Outside corporate directors named as defendants in D&O litigation are rarely required to pay settlements or judgments out of their own personal assets, as prior research has shown. But the question of how frequently outside directors are held liable is a different question from the question of whether and to what extent directors are held accountable.

 

A June 2013 paper by Harvard Business School professors Francois Brochet and Suraj Srinivasan entitled “Accountability of Independent Directors – Evidence From Firms Subject to Securities Litigation” (here) takes a look at this question of independent director accountability. The authors report that while directors are rarely held liable, independent directors that are named as defendants in securities suits are more frequently held accountable. A July 26, 2013 post on the Harvard Business School website about the paper can be found here.

 

The authors start by noting that investors have two mechanisms for holding independent directors accountable. Investors can name independent directors as defendants in lawsuits and they can also express their displeasure with the ineffectiveness of the directors’ oversight of manager by voting against the directors’ reelection. In order to assess the extent to which directors are held accountable, the authors studied the incidence of independent directors being named as securities suit defendants and the record of shareholder votes against those directors.

 

The authors examined a database of 921 securities class action lawsuits filed between 1996 and 2010. The authors found that with respect to the companies that were named as defendants in these suits, 11% of their directors were named as defendants. The likelihood of an independent director being named as a defendant is much higher for directors serving on the audit committee (54% of named independent director defendants); for directors that sold shares (16% of named independent director defendants); or that have been on the board for the entire class period. The incidence is also higher when the lead plaintiff is an institutional investor and when the lawsuit is files under Section 11.

 

The authors then examined subsequent shareholder votes involving the directors named as defendants. The authors found that these independent director defendants have a great percentage of withheld votes (5.47%) than a controlled sample of independent directors whose companies had not been sued.

 

The authors also noted that accountability can also be reflected in a greater turnover among independent directors who have been named as defendants. The authors found that independent directors that are named as securities suits defendants are more likely to lave the board of the sued company within two years of the lawsuit than other directors in the same firm. The propensity of directors to leave the board is greater in lawsuits that are not dismissed and for audit committee members. The likelihood of leaving the board increased for both independent directors named as defendants and for other directors of companies that have been sued after 2002 (post-SOX), which the authors “use as a proxy for greater governance sensitivity.”

 

The authors also examined lawsuit outcomes when independent directors are named as defendants. They found that the more independent directors are named as defendants, the less likely the lawsuit is to be dismissed, settle faster, and settle for a larger amount. The authors noted that “some of our evidence points to the strategic naming of independent directors by plaintiffs to gain bigger settlements.”

 

The authors conclude that “overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.” In other words, though independent directors are only infrequently held liable, that does not mean that they are not held accountable.

 

Does a D&O insurance policy provide coverage for attorneys’ fees awarded in settlement of a breach of contract class action? That was the question before the court in an insurance coverage action brought by the Screen Actors Guild (SAG) against its D&O insurer. In a July 11, 2013 decision, Central District of California Judge Dolly M. Gee, applying California law, held that because there was no coverage under the policy for the underlying breach of contract claim, the policy did not cover the attorneys’ fee award either.

 

A copy of Judge Gee’s opinion can be found here. A July 19, 2013 memo from the Baker Hostetler law firm about the ruling can be found here.

 

Background

Prior to the events that gave rise to the coverage dispute, SAG had entered a collective bargaining agreement in which the actors’ organization had agreed to collect foreign royalty payments and to distribute them to its members. In September 2007, Ken Osmond (who played the part of Eddie Haskell in the TV show “Leave it to Beaver”) filed a class action alleging that SAG had collected over $8 million of the foreign levies but had failed to remit the funds to the SAG members. Osmond asserted claims for conversion, unjust enrichment, accounting and violation of the California Business Code. Osmond sought restitutionary relief, compensatory and punitive damages, a constructive trust, costs, reasonable attorneys’ fees, prejudgment interest and injunctive relief.

 

SAG tendered the claim to its D&O insurer, which agreed to pay defense cost but denied coverage for any indemnity amounts. The parties to the underlying dispute reached a settlement agreement whereby SAG agreed to a plan for the payment of the foreign levies. In approving the class settlement, the court in the underlying claim awarded Osmond an enhancement payment of $15,000 and awarded class counsel attorneys’ fees of $315,000. SAG requested reimbursement from its D&O insurer for the $330,000 award. The carrier responded that the fee award was not covered under the policy. SAG initiated coverage litigation against the carrier and the parties cross-moved for summary judgment.

 

The July 11, 2013 Order

In a July 11 Order, Judge Gee granted the carriers’ motion for summary judgment and denied SAG’s cross-motion for summary judgment.

 

Referring to the 2012 decision of the California Intermediate appellate court in Health Net, Inc. v. RLI Ins. Co., as well as other California cases, Judge Gee identified a principle under California law that the courts had articulated, which is that “if a contracting party fails to pay amounts due under a lawful contract and is sued for that failure to pay, it cannot then obtain a windfall by having its payments covered by an insurance policy covering only ‘wrongful act.’”

 

SAG attempted to circumvent these principles by contrasting the specific language in its policy with the policy language at issue in the earlier cases and arguing that its policy broadly provided coverage for “damages.” Judge Gee found said that this argument “is not persuasive.” She found that the definition of the term “Wrongful Act” in SAG’s policy was similar to the definition of the term in the policies at issue in the prior cases. Judge Gee expressly rejected the notion that there could be coverage for attorneys’ fees as “damages” if there was no underlying “Wrongful Act” alleged. She cited the Health Net decision for the principle that “if the entire action alleges no covered wrongful act under the policy, coverage cannot be bootstrapped based solely on a claim for attorney’s fees.”

 

Judge Gee found that the parties’ submissions and even from SAG’s own presentation in the insurance coverage dispute lead to “but one result,” which is that because SAG was “obligated to account for and distribute the foreign levy funds to the plaintiff class,” SAG “failed to establish that the $330,000 fee award arises from a ‘covered’ Claim under the Policy.” She concluded that the insurer has no duty to indemnify SAG for the fee award and she granted summary judgment in the insurer’s favor.

 

Discussion         

This dispute involved two frequently recurring D&O insurance coverage issues: first, whether a D&O policy covers breach of contract disputes; and second, whether or not a D&O insurance policy covers the amount of an award to the plaintiffs’ attorneys in an underlying claim.

 

Many D&O insurance policies (typically those issued to private companies) have express exclusions precluding coverage for breach of contract claims (as discussed here and  here). However, Judge Gee’s decision here that there was no coverage for the underlying claim here did not depend on her interpretation of a policy exclusion; instead, she found that there was no coverage for the underlying claims against the SAG – for collecting but failing to remit the foreign levies – because the underlying claim did not allege a “Wrongful Act.”

 

There have been many cases holding that insurers are not liable to indemnify their insureds for claims against the insureds for failing to remit amounts the insured was obligated to pay to others. However, these determinations are typically based on the argument that in remitting the amounts due, the insured had not incurred a “Loss” under the policy. These “no loss” principles are fairly well established, as recently discussed for example here. Typically these cases hold that amounts due as a result of a pre-existing duty are not covered Loss

 

 It is interesting that Judge Gee’s analysis here did not depend on, or even refer to, the “no loss” line of cases; the carrier, in reliance on existing California case law, made a different argument, obviously because it could (owing to the case law), but also perhaps because the existence of the $330,000 fee award might have made the “no loss” argument tougher to sustain. Indeed, the SAG did argue here that because fee award represented “damages” and therefore came within the policy’s definition of “Loss.” Judge Gee concluded, in reliance on the prior California cases, that it doesn’t matter whether or not there is “Loss” if there is no “Wrongful Act.”

 

The question whether or not a D&O insurance policy provides coverage for the amount of a plaintiffs’ fee award in an underlying claim is a recurring issue. As I discussed in a recent post, this question often comes up in the context of the settlement of shareholders’ derivative lawsuits, which often include a plaintiffs’ fee award as a part of the underlying settlement. The D&O insurers often argue that the amount of the fee award does not represent “damages” or otherwise is outside the policy definition of Loss. The insurer argue that the fee award represents an amount the company had to pay in order to secure the benefit that inured to the company in the derivative lawsuit settlement.

 

There are several obvious differences between the derivative lawsuit settlement context and the circumstances involved in this case. Among other thing, in connection with a derivative lawsuit, the carrier has usually acknowledged coverage of the underlying claim. In addition, in a derivative lawsuit settlement, the carrier has the argument that the derivative settlement represented a benefit secured for the insured company; the context in this dispute was far different. The present dispute does illustrate another example of the recurring question of coverage for the amount of an attorneys’ fee award in connection with the settlement of an underlying claim.

 

For Many Years, People Actually Watched a TV Show with a Main Character Named Beaver Cleaver: Here at The D&O Diary, we can’t pass up the chance to obvious opportunity to roll some video from a classic TIV show like Leave it to Beaver. Here’s a short clip that includes in the second half a brief yet archetypical dialog between Mrs. Cleaver and Eddie Haskell. It was a more innocent time then; now, I am not sure which is harder to believe – that somebody actually made this TV show or that people actually watched it.

 

//www.youtube.com/embed/MohwVOYzlPw

The many travels of readers’ D&O Diary mugs have continued, with stops in places both familiar and exotic. The results are a variety of mug shots taken on location in places both far and wide. As reflected in the pictures below, the mug is at ease with lobsters, gnomes and volcanoes, and is an appropriate ornament at temples, halls and castles.

 

Readers will recall that in a recent post, I offered to send out to anyone who requested one a D&O Diary coffee mug – for free – but only if the mug recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In prior posts (here, here and here), I published the first three rounds of readers’ pictures. The pictures have continued to arrive and I have published the latest round below.

 

First up is the fascinating shot pictured at the top of the post, which was taken by Jill Dominguez of Energy Insurance Mutual. Jill sent in the picture taken in Key West, Florida. She took the picture on the first day of sportsmen’s lobster season, or “going bugging” as they say in Key West. Jill reports that “You have to get up pretty early to catch these guys and a nice mug of D&O Diary coffee helps to get the ‘bugs’ out!”

 

Loyal reader Jeff Ward of the Loss, Judge & Ward law firm traveled with his sons to Cooperstown, New York, and of course they took their D&O Diary mug with them. They sent in several great pictures of the Baseball Hall of Fame, including this shot of the site of the first Hall of Fame induction, as well as the Cleveland Indians exhibit at the Hall of Fame. (Go Tribe!)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The D&O Diary is partial to the Cleveland sports team (for better or worse), but we understand that readers have their own loyalties. You don’t have to guess at which teams loyal reader Sam Rudman of the Robbins Geller Rudman & Dowd law firm supports. (Sam reports that his Mets gnome was AWOL on the day of the mug shot photo shoot).

 

 

 

 

 

 

 

 

 

 

 

 

Our good friend and former colleague Diane Parker of Allied World Assurance Company traveled out west on her vacation, and apparently she took her D&O Diary mug with her travels. She sent in this really beautiful shot of “what is left” of Mount St. Helens in Washington State.

 

 

 

 

 

 

 

 

 

 

 

 

A very different kind of mountain is also being transformed in New York City. As reflected in this picture submitted by Peter Taub, a 40-ton mountain of sand on Water Street in New York City is being sculpted into a massive sand castle, as part of the Water Street Pops street festival.

 

 

 

 

 

 

 

 

 

 

 

Finally, Gil Jensen of the Musick Peeler law firm in Los Angeles sent in these pictures from Southeast Asia where he had traveled with his daughter. Gil says that “My youngest daughter is in grad school in Melbourne. She suggested in June: ‘Hey Dad, let’s go to Cambodia.’ My initial thought was – great, what a perfect opportunity for some D&O Diary Mug Shots.” From the collection of pictures Gil sent in. it really does appear that the purpose of his visit to Cambodia was to find just the right location for a mug shot. Gil explained that he even had a special carrying case (“ the Chubb Executive Protection bag from a PLUS International Conference from a few years ago”) to make sure that the mug remained undamaged during his travels.

 

The first picture below was taken in front of The Bayon within Angkor Thom just north of Siem Reap (part of the Angkor Wat area). 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 For the second picture below, Gil explains, he traveled “a little farther afield (my version of Heart of Darkness).”. The picture was taken in “the overgrown temple complex Beng Melea (about 70 km from Angkor Wat). Other than a small group of tourists from India and a few Khmer kids, this temple site was totally deserted.”

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

I have to say I really enjoy the idea of loyal D&O Diary readers traveling all over the country and the world with their mugs and cameras at the ready looking for just the right opportunity to capture a classic mug shot. The pictures are great, and I look forward to receiving and publishing many more.

 

As I noted in my last mug shot gallery, I recently ordered another supply of mugs, so if there are more readers out there who would like to have a mug, please just let me know. Just remember, if you get a mug, you have to send back a picture. If you request a mug, please be patient, it will likely be the end of August before we are able to ship out the next batch.

 

Thanks to everyone for the great mug shots. Cheers!

The volume of misstatement-related securities litigation in Japan has “increased dramatically” since the 2004 revisions to Japanese securities laws, according to a June 2013 report from the consulting firm Alix Partners. The report, entitled “Recent Trends in Japanese Securities Litigation: 2000-2012,” can be found here. Even though misstatement-related securities suit filings in Japan were down in 2012, last year may still go down as a milestone year, as the year in which foreign investors “discovered” securities litigation in Japan.

 

According to the report, misstatement related cases in Japan were virtually nonexistent before 2004. In 2004, Japanese securities laws were amended to reduce the burden of proof for plaintiffs and to introduce a presumptive rule for damages. Since these revisions, “the volume of litigation has increased dramatically,” even though Japanese legal procedures do not allow for class-action lawsuits.

 

Between 2007 and 2012, there were a total of 55 lawsuits involving misstatements, as well as 210 lawsuits involving the sales of financial products (more than double the number during the pre-2007 period). Though the number of misstatement-related lawsuits decreased to seven in 2012 from eleven in 2011, 2012 “will perhaps be remembered as the year when Japanese securities litigation was ’discovered’ by foreign investors.”

 

Prior to 2012, the plaintiffs in misrepresentation cases in Japan had been domestic individuals or institutional investors. In 2012, a large group of overseas investors filed litigation involving the Olympus scandal. Though there had previously been a lawsuit in Japan involving domestic investors, on June 28, 2012, a group of 48 overseas institutions and pension funds filed a lawsuit seeking 19.1 billion Yen in damages. According to the report “the Olympus filing became the first major litigation in Japan to be initiated by foreign institutional investors,” and the case has “generated more international attention” than prior cases.

 

One reason for these investors’ move to Japan is the U.S. Supreme Court’s decision in National Australia Bank v. Morrison, which held that the U.S. securities laws only apply to transactions in the U.S. Investors who purchased their Olympus shares could not resort to the U.S. courts (although the small number of investors that purchased Olympus ADRs in the U.S. did initiate a securities class action suit in U.S. Court.)

 

It is not just that the non-U.S. purchasers did not have the option of filing in the U.S. In addition, the revised Japanese securities laws “may lead to more favorable outcomes for plaintiffs than they could realize under U.S. securities laws,” owing to the significantly reduced burden of proof for plaintiffs and to the “no-fault liability on the part of corporations for their misstatements.” These features could make the jurisdiction more attractive to some claimants.

 

There has also been increase in Japan in the litigation between financial institutions and their customers concerning suitability principles and the requirement to explain financial products. Since 2007, these cases have “increased dramatically,’ peaking with 53 in 2011. Though there were only 39 such cases in 2012, the size of the cases has grown.

 

Readers may be familiar with the study of Japanese Securities Litigation that was published by NERA Economic Consulting  (which I discussed here). The Alix Partners report acknowledges the NERA report but notes that the two reports are not consistent because “the authors used different methods in building a database and analyzing trends — by excluding criminal cases and classifying cases using a different set of definitions.”

 

It may be particularly important to note the further explanatory observation in footnote 8 to the Alix Partners report, in which the authors state that the number of cases cited in the report “is based on court rulings; the district and upper court decisions that involve the same case are counted separately.” This methodology would obviously result in a larger overall tally than might a different approach.

 

Special thanks to a loyal reader for sending me a copy of the Alix Partners report.

 

Legal Challenge to Conflict Mineral Disclosure Rules Rejected: In a July 23, 2013 opinion, Judge Robert J. Wilkens rejected the legal challenge to the SEC’s conflict minerals disclosure rules that the National Association of Manufacturers and others had mounted. Judge Wilkens found “no problems with the SEC’s rulemaking” and disagreed that the conflict minerals disclosure scheme transgresses the First Amendment. The Court concluded that the plaintiffs’ claims “lack merit.” A copy of Judge Wilkens opinion can be found here.

 

As discussed at length here, the Dodd-Frank Act instituted requirements for the SEC to promulgate rules requiring companies to disclose their use of certain minerals originating in the Democratic Republic of Congo and adjoining countries. The specific minerals at issue are tantalum, tin, tungsten and gold. On August 22, 2012, the SEC adopted the conflict mineral disclosure rules. The SEC’s August 22, 2012 press release can be found here and the rule itself can be found here.

 

The conflict mineral rules are widely expected to be very challenging, as discussed here. For that reason various groups sought to block the implementation of the rules through a court challenge. In his July 23 opinion, Judge Wilkens rejected the plaintiffs’s summary judgment motion and upheld the SEC’s (and intervenor Amnesty International’s) cross-motion for summary judgment.

 

As Broc Romanek wrote in a July 24, 2013 post on his TheCorporateCounsel.net blog (here), the ruling means “the SEC’s rules go forward as they currently exist (ie. no de minimis exception, etc.).” He adds that even if the challengers appeal the district court’s ruling, “with the first report due May 31, 2014, all companies should be operating on the assumption that the rules are indeed the rules and start preparing now.”

 

As I noted in a recent post about the conflicts minerals disclosure rules, many companies had been playing a waiting game and deferring what they knew would be a difficult task in the hope that the legal challenge would succeed. Now that the district court has rejected the legal challenge, many companies will be scrambling to meet the May 31, 2014 deadline. I predict we will all be hearing a lot more about this issue and the problem companies are facing trying to comply with the SEC’s disclosure rules.

 

More Libor Litigation: The Libor scandal captured the headlines a year ago at this time. Though the story has moved out of the headlines, the scandal story continues to grind on. And though the motion to dismiss was largely granted in the consolidated Libor antitrust litigation (as discussed here), claimants have demonstrated that they are willing to continue to try to fight on.

 

In the latest examples of the continuing fight, earlier this week two U.S. local governments each filed their own separate lawsuits against the Libor rate-setting banks. First, on July 22, 2013, the City of Houston, Texas filed an action in the Southern District of Texas against the Libor rate-setting banks, alleging that the banks’ manipulation of the benchmark rates artificially suppressed its returns on $1.1 billion in interest rate swap agreements. A copy of Houston’s complaint can be found here.

 

On July 23, 2013, Sacramento County, California filed an action in the Eastern District of California alleging that the Libor rate-setting banks manipulation caused it to lose money from bond issuances. The county’s complaint, which can be found here, alleges violations of federal antitrust laws, California antitrust laws and California state common law.

 

These latest cases illustrate a point that I have made elsewhere, which is that despite the setback, the Libor claimants are continuing to press ahead. It remains to be seen whether these latest claims will succeed where others have stumbled. The one thing that is clear that we have much further to go in the playing out of the Libor scandal and the related litigation wave.

 

Securities class action lawsuit filings “remained at depressed levels” during the first half of 2013 according to the latest report from Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. The report, entitled “Securities Class Action Filings: 2013 Mid-Year Assessment,” can be found here. The organizations’ July 24, 2013 press release about the report can be found here. My own analysis of the first half securities suit filings can be found here.

 

According to the report, there were 74 securities class action lawsuit filings in the year’s first half, which represents a 16 percent decline from the first half of 2012, but a 16 percent increase over the second half of 2012. The 74 filings in the first half of 2013 were well below the historical average of 95 per six-month period.

 

If filings were to continue at the same pace for the remainder of 2013, the year would finish with 148 filings, which would be the second-lowest total number of filings since 1997. The projected annualized rate is well below the 1997-2012 average of 191.

 

The increase in filings in the first half of 2013 compared to the second half of 2012 is primarily due to an increase in filings against companies in the technology and energy sectors. The increase in energy companies primarily relates to oil and gas companies, and is similar in magnitude to an uptick in energy filings observed in late 2011 and early 2012.

 

The number of M&A related filings in the year’s first half decreased markedly from high levels observed in 2010 and 2011. The report notes that “these actions are now being pursued primarily in state courts after the unusual jump in federal M&A filings in 2010 and 2011.”

 

In a particularly interesting observation, the report notes that federal filings against companies listed on the Over-the-Counter Bulletin Board (OTCBB) and Pink Sheets have increased over the last 18 months. These groups of companies typically are smaller firms with lower market capitalizations. Historically, less than four percent of filings involved these companies. However, during the last 18 months at least eight percent of filings have involved these companies. The increased presence of these smaller companies has meant, among other things, that the average disclosure losses theoretically involved in these cases are well off from historical levels.

 

Just as the number of filings against smaller companies has increased, filings against S&P 500 companies have declined in recent years. Of the 74 filings in the year’s first half, only seven involved S&P 500 companies, which represents the lowest level of filing activity against S&P 500 companies in 13 years.

 

During the first half of 2013, the number of filings against foreign issuers declined 50 percent from the same period in 2012. The percentage of all filings against non-U.S. companies  fell to 14.9 percent – less than the percentage of filings against non-U.S. companies in 2011 and 2012 but similar to the proportions in the years prior to 2010. The decline compared to more recent years is largely attributable to the decline in the number of filings against U.S.-listed Chinese companies.

 

In its analysis of dismissal trends, the report notes that, compared to prior dismissal patterns, cases filed in the years 2003 through 2005 were being dismissed at greater rates. The report notes that “filing dismissal rates continued to increase in years 2008, 2009 and 2010.” For the 2008 year, 50 percent of filings have already been dismissed. For the 2009 and 2010 year, dismissal rates are 53 and 56 percent, respectively. Part of the increase in dismissal rates is due to the surge of M&A cases that began in 2009. M&A cases have much higher dismissal rates than non-M&A filings. On the other hand, a case involving an institutional investor lead plaintiff is much less likely to result in a dismissal.

 

The press release accompanying the report has a very interesting quotation from Stanford Law School Professor Joseph Grundfest, who predicts that there will be a “change in defense litigation strategy.” Grundfest noted that in the Amgen case four U.S. Supreme Court  justices suggested they welcomed arguments over the continuing validity of the “fraud on the market” theory. Grundfest notes that

 

The defense bar is rising to the invitation. We are observing class certification challenges on the grounds that the fraud on the market doctrine should not apply. If this defense strategy is successful, and if the Supreme Court eventually backs away from the fraud on the market doctrine, then the class action securities fraud litigation market will likely shrink significantly. This potential evolution of legal doctrine represents the largest “risk factor” for anyone trying to predict the future course of the securities fraud litigation market.

 

One observation I have with respect to the report’s analysis is that all of the report’s observations and comparisons are based on the absolute number of filings. I think it is important to compare the number of filings to the number of publicly traded companies. As I noted in my analysis of the first half filings, the number of publicly traded companies declined about 24 percent between 2004 and 2012, and the absolute number of filings also declined about 24 percent during that period. Comparisons between the absolute number of filings now and the absolute average number of filings reflect this same analytical shortcoming, as the average reflects the number of filings in years when there were many more publicly traded companies. A relative analysis would be more meaningful than simply comparing absolute numbers.

 

Failing to take into account the decline in the number of publicly traded companies can result an incomplete understanding of filing rates (as opposed to filing numbers). As I have said elsewhere, even though the absolute number of filings is down, all else equal, the chance than any given publicly traded company will get hit with a securities class action lawsuit is about the same as it was ten years ago.

 

I also have a comment about the report’s observation that 2013 is on pace for the second lowest number of annual filings since 1996. The year with the lowest number of filings since 1996 was the year 2006, when there were a total of only 120 securities class action lawsuits. But immediately after that came the credit crisis and a huge wave of related litigation. My point is that securities class action filing activity ebbs and flows. There have been ebb periods before, often followed by periods of flow. Absent a change in the law of the order of magnitude that Professor Grundfest suggested might be coming, historical patterns suggest that some point there will be an influx of new securities suits.

 

The collectors’ edition D&O Diary mugs that we have sent to interested readers have proven to be both ceremonial and functional, as reflected in the latest round of readers’ pictures. And the mugs have once again proven to be well-travelled, as well.

 

Readers will recall that in a recent post, I offered to send out to anyone who requested one a D&O Diary coffee mug – for free – but only if the mug recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In prior posts (here and here), I published the first two rounds of readers’ pictures. The pictures have continued to arrive and I have published the latest round below.

 

The first picture underscores just how global the D&O insurance industry is, as well as the international reach of The D&O Diary.  Anita Panditaa of ICICI Lombard General Insurance Company Limited in New Delhi, India sent in this picture of the company’s Financial Lines division underwriting and claims team. The team is headed by Bhavesh Patel, who is holding the mug. Anita is standing directly behind him. Anita reports that everyone on her team reads The D&O Diary

 

 

 

 

 

 

 

 

 

 

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The D&O Diary mug also fits in at home as well as overseas, and also helps to  celebrate diversity. Dr. Harold Barnett of the Roosevelt University Heller College of Business sent in this picture, about which Barnett wrote: “I had a hard time choosing a Chicago background for my D&O Diary mug. But with the recent Supreme Court rulings on DOMA and the Illinois House of Representative just refusing to vote on same sex marriage, I thought the Pride Parade was the place to be.”

 

 

 

 

 

 

 

 

 

 

 

 

John Coleman of AON Risk Services, Global Broking Division, in London sent in this picture taken (with the mug, of course) at the Southern 100 International Road Race. John’s explanation of the picture is reproduced in the indented text below the picture.

 

 

 

 

 

 

 

 

 

 

 

 

I’ve been racing motorcycles for 9 years and at the age of 47 I must say I’m starting to feel like I’m getting a bit old for mixing it with twenty years olds on 600cc race bikes. I started riding in 1996 when my father bought a Harley Davidson on a bit of a whim, in his usual generous style he said I could ride it whenever I liked if I did my motorcycle test, which I duly did. After riding it for a few years I purchased my own Japanese commuter bike which I soon traded in for a Supersport 600, shortly after that I did a track day and it all seemed to snowball from there. Within three years I’d got myself a race license and a year later I was EMRA’s 600cc Roadstock Championship runner-up. I continued to race around the country successfully but never managed to repeat my achievements in my first year, starting racing at 38 was probably a bit too late, most of the professionals retire at that age.

 

As well as racing on the majority of the circuits in the UK including Brands Hatch, Donington and Silverstone I have also raced the roads of the Isle of Man including three years on the famous 37 ¾ mile TT Mountain Course and most recently for my second visit to the Billown course (on the outskirts of Castletown, IoM) for the Southern 100 International Road Races. Unlike the fast, open and flowing roads of the TT course, the Billown course is 4 ¼ miles of narrow country lanes but you are still hitting speeds of up to 150mph which makes for a more intense experience. This year’s event was blessed with amazing weather, unusual for a rock in the middle of the Irish Sea, but unfortunately marred by three deaths in three separate incidents. Everyone involved is aware of the risks in the sport and accepts the dangers, it’s partly why we do it. It often gets commented to me that it’s strange that a person who works in a risk assessing industry would do anything so dangerous for a pastime. Like anyone else in insurance, I have assessed the risks and come to the conclusions that the reward out ways the risk.

 

Finally, Iris Chu sent in this picture taken in her Shanghai office of Marsh (Beijing) International Brokers Co. She reports that she was happy to receive her mug, but sadly, as the picture reflects, the mug was damaged when it arrived.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Even worse, by the time I learned of this calamity, I had already given away all of the mugs, so I was unable to replace the damaged one Iris received. The shipping mishap with Iris’s mug and the many requests I have continued to received since I ran out of mugs have helped me to decide to just go ahead and order another round of mugs.

 

My order of  a second round  of mugs not only means that I can now replace Iris’s damaged mug but also means that I can fulfill the many mug requests I received after I depleted my original stock. It also means that if there are others out there who want a mug but who had not previously requested one, well, you can just let me know and I will send you one, too. But remember – if you request a mug, you are agreeing to send a picture of the mug back to me. Those awaiting or requesting mugs will have to be a little patient. Owing to upcoming work and travel schedules, it likely will be late August or early September before I can ship the next round.

 

Many thanks to the readers for their great pictures. I look forward to publishing many more pictures I the very near future.

 

As part of its scheme to improve corporate transparency and director accountability, a UK government ministry has proposed what UK Business Secretary Vince Cable calls “tough measures” to “give the public greater confidence that irresponsible directors will face consequences for their actions.” These proposals, if adopted, could significantly increase UK corporate directors’ liability exposures in the bankruptcy context. The increased exposures could have significant D&O insurance implications.

 

As discussed in the ministry’s July 15, 2013 press release (here), the UK Department of Business Innovation & Skills has released a discussion paper entitled “Transparency & Trust: Enhancing the  Transparency of UK Company Ownership and Increasing Trust in UK Business” (here). The paper’s proposals are intended to address commitments the government made at the June 2013 G8 summit. The discussion paper has been released to solicit public comment. The discussion period ends September 20, 2013.

 

According to the ministry’s press release, the paper’s proposals are “aimed at addressing opaque company ownership structures and improving the accountability of the company directors.” The paper’s first part looks at ways to “inject greater transparency around who really owns and controls companies in the UK.” The paper proposes a number of measures to improve corporate transparency, including requiring companies to obtain and hold information on who owns and controls them, and prohibiting bearer shares. It is hoped that these and other measures would “help to tackle tax evasion, money laundering and the financing of terrorism, and improve the investment climate in the UK.”

 

The paper’s second section “sets out ways of making directors more accountable for misconduct or company failure” by, among other things, giving regulators greater power to disqualify directors, expanding the factors courts can take into account when disqualifying directors, and extending the time limits for the government to bring a disqualification proceedings in cases involving insolvent companies from the current two years to five years.

 

The paper also presents a proposal to give courts the power to hold directors personally liable to creditors if a director is disqualified by misconduct in connection with a company’s insolvency. The paper notes that “a complaint frequently heard from creditors is that although disqualification can prevent a director acting as such in the future, it provides no compensation to those who have suffered from their misconduct.” After noting that other jurisdictions allow creditors to pursue claims against directors in insolvency proceedings, the paper proposes giving courts powers to make compensatory awards at the time they make a disqualification order. 

 

It is hoped that this measure would ‘improve confidence in the insolvency regime.” The aim would be “to increase the likelihood of culpable directors being called to account for their actions whilst providing better recourse to funds for creditors who have suffered. “ The paper also proposes giving liquidators the statutory right to sell or assign fraudulent and wrongful trading actions.

 

These measures are at this point merely proposals and they may not ultimately be implemented. However, according to a July 18, 2013 memo from the Clifford Chance law firm (here), if the measures are implemented, they would “add significantly to the circumstances in which directors might find themselves personally liable if a company fails.”

 

The law firm memo also points out that one concern arising from these proposals is the question whether “this new potential liability for creditors’ losses is likely to be covered” by D&O insurance.
As the memo points out, insolvency is one of the important contexts in which a D&O policy is intended to provide protection. But though the directors should expect that the company’s D&O policy would protect them if they are the target of a claim to compensate creditors, there are “potential pitfalls.”

 

The new form of proposed liability would arise in a disqualification proceeding after the company has failed. The law firm memo notes that a failed company is unlikely to have a D&O insurance policy still in place by the time the liability action is asserted. Before a company fails and while D&O insurance is still in place, a director might try to take advantage of policy provision allowing notice of circumstances that may give rise to a claim, by notifying the insurer of the passivity of a creditor compensation claim. However, before the company has failed, the possibility of a later compensation claim “remains only a remote – and speculative – possibility” that may not be sufficient to support a notice of circumstances. This problem would be “exacerbated” if the government extends the time within which disqualification proceedings may be brought from the current two to five years.

 

Some companies facing bankruptcy may procure a run-off policy, to provide insurance protection for claims arising from pre-bankruptcy conduct. The law firm memo notes an interesting pitfall that I suspect may be unique to UK policies. The memo states that “directors that have been disqualified are typically excluded,” and adds that “run-off cover does not extend to directors who have been disqualified from acting as directors.” Perhaps a reader from the UK can educate me on this provision, as I am not familiar with D&O policy provisions expressly precluding coverage for disqualified directors.

 

But as the law firm memo points out, as a result of these provisions precluding coverage for disqualified directors, the directors “may find that they are unable to avail themselves of the run-off cover in the very situation in which they need it (although up to the date that the director is disqualified the run-off cover may at least cover the costs of defending a creditor compensation claim).”

 

It will be very interesting to see whether the proposed new director liability provisions are implemented. As the law firm memo concludes, “directors concerned about the Government’s proposals to expand their personal liabilities would be well advised t review their D&O policy wordings carefully or face the risk of having to bear substantial compensatory awards themselves if the new proposals come into effect.”

 

D&O Insurance in India: While I am on the topic of D&O exposures and insurance outside the U.S. I thought I should also briefly note the July 18, 2013 article in The Times of India entitled “Lawsuits Make Companies Go for CEO-Director Cover” (here) which reports that more Indian companies are expressing interest in D&O insurance. The article notes that until recently D&O insurance was viewed in India as “an exotic cover,” most of interest to Indian companies with U.S. listings.

 

Now, according to the article, D&O insurance is drawing interest from many mid-to-large size companies. The increase in interest follows “a spate of high profile cases such as iGate and Satyam,”   as well as activates of foreign institutional investors. For example, the Children’s Institutional Fund threated to sue independent directors of Coal India for not protecting shareholders interests. The article also notes that regulatory actions and employment practices activities also have been the source of many claims notifications.

 

The article reports that D&O insurance remains relatively inexpensive in India. According to the article, “companies can even now get cover for up to $1 million for equivalent of $1,000.”

 

Midnight in Yoknapatawpha County:  On November 18, 2013, in an entertaining opinion written in connection with a really dumb lawsuit, Northern District of Mississippi Chief Judge Michael P. Mills rejected the claims asserted by the holders of William Faulkner’s literary rights that the makers of the Woody Allen movie Midnight in Paris had infringed the Faulkner copyright when they quoted a line in the movie from Faulkner’s novel Requiem for a Nun. A copy of Judge Mills’s opinion can be found here.

 

The dispute centers on a quote of a statement by a character in the novel that “The past is never dead. It’s not even the past.” The literary rights holders contended that the moviemakers infringed the Lanham Act and the Copyright Act with a line in the movie in which one character says “The past is not dead. Actually, it’s not even past. You know who said that? Faulkner, and he was right. I met him too. I ran into him at a dinner party.” 

 

The opinion opens with admirably succinct plot synopses of the movie and of the book. In a footnote after the synopses, Judge Mills disagrees with the defendants’ characterization of the novel as “relatively obscure, “noting that  “nothing in the Yoknapatawpha canon is obscure. Having viewed the two works at issue in this case, the court is convinced that one is timeless, the other temporal.”

 

After a lengthy analysis, Judge Mills rejected the plaintiffs’ copyright claim, holding that no substantial similarity exists between the copyrighted work and the allegedly infringing work and that the movie’s use was de minimis. He also rejected the plaintiffs’ Lanham Act claim, noting that the movie’s brief literary allusion cannot “possibly be said to confuse an audience as to an affiliation between Faulkner and Sony. Allusion is not synonymous with affiliation, nor with appropriation.”

 

Though the case required Judge Mils to compare Midnight in Paris to Requiem for a Nun, he expressed his gratitude that “the parties did not ask the court to compare The Sound and the Fury with Sharknado.” 

 

Just in case the holders of Faulkner’s literary rights should read this blog post, let me emphasize to readers that my quotation of language above from Requiem for a Nun should not in any way be interpreted as representing an affiliation between Faulkner and his works and this blog, nor should the quotation be interpreted as a form of an endorsement.

 

Special thanks to a loyal reader for sending me a copy of the opinion.

 

They Return With All Sorts of Wild Ideas: In a July 6, 2013 Economist magazine article discussing how students returning to China from studies in the West are now finding it harder to find employment, the article suggests a number of possible reasons. The article suggest that they are finding the Chinese labor market so challenging because there is a glut of so-called “sea turtles” returning and also because the local schools are now turning out more qualified graduates who are better matched to Chinese employers’ current needs.

 

The article also quotes an unnamed investment banker who suggests another reason that many Chinese employers are reluctant to employ the returning students, which is that the returning students “often cling to quaint Western notions like transparency, meritocracy and ethics, which puts them at a disadvantage in China’s hyper-Darwinian economy, where locals are more willing to do whatever the boss or client wants.”

 

Summer’s Here and the Time is Right for Dancing in the Street: In his July 20, 2013 Wall Street Journal book review, David Kirby relates the account in Mark Kurlansky’s new book Ready for a Brand New Beat of how in July 1964 Martha Reeves came to record the song “Dancing in the Street.” She had arrived at the Motown Studios as then rising-star Marvin Gaye had begun work on the song, which had been set up for a male vocalist. On the spur of the moment, Gaye suggested that the 21 year-old Reeves give the song a try. She nailed the song on her first attempt – but Gaye had neglected to engage the recording machine. Frustrated to have to sing it again, Reeve’s second take – the one that became one of Motown’s iconic songs – carried just a note of aggression. According to Kurlansky, the song went on to be a rallying cry for social upheaval during the 60’s.

 

It doesn’t matter what you wear, just as long as you are there. Here’s a classic video of Reeves performing “Dancing in the Street,” to get your feet tapping on a Monday morning. (Sorry about the advertisement at the beginning; it is short).

 

//www.youtube.com/embed/CdvITn5cAVc

The difficulty with pure “claims made and reported” insurance coverage was put into sharp relief in a recent decision out of the South Carolina federal court. The question before the court was whether there is coverage for a claim made during the policy period of one claims made and reported policy but not reported to the insurer until the subsequent renewal policy period.

 

In a July 9, 2013 opinion, District of South Carolina Judge Cameron McGowan Currie, applying South Carolina law, held that the notice in the subsequent policy period was untimely and therefore that there was no coverage for the claim made during the prior period. A copy of Judge Currie’s opinion can be found here.

 

Background

GS2 Engineering and Environmental Consultants purchased a series of six one-year professional liability insurance policies from the same carrier. The key policy periods for purposes of the insurance dispute are the last two renewal policies, which covered the period August 7, 2009 to August 7, 2010 (the “2009 Policy”) and August 7, 2010 to August 7, 2011 (the “2010 Policy”). Both of these policies were claims made and reported policies, and both contained this language in their introductory paragraphs:

 

This is a claims made and reported policy …. This policy has certain provisions and requirements unique to it and may be different from other policies an “insured” may have purchased …. “Claims” must be first made against the “insured” during the “policy period” and “claims” must be reported, in writing, to us during the “policy period”, the automatic extended reporting period or the extended reporting period, if applicable.

 

The policies provided coverage for claims arising from specified services, when the following criteria were met:

 

Such act, error or omission must commence on or after the “retroactive date” and before the end of the “policy period” and the “claim” is first made against the “insured” during the “policy period” and reported to us during the “policy period”, the automatic extended reporting period or the extended reporting period, if applicable.

 

The policies’ extended reporting provisions (ERP) provided as follows:

 

IV. Extended Reporting Period

                A. You shall be entitled to an automatic extended reporting period without additional charge upon termination of coverage as defined in this section. This period starts at the end of the “policy period” and lasts for thirty (30) days.

                B. In addition to the automatic extended reporting period you shall be entitled to purchase an extended reporting period of up to three (3) years in duration upon termination of coverage as defined in this section …

…

                E. For the purposes of this automatic extended reporting period and the Extended Reporting Period endorsement, termination of coverage means any cancellation or nonrenewal of this policy except for fraud or material misrepresentation, a material change in the nature or extent of the risk or nonpayment of premium.

 

Richland School District filed a lawsuit against GS2. The lawsuit was served on GS2’s counsel on April 14, 2010, nearly four months before the expiration of the 2009 policy. The 2010 policy went into effect on August 7, 2010. The insurer received its first notice of the lawsuit from Richland School District on September 23, 2010 – roughly 47 days into the 2010 policy period – when the school district’s counsel sent the carrier a copy of the summons and complaint. GS2 itself first communicated with the insurer about the claim on November 12, 2012, in response to an October 6, 201o inquiry from the insurer.

 

The insurer disclaimed coverage for the claim and coverage litigation ensured. The insurer moved for summary judgment.

 

The July 9 Opinion

In his July 9 opinion, Judge Currie, applying South Carolina law, granted the defendant insurance company’s motion for summary judgment.

 

Judge Currie preceded her discussion of the legal issues by noting that because GS2 had renewed its policy, it was not eligible either for the automatic thirty-day ERP or purchase of a longer ERP. She also noted based on the facts recited above that GS2 had not both received and reported the claim during the same period.

 

Judge Currie stated that the question before her was how the claims made and reported provisions of the policies should be applied where the insured is covered under a series of renewal policies that contain extended reporting period provisions that are unavailable in the event of renewal.

 

GS2 cited several court decisions in which courts had found the claims made and reported policy language to be ambiguous, construed the language in the favor of the insured, and held that the renewal of the particular policies before the court resulted in an extension of the reporting period from one policy year into the subsequent year. Among other things these cases discussed the expectation of continuous coverage created by the series of renewals.

 

The insurer, in turn,  cited multiple cases that supported the conclusion that the renewal of a claims made and reported policy does not modify the requirement that claims be reported in the same policy period in which they are made unless an ERP applies.

 

After reviewing the cases, Judge Currie concluded that the cases the defendant cited “better reflect the nature of the policies at issue and their actual language.” She concluded that the South Carolina Supreme Court

 

would apply this reasoning to exclude coverage under the facts of this case and language of the present policy, which clearly and repeatedly advises that coverage requires a claim to be made and reported during the same policy period. Any ambiguity which might be found in the ERP, when read in isolation, is clarified by the language found in the introductory and basic coverage provisions quoted above….Even if the court were to find the ERP provisions … ambiguous, it would, at most, construe them to extend the automatic thirty-day ERP to renewed policies. Under the facts of this case, that would not lead to a different result as the claim was first reported to the insurer more than thirty-days after the close of the 2009 Policy Period, which is the policy period in which the claim was made.

 

Accordingly, Judge Currie rejected GS2’s argument that all of the policies should be treated as a continuing policy or that the 2009 policy’s reporting period should be extended into the 2010 policy. She granted the insurer’s motion for summary judgment.

 

Discussion

The requirements of a pure claims made and reported policy are harsh. This is most obvious in the context when a claim is made just before the claims made and reported policy expires. Picture, if you will, a claim that arrives on the final day of the policy period, the day before the policy renews. Even in the exercise of the utmost effort, the policyholder might not be able to get the notice of the eleventh hour claim to the insurer before the policy expiration. Yet, if the principles of this case were applied to that situation, there would be no coverage for the eleventh hour claim, an absurd result that cries out for some practical accommodation. The universal expectation under those circumstances, I think, would be that the carrier should accept the notice after the policy renewal to avoid a manifestly unfair outcome. (Maybe some particularly hard-hearted claims professionals would reject any accommodation, but I think most fair-minded people would expect the accommodation).

 

If you accept for the sake of discussion that some accommodation would have to be made in the case of the eleventh hour claim, why isn’t it right to expect some accommodation where as here the time gap was greater? The response likely would be that the policyholder was not diligent in fulfilling its notice obligations under the policy and therefore should not receive any accommodation.

 

Here’s the problem for me anytime I look at an insurance coverage dispute involving notice issues – late notice happens. I have seen it over and over again during the course of my many decades in this business. Even the most diligent company may blow a notice deadline. Smaller companies don’t always have personnel focused on insurance issues. Larger companies have difficulties when claims information is not communicated up through the organization. Companies are focused on making goods and delivering services. As a result, from time to time they may – and in my experience often do – fail to attend to insurance notice obligations in a timely manner.

 

Often the analysis of a failure to provide notice issues takes on a judgmental tone, as in “it is the company’s own fault for failing to give notice” or something like that. But notice is not a moral issue, it is purely procedural. It is the means by which the insurer is advised that a situation has arisen in which its policy may be implicated. Of course, late notice can be unfair to the carrier – for example, if notice arrives so late that the carrier’s interests are prejudiced. But there was no suggestion here that the carrier’s interests were prejudiced. Instead, a carrier that accepted a succession of six annual renewal premiums and that undeniably was on the risk when the claim was made escaped its coverage obligations based on the delayed notice. Not because it was prejudiced, mind you, but simply because the notice was late.

 

In many current policies, the harsh edges of claims made and reported requirements have been ameliorated somewhat. Many policies now require notice only “as soon as practicable” and provide a post-expiration period of 60 or as many as 90 days in which claims may be reported. These policies are more practical because they recognize the reality that even when a company is diligent, it may not provide notice right away.

 

These more accommodating notice provisions underscore the ultimate problem here, which is that the policy here was a pure claims made and reported policy. As this case with its harsh outcome demonstrates, pure claims made and reported policies are unfavorable to policyholders and should be avoided where possible. There are of course certain insurance products, or certain companies in certain industries, for which a pure claims made and reported policy may be the only availlable option.  (Please note that I am expressing no opinions about the placement of this policy; I have no way of knowing what options might have been available to this insured or what other considerations might have entered into the policy placement.)

 

There is of course another lesson from this case (as my friends on the carrier side would no doubt be quick to point out), and that is that companies must be attentive to their interests and do everything they can to try to preserve all of their rights under their insurance policies. The problems this company encountered here can be avoided, but it requires companies to have processes in place to make sure that their insurance interests are protected. As this case show, the price for failing to do so is steep. As this case also shows, even when notice requirements can produce harsh results, courts are prepared to enforce them. Companies should pay heed and conduct themselves accordingly.

 

I know some readers may have some strong views about these topics and my comments. For all I know there may be some real fans of pure claims made and reported policies out there. I encourage readers to post their remarks using this blog’s comment feature.

 

Does the multiplied portion of an attorneys’ fee award constitute the “multiplied portion of multiplied damages” such that it is precluded from coverage under a D&O insurance policy? That was the question addressed in a July 16, 2013 decision from the Seventh Circuit. In an interesting opinion from Chief Judge Frank Easterbrook, the appellate court, applying Illinois law, concluded that the multiplied portion of the fee award does not represent multiplied damages and accordingly the entire fee award is within the D&O policy’s coverage.

 

Background

Amicas agreed to merge with Thoma Brava in a transaction valued at $5.35 per share. Shareholders filed a state court action in Massachusetts objecting to the merger. After the Massachusetts court entered a preliminary injunction stopping the merger vote, the lawsuit settled. Amicas shareholders ultimately received $6.05 per share in the merger transaction, representing a $26 million increase in the value of the transaction.

 

The Massachusetts lawsuit plaintiffs sought to recover their attorneys’ fees. The Massachusetts judge awarded the plaintiffs’ attorneys fees consisting of a lodestar of $630,000, increased by a multiplier of five. The multiplier represented an adjustment for the risk to the plaintiffs’’ lawyers that they might have recovered nothing and also for the “exceptionally favorable result” for Amicas’ shareholders. The total value of the award after application of the multiplier was $3,150,000.

 

The D&O insurer for Amicas acknowledged coverage for the lodestar amount, but disputed that its policy covered the multiplied amount of the fee award. In making this argument, the carrier relied on the policy’s definition of the word “Loss” for which the policy provides coverage. The definition states that “Loss shall not include civil or criminal fines or penalties imposed by law, punitive or exemplary damages, the multiplied portion of multiplied damages, taxes, [etc.]”

 

The carrier filed an action in federal court in Illinois seeking a judicial declaration that the multiplied portion of the fee award represents the “multiplied portion of multiplied damages,” and is therefore not within the policy’s definition of covered loss. Amicas filed a counterclaim against the insurer for its bad faith refusal to pay the multiplied portion of the fee award.

 

The district court ruled that the D&O insurer owes the full amount of the fee award, but rejected Amicas claim for bad faith. Both sides appealed.

 

The July 16 Opinion

In a short eight-page opinion written by Chief Judge Easterbrook for a unanimous three-judge panel, the Seventh Circuit, applying Illinois law, affirmed the district court on both issues.

 

Judge Easterbrook began by noting that the award of attorneys’ fees differs from “damages” and that “nothing in [the] policy defines the word ‘damages’ broadly enough to include attorneys’ fees.” He also noted that the court could not find a decision from any court that addressed the question whether the phrase “multiplied portion of multiplied damages” includes the multiplied portion of an attorney fee award. 

 

Looking at the policy language itself, Judge Easterbrook noted that “the context of the phrase …tells us that treble damages and the like are the target.” The list of items that the definition excludes from the definition of covered loss “covers a category of losses that insurers regularly exclude to curtail moral hazard – the fact that insurance induces the insured to take extra risks.”

 

However, Judge Easterbrook noted, adversaries attorneys fees “are not remotely like punitive damages, trebled damages, or criminal fines and penalties,” adding that “ a multiplier of hourly rates provides compensation for the attorneys’ risks,” which “does not entail a moral hazard.”

 

Judge Easterbrook then went on to state that the way that the state court judge had calculated the fee award is irrelevant to whether or not fee award is covered. The state court judge could have, rather than using a multiplier, reached the same fee award amount by simply reckoning it as 12.11% of the shareholders’ gain, in which case, Judge Easterbrook said, “we assume that [the insurer] would not be relying on the exclusion.” He added the observation that “why should it matter that the judge got to the final award using the lodestar method rather than the percentage-of-benefit method?”

 

Finally, the Court rejected Amicas’ bad faith cross-appeal, finding that “the insurer did what Illinois prefers: it filed a declaratory judgment action to resolve the meaning of the policy.”

 

Discussion

The interesting thing about this opinion is that it appears that the parties and the court both assumed that plaintiffs’ fees were covered under the policy; the only dispute was over the amount of the fee award that was covered.  This is an interesting context for the dispute because the more common quarrel, at least from a historical perspective, is whether or not there is any coverage at all under a D&O policies for a plaintiffs’ fee award (See a recent post here for a discussion of this issue). This question often arises in the very type of merger objection lawsuit as was involved in the underlying litigation here.

 

To be sure, the question usually arises where the defendants have agreed to pay the plaintiffs’ fees as part of a settlement of a merger objection suit. In this case, the fee award was the product of an actual court award – although, it should be noted, an award made only after the underlying merger objection case had settled. It is interesting to me that — at least from the face of the Seventh Circuit’s opinion — there did not seem to be a dispute on the question whether the policy here provided any coverage for plaintiffs’ fees. (Indeed, Judge Easterbrook says in an opening paragraph of the opinion that the insurer had issued a policy that covered “not only what Amicas and its directors pay their own lawyers, but also what Amicas must pay to its adversaries’ lawyers.”) The only fight here was whether there was coverage for the multiplied portion of the award – not because it involved a fee award, but because it involved a multiplied portion.

 

I can certainly see how the carrier got to the position it took in the case. If you don’t get hung up on the question whether or not a fee award represents “damages,” the language precluding multiplied damages from the definition of covered loss might well be relevant. However, in the wake of Judge Easterbrook’s opinion, it seems unlikely that any carrier will try to raise the argument again.  There is really no room left for a carrier to try to argue that the amount of an attorney fee award represents damages.

 

In addition, it will be very hard for any carrier to try to argue that the question of whether or not an attorney fee award is covered depends on the method the court uses in determining the size of the award. Whether the court in calculating the amount of a fee award  uses a multiplier or a percentage of recovery measure, or some other approach, should not make a difference to the question of whether or not a D&O insurance policy provides coverage for a plaintiffs’ attorneys’ fee award.

 

There is one contextual issue here that bothers me. And that is that the exclusionary language at issue here was not in the exclusion section of the policy; rather, it was in the policy definitions section of the policy. The language clearly operates like a policy exclusion. Indeed, Judge Easterbrook even referred in his opinion to the specific phrase at issue as “an exclusion.”

 

I know that the appearance of this language in the definitions section is standard (if not universal). But that is a feature of the standard D&O policy structure that has always bothered me. I think a policyholder ought to be able to look at the policy’s exclusions section and be able to discern from a review of that section what loss the insurer intends to exclude from coverage. Analytically, the definitions section should say what is included within the meaning of the term loss, and the exclusions section should say what is excluded from loss. 

 

Some might think this a mere formality as the policy must be read as a whole in any event. However, one of the recurring concerns I have heard policyholders express over the years about their D&O policy is that they are surprised when they have a claim to find out things that the carrier will say is not covered. One way to try to avoid this problem would be for the policy to say more clearly what the insurer intends to assert is not covered under the policy. A small step to providing this kind of clarity would be to put all of the policy’s exclusionary language in the exclusions section.

 

I know that the standard D&O policy form, with the presence of this exclusionary language in the definition of Loss, is unlikely to change any time soon. I still think it is worth calling attention to this issue. It is worth thinking about ways to make the policy more transparent to the policyholder. One way to do that is to make sure that all of the exclusionary language is in the exclusions section of the policy.

 

In an environment where public company directors and officers face increasing scrutiny and expanding liability exposures, the indemnification and insurance protections available to them are increasingly important. A July 15, 2013 memorandum from the Gibson Dunn law firm entitled “Director and Officer Indemnification and Insurance – Issues for Public Companies to Consider” (here) takes a look at these complementary and critical liability protections for corporate officials. The memo provides a useful overview of the issues that companies and their boards should consider in connection with corporate indemnification and D&O insurance.

 

The memo explains that most companies rely on some combination of three liability protections for their corporate directors and officers. The first of these are so-called “exculpatory” charter provisions, which are permitted under Delaware General Corporation Law and equivalent statutes in other states. These provisions generally insulate directors from liability for monetary damages for breaches of the duty of care, but not breach of the duty of loyalty or actions found to be in bad faith.

 

The “first line of defense” when corporate officials do face liability is indemnification. Indemnification is “broader than insurance in some respects, so it can provide protection in situations where insurance coverage may be more limited” – for example, in the early stages of an investigation, when the costs typically would not be insured because no claim has yet been made.

 

Delaware’s courts and the courts of most other states generally enforce indemnification provisions as written in corporate bylaws. Nevertheless, corporate officials interested in securing their indemnification rights will want to consider entering a written indemnification agreement. The advantage of an agreement is that it enables companies and their officials to address the rights in more detail. For example, agreements often provide definition of key terms and outline procedures and time frames for obtaining payment and specifying who will authorize indemnification payments. The agreements can include presumptions in favor of indemnification and provide for “fees on fees” (that is, indemnification of fees incurred to enforce indemnification rights). An indemnification agreement can also provide an added layer of protection against unilateral amendment or rescission of indemnification rights.

 

In the end, however, the company’s indemnification commitment is only as reliable as the company’s balance sheet. A key purpose of D&O insurance is to “fill gaps” when indemnification is unavailable – for example, when the corporation is insolvent or unable to indemnify due to legal prohibition. Examples where the company cannot indemnify include derivative suit settlements (which may not be indemnifiable under some state’s laws) or where the individual has not met the standard of conduct for indemnification. In these situations or when the company is insolvent, the D&O insurance can provide the “last line of defense.”

 

As the memo notes, D&O insurance is not an “off the shelf” product. The policy terms and conditions are the subject of extensive negotiation. Minor wording changes “can mean the difference between having and not having coverage, or having significantly more limited coverage.”

 

In addition to the terms and conditions, D&O Insurance program structure also matters as well. A company’s D&O insurance will often involve multiple layers of insurance, usually composed of a layer of primary insurance and one or more layers of excess insurance above the primary layer. Though the excess insurance usually is intended to be “follow form” insurance – that is, providing the same coverage as the primary layer — there can be important wording considerations pertaining to the excess insurance as well. Among these considerations is the question of the “trigger of coverage.” 

 

Many older excess D&O insurance policies specified that they would only apply if the underlying insurance was exhausted by payment of loss. These provisions could cause problems when for one reason or another there was a payment “gap” in the underling insurance (about which, refer here). More modern policies specify that the excess insurance will apply regardless of whether the underlying amount is paid by the underlying insurer, the policyholder or a third party. (For a more detailed discuss of the problems associated with D&O insurance layering, refer here.)

 

Another increasingly common feature of many D&O insurance programs is Excess Side A insurance, which provide an added layer of protection when the company is unable to indemnify whether due to insolvency or legal prohibition, Many of these Excess Side A policies include so-called “Difference in Condition” (DIC) protection as well, by which the policy will be triggered – and will fill the gap – for example if an underlying insurer is insolvent or wrongfully refuses to pay.

 

The memo cites the recent Second Circuit opinion in the Commodore International case (about which refer here), in which the several layers of the bankrupt company’s D&O insurance program had been written by carriers that were insolvent when the time to make insurance payments arrived. As the memo note, “the Commodore case provides a compelling illustration of why Side A DIC coverage is so important.”

 

The memo also includes a brief discussion of the increasing importance of cyber liability issues. The emergency of these issues has important implications for board oversight issues. The issues also raise important D&O liability insurance issues, and also present the need for policies “that are specifically designed to address cyber liability issues.” The memo notes that there are now policies available in the marketplace that typically provide “for losses that the company incurs in responding to a cyber incident, such as the cost of notifying customers of a data breach, and claims brought by third parties, such as customers alleging unauthorized disclosure of their data.” (My recent discussion of the critical importance for boards to consider and address the question of insurance for cyber issues can be found here.)

 

According to the memo, given all of these important considerations, “D&O insurance should be reviewed annually,” because “changes in the external environment and the D&O insurance market may warrant changes in coverage.” The memo notes that “for the first time in several years, companies reviewing their D&O insurance can expect higher premiums and the possibility of restrictions of coverage.”

 

The memo closes with a very important message for every D&O insurance policyholder:
“Due to the complexity of policy language and the issues involved, expert advice from qualified professionals is important in obtaining a through understanding of the coverage available under a company’s D&O insurance program.” The professionals should include both legal counsel and skilled insurance professionals. The memo notes that “many boards of directors seek comprehensive analyses of their companies’ D&O insurance programs, undertaken with the assistance of experts, at the time of the initial purchase or renewal of D&O insurance coverage.”

 

My recent discussion of advancement and indemnification issues can be found here. In a prior post (here), I examined the limits of indemnification. My own overview of indemnification and insurance can be found here. Finally, in my series entitled “The Nuts and Bolts of D&O Insurance” (here), a provide an basic overview of D&O insurance.