supctsealOn June 25, 2014, in an unexpected development at the end of its current term, the U.S. Supreme Court held in Fifth Third Bank v. Dudenhoeffer that ESOP fiduciaries are not entitled to a “presumption of prudence” in connection with their decision to invest in or maintain investments in employer stock.  In a unanimous opinion written by Justice Stephen Breyer, the Court held that ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, other than the duty to diversify plan assets.  A copy of the court’s opinion can be found here.

 

In recent years, several of the Circuit courts had recognized the existence of a presumption of prudence for ESOP plan fiduciaries. Many ESOP plan fiduciaries had successfully relied on the presumption as the basis for a motion to dismiss claims filed against them under ERISA. The Supreme Court’s opinion could make it more difficult for ESOP fiduciaries to obtain dismissal in ERISA stock drop cases. However, the Court did recognize the importance of motions to dismiss in helping to weed out meritless suits. The Court laid out several guidelines for the lower courts to use in considering motions to dismiss in ERISA stock drop suits. The net effect of the Court’s opinion is that the environment for ERISA stock drop litigation has been substantially changed.

 

Background

Congress has recognized that Employee Stock Ownership Plans (ESOPs) and Eligible Individual Account Plans (EIAPs), which invest in employer stock, further an important public policy goal by encouraging employee ownership. The lower courts in turn had held that fiduciaries of these types of plans should not be subject to liability for investing in employer stock, as that was the reason the plans were created, consistent with the Congressional objective of fostering employee ownership.

 

In a 1995 decision, Moensch v. Robertson (here), the Third Circuit concluded that fiduciaries of plans that required or encouraged investment in employer stock were entitled to a presumption that they acted prudently under ERISA by investing in the employer stock. This presumption could only be overcome by a showing that the plan fiduciaries abused their discretion by continuing to invest in the employer stock. Several circuit courts adopted the Moench presumption of prudence; however, the courts disagreed about whether the presumption could be raised at the motion to dismiss stage and how the presumption could be rebutted.

 

This case involves Cincinnati-based Fifth Third Bank and arises out of the global financial crisis. The plaintiffs in the case are employees of the bank and participants in the company’s profit sharing plan. Participants in the plan had the option of investing the funds in their plan accounts in several different investments, including the stock of Fifth Third Bank. The bank matched a portion of an employee’s investment in their plan account with stock of the bank, although after a period the employee was free to transfer the stock match investment to other authorized investments.

 

In their complaint, the plaintiffs allege that the bank, its CEO and the plan fiduciaries breached their fiduciary duties under ERISA by maintaining significant plan investments in company stock and maintaining company stock as an investment option at a time they knew that it was imprudent to do so. The company’s share price declined as the global financial crisis unfolded.

 

The district court granted the defendants’ motion to dismiss the complaint, holding that as ESOP plan fiduciaries the defendants were entitled to a presumption that their decision to remain invested in employer stock was reasonable. The district court also found that the plaintiffs had failed to allege facts sufficient to overcome the presumption. The plaintiffs appealed.

 

In a September 7, 2012 opinion (here), the Sixth Circuit held that the district court had erred in concluding that the presumption of reasonableness applied at the motion to dismiss stage. The Sixth Circuit considered the presumption to be evidentiary, subject to factual rebuttal, and therefore not appropriate to consider and apply at the motion to dismiss stage. The Sixth Circuit also found that the plaintiffs’ allegations were sufficient to state a claim. The defendants filed a petition for a writ of certiorari, which the Supreme Court granted.

 

In support of the bank’s cert petition, The U.S. Department of Labor filed an amicus brief in which the agency urged the Court to grant cert in the case on the grounds that a split exists between the circuits. However, rather than arguing for or against the position adopted by the Sixth Circuit, the DoL argued that there should be no presumption of prudence at all, saying that “ERISA’s text and purposes do not call for the application of a presumption at any stage of the proceedings.” The DoL argued further that the judge-created presumption of prudence is based “largely on policy considerations that extend beyond ERISA’s text and are unconvincing in their own right.”

 

The Court’s Opinion 

In a unanimous opinion written by Justice Breyer, the court held that ESOP fiduciaries are not entitled to a presumption of prudence. The Court said:

 

In our view, the law does not create a special presumption favoring ESOP fiduciaries. Rather the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.

 

The Court expressly rejected the defendants’ argument that that the Congressional policy expressed in ERISA in favor of employee ownership meant that ESOP plan fiduciaries were entitled to a more “relaxed” duty of prudence.

 

The Court also rejected the defendants’ argument that the existence of a presumption of prudence was necessary to discourage meritless, burdensome lawsuits. The Court said that “we do not believe that the presumption at issue here is an appropriate way to weed out meritless lawsuits,” adding that “the proposed presumption makes it impossible for a plaintiff to state a duty-of-prudence claim, no matter how meritorious, unless the employer is in very bad economic circumstances.” The presumption “does not readily divide the plausible sheep from the meritless goats.” The task of weeding out the meritless suits “can better be accomplished through careful context-sensitive scrutiny of a complaint’s allegations.”

 

The Court did recognize motions to dismiss as “one important mechanism for weeding out meritless claims.”  The Court identified several factors for the lower courts to keep in mind when considering motions to dismiss in ERISA liability suits. First, “where a stock is publicly traded, allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing a stock are implausible as a general rule.” Second, where the claim is based on a failure to act on nonpublic information, the courts must recognize that fiduciaries cannot be required to break the law, such as by insider trading. Similarly, where the claim is based on a decision not to trade, the court evaluating a motion to dismiss should consider whether not trading would give rise to disclosure issues or would the stock price and thereby harm the fund.

 

Discussion

In recent years, the presumption of prudence has been an important first line of defense in ERISA stock drop litigation.  The Supreme Court’s conclusion that ESOP fiduciaries are not entitled to the presumption will make it more difficult for ESOP fiduciaries to obtain dismissal of an ERISA stock-drop lawsuit filed against them.

 

Just the same, the Court did also emphasize the importance of motions to dismiss in helping to weed out meritless lawsuits. The motion to dismiss mechanism, the Court said, “requires careful consideration of whether the complaint states a claim that the defendants acted imprudently.” The guidelines the Court laid down for lower courts to consider while reviewing motions to dismiss in ERISA liability lawsuits address many of the kinds of allegations that plaintiffs often allege in ERISA stock drop suits. In particular the Court’s suggestion that plan fiduciaries can rely on the share price and that the duties of plan fiduciaries do not require them to trade on inside information could help defendants seeking to have an ERISA stock drop suit dismissed.

 

In other words, the Supreme Court’s decision introduces a host of factors that will affect how the trial courts address and rule upon the motions to dismiss in ERISA stock drop suits involving ESOP fiduciaries. These new factors mean that the way that motions to dismiss are framed will change. What that ultimately will mean in terms of outcomes definitely remains to be seen. The lower courts will have to sort out these issues.

 

There is no doubt that the Court’s holding that the ESOP plan fiduciaries are not entitled to a special presumption of prudence represents a setback for fiduciaries named as defendants in ERISA stock drop suits. The consequences from this ruling may not only be that fewer of these cases are dismissed, it may also mean that more of them are filed. Indeed, some have suggested that the ruling may even act as a deterrent for employers from offering company stock. A June 25, 2014 Forbes article about the ruling (here) quotes two commentators as saying that companies may just stop offering their own stock to employees until lower courts decide more cases.

 

The one thing I know for sure is that this decision represents a significant change in the environment for ERISA stock drop litigation involving ESOP fiduciaries.  

 

gavel1The onslaught of litigation filed after the advent three years ago of the Dodd-Frank “say on pay” requirements may finally be winding down. According to a June 23, 2014 memorandum from the Pillsbury law firm entitled “Is Proxy Disclosure Shareholder Litigation on Executive Compensation Finally Over?” (here), the litigation came in three distinctive waves. The first two waves have died down and the third wave is waning, and we may be nearing the point where we can close the book on what has largely proven to be a less than successful plaintiffs’ litigation approach.

 

The first of the three waves of shareholder litigation involved lawsuits filed against companies that experienced a negative say on pay vote. (Readers will recall that the Dodd-Frank Act included provisions requiring listed companies to hold a nonbinding shareholder vote on executive compensation, an arrangement commonly referred to as “say on pay.”) This phase in the litigation progression has long been over. The last of these lawsuits were filed in September 2012. Overall there were a total of 24 of these cases filed that were not consolidated, involving 21 companies. Motions to dismiss were granted in 50% of the cases. Five of the cases settled. A very small number of these cases remain pending.

 

The second wave of these executive compensation related lawsuits involved an effort by plaintiffs to enjoin annual meetings by contending that the disclosure in proxy statements regarding executive compensation was inadequate. Although these lawsuits involve many of the same features as M&A litigation — including the pressure on defendants to settle to avoid complicating a pending event — as it turned has out, many companies involved in these cases, unlike  companies in M&A related litigation, chose to fight rather than to settle. And “when those companies fight, they win.”

 

According to the memo, there were 31 of these second wave lawsuits filed in total. Nearly 40 percent of these cases have resulted in a denial of the motion to enjoin the annual meeting and over 25 percent have been voluntarily dismissed. Plaintiffs have prevailed on motions to preliminarily enjoin the annual meeting, in whole or in part, in only two cases: In April 2012, in a case involving Brocade; and in October 2012, in a case involving Abaxis. Only two of these second wave cases have been filed recently, with one in December 2013 and another in January 2014. The motion for preliminary injunction was denied in both of these more recent cases.  

 

In the third phase of this executive compensation-related shareholder litigation, the lawsuits alleged that the executive compensation award was not made in compliance with the relevant plan. The kinds of allegations raised in these cases fall in three categories: (1) that the amount of shares awarded under a stock incentive plan exceed the maximum annual limit imposed by the plan; (2) that the award was made under a stock incentive plan that had lapsed due the board’s failure to seek shareholder re-approval; (3) that the Board had made a stock award that was not tax deductible under the relevant provisions of the federal tax laws.

 

According to the memo there have been a total of 34 of these third wave cases filed that have not been consolidated, involving 29 companies. Motions to dismiss have been granted in 20 percent of these cases and denied in 9 percent of the cases. Dismissal motions remain pending in another 20 percent of the cases. 24 percent of the cases have settled, but as the memo details, in the cases that have settled, the plaintiffs have had a difficult time obtaining a fee award in the amount sought. In several key cases, the amount of the award has only been a small fraction of the fees sought. The fee award decisions “may give plaintiffs’ counsel pause in considering whether or not to file third wave cases in the future.”

 

In any event, the kinds of issues that have led to these third wave lawsuits are preventable. The memo concludes with a short summary of the steps that companies can take to ensure that questions are not raised later about whether or not a stock award is in compliance with the operative stock compensation plan. These steps include taking care to ensure that no award exceeds limits in the plan; ensuring that the plan is re-approved every five years; and ensuring that the proxy materials do not guarantee that every stock award will be exempt from tax deduction limits under the Internal Revenue Code.

 

The memo includes a detailed appendix incorporating extensive numerical details and analysis of each of the three successive waves.

 

Special thanks to Sarah Good of the Pillsbury law firm for sending me a copy of the memo.

dolAccording to a June 23, 2014 Wall Street Journal article entitled “U.S. Increases Scrutiny of Employee-Stock Ownership Plans” (here), the federal government is “stepping up scrutiny of how U.S. companies are valued for employee-stock ownership plans.” This increased scrutiny includes increased litigation activity, often alleging that ESOP share valuations are flawed. The targets of this litigation include not only the appraisers who valued the shares but also the plan trustees that have fiduciary duties to “put the interests of workers first.”

 

As of fiscal 2011, the latest year for which information is available, about 6,800 U.S. companies had employee stock ownership plans, involving more than 13.4 million workers. The plans have amassed total assets of $940 billion. For many of the workers participating in these plans, the ESOP is the principal or sole retirement benefit.

 

According to the Journal article, the government contends that “some owners are selling stakes in their companies to employee-stock-ownership plans at inflated prices.” The U.S. Department of Labor is the plaintiff in 15 current ESOP-related lawsuits, virtually all of which involve alleged “shoddy estimates” of company shares. The agency has filed a total of 28 ESOP-related lawsuits since October 2009, double the number of lawsuits filed during the previous six years. Since the start of fiscal 2010, the Department of Labor has recovered over $241 million through lawsuits and through investigations that were resolved without a lawsuit being filed, nearly all of which involve valuations.

 

According to the lawsuits described in the article, the target in many of these lawsuits is the appraiser that provided the valuation although the article notes that “the agency also is getting tougher on trustees who work on behalf of employee-stock ownership plans – and have a fiduciary duty to put the interests of workers first or face financial liability if things go wrong.”

 

Problems often emerge when company management are involved in the appraisal process. According to the article, 95% of companies with ESOPs are closely held, forcing appraisers to rely heavily on company management for information.

 

The Journal article primarily is focused on lawsuits brought by the U.S. Department of Labor, but as several of the examples cited in the article make clear, company employees often file their own separate lawsuits when earlier share price valuations prove to have been inflated. While these employee lawsuits often also target the appraisers, the targets of the employee lawsuits often involve the plan trustees.

 

The Journal article makes it clear that in many cases there may be good reason for the government’s scrutiny of ESOPs. Valuation issues clearly are a recurring problem. Many insurance industry professionals know that for purposes of management liability insurance ESOPs are sometimes viewed as a riskier class of business than are other private companies.

 

However, the article does make it clear that there are certain factors than can help avert faulty appraisals, such as through the requirement that the ESOP obtain a share price evaluation when a stock plan is started and a requirement that workers are told once a year how much their shares are worth. The presence of factors showing that the appraiser performing the appraisal was independent and that the appraisal was not influenced by management (such as through management provided revenue estimates) also may help avoid problem valuations. The presence of these and other factors supporting the share valuation the company uses could help reassure insurance underwriters about companies with ESOPs.  

sup ct 5On June 23, 2014, the U.S. Supreme Court released its long-awaited decision in Halliburton Co. v. Erica P. John Fund, in which the Court had taken up the question whether or not to set aside the presumption of reliance based on the fraud on the market theory that the Court first recognized in its 1988 decision in Basic, Inc. v. Levinson.  The case was closely watched because its outcome had the potential to transform securities class action litigation in the United States.

 

In the end, the Court, in an opinion written by Chief Justice John Roberts and joined by five other justices, declined to overturn Basic, but held that a securities class action defendant should have the opportunity at the class certification stage to try to rebut the presumption by showing that the alleged misrepresentation did not impact the defendant company’s share price. The Supreme Court’s opinion can be found here. Justice Thomas, joined by Justices Scalia and Alito, wrote an opinion concurring in the judgment in which he contended that the Court should have overturned Basic.

 

While the Court’s decision will not alter the securities litigation landscape as much as might have been the case if it had overturned Basic, the Court’s holding that defendants may at the class certification stage seek to rebut the presumption of reliance based on the absence of price impact could have a significant effect on securities litigation. In many cases, plaintiffs may be unable to obtain class certification where in the past they might have been able to have a class certified. In any event, the class certification phase likely will become more costly as the parties dispute the issues surrounding the impact of the alleged misrepresentation on the share price.

 

Background

Since the U.S. Supreme Court’s 1988 decision in Basic, Inc. v. Levinson, securities plaintiffs seeking class certification have been able to dispense with the need to show that each of the individual class members relied on the alleged misrepresentation, based on the presumption that in an efficient marketplace, a company’s share price reflects all publicly available information about a company, including the alleged misrepresentation, and that the plaintiff class members relied on the market price.

 

In the U.S. Supreme Court’s 2013 decision in Amgen (about which refer here), at least four justices (Alito, Scalia, Thomas and Kennedy) appeared to question the continuing validity of the presumption. In his concurring opinion, Justice Alito asserted that the presumption “may rest on a faulty economic premise,” and specifically stated that “reconsideration” of the Basic presumption “may be appropriate.”

 

Recognizing the opportunity to have the Court reconsider the fraud on the market theory, the defendants in the long-running Halliburton securities class action litigation sought to have the Court consider whether the Court should “overturn or significantly modify” the Basic presumption of “class wide reliance derived from the fraud on the market theory.”

 

The Halliburton case has been pending since 2002. In their complaint, the plaintiffs allege that the company and certain of its directors and officers understated the company’s exposure to asbestos liability and overestimated the benefits of the company’s merger with Dresser Industries. The plaintiffs also allege that the defendants overstated the company’s ability to realize the full revenue benefit of certain cost-plus contracts.

 

For several years, the parties in the case have been engaged in full-scale combat on the issue of whether or not a class should be certified in the case. Indeed, the class certification issue in the case has already been before the U.S. Supreme Court; in 2011, the Court unanimously rejected  the company’s argument (and the Fifth Circuit’s holding) that in order for a plaintiff to obtain class certification, the plaintiff must first establish loss causation.

 

Following the Supreme Court’s earlier ruling, the case was remanded back to the lower courts. In June 2013 the Fifth Circuit affirmed the certification of a shareholder class in the case.  In its opinion, the Fifth Circuit expressly affirmed the district court’s holding that Halliburton could not present evidence at the class certification stage that the alleged misrepresentation did not impact the company’s share price and therefore that there was no basis for the presumption of reliance. Halliburton filed a petition for writ of certiorari, which the U.S. Supreme Court granted.  

 

The Court’s June 23, 2014 Opinion 

In an opinion for the Court written by Chief Justice Roberts, the Court vacated the Fifth Circuit’s judgment and remanded the case for further proceedings.

 

At the outset, the Court declined to overturn Basic, noting that “before overturning a long-settled precedent … we require a special justification,” and concluding that “Halliburton had failed to make that showing.” In reaching this conclusion, the Court rejected Halliburton’s argument based on statutory analysis that plaintiffs should always have to prove individual reliance. The Court also rejected Halliburton’s argument that Basic should be overturned based on changes in economic theory surrounding the “efficient market” hypothesis on which the fraud on the market theory is based.

 

The Court also declined to overturn Basic in reliance on principles of stare decisis, holding that these principles have “special force in respect to statutory interpretation.” While noting Halliburton’s argument that the Basic presumption produces a number of “serious and harmful consequences,” such as allowing plaintiffs to “extort large settlements from defendants for meritless claims,” the Court said that “these concerns are more appropriately addressed to Congress, which has in fact responded to some extent to many of the issues Halliburton raised,” for example, through the PSLRA.

 

The Court also rejected Halliburton’s argument that in order to obtain class certification the plaintiffs should have to prove that the alleged misrepresentation actually affected the defendant company’s share price. The Court said requiring the plaintiffs to make this showing “would radically alter the required showing for the reliance element” in a 10b-5 case. The Court said that “for the same reasons we declined to completely jettison the Basic presumption, we decline to effectively jettison half of it by revising the prerequisites for invoking it.”

 

But while the Court declined to require plaintiffs to directly prove price impact in order to invoke the Basic presumption, the Court did agree that defendants “should at least be allowed to defeat the presumption at the class certification stage through evidence that the misrepresentation did not in fact affect the stock price.”

 

The Court noted that the defendants already may introduce price impact evidence at the merits stage and that in many cases plaintiffs already introduce price impact evidence (such as event studies) at the class certification stage to show that the market price of the defendant’s stock responds to information about the company, to establish that the market for the company’s shares is efficient. The court reasoned that if plaintiffs were allowed to present price impact evidence to satisfy the efficient market requirement (which requirement the Court described as “an indirect proxy for price impact”), it makes no sense to preclude the introduction of evidence for the direct purpose of showing that the alleged misrepresentation did not impact the price:

 

Price impact is thus an essential precondition for any Rule 10b-5 class action. While Basic allows plaintiffs to establish that precondition indirectly, it does not require courts to ignore a defendant’s direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock market’s price and, consequently that the Basic presumption does not apply.

 

The Court concluded by saying with respect to the Basic presumption of reliance that “defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”

 

In a separate opinion in which he concurred in the Court’s judgment, Justice Thomas, joined by Justices Scalia and Alito, argued that Basic should be overruled noting that “Logic, economic realities, and our subsequent jurisprudence have undermined the foundations of the Basic presumption.”

 

Discussion 

Because the Court did not, as Justice Thomas urged in his separate opinion (a dissenting opinion in all but name), overturn Basic, the Court’s second Halliburton opinion will not have the dramatic impact on class action securities litigation that it might have. Nevertheless, the Court’s ruling will have a significant impact on class certification in misrepresentation cases under Rule 10b-5. It will introduce a significant level of inquiry and dispute at the class certification stage, and it will result in some cases in the denial of class certification motions in cases in which class certification might have been granted in the past.

 

At a practical level, there will be a lot of issues for the lower courts to sort out. There undoubtedly will be significant disputes regarding the type of evidence that is permitted to address the issue of price impact. There will be disputes about the quantum of evidence the defendants must provide in order to rebut the presumption. There undoubtedly will be issues surrounding the type and scope of discovery permitted as the parties wage a battle of experts on the price impact issue. The lower courts could be wrestling with these issues for years.

 

Because the price impact dispute will require the parties to present expert analyses on the question of whether or not the alleged misrepresentation affected the share price, the dispute could prove costly, particularly as the parties and the courts sort out the issues noted in the preceding paragraph. These processes could significantly increase defense expenses at an earlier stage of the proceedings. Justice Ginsburg, in a concurring opinion in which Justices Breyer and Sotomayor joined, noted that because the Court recognized that “it is incumbent upon the defendant to show the absence of price impact,” the Court’s holding “should impose no heavy toll on securities fraud plaintiffs with tenable claims.” Her opinion makes no comment with respect to the additional costs defendants undoubtedly will incur at the class certification stage in an effort to try to rebut the presumption.

 

Another consequence of the Court’s opinion is that it may affect the way that plaintiffs plead their cases. The Basic presumption only applies to misrepresentation cases under Rule 10b-5. It does not apply to cases in which the allegedly misleading statement is an omission. In omissions cases, the plaintiffs rely on a different presumption, the Affiliated Ute presumption, which arguably is unaffected by the Court’s holding in this case. In addition, the Basic presumption does not apply to cases in which the plaintiffs allege violations of Sections 11 and 12 of the ’33 Act. In order to try to avoid the procedural hurdles that the Court’s opinion in Halliburton introduces, plaintiffs may seek to cast their cases as omissions cases or may prefer to pursue ’33 Act claims rather than claims under the ’34 Act and Rule 10b-5. 

 

From an insurance perspective, the Court’s holding in this case will not have the disruptive impact that it might have had if the Court had overturned Basic. The Court’s ruling that defendants may seek to rebut the presumption of reliance by showing the absence of price impact may result in classes being certified in fewer cases, which would be beneficial for defendants and their insurers. However, the dispute of price impact issues could increase overall defense expenses, perhaps significantly, which could have its own impact on D&O insurers. Whether the ruling will result in fewer cases being filed remains to be seen.

 

In the end, the insurance marketplace will have to wait and see how these issues play out, and in the interim it seems unlikely there will be any immediate changes in the way D&O insurance is underwritten and priced. There will, however, be some discussion in the marketplace about the extent of coverage available for the kind of price impact event studies that the Halliburton court discussed. At least one carrier has already introduced, in anticipation of the Halliburton ruling, an endorsement providing that no retention is applicable to the cost of an event study. There may be other marketplace developments along these lines as the marketplace responds to the Court’s ruling.

 

Very special thanks to the several readers who sent me copies of the Halliburton decision.  

 

delaware2As I noted in a recent post (here), in response to a recent Delaware Supreme Court decision upholding the facial validity of fee-shifting bylaws, proposed legislation was  introduced in the Delaware General Assembly to limit the Supreme Court’s ruling and to restrict the ability of Delaware corporations to utilize their bylaws to shift the costs of litigation to unsuccessful shareholder litigants.

 

However, as discussed in detail in a June 20, 2014 memo from the Skadden Arps law firm entitled “Fee Shifting: Bylaws: The Current State of Play” (here), the legislative proposal has now been withdrawn, in order for representatives of the Delaware bar to study the use of fee-shifting bylaws, in anticipation that the Delaware legislature will take up the issue again in 2015. Broc Romanek’s discussion on his TheCorporateCounsel.net blog of the recent action withdrawing the proposed legislation can be found here.

 

Background

As I discussed in a recent post (here), in a May 8, 2014 decision in ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court upheld the facial validity of a nonstock corporation’s bylaw provision shifting attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation. Because the court’s holding seemed to be equally applicable to stock corporations as well as to nonstock corporations, the decision appeared to open the way for all Delaware corporations to adopt fee-shifting bylaws. The possibility that companies might be able to shift litigation costs to unsuccessful shareholder claimants potentially could have transformed shareholder litigation.

 

On May 22, 2014, the Delaware Corporate Law Council proposed an amendment to the DCGL that according to the amendment’s synopsis is “intended to limit the applicability of [the Delaware Supreme Court decision in ATP Tours, Inc. v. Deutscher Tennis Bund] to non-stock corporations, and to make clear that such liability may not be imposed on holders of stock in stock corporations.”

 

As discussed in the recent Skadden law firm memo, the legislative proposal, like the Delaware Supreme Court’s decision in the ATP Tour case, “became the subject of much attention and debate from the media and legal commentators and prompted a significant amount of lobbying effort.” Legal reformers argued that the ATP Tour decision “gives corporations a means to protect their stockholders against the high costs of litigation by deterring the filing of abusive, duplicative suits.”

 

The Latest Legislative Development

On June 18, 2014, the legislative proposal was withdrawn and the Delaware Senate introduced a resolution addressing the issue of fee-shifting bylaws.  The resolution notes that Delaware law is “balanced and flexible” and “protects legitimate interests of all stakeholders.” The resolution further notes that “maintaining balance, fairness and predictability requires attention to ensure that statues, court rules, and judicial doctrine … do not encourage meritless litigation and impose unnecessary costs.” At the same time, the resolution notes, various groups have “expressed concern about the potential unintended consequence of permitting stock corporations to adopt such bylaws and the chilling impact it could have on meritorious litigation.”

 

The resolution goes on to state that Delaware’s governor and legislature “strongly support a level playing field that provides the ability for stockholders and investors to seek relief” and that the proliferation of fee-shifting bylaws “will upset the careful balance that the State has strived to maintain.”

 

In recognition of the “complexity and importance” of these issues, the Senate resolution calls upon a number of groups to continue their “ongoing examination” of the State’s laws “with an eye toward maintaining balance, efficiency, fairness and predictability.” The examination is expressly requested to include whether the adoption of legislation relating to fee-shifting bylaws would be appropriate for the General Assembly to consider in 2015.

 

The groups urged to conduct this examination include the Delaware State Bar Association, its Corporation Law Section, and the Council of that Section.

 

Discussion 

For the time being, it is unclear whether or not fee-shifting bylaws will be permitted in Delaware. The Skadden law firm’s memo urges caution for companies considering the adoption of fee-shifting bylaws. As the memo notes, “there is a significant risk that adoption of fee-shifting bylaws could generate a meaningful adverse reaction from, among others, governance advocates, proxy advisory firms, and some stockholders.”

 

Even though the Delaware legislature will not be acting until 2015 at the earliest, there are good reasons for companies to proceed cautiously in considering the adoption of a fee-shifting bylaw. The law firm memo outlines a number of specific items for companies to consider in that regard, including, for example, the company’s stockholder profile and its relationship with its shareholder base.

 

While the memo urges caution on fee-shifting bylaws, the law firm continues to believe that companies should consider the adoption of forum selection bylaws. As I discussed in a recent post (here), even though questions continue to surround the possibility that companies might be able to try to control abusive shareholder litigation through the use of fee-shifting bylaws, the adoption of forum selection bylaws has become increasingly common as a possible way to try to “reduce the cost and risk of multi-jurisdictional stockholder litigation.”

 

More About Forum Selection Bylaws: A lawsuit filed on June 19, 2014 in the Delaware Chancery Court raises interesting questions about the extent of the ability of corporations and their boards to adopt forum-selection bylaws. According to a June 20, 2014 Law 360 article entitled “First Citizens Sued Over ‘Only in NC’ Forum Choice Bylaw” (here, subscription required), the City of Providence, Rhode Island, a shareholder of First Citizens BankShares, has filed a lawsuit challenging the validity of a bylaw recently adopted by First Citizens that designates North Carolina as the exclusive forum for a wide variety of shareholder suits, even though the company is organized under the laws of Delaware.

 

According to the article, the dispute arises out of the planned merger of First Citizens and South Carolina-based First Citizens South. The bylaw designating North Carolina as the exclusive forum for shareholder litigation was adopted the day before the merger was announced. In its lawsuit, the City of Providence seeks a judicial declaration that the bylaw is invalid under Delaware General Corporation Law provisions giving the Delaware Chancery Court exclusive jurisdiction for many shareholder claims against Delaware corporations. The City of Providence alleges that First Citizens’ board breached their fiduciary duties by adopting the bylaw and seeks to have the court declare the bylaw invalid and unenforceable.

 

As discussed here, in June 2013, the Delaware Chancery Court upheld the validity of a bylaw adopted by Chevron’s board that designated Delaware as the exclusive forum for adjudication of various shareholder disputes. This latest lawsuit against First Citizens raises the interesting question of whether or not boards of Delaware corporations appropriately may adopt bylaws designating a forum other than Delaware as the exclusive forum for shareholder disputes. The City of Providence alleges in its lawsuit challenging First Citzens’ recently adopted bylaw that the company’s bylaw improperly deprives the company’s shareholders of their rights to avail themselves of Delaware’s courts.

 

It will be interesting to see how broadly the Delaware courts will extend the rights of boards to adopt forum selection bylaws and in particular to see whether or not the Delaware court will conclude that the board’s authority in that regard includes the right to designate a forum other than Delaware as the exclusive forum for shareholder disputes.

Due to personal circumstances, I will not be adding new posts for the next few days.To hold things over until I return, I thought I would post a link to the Q&A I did with Tom Fox on his FCPA Compliance and Ethics Blog last week. The Q&A covers a lot of ground, from my childhood, through college and lawschool, and then straight to how I started my blog and how the “mug shot” series came about. The Q&A can be found here. Special thanks to Tom for inviting me to participate in the Q&A on his blog.

 

 

spainIn an interesting June 11, 2014 Financial Times article entitled “Spain’s Renewal Must Include Governance Improvements” (here), financial journalist and commentator Tony Barber identifies corporate governance issues that he believes Spanish companies have been slow to address. According to Barber, while there may be historical explanations for many of the long-standing corporate governance practices in Spain, Spanish companies’ increasingly international shareholder base will require the companies to meet higher governance standards.

 

Barber acknowledges that corporate governance practices at Spanish companies have improved since the CNMV, the national financial market regulator, published a non-binding code of good governance in 2006. But progress has been slow and “some of the biggest, most internationally active Spanish companies can certainly do better.” According to Barber, the current government has plans to update the 2006 code. It has also sent a bill to parliament that will increase shareholders’ control over executive pay, strengthen the voice of minority shareholders and address potential conflicts of interest.

 

Barber identifies four additional governance issues that, in his view, many Spanish companies need to address. First, he says that “too many combine the roles of chairman and chief executive in one person.” Second, the boards are often “too old and universally old.” Third, many boards are too large. And finally, “some boards contain too few credible independent directors.” Among other things, these practices allow the concentration of power in one person’s hands.

 

The current board practices of many large Spanish companies “have deep roots in Spanish business culture.” This culture is a lingering vestige of practices during the Franco era, when Spain “remained in most respects a self-enclosed world, dominated by a handful of mighty financiers and industrialists.”

 

These old habits die hard, even though in a wide variety of industries Spanish companies “stride the globe” and even though foreign investors hold roughly 40 percent of the equity of the companies in Madrid’s blue-chip Ibex-35 index. Even companies like Banco Santander that have started to make changes still have boards that are almost exclusively Spanish. Even after adding former U.S. banking regulator Sheila Bair to its board in January, the bank’s 16-person board consists of 14 Spaniards, a Chilean and Bair. Three board members belong to one all-powerful family.

 

Barber contends that “national as well as gender-diversity is something that Spanish companies need to get to grips with.” Even when Spanish companies select foreign directors, they tend to turn first to Spanish-speaking countries. Barber comments that “it stretches credulity to suggest that such appointments reflect a meticulously conducted search for the best candidate. “

 

To underscore the importance of these issues for Spanish companies, Barber cites as an example the recent decision of Pemex, the Mexican national oil company, to sell most of its 9.2 percent investment in Repsol, the Spanish energy group. Among other things, Pemex cited Repsol’s governance practices as a reason for the sale. While not meaning to suggest that Pemex’s views on governance represent some sort of a standard, Barber said that “there is no doubt that international investors would welcome higher standards at some of Spain’s best known companies.”

 

Barber closes his article with a reference to the recent abdication of King Juan Carlos, noting that “modern Spain is embarking on a project of national renewal that calls for brave decisions in difficult times.”  Improving corporate governance “will form part of the contribution of Spanish business to this task.”

 

The practices and the resistance to reform in Spain may be best understood by reference to the country’s particular history, but many of the concerns are not unique. Other countries have their own versions of many of these issues. Just the same, it is interesting to consider this country-level perspective on corporate governance practices

aguilarIn a June 10, 2014 speech entitled “Boards of Directors, Corporate Governance and Cyber-Risks: Sharpening the Focus” delivered at the New York Stock Exchange, SEC Commissioner Luis A. Aguilar highlighted the critical importance of the involvement of boards of directors in cybersecurity oversight. In his speech, Aguilar stressed that “ensuring the adequacy of a company’s cybersecurity measures needs to be a part of a board of director’s risk oversight responsibilities.”  He added the warning that “boards that choose to ignore, or minimize the importance of cybersecurity oversight responsibility, do so at their own peril.” A copy of Aguilar’s speech can be found here.

 

Aguilar opened his speech by highlighting the extent of the risks associated with cybersecurity. He emphasized the “widespread and severe impact that cyber-attacks could have on the integrity of the capital markets, infrastructure and on public companies and investors.” In light of these risks, Aguilar said that “effective board oversight of management’s efforts to address these issues is critical to preventing and effectively responding to successful cyber-attacks and, ultimately, to protecting the company and their consumers, as well as protecting investors and the integrity of the capital markets.”

 

Aguilar noted that risk management oversight is an increasingly important board role, adding that “there can be little doubt that cybersecurity also must be considered as part of the board’s overall risk oversight. “ Aguilar specifically referenced the recent effort by proxy advisory firm ISS to oust many directors of Target Corporation for allegedly lax cybersecurity oversight, which, he said, “should put directors on notice to proactively address the risks associated with cyber-attacks.” (It should be noted, however, that at the June 11, 2014 Target Corp. annual meeting all board members were re-elected.)

 

Aguilar emphasized that the threats of a cyber-attack include not only the risk of business disruption and reputational harm but also for directors “the threat of litigation and potential liability for failing to implement adequate steps to protect the company from cyber-threats.” He noted that –“perhaps unsurprisingly” – Target and Wyndham have each recently been hit with shareholder lawsuits relating to those companies’ data breaches, commenting that “boards that choose to ignore, or minimize, the importance of cybersecurity responsibility do so at their own peril.”

 

In discussing what boards can and should be doing on cybersecurity issues, Aguilar said that the place for boards to begin in assessing their company’s cybersecurity readiness is the National Institute of Standards and Technology’s February 2014 report entitled the “Framework for Improving Critical Infrastructure Cybersecurity” (here), which he said is “likely to become a baseline for best practices by companies, including in assessing legal or regulatory exposure to these issues or for insurance purposes.”

 

In order to translate the concepts in the NIST’s Framework into action, boards need to take steps to address the knowledge gap that often exists at the board level on cybersecurity issues. Aguilar recommends that boards create a separate enterprise risk committee at the board level in order to ensure that there is sufficient focus at the board level on the adequacy of resources and overall support provided to company executives responsible for risk management. Boards should also develop “a clear understanding of who at the company has primary responsibility for cybersecurity risk oversight and for ensuring the adequacy of the company’s cyber-risk management practices.”

 

The key, according to Aguilar, is to ensure that the company is appropriately prepared to respond in the event of a cyber-attack. Boards, he said, “should put time and resources into making sure that management has developed a well-constructed and deliberate plan” for responding to a data breach or other cyber incident.  The plan should include, among other things, a framework for determining  “whether and how the cyber-attack will need to be disclose internally and externally.” He added a suggestion that in undertaking this disclosure the company should go beyond the impact on the company and consider the impact on others, including consumers or other groups.

 

Aguilar closed his speech by emphasizing that “given the heightened awareness of these rapidly evolving risks, directors should take seriously their obligation to make sure that companies are appropriately addressing [cybersecurity] risks.”

 

Aguilar’s speech represents yet another confirmation that cybersecurity is a board level issue. He also emphasized that board failure to address these issues represents a liability exposure for directors. While he referred only to the efforts of shareholders to hold board members accountable through litigation, the fact is that – as his speech itself underscores – cybersecurity is an increasingly important issue to the SEC. It is not too much to say that a message implicit in his speech is that the Commission itself may hold boards accountable for their responsibilities as well. At a minimum, Aguilar’s speech underscores that cybersecurity is an issue on which the Commission is focused and about which the Commission is concerned.  

njHas notice of claim been provided “as soon as practicable” if it is sent to the insurer during the policy period but six months after service on the insured of the underlying complaint? Apparently not, at least according to a June 6, 2014 opinion of a New Jersey intermediate appellate court, applying New Jersey law. In addition, the New Jersey appellate court further held that an insurer on a claims made policy does not have to plead or prove that it was prejudiced by the late notice. The appellate court affirmed the trial court’s entry of summary judgment in favor of the insurer.  A copy of the appellate court’s opinion can be found here.

 

I have to admit that I have some issues with this decision, for reasons discussed below.

 

Background

The plaintiffs in the coverage action are assignees of the insured. The plaintiffs operate a church and child care center. The plaintiffs decided to relocate their operations and they entered a contract to buy a piece of land for the purpose. The plaintiffs also entered a separate arrangement to obtain financing for the land purchase from the insured, which is a mortgage financing company. The insured ultimately failed to provide the financing for the land transaction and the transaction fell through. The plaintiffs sued the insured to recover the various costs the plaintiffs had incurred in trying to complete the land transaction and the mortgage financing. Ultimately the insured settled with the plaintiffs for a small cash payment and for the assignment to the plaintiffs of its rights under its D&O insurance policy.

 

The insured’s insurance policy ran for the period from January 1, 2006 to January 1, 2007. The insured was served with the plaintiffs’ complaint in the underlying action on February 21, 2006. However, the insured did not provide notice of the complaint to its insurer until August 28, 2006. The insurer denied coverage on a number of grounds including the ground that the insured had not provided notice of claim to the insurer “as soon as practicable” as required under the policy.

 

The notice provisions of the policy state that:

 

(a) The Company or the Insureds shall, as a condition precedent to the obligations of the Insured under this policy, give written notice to the Insurer of any Claim made against an Insured as soon as practicable and either:

(1) anytime during the Policy Period or during the Discovery Period (if applicable); or

(2)  within [thirty] days after the end of the Policy Period or the Discovery Period (if applicable), as long as such Claim is reported no later than [thirty] days after the date such Claim was first made against an Insured.

 

After the assignment to the plaintiffs of the insured’s right under the policy, the plaintiffs filed an action against the insurer seeking a judicial declaration that the policy covered the underlying claim. The parties filed cross-motions for summary judgment. On February 3, 2013, the trial court granted the insurer’s motion for summary judgment, based in its finding that the insured did not provide the insurer with notice of the underlying claim as soon as practicable and therefore that coverage was barred. The plaintiffs appealed.

 

The June 6 Opinion 

On June 6, 2014, in an unpublished per curiam opinion, the Superior Court of New Jersey, Appellate Division, affirmed the trial court’s ruling.

 

The appellate court observed that the insured had provided the insurer with notice of claim “over six months after plaintiffs served them with the complaint.” The court added that “No explanation for this lengthy delay was provided.”  The appellate court cited with approval its own prior decision in a 1963 case in which the earlier court had held that a delay of five and one-half months in providing notice was not “as soon as practicable” under the terms of a similar policy.

 

The appellate court also noted that the notice provision required notice to be provided to the insurer both within the policy period and as soon as practicable. Because “the insured did not meet both of the notice requirements that were unambiguously expressed in the policy, we conclude that coverage was properly denied to the insureds and by extension, to plaintiffs as their assignees.”

 

In reliance on the New Jersey Supreme Court’s 1985 holding in Zuckerman v. National Union Fire Insurance Co., the appellate court also rejected the plaintiffs’ argument that the insurer had to show that it was prejudiced by the late notice in order to assert the late notice as a defense to coverage. In Zuckerman, the New Jersey Supreme Court had held that with respect to claims made policies (like the one involved here) an insurer need not show that it was prejudiced by an insured’s failure to provide notice as soon as practicable in order to deny coverage. The New Jersey Supreme Court had said in Zuckerman that to require an insurer to make such a showing would constitute an “unbargained-for expansion of coverage, gratis, resulting in the insurance company’s exposure to a risk substantially broader than that expressly insured against in the policy.” The appellate court said that as an intermediate appellate court, “we are bound to follow and enforce the decisions of the Supreme Court.”

 

Discussion

As anyone involved in the insurance business knows, late notice happens. Delayed notice is provided to insurers all the time. The delays in providing notice happen for all sorts of reasons or for no reason at all. Usually, the delay arises because the person within the organization who knows about the lawsuit is not the same person within the organization who knows about the organization’s insurance.  (This problem about the location of insurance knowledge within an organization is the reason why it is a good idea to seek to have the notice provision amended by endorsement to provide that the clock does not start to run on notice issues until certain specified persons find out about a claim.)

 

In the context of an industry in which belated notice is a regular occurrence, a delay of six months is nothing.  For that reason, I simply don’t understand the comment by the court with respect to the timing of the notice here that “no explanation for this lengthy delay was provided.”  In my humble opinion based on over thirty years in the D&O insurance business, it is not even remotely accurate for the appellate court to suggest that a six-month delay in providing notice is “lengthy.” I would describe it as “normal” or “par for the course” or “basically, the kind of thing that happens when any process requires the involvement of people.”

 

Not only was the delay in providing notice here not “lengthy,” but the insurer was provided notice during the policy period. This is not a case where the notice finally came sailing in months after the insurer was off of the risk. The insurer was still on this risk when it received notice.

 

And not only that, the insurer here did not even claim that it was prejudiced in any way by the six month delay in providing notice. What is the point of harshly enforcing a mere procedural requirement in a punitive way given that the condition was fulfilled during the contract period and nothing about the fulfillment of the condition was detrimental to the insurer?

 

And here’s the final issue – the appellate court did not even ask what the word “practicable” means and whether or not in this case the insured did provide notice as soon as was practicable for this insured. One definition of the word “practicable” in an online dictionary is that the word means “capable of being done” or “capable of putting into effect.”  Seems to me that the insured here provided notice as soon as it was capable of providing notice.

 

The term “as soon as practicable” is meant to be both a liberalizing term and to provide flexibility, by contrast to the use in some policies of terms requiring provision of notice within a specified time period (say, 60 or 90 days). The more flexible standard is meant to be less rigid than the precise time requirement – and frankly it is meant to be a looser standard. Basically, the term means that the insured should provide notice of claim as soon as it can.  There is nothing in standard industry practices to suggest that the provision of notice during the policy period and six months from service of the claim is not “as soon as practicable” – unless the six month delay prejudiced the insurer in some way, which is a factor that is not present here.

 

I will say that I don’t know where courts get off with this idea that when a policyholder seeks coverage for a claim that it is trying to get “unbargained-for expansion of coverage.” In this case in particular, the suggestion that the insured’s assignee was looking for unbargained-for coverage is a completely unwarranted statement. To the contrary, the courts’ harsh and unwarranted construction of the notice provisions represents a completely unjustified diminution of coverage.

 

It is hard to question the position that the insurer took in this case with respect to late notice, given that two courts have concluded that under New Jersey law the notice here was not “as soon as practicable.”  Just the same, I have to say that the fact that an insurer would take the position that the insurer took on the notice issue here is a relevant topic in a discussion with a client about the insurer’s claims handing practices.  

sdnysealOn May 8, 2014, Southern District of New York Judge Deborah Batts, applying New York law, held that a there was not a sufficient “factual nexus” between a securities suit filed after the expiration of a failed bank’s D&O insurance policy and an FDIC claim that had been first made during the policy period and therefore — because the subsequent claim did not relate back to the prior claim — it is not covered under the policy. The decision raises interesting questions about degree of overlap required to make different claims interrelated.

 

A copy of the opinion can be found here. This decision is discussed in a June 5, 2014 post on the Sedgwick Insurance Law Blog (here). A May 19, 2014 post on the Wiley Rein law firm’s Executive Summary blog can be found here.

 

Background

State banking authorities closed the Park Avenue Bank on March 12, 2010. Three days after the bank close, Charles Antonucci, the bank’s President and CEO,  was arrested and charged with attempting to defraud the Troubled Asset Relief Program and for self-dealing with bank funds, which included several “round trip transactions” that he claimed were personal investments in the bank.

 

On September 1, 2010, the FDIC sent certain former directors of the bank a demand letter in which the FDIC asserted claims against the individuals for alleged breaches of fiduciary duty, negligence and gross negligence. The demand letter asserted that the individuals’ acts and omissions caused the bank a loss of approximately $50.7 million. The FDIC’s claim, as Judge Batts later summarized it, “primarily focused on [the individuals’] deficient policies, internal controls, and practices, which ultimately led to PAB’s failure,” such as having inadequate collection procedures and failing to properly supervise employee compensation. However, as Judge Batts also noted, the FDIC demand letter also alleged that the individuals “failed to act on allegations of improper conduct made against [Antonucci], ultimately causing significant financial harm to the bank.”

 

The individuals notified the bank’s D&O insurer of the FDIC claim. The D&O policy in force at the time had a policy period from September 9, 2008 to September 9, 2009, but the period had been extended to November 8, 2010. The D&O insurer accepted the FDIC demand letter as a claim under the policy.

 

On February 12, 2012, well after the expiration of the D&O policy, Bruce Kingsley filed a lawsuit against the bank’s former directors under Arizona securities laws. The Kingsley complaint alleges that Antonucci had made material misrepresentations and omissions in order to induce the Kingsley plaintiffs to make investments in two customers of the bank. The investments were actually used to fund Antonucci’s round-trip transactions. The Kingsley plaintiffs contended that the bank’s former directors should be liable for their “lax oversight” of Antonucci and for the bank’s lack of “sound corporate governance.” The Kinglsey complaint alleged that the directors “did not act in good faith with respect to their control or lack of control of Antonucci” and “did not take reasonable steps to maintain and enforce a reasonable and proper system of appropriate supervision and internal controls.”

 

The directors submitted the Kingsley lawsuit to the bank’s D&O insurer asserting that the FDIC demand letter and the Kingsley lawsuit involved interrelated wrongful acts. The D&O insurer denied coverage for the Kingsley lawsuit contending that the lawsuit had been filed after the policy had expired and that the two claims did not involve interrelated wrongful acts.

 

The directors filed an action in the Southern District of New York seeking a judicial declaration that the two claims involved interrelated wrongful acts and that the D&O insurer had breached the policy when it denied coverage for the Kingsley lawsuit. The D&O insurer filed a motion to for judgment on the pleadings.

 

In the policy, Interrelated Wrongful Acts are defined as “Wrongful Acts which have as a common nexus any fact, circumstance, situation, event, transaction or series of related facts, circumstances, situations events or transactions.”  Under the policy all claims based on Interrelated Wrongful Acts “shall be considered a single Claim” that is “deemed to be first made on the date the earliest of such Claim was first made.”

 

The May 8 Ruling 

In her May 8, 2014 memorandum and order, Judge Batts granted the D&O insurer’s motion for judgment on the pleadings, ruling that the two claims do not present Interrelated Wrongful Acts “because they do not share a sufficient factual nexus.” Because the two claims are not related, the D&O insurer did not breach the policy by declining coverage for the Kingsley Claim.

 

In reaching this conclusion, Judge Batts considered several cases under New York law in which courts had interpreted interrelated wrongful acts provisions and in which the courts had held that for two claims to be related they must “share a sufficient factual nexus.” She observed, based on her review of the cases that “where courts have found a sufficient factual nexus, the two claims had specific overlapping facts.”

 

Here, Judge Batts said, “the factual overlap between the two Claims is tenuous at best; Plaintiffs allegedly failed to act properly with respect to Antonucci, whether it be their control and oversight of him, as alleged in the Kinglsey Complaint, or their failure to investigate allegations of his misconduct, as alleged by the FDIC.”

 

Judge Batts said with respect to these allegations about Antonucci, “if painted in broad strokes, the two Claims may arise out of the same deficient corporate structure or Plaintiff’s lack of oversight.” However, she said, the directors “merely plead in a conclusory manner that the two Claims share common facts and circumstances, yet, as previously explained, the FDIC Claim merely references Antonucci’s general misconduct whereas the Kingsley Claim makes specific allegations of his fraud on the Kingsley plaintiffs.” The directors “bald allegation” that the two Claims arise out of a common set of circumstances “are insufficient to demonstrate a common factual nexus.”

 

Without more, Judge Batts said, “there simply is not a sufficient factual nexus between the FDIC Claim and the Kingsley Claim.” To interpret the two as interrelated “would be to grant the insured more coverage than he bargained for and paid for.”

 

Discussion

In considering Judge Batts’s decision, I will begin where she ends, with her saying that if these two claims were considered to be interrelated, the insureds would be getting more coverage than they bargained and paid for. I find this a curious statement, since the bank had bargained and paid for a policy providing that coverage extended not only to claims made during the policy period but also to claims made subsequent to the policy period if the subsequent claims were related to a claim made during the policy period. The problem is not that the bank did not bargain and pay for the kind of coverage the directors are seeking here; the problem is, as I have frequently noted on this blog, that relatedness issues are notoriously elusive.

 

The difficulty here, as in all coverage cases involving relatedness issues, is determining what degree or quantum of relatedness is sufficient to make alleged wrongful acts interrelated. It is not as if the FDIC Claim and the Kingsley claim were entirely unrelated – there is at least one important area of overlap:  both involve allegations that the board had breached its duties to supervise and control Antonucci. Judge Batts in fact acknowledged the overlap is evident when the picture here  is “painted in broad strokes.”

 

Indeed, I think a reasonable person might easily conclude that the two claims, involving as they do allegations of lack of proper oversight of Antonucci, have “as a common nexus” a “circumstance” or “situation.” In that regard, I note that the policy’s definition of Interrelated Wrongful Acts is written very broadly; it provides that Wrongful Acts are Interrelated if they have as a common nexus “any fact, circumstance, situation, event or transaction.”

 

The word “any” is very comprehensive – if there is any fact circumstance or situation having a common nexus, then the Wrongful Acts are interrelated. Judge Batts faulted the directors’ argument because the overlap on which the directors relied was “painted in broad strokes” – that is, it only appeared at a high level of generalization. However nothing about the policy says that this level of generalization is insufficient. To the contrary, and to reiterate, the policy itself refers to any fact, circumstance, situation, event or transaction

 

The comprehensiveness of this definition communicates that it was intended to be interpreted and applied very broadly. In fact, insurers often are arguing that it should be interpreted very broadly, as for example when arguing that a subsequent claim is related to a prior claim made during a prior policy period in which the insurer did not provide coverage (refer for example here), or when the insurer is arguing that multiple claims made over multiple policy periods triggers only a single policy of insurance, not multiple policies (here).

 

Even recognizing all of the points Judge Batts made in her ruling, I still think it could reasonably be argued that the definition is amply expansive to include both of the claims involved here. And – to turn Judge Batts’s valedictory declamation on its head – since the policyholder expressly bargained and paid for a policy that provided coverage for subsequent claims that are interrelated with claims that are made during the policy period, the insurer here ought to provide coverage for the Kingsley claim, particularly given the breadth of the scope of the definition of Interrelated Wrongful Acts.  

 

As I have said previously about cases interpreting and applying interrelated wrongful act provisions, the cases taken collectively illustrate nothing so much as how elusive these issues can be. This case is a good example of this principle. The problem of course is that this is not some theoretical exercise. The individuals seeking coverage here now have no insurance to rely on to defend themselves against the allegations in the Kingsley complaint.

 

All of that said, I understand the Insurer’s position here as well. The Kingsley complaint was a securities fraud lawsuit relating to the bank CEO’s involvement in a third party (or self-interested) transaction. The FDIC demand letter related to the alleged mismanagement of the bank. I can see why the insurer felt that the two claims were unrelated. That is the problem with interrelatedness disputes. There are no clear answers and the outcomes wind up being a matter of perspective.