlement? It Depends” can be found here.

As the law firm memo states, “as public company M&A deal litigation has accelerated, D&O insurers are relying on the bump-up exclusion more frequently and applying it more broadly to exclude coverage.” The law firm memo also makes it clear that the outcome of litigation over the bump-up litigation has been highly variable, depending on a wide variety of factors, including, the memo notes, “The wording of the exclusion, the structure of the underlying deal, and the law of the jurisdiction applicable to the insurance contract.”

When it comes to the issue of the wording of the exclusion, I have strong views, which, in fact, I have raised in prior posts. In order to review my concerns, it might be helpful to review the language of a typical exclusion. Here is the exclusionary language at issue in the WTW litigation:

In the event of a Claim alleging that the price or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all the ownership interest in or assets of 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 or consideration is effectively increased; provided, however, that this paragraph shall not apply to Defense Costs or to any Non-Indemnifiable Loss in connection therewith.

Readers will note that this exclusion refers to the acquisition of “an entity.” Many disputes involving the bump up exclusion involve the question of what the phrase “an entity” refers to. In coverage disputes involving bump up exclusions with language similar to this, insurers argue that the exclusion applies whether or not the insured company is the acquiror or the acquisition target – in both cases, the transaction involves the acquisition of “an entity.” Although this formulation – that is, wording that makes the exclusion appliable whether or not the insured company is the acquiror or the acquisition target – is common in the industry and arguably is the most common bump-up exclusion language, there is alternative language available in the marketplace in at least some instances that restricts the exclusion’s application to circumstances when the insured company is the acquiror.

From my perspective, the insurance issues are (or at least should be) categorically different depending on whether the insured company is the acquiror or the acquisition target.

On the one hand, if the insurer company is the acquiror, the company cannot simply underpay for an acquisition and then turn to the insurer as some sort of third-party capital partner with the expectation that the insurer should make up the shortfall. In that circumstance it is quite reasonable that the amount of the shortfall should be excluded from coverage. (The law firm memo refers to this circumstance as involving “buy-side” insureds, for which coverage, according to the memo, traditionally has been excluded.)

On the other hand, if the insured company is the acquisition target (that is, when the insured company is on what the law firm memo calls the “sell-side”), and shareholders have alleged that the company and its executives wrongfully agreed to sell the company for an insufficient amount, those allegation look and sound like the very kind of thing the policy is designed to insure against; the shareholders’ allegations that in agreeing to sell the company for an insufficient amount the executives breached their duty of care or duty of loyalty has all the hallmarks of a classic D&O claim. In my view, the shareholders’ damages for the executives’ alleged violations of their duties in agreeing to sell the company for an insufficient amount arguably represent the very kind of thing for which the policy should provide protection.

As I noted above, there is language available in the marketplace that restricts the reach of the bump-up exclusion to those circumstances when the insured company is on the “buy side”; under exclusions with this formulation, the exclusion does not apply when the insured company is on the “sell side.” This language is clearly preferable, although, to be sure, this more restrictive language is not always available, and the presence or absence of this more restrictive language in a policy must be weighed in the policy acquisition process against all of the other policy terms and conditions on offer, including pricing, limits, retentions.

The law firm memo also identifies another issue that frequently arises with respect to the bump-up exclusion, and that is whether or not the specific transaction involved is an “acquisition” of the type to which the exclusion is intended to apply.

The memo cites two examples of disputes where the transaction at equal is a so-called “merger of equals.” In one of the cases the memo discusses, the court found that a transaction of this type is an “acquisition” of the type to which the exclusion applies; in another case the memo discusses, the court concluded that a merger of equals is not an “acquisition” of the type to which the exclusion was intended to apply. The disparity of outcomes of this issue highlights another concern with the language involved in the bump-up exclusion; all parties would benefit if there were greater certainty about the kinds of transactions to which the exclusion applies.

The law firm memo correctly notes that the question whether a bump-up exclusion applies to a particular settlement “depends on the wording of the exclusion, the structure of the underlying deal, and the law of the jurisdiction applicable to the insurance contract.” However, many of the disputes over the exclusion’s applicability arguably could be avoided altogether if the concerns with the typical exclusionary language were addressed  — and, in my view, would produce outcome more consistent with the overall purposes of the insurance policy if the bump-up exclusion were limited to the circumstances when the insured is on the “buy side,” and would not apply if the insured company is on the “sell side.”

I think everyone – insurers and policyholders alike – would benefit if there were further discussion within the D&O insurance industry of the bump-up exclusion and a reconsideration of what its purposes are and how it should operate in light of the larger purposes of the D&O insurance policy.

In the meantime, it is important for public companies and their advisors to review proposed D&O insurance policy language to ensure, as the law firm memo puts it, “sufficient coverage in the event of post-close merger litigation.” The law firm itself says that “we expect insurance carriers will include broad and effective exclusion provisions that will limit coverage of breach of fiduciary duty claims arising out of an M&A transaction.” This observation underscores both the importance of the language in the bump-up exclusion and the need for the industry as a whole to reconsider these issues.