One of the recurring D&O insurance coverage issues is whether or not the so-called “bump-up” exclusion precludes coverage for amounts paid in settlement of post-merger litigation. The outcome of these disputes is often a reflection of several situation-specific factors, including the specific policy language involved, the nature of the underlying transaction, the claims alleged in the underlying litigation, the features of the settlement, and the applicable law. All of these factors came into play in a recent Delaware Superior Court decision in which the court held that the primary policy’s bump-up exclusion does not preclude coverage for the settlement of the lawsuit relating to the 2017 merger of Harman International Industries and Samsung’s American division. The court’s January 3, 2025 opinion, as amended in a January 7, 2025 corrected opinion, can be found here.

Background

In November 2016, Harman and Samsung Electronics America, Inc. announced that they had entered into an Agreement and Plan of Merger. The transaction was completed in March 2017, as a subsidiary of Samsung, Silk Delaware, created for the transaction, “merged with and into Harman,” though a “reverse triangular merger.” Both companies survived, with Harman “a wholly owned subsidiary of Samsung,” and with the outstanding stock of Harman cancelled and converted in a right to receive cash.

In July 2017, Judith Baum filed an amended class complaint against Harman and others alleging that the defendants had violated Sections 14(a) and 20 of the Securities Exchange Act of 1934. The suit alleged that Harman had issued a misleading proxy statement in order to “secure shareholder support for the undervalued Acquisition.” Among other things, Baum alleged that Harman’s valued was “far greater than the $112.00 per share that shareholders received.” Baum alleged that as a result of the defendants’ wrongdoing, the putative class “suffered damage and actual economic loss (i.e., the difference between the price Harman shareholders received and Harman’s true value at the time of the Acquisition).” The Baum action ultimately settled for $28 million.

At relevant times, Harman maintained a $40 million program of D&O insurance, consisting of a layer of primary insurance and two layers of excess insurance. Harman submitted the Baum lawsuit to its insurers as a claim. The primary insurer accepted the claim and acknowledged its obligation to fund the company’s defense but reserved its rights to deny coverage with respect to any settlement or judgment of the claim. The primary insurer ultimately denied coverage for the settlement in reliance on the policy’s bump-up exclusion. . The excess insurers adopted the primary insurer’s coverage position. Harman sued the insurers in Delaware Superior Court seeking coverage for the settlement amount. The parties filed cross-motions for summary judgment in the coverage lawsuit.

The Relevant Policy Language

The primary policy’s definition of “Loss” provides in pertinent part that:

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.

The Court’s Opinion

In his January 3, 2025, opinion, as amended in the updated January 7, 2025, opinion, Judge Paul R. Wallace granted Harman’s motion for summary judgement and denied the insurers’ motion for summary judgment. Judge Wallace held that the bump-up exclusion does not preclude coverage for the $28 million settlement of the underlying action.

Harman had argued that the insurers cannot satisfy their burden to establish that all of the elements of the exclusion apply. Specifically, Harman argued that the insurers cannot show that the underlying transaction was an “acquisition of all or substantially all of an entity’s assets or ownership”; that the Baum action settlement was “related only to the allegation of inadequate consideration”; and that the Baum action settlement “represented an effective increase in consideration.”

The court first found that the underlying transaction was an “acquisition” within the meaning of the exclusion. The reverse triangular merger form the parties had used in the transaction, the court said, was “was an acquisition that used a merger as a means to complete Samsung’s acquisition of all or substantially all the ownership interest of Harman.” Judge Wallace also found that based in itscharacteristics, as well as its legal form, the transaction was an “acquisition” for purposes of analyzing the potential applicability of the bump-up exclusion.

As for whether the Baum action settlement represented an effective increase in the deal price, Judge Wallace focused on the allegations of the plaintiff in the underlying action that the defendants had violated the Exchange Act. Judge Wallace said that a “cured inadequate deal price” isn’t a remedy for Sections 14 and 20 claims; as only violations of Sections 14 and 20 were alleged, “there is no claim plead where inconsiderate deal price is a viable remedy.” So, Judge Wallace rhetorically asked, “how could the settlement amount now be deemed to be comprised in any part of a sum reflecting an increase in deal price or consideration?”

Finally, Judge Wallace found that the insurers had not carried their burden of showing that any amount of the settlement pertained to curing an inadequate deal price. Judge Wallace quoted deposition testimony that at the time of settlement, the defendants’ estimated costs to defend the action were between $25 and $30 million – the $28 million settlement amount, Judge Wallace noted, is in the middle of that cost of defense estimate. Judge Wallace also found that the $28 million settlement amount was “grossly inadequate” if it were intended to represent the inadequate deal price, as the Baum action complaint had claimed the deal price was short over $279 million. Judge Wallace also found that the composition of the settlement class was inconsistent with the proposition that the settlement amount was intended to compensate for inadequate deal value.

Discussion

As I have noted in numerous post on this site, most recently here, the potential application of the bump-up exclusion to preclude coverage for the settlement of a merger objection lawsuit is a frequently recurring and often hotly contested D&O insurance coverage issue. And as I noted at the outset of this post, the outcome of these disputes is a reflection of numerous case-specific factors, including the wording of the applicable exclusion, the structure of the underlying deal, and even of the law of the jurisdiction applicable to the insurance contract.

One particular recurring disputed issues is whether the specific transaction involved is an “acquisition” or otherwise is the type of transaction to which the exclusion was intended to apply. In that respect, Judge Wallace’s opinion is interesting, as he seemed to adopt a broad interpretation of what might constitute an “acquisition”; in particular, his conclusion that the reverse triangular merger is, in form and in its characteristics, the kind of “acquisition” to which the exclusion applies is interesting. This part of the opinion probably gladdened the hearts of many insurer-side coverage advocates.

The rest of Judge Wallace’s opinion was undoubtedly less satisfactory to the insurers.

I suspect the insurers are probably still in a state of disbelief that the settlement of a lawsuit in which the plaintiff expressly alleged that the defendants’ alleged wrongdoing caused the plaintiff class to receive inadequate consideration is — because recovery of inadequate consideration is not a recognized remedy for the specific legal theories asserted — not a claim for the recovery of inadequate consideration. The insurers are undoubtedly saying out loud to anyone that will listen, “But that is what the plaintiff sought! That was the harm the plaintiff alleged! Those are the damages they were after!”

The final part of the opinion, in which Judge Wallace found that the defendants had not established that any portion of the settlement represented compensation for inadequate consideration, is probably also disappointing to the insurers, although the record does seem to suggest that the settlement of the underlying case was a cost of defense type settlement. The testimony, at least as interpreted by Judge Wallace, showed that the settlement amount was consistent with the estimated costs of defense but inconsistent with the plaintiff’s inadequate consideration theory.

I can easily imagine that part of the insurers’ reaction is: here we go again with the Delaware courts. As I have frequently observed on this blog, and as numerous others have also observed, Delaware’s courts have a well-deserved reputation for being policyholder favorable. The insurers may be forgiven if they conclude that this is just one more example of Delaware courts policyholder favoritism. Long-time readers may recall that back in 2021, Judge Wallace had previously held (among many other things) that the bump-up exclusion did not apply to preclude coverage of a Section 14(a) merger objection lawsuit in the Northrup Grumman case, as discussed here; in my discussion of that prior ruling, I had commented that the best way to understand the outcome of that case is to appreciate that Delaware is an actively policyholder-favorable forum.  

From my perspective, there is more to think about here than just whether policyholders are likely to win insurance coverage disputes in Delaware. I think it is more important to ask the question of the bump-up exclusion as it is currently typically worded is functioning as intended, from the perspective of either party.  The insurers may well feel that it is not functioning as intended when it is held not to apply to the settlement of a claim in which the plaintiff expressly sought to recover inadequate acquisition consideration. From a policyholder perspective, I have long questioned whether it should apply when the underlying transaction involves the acquisition of the insured company (so-called “sell side” transactions), rather than the insured company’s acquisition of another company (so-called “buy side” transactions).

In prior posts, I have suggested that it may be time for the industry as an industry to re-examine the bump up exclusion. The current wording leads to too many insurance coverage disputes, and it often produces results that may leave either insurers or insureds disappointed and frustrated. In my view, everyone would benefit if, as an industry, we were to step back and ask: what is the purpose of the bump-up exclusion and how should it operate in light of the larger purposes of the D&O insurance policy?

These issues are not going away. The Fourth Circuit is currently considering the appeal of the bump up issues in the WTW case, as discussed here, and we can be sure that at some point this year, we will be talking about these issues again in the context of that case. Set a watch on it, we will be talking about these issues again in a few months’ time when the Fourth Circuit issues its opinion in the WTW case.

There is also a lot of speculation that M&A activity will be ramping back up under the incoming Trump administration. If that proves to be the case, it seems likely that along with the M&A transactions, there will be merger litigation, and along with it, renewed battles about the preclusive effect of the bump up exclusion. All the more reason for the D&O insurance industry to reexamine what the bump up exclusion is for, how it should be worded, and how it should fit in with the rest of the D&O Insurance policy.

Special thanks to a loyal reader for sending me a copy of Judge Wallace’s opinion.