An important accessory to the indemnification rights of directors and officers is their right to have their defense expenses advanced while the claims against them are pending, before their ultimate right to indemnification has been determined.  A frequently recurring issue is the question of when the company may withhold advancement. This issue often arises when new management has asserted claims against former managers they blame for problems at the company.

 

A recent decision by the Ontario Court of Appeal, applying Ontario and Canadian federal law, affirmed the holding of the lower court that Look Communications, the company involved, did not have to advance the costs certain former directors and officers incurred in defending claims the company had filed against them. Though the decision will be of greatest interest to directors and officers of companies in Canada, it nevertheless provides an interesting perspective on the rights of advancement here in the U.S. as well. A copy of the Ontario Court of Appeal’s July 4, 2013 opinion can be found here.

 

Background

Look Communications is a technology company organized under the Canadian Business Corporations Act (CBCA). Its business fortunes faltered and its board ultimately approved a sale of its assets through a court-supervised process. Following the sale, the board authorized the payment of bonuses to certain officers and directors and also allowed corporate officials to receive compensation for the cancellation of certain stock option and other equity rights. Altogether the company paid over $20 million in bonus compensation and in compensation for the options and equity rights, representing about 32% of the asset sale proceeds.

 

After the award of the bonuses and other compensation was disclosed, shareholders filed significant objections. The board authorized the payment of $1.5 million in retainers to law firms acting on behalf of the directors and officers, who then resigned once the retainers had been paid.

 

In July 2011, after an investigation by Look’s new management, Look commenced an action against the former directors and officers alleging that the individuals had breached their fiduciary duties and seeking repayment of the bonuses and equity cancellation payments. The individual defendants, in reliance on the company’s by-laws as well as a written indemnification agreement, demanded that the company advance their expenses incurred in defending against the company’s lawsuit. The company refused and the individuals filed separate actions seeking judicial declarations of their advancement and indemnification rights.

 

Under Section 124 of the CBCA, a company may indemnify its directors and officers for legal proceedings in which the individuals become involved as a result of their association with the company, as long as the individual seeking indemnification “acted in good faith and with a view of the best interests of the corporation.” Look’s by-laws made these permissive indemnification rights mandatory. A separate indemnification agreement required Look to advance legal costs in any proceeding, including one brought by Luck itself, subject only to an obligation to repay if a court determined that the individual was not entitled to indemnification.

 

The former directors and officers argued in reliance on the by-laws and indemnification agreement that they were entitled to automatic advancement of their defense fees; that they were also entitled to a presumption that they had acted in good faith; and that their ultimate entitlement to indemnification could only be determined after a full evidentiary trial.

 

Look relied on Section 124(4) which provides that a corporation is permitted to advance defense fees only “with the approval of the court.” Look argued that this provision required the court to preliminarily assess the parties’ conduct to determine whether the persons seeking advancement had acted in good faith. Look further argued that the individuals had not acted in good faith and were not entitled to advancement and submitted affidavits and other materials in support of this position.

 

As discussed here, in a September 28, 2012 decision, Justice Lawrence A. Pattillo of the Ontario Superior Court of Justice held that the individual directors and officers were not entitled to advancement. Among other things, Justice Pattillo held that under Section 124(4) court approval was required for advancement and that approval can be granted only if the officer or director claiming advancement “acted honestly and in good faith with a view to the best interests of the corporations.”

 

Justice Pattillo concluded that the company had made out a strong prima facie case that the former directors and officers had acted in bad faith by awarding themselves over 30% of the assets sales value, and authorizing the payment of the legal retainer on their own behalf before resigning. 

 

The individuals appealed. On appeal, the individuals urged the appeals court to avoid imposing a merits-based threshold on advancement, arguing that were the court to impose such a threshold directors and officers would be required to litigate the merits of the underlying case in the separate action to determine whether or not they were entitled to advancement.

 

The July 4 Opinion

In a July 4, 2013 opinion written by Justice Robert J. Sharpe for a unanimous three-judge panel, the Ontario Court of Appeal dismissed the individuals’ appeal and affirmed the lower court’s ruling, holding that the statute “imposes a judicial filter on advance funding and the strong prima facie test for determining whether advancement should be denied is apt.” The Court added that the “test comports with the statutory requirement for court approval but also is sufficiently stringent to ensure that advance funding is ordinarily available to those claiming it unless there is strong evidence of bad faith.”

 

The individuals had attempted to argue, in reliance on Delaware law, that their defense expenses ought to be advanced without scrutiny of their conduct, subject only to an undertaking to repay if it is later determined based on the outcome of the underlying proceeding that they are not entitled to indemnification. Justice Sharpe wrote:

 

In my view, apart from demonstrating that it is motivated by a very different underlying policy than adopted by Parliament in Section 124(4), Delaware law does not assist us in resolving the issue on this appeal. Unlike the CBCA, the Delaware General Corporation Law does not require court approval of the advancement of legal expenses. (Citations omitted). By enacting Section 124 (4), Parliament has determined that whatever corporate by-laws or agreements promise, by statute, advancement of legal costs requires court approval and court approval should be withheld if the officer or director has not acted in good faith and in the best interests of the corporation. That represents a fundamentally different policy choice that that prevailing in Delaware, a policy choice that this court must respect.

 

Justice Sharpe went on to conclude that the individuals’ indemnification agreements did not alter the statutory requirement for judicial supervision. Justice Sharpe agreed that if the agreements’ wording alone controlled, advance funding could only be denied on the basis of a final and conclusive judicial determination. However, the court concluded, the “issue must be decided on the basis of the overriding language of Section 124(4)” which provides that the right of advancement is “subject to court approval before trial.”

 

The Court of Appeal concluded based on the evidentiary record presented to the court below that the lower court had not erred in concluding that the company had made out a strong prima facie case of bad faith, and properly concluded that the individuals were not entitled to advancement of their costs in defending the claims the company had filed against them.

 

Discussion

In the Ontario appellate court’s view, the indemnification provisions in the Canada Business Corporations Act represent “a fundamentally different policy choice than that prevailing in Delaware.” Section 124(4) “imposes a pre-trial good conduct filter,” while under the Delaware statutes “advance costs are awarded without any scrutiny of the conduct.”

 

Section 124(4) does indeed provide for indemnification under the related statutory provisions “with the approval of the court.” In that respect, the appellate court’s conclusions are unremarkable – they are simply a reflection of the statutory language specifying a requirement for judicial supervision for the implementation of statutory indemnification rights. However, the Ontario Court not only held that the “judicial filter” requirement applied to the individuals’ statutory indemnification rights, but it also held that the requirement for judicial supervision applied to the interpretation of the individuals’ contractual indemnification rights.

 

It is not at all uncommon for new management to pursue claims against a company’s former management. New managers often blame the former managers for problems besetting the company. One very good reason that well-advised managers will seek to put contractual indemnification agreements in place is so that if the managers are the target of claims after they have left the company, they can claim their rights of indemnification notwithstanding the arrival of new management. The contractual indemnification provides them an extra measure of protection and some level of assurance that their rights will be protected if claims later arise.

 

The Ontario court’s interpretation of the statutory provision to require judicial supervision not only of statutory indemnification rights but also of contractual indemnification rights at a minimum adds an additional procedural layer for individuals seeking to rely on their indemnity rights to defend themselves. This result is not necessarily compelled by the statutory language, and even the appellate court agreed that if indemnification issue were determined solely on the basis of the language of the agreement, “advance funding could only be denied on the basis of a final and conclusive judicial determination.” However, the Ontario appellate court nevertheless found that the statute’s “overriding language” imposed requirement of preliminary judicial supervision even on the individuals’ contractual rights.

 

In addition to the additional procedural burdens these requirements put on the individuals seeking indemnification, there is the additional concern of the impact of a “finding of a strong prima facie case of bad faith” on any D&O insurance that may be available to these individuals. There are at least two potential impacts, one having to do with the applicable retention and the other having to do with the possible operation of policy exclusions.

 

The judicial determination that the individuals are not entitled to advance funding means as a practical indemnification is not available to them. The individuals would then seem to have an argument that the Side A retention is applicable to their claim for policy benefits. In most instances, the Side A retention is zero, meaning that — if coverage is otherwise available under the policy — the individuals would have a basis on which to argue that they are entitled to first dollar coverage under the policy.

 

Which of course begs the question of whether coverage is otherwise available under the policy. One issue an insurer undoubtedly would explore in these circumstances is whether or not the judicial determination would trigger the preclusive effect of the conduct exclusions. The individuals would argue that even a judicial finding of “a strong prima facie case of bad faith” is not enough to trigger the conduct exclusion, which typically will provide that it applies only after a “final adjudication” The court’s prima facie determination is an interim, interlocutory determination; it is by no means a final adjudication. Moreover, the finding of bad faith arguably represents something other then a determination of criminal, fraudulent or even dishonest conduct. The individuals would appear to have a substantial basis on which to argue that this type of judicial determination would not implicate the typical conduct exclusion wording.

 

It is worth observing as a final note that though this case represents the rare case where individual directors and officers were denied their rights to advancement of their defense expenses, the outcome is a direct reflection of the specific statutory language involved and of the unusual circumstances presented. But even though the result if the outcome of very jurisdiction-specific and case-specific factors, it nevertheless provides an interesting example from which to consider the rights of individual directors and officers to have their costs of defending claims advanced on their behalf. 

 

Special thanks to loyal reader James Camp for providing me with a copy of the Canadian appellate court’s opinion.

 

In my former days on the carrier side, our D&O insurance group advocated for our policyholders a program of securities litigation loss prevention, on the theory that there are steps companies can take to make themselves less likely to be a securities suit target or better able to defend themselves if they are hit with a suit. The concept of securities litigation loss prevention remains a worthy idea although not always as frequently discussed as perhaps it should be. 

 

Because of my past interest in this topic, I was particularly pleased to see the recent memo from the Latham & Watkins law firm entitled “Giving Good Guidance: What Every Public Company Should Know” (here). The memo provides a good overview of the issues public companies should consider in developing their approach to earnings guidance, and it also sets out practical steps companies can take to try to reduce the possibility of guidance-related liability.

 

The memo begins with a review of the legal context, noting with respect to earnings guidance that “the legal landscape should be carefully understood before management takes the plunge.” The memo provides a cautionary note with the observation that it is possible “to make critical mistakes that can have significant economic consequences under the federal securities laws and in the financial markets.” At the same time, however, “it is possible to give guidance in a deliberate and careful way without incurring undue liability.”

 

After reviewing the basic liability landscape, as well as critical considerations arising from the statutory safe harbor provisions and regulatory provisions such as Regulation FD, the memo reviews two basic questions – that is, how far to go and what to say in giving guidance – and provides critical guidelines. In particular, the memo emphasizes the importance of having a carefully considered company-specific plan for giving guidance that takes advantage of opportunities to accompany disclosure with meaningful cautionary statements.

 

In a particularly useful section, the memo lays out ten rules for “giving good guidance,” all of which are built around having a controlled process involving designated spokespersons delivering carefully considered message accompanied by meaningful cautionary statements. The memo concludes with an appendix of frequently asked questions.

 

I am pleased to be able to link to the law firm’s memo here and to recommend it for company management interested in taking steps to try to reduce the securities litigation exposures arising from providing earnings guidance. It is a favored indoor pastime these days to bemoan the fact that we have a hyperactive litigation system that can impose enormous costs on operating companies. But the fact is that there are steps companies can take to reduce their risk of becoming involved in a securities suit. While there may be much to lament about our litigious system, there are steps companies can take to try to do something about it, and that is a much more positive and practical way for companies to deal with the litigation threat.

 

In an earlier post (here), I discussed the question of the role of D&O insurers in the securities litigation loss prevention process. To see a recent post discussing M&A-related litigation loss prevention, refer here.

 

The SEC’s New Policy to Require Liability Admissions in Certain Cases: Following on Judge Jed Rakoff’s concerns in the Citigroup SEC enforcement action in connection with the proposed settlement that the company had neither admitted nor denied wrongdoing, the SEC, under new leadership, has reconsidered its longstanding policy and now will no longer allow defendants to settle cases without also admitting liability.

 

Though the new policy has yet to be applied in a specific case, commentators have already raised a number of concerns with the SEC’s proposed new approach. In a July 2, 2013 New York Times Deal Book column (here), Wharton School professor David Zaring raises the concern that the new approach could prove very costly for the SEC, as defendant companies will be very reluctant to make admissions that could be used against them in related civil litigation. These disincentives will make it that much harder for the SEC to resolve cases and in the end require the agency to take more cases to trial, a prospect that could drain the agency’s already strained resources.

 

In addition to the concern that admissions could be used against them in related civil litigation, the companies face yet another problem with the possibility of admissions. That is, the admissions could potentially serve as a basis for a company’s D&O insurer to deny coverage based on the policy’s misconduct exclusion. The possibility that an admission might cost the company its D&O insurance protection would provide yet another deterrent for companies from entering into admissions as part of an SEC enforcement action settlement.

 

Can the Countrywide Derivative Suit Survive the BofA Acquisition?: When does a derivative lawsuit survive a merger? That was the question before the Delaware Supreme Court earlier this week in connection with the derivative suit filed against the management of Countrywide Mortgage prior to the company’s acquisition by Bank of America. The case came to Delaware’s highest court by way of a certified question from the Ninth Circuit, which had asked whether under Delaware law the shareholder plaintiffs could maintain the suit notwithstanding the merger in light of the “fraud exception” to Delaware principles about post-merger shareholder standing.

 

In a July 3, 2013 post on her Reuters blog (here), Alison Frankel has an interesting summary of the issues as well as of the parties’ arguments. As Frankel explains, under Delaware law, derivative suit plaintiffs lose their standing to pursue claims on behalf of the company when they lose their ownership interest as a result of a merger. The one exception is when the merger was a itself a fraud intended only to protect the board, which the BofA acquisition was not. The question was whether the Delaware Supreme Court might recognize other circumstances, such as those involved here, where the derivative suit might survive the merger, given Countrywide’s alleged misconduct. The plaintiffs’ arguments in that regard relied heavily on various statements the Delaware Supreme Court had made in prior cases about Countrywide’s conduct.

 

Frankel’s column summarizes the parties’ arguments on these issues and the question of whether or not the court would have to recognize a new exception to the general rules in order to recognize the right of the plaintiffs to pursue their claims. This will be very interesting case to watch — it will be interesting to see what the Delaware Supreme Court does.

 

Travel has a definite allure. The opportunity to break from the routine and to experience something new offers the perfect antidote to the tedium of everyday life.

 

But travel also entails its own set of concerns and constraints. Flight delays, lost baggage and foul weather can quickly turn an alluring adventure into a travel nightmare. And the challenge of navigating an unfamiliar city and dealing with an unknown language and strange customs, cuisines and currencies can sometimes be overwhelming.

 

That is why the one of the most critical travel decisions is the selection of the right hotel. A good hotel can provide a place to retreat when plans go awry or when weariness sets in. The very best hotels are themselves a part of the travel experience, a place to which you would gladly return simply for its own sake.

 

In a prior post (here), I set out a few of my hotel recommendations. In this post, I add a few more based on more recent travel. I offer these suggestions for whatever use they may be for readers visiting the mentioned destinations. I also hope that by offering my recommendations, readers will be encouraged to add their own recommendations, using the comment feature in the right column.

 

I should note at the outset the criteria on which my hotel assessments are based. Although I believe that selection of the right hotel is one of the indispensable elements of successful travel, I am not a big believer in spending a lot of money on hotels. First of all, I am really cheap. Second of all, I find that the extra cost associated with expensive hotels rarely adds significantly to the value – and sometimes costly hotels are singularly uncomfortable places.

 

For me, the best hotels are quiet, clean and inexpensive, and provide a good base from which to explore the surroundings.

 

Based on these standards, the best hotel in which I have recently stayed is the Mandala Hotel in Berlin. The hotel is located on Potsdamer Strasse, adjacent to Potsdamer Platz, at the junction of former East Berlin and West Berlin. It is a new hotel and its rooms are sleek, modern and spacious. Each room has a kitchenette. The hotel has a modern fitness center and wi-fi is included in the cost of the room. It is walking distance from the Brandenberg Gate and the Tiergarten, and a block away from a major transport hub in the Platz. Across the street is the Sony Center, a multi-building structure with shops, theaters and restaurants. A single occupancy room is only about €170. (My travel post about Berlin can be found here.)

 

Another hotel that I enthusiastically recommend is the Gibson Hotel in Dublin (pictured at the top of this post). It is also a new hotel, with very modern rooms, a fully equipped fitness center and free wi-fi. The staff is friendly, cheerful and helpful. Every bit of tourist advice we received from the staff at the front desk was solid gold. The hotel is located at the terminus of the new Luas tram line and is a ten-minute walk along the Liffey River to the city center. The hotel was built at the tail end of the days of the Celtic Tiger, on the assumption that it would be surrounded by ranks of then-planned office towers. Most of the planned buildings were never built and so the hotel is forced to attract clientele based on price. Though this is a modern, upscale hotel, a single-occupancy room can run as low as €99. (My travel post about Dublin can be found here.)

 

By contrast to these two newer hotels, another hotel I am happy to give my highest recommendation to is an older, more traditional hotel in a very old and traditional city. The Old Bank Hotel is located on High Street in Oxford, directly across from All Souls College and in the heart of the ancient college town. It is a boutique hotel, with comfortable furnishings and original artwork. The cost of the hotel not only includes a sumptuous breakfast but also the opportunity to take a tour of the surrounding colleges with an expert tour guide. The rooms have an old fashioned elegance. This hotel is a little pricier than the others but well worth the cost. (The travel post in which I describe our visit to Oxford and other sites can be found here.)

 

Another more traditional hotel that I very much enjoyed is the Innside Madrid Genova, located on the Plaza Alonzo Martinez in Madrid. The hotel is located in a neoclassical 19th Century building that has been recently been retrofitted with modern hotel rooms. Breakfast, which includes one of the best cups of coffee I have ever enjoyed, is served in a bright, airy atrium. The hotel has a modern fitness center. It is located on one of the central metro lines. The Museo del Prado and the Buen Retiro Park are about a ten minute walk away, and the Malasaña district, with its lively street life, is nearby. A single occupancy hotel room is about €160 a night. (My travel post about Madrid can be found here.)

 

Finding a pleasant hotel in Europe is one thing, but it can be even more critical when traveling in Asia given the distances and the increased level of travel challenge involved. One hotel I am particularly happy to recommend is the Conrad Hotel in Hong Kong. This hotel is unquestionably more expensive than my usual preferred hotels, but its location and accommodations would be very hard to beat. The hotel is located in the Pacific Place business district, adjacent to a very high end shopping mall full of shoppers from the Mainland intent on filling their suitcases with luxury goods. The hotel is walking distance from the Zoological Gardens, and nearby to the tram line that runs to the top of Victoria Peak. The varied breakfast buffet runs from traditional English breakfast to a full array of Asian choices. The hotel has a complete fitness center, which can be particularly important for helping to overcome jet lag. This hotel is not cheap, but it is worth it. (The travel post about my visit to Hong Kong can be found here.)

 

Another Asian hotel that I can recommend at least to first time visitors is the Westin in Beijing. Beijing can be a daunting and even overwhelming place, and for a first visit, I think many Americans would prefer to have a hotel that includes familiar comforts and reliable features. The Westin Hotel Financial Street in the Xi Cheng district may not be charming or even particularly distinctive, but it is very comfortable with well-appointed Western-style hotel rooms. The hotel has a complete fitness center and free wi-fi (although you can’t access Facebook, Twitter or Google). Though the hotel is pleasant but otherwise unremarkable, it does offer one amenity that more than makes up for everything else, and that is the absolutely astonishing breakfast buffet. The range of choices and quantity and quality of the food make the breakfast a truly wonderful experience. The hotel is located in a canyon of new, modern office buildings, so it is not the most ideal base for exploring, but the cabs are cheap and so it is easy to range around the city. Tiananmen Square is only a short cab ride away. Seasoned visitors may prefer a different hotel or a different location, but for a first time visitor to Beijing, the Westin does just fine. (The travel post about my Beijing visit can be found here.)

 

In my previous post about hotels, I described my then all-time favorite hotel, the Base2Stay in London. The hotel remains among my favorites, but after a recent series of extensive renovations, the hotel has changed its name. It is now known as the Nadler Kensington. I continue to favor this small hotel. The rooms and common areas are decorated in a simple Scandinavian style, which though perhaps austere to the point of severity, are practical and efficient. The location may not be fashionable, but it is functional – it is located a block from the Earl’s Court tube stop, on the Piccadilly Line (which also serves Heathrow), in an area with pubs, shops and cafes, and on a quiet street full of school kids and Mums pushing prams. The people who work at the hotel are friendly and helpful. A single occupancy room runs around £105 a night.

 

Though I remain a big fan of the hotel now known as the Nadler, I have also recently tried out a couple of other hotels in London that I am also happy to recommend. These two alternative hotels may present a more attractive choice for some visitors because of their locations. For visitors intended to sample the London theater scene, the Fielding Hotel near Covent Garden is a good choice. This small hotel is located on a short, quiet pedestrian street adjacent to the Royal Opera in the heart of the West End theater district. The rooms are small but charming, quiet and comfortable, and it would be pretty hard to beat the hotel’s location. It is surrounded by restaurants, pubs, and theaters and many of the city’s attractions are within easy walking distance. The hotel does not have a lift so this is not a good choice for someone with mobility issues but it is otherwise a little jewel of a hotel. A double occupancy room runs about £180 a night. 

 

Another London hotel I can recommend in a quieter part of town is the Mornington Hotel, which is located in a quiet residential neighborhood just north of Hyde Park, near the Lancaster Gate tube station. The hotel is a short block from the Park and walking distance from the Paddington train station. The rooms are Spartan but clean and efficient. The proximity of Hyde Park and Kensington Garden make this hotel a great stop for visitors who want to enjoy London’s outdoor attractions. At the same time, owing to the proximity of the tube station, many of the city’s other attractions remain accessible. A single occupancy room runs about £130 a night. (My most recent travel post about visiting London can be found here.)

 

I have a few other European hotel recommendations as well. In Munich, I enjoyed a stay at the Pullman, a quiet, comfortable hotel in a mostly residential area at the Nordfriedhof station, just three stops from the city center on the main north-south U-bahn line. The Lufthansa bus from the airport stops directly opposite the hotel. The breakfast buffet is superb. In Barcelona, I stayed at the Hotel Alexandra, which is in an upscale shopping district, just a block away from the Rambla de Catalunya, the city’s famous boulevard with its pedestrian zone it its wide central median. The hotel is a good jumping off point for exploring the city. (My travel posts about Munich and Barcelona can be found here and here, respectively.)

 

When I am trying to locate a suitable hotel in an unfamiliar city, I rely on three resources: friends’ recommendations (for example, the Innside Genova in Madrid was the recommendation of a friend who lives nearby); Trip Advisor (which was how I found the Mandala in Berlin, the Old Bank in Oxford and the Gibson in Dublin); and Frommer’s (through which I found both the Fielding and the Mornington Hotels in London). Trip Advisor can be very good, and I find it reliable. However, there are some cities where it just has too many hotels – it is not very useful in London and New York, for example. Frommer’s is very safe and I find it a reliable source when traveling with my family. However, sometimes the Frommer’s preferred hotels can be, well, a little dull.

 

When I am looking for a hotel, I always prefer a friend’s recommendation, when it is available, and that is why I have taken the time to write this post. I wanted to make sure to pass along all of my best hotel recommendations, for whatever help they may be to others. By the same token, I hope that readers share their recommendations as well. I hope readers will take the time to post a note with their favored hotel recommendations, using the comment feature in the right hand column. As always, I welcome readers’ comments about my notes and observations as well.

 

Afterword: There is yet another reason why I wrote this post. This past holiday weekend, I was able to get away with my family to Pentwater, Michigan, our lakeside rural retreat (which I wrote about in a prior post,  here). While away in Michigan, I enjoyed a number of extended, hours-long bike rides. As I pedaled away the miles, this blog post more or less wrote itself. It was in effect a mental exercise to accompany the physical exertion of the bike ride. I always return from vigorous exercise bursting with new ideas. I hope at least some of the other newly hatched ideas eventually find their way onto this site. For that matter, I hope I have a chance for further long bike rides and even more ideas.

 

In the meantime, I really do hope that readers will supplement this blog post with their own hotel recommendations. I look forward to hearing about everyone’s favorite hotel experiences.

 

An important recurring issue is the questions whether the prior filing of a securities class action lawsuit tolls the applicable statute of repose under the federal securities laws. In an important June 27, 2013, the Second Circuit issued an important decision on this question, holding that the tolling doctrine does not apply to three-year statue of repose under the Securities Act of 1933. A copy of the Second Circuit’s opinion can be found here.

 

In the following guest post, Susanna M. Buergel, Charles E. Davidow, Brad S. Karp, Daniel J. Kramer, and Richard A. Rosen of the Paul Weiss law firm take a look at the Second Circuit’s opinion and discuss its implications. Jane B. O’Brien also contributed to the law firm’s memo. I welcome guest post submissions from responsible commentators on topics of interest to readers of this blog. If you would like to have a guest post considered for publication on this site, please send it directly to me. Here is the Paul Weiss firm’s guest post:

 

On June 27, 2013,  in Police & Fire Retirement System of the City of Detroit v. IndyMac MBS, Inc., — F.3d —-, No. 11-2998-cv, 2013 WL 3214588 (2d Cir. June 27, 2013) (“IndyMac”), the Second Circuit issued an important decision, holding that the tolling doctrine established in American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974) (“American Pipe”), does not apply to the three-year statute of repose in Section 13 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77m, et seq. This decision is likely to have significant consequences for securities class action litigants.

 

The Court’s Holding

In IndyMac, the lead plaintiffs asserted claims under Sections 11, 12(a) and 15 of the Securities Act arising out of IndyMac’s issuance of securities in 106 different offerings.  The district court dismissed for lack of standing all claims arising from the offering of securities not purchased by the lead plaintiffs. In re IndyMac Mortgage-Backed Sec. Litig., 718 F. Supp. 2d 495 (S.D.N.Y. 2010). Five members of the putative class that did purchase those securities moved to intervene in the action to pursue the claims that had been dismissed. The district court denied the motions to intervene on the ground that the Section 13 repose period had lapsed and could not be tolled by American Pipe or extended by Federal Rule of Civil Proceedure 15(c). See In re IndyMac Mortgage-Backed Sec. Litig., 793 F. Supp. 2d 637 (S.D.N.Y. 2011). An appeal to the Second Circuit by certain of the proposed intervenors followed.

 

Section 13 of the Securities Act contains two limitations periods: (i) a one-year statute of limitations from the date of discovery of the violation; and (ii) a three-year statute of repose from the date the security was bona fide offered to the public.[1]   Although it is well established under American Pipe that the one-year statute of limitations is suspended while the class action is pending, prior to the Second Circuit’s decision in IndyMac, there was a split of authority within the Circuit on the question of whether the statute of repose is similarly suspended. 

 

The Second Circuit held that Section 13’s statute of repose is not tolled by the filing of a class action complaint. In reaching this conclusion, the Second Circuit found that, to the extent American Pipe tolling is an equitable doctrine, as the appellees argued, then its application to Section 13’s repose period is barred by Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991), in which the Supreme Court held that equitable tolling principles do not apply to that period. Slip op. at 15. If, on the other hand, it is a “legal” tolling rule based on the class action provisions of Federal Rule of Civil Procedure 23, as the appellants argued, its application to a statute of repose is barred by the Rules Enabling Act, 28 U.S.C. § 2072(b), which prohibits a Federal Rule of Civil Procedure from operating to “abridge, enlarge or modify any substantive right.” Slip op. at 15–16. 

 

The Second Circuit was not persuaded by the appellants’ argument that such a rule would burden the courts and disrupt class action litigation and noted that even if such a problem arose, it would be for Congress, not the courts, to address. Id. at 17.

 

The Implications of IndyMac

By giving effect to Section 13’s statute of repose, the IndyMac decision allows issuers and underwriters of securities to know, by a date certain, when all potential claims arising out of a particular securities issuance have been extinguished. In addition, the Second Circuit’s decision is likely to have significant consequences for class action practice beyond the Securities Act context. 

 

First, the Second Circuit’s analysis appears to be equally applicable to other statutes of repose. IndyMac lends strong support to the argument that no statutes of repose may be tolled under American Pipe, including the five-year statute of repose governing claims brought under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq. In addition, the Second Circuit’s holding raises questions as to the enforceability of private agreements to toll statutes of repose like Section 13. 

 

Second, although IndyMac happens to have involved plaintiffs that intervened in the class action, its statutory analysis is almost certainly equally applicable to the claims of class members who elect to opt out of a class to pursue individual litigation. Thus, IndyMac will likely require class members to make a more prompt decision as to whether to opt out. 

 

Third, nothing in IndyMac suggests that it will not be applied to litigations that are currently pending. As a result, the decision is likely to be invoked in pending opt-out actions.

 

Fourth, IndyMac is likely to halt the tendency of sophisticated and large institutional investors to wait to file individual actions until the class action has proceeded well into, and indeed sometimes after, merits discovery. If institutional investors are now forced to file their actions earlier, this might obviate the problem of having to negotiate a class settlement only to find that large numbers of class members have decided to opt out. Such a development would be particularly welcome because standard “blow” or termination provisions have historically not protected defendants against significant downside risks. The ruling may also permit earlier discussions that could lead to the global resolution of all related matters arising out of the same core set of facts. 

 

Finally, IndyMac may result in other changes to class action practice, including pressure to brief class certification motions earlier in the life of the litigation. 

*          *          *

This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its content. Questions concerning issues addressed in this memorandum should be directed to:

Susanna M. Buergel                   Charles E. Davidow                   Brad S. Karp

212-373-3553                             202-223-7380                            212-373-3316

sbuergel@paulweiss.com          cdavidow@paulweiss.com        bkarp@paulweiss.com

 

Daniel J. Kramer                        Richard A. Rosen

212-373-3020                            212-373-3305

dkramer@paulweiss.com          rrosen@paulweiss.com

                                                

 

Jane B. O’Brien contributed to this client alert.

[1]“No action shall be maintained to enforce any liability created under section 77k or 77l(a)(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created under section 77l(a)(1) of this title, unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under section 77k or 77l(a)(1) of this title more than three years after the security was bona fide offered to the public, or under section 77l(a)(2) of this title more than three years after the sale.” 15 U.S.C. § 77m.

Buoyed by an influx of case filings in the final days of June, securities class action lawsuit filings during the first half of 2013 remained roughly on pace with 2012 filings, although well below the historical average number of filings. Though the absolute numbers of filings so far this year are below historical averages, the number of filings relative to the number of publicly traded companies remains level with past years. Roughly one in five of the first half filings involved companies in the life sciences sector.

 

During the year’s first half, there were 75 new securities class action lawsuit filings, putting the filing levels on pace for a year-end total of about 150 lawsuit filings. Thus the profected number of filings is about the same as the 2012 year-end total number of filings of 152. The first half filing numbers were significantly boosted at the end of June, when during the last ten business days of the month there were 11 new securities lawsuit filings, representing almost 15% of the filings in the year’s first six months.

 

The securities suit filings during 2012 were unevenly spread between the year’s two halves, as there were a greater number of filings in the first six months of the year (when there were 88 new securities class action lawsuit filings) and the last six months of the year (when there were only 64 filings). The 75 new filings in the first six months of 2013 were about 15% below the number of filings in the first half of 2012 – but about 17% above the number of filings in the second half of 2012.

 

Though the YTD filings through this year’s first six months puts us on an annualized pace roughly equal with the filing numbers for the full year of 2012, the number of filings so far this year puts us on a pace well below the historical average number of filings. The average annual number of securities class action lawsuit filings during the period 1996 through 2011 was 193, meaning the projected annual number of filings for this year based on the filings so far is about 22.2% below the historical average. Similarly, the 75 securities suit filings during the first half of 2013 is about 22.6% below the average number of filings during six-month half-year periods between the first half of 1997 and the second half of 2011 (97) 

 

It would be easy to conclude from these comparisons that securities class action law filings are declining. However, before jumping to any conclusions about filing trends, the number of filings needs to be considered on a relative basis as well as an absolute basis. When the filing levels are considered relative to the number of publicly traded companies, the current filing levels are revealed to be far more consistent with prior levels than might appear to be the case when only absolute filing numbers are considered.

 

Consider these data: there were 202 securities class action lawsuit filings in 2004, compared to only 152 in 2012. However, there were also about 6,097 publicly traded companies at the end of 2004, compared with only 4,943 at the end of 2012. That is, the number of publicly traded companies declined by about 23.3% during the period between 2004 and 2012. All else equal, one would expect that the number of securities class action lawsuits would decline roughly in line with the decline in the number of publicly traded companies. And that is exactly what happened – the decline in the number of lawsuit filings between 2004 and 2012 of 24.7% is just about the same as the 23.2% decline in the number of publicly traded companies.

 

In other words, everyone should be very wary of headlines that inevitably will appear in the mainstream media about declines in securities class action lawsuit filings. The numbers of lawsuits may well have declined compared to historical average numbers of filings, but the rate of lawsuit filings relative to the number of publicly traded companies remains roughly level. Don’t get sucked in by facile but misleading assertions about declines in the number of securities class action lawsuits filings. The fact is, publicly traded companies continue to be sued in securities class action lawsuits at about the same rate as they have been in the past.

 

The securities class action lawsuit filings during the first half of 2013 lacked any clearly discernible characteristics. Unlike the period 2007-2011, when the lawsuit filings were driven by credit crisis-related allegations, and 2011, when an influx of suits against U.S.-listed Chinese companies drove lawsuit filings, there was no industry event or sector slide that generated a concentrated number of securities suits.

 

The 75 securities suit filings during the year’s first half were spread among companies in 56 different Standard Industrial Classification code (SIC code) categories. The only SIC Code category with more that three companies sued during the year’s first half was SIC Code 2834 (Pharmaceutical Preparations), which had a total of nine new lawsuits, representing about 12% of all first half lawsuit filings.

 

There were a total of 15 new securities suits filed against companies in the life sciences industries (represented by companies in the 283 SIC Code group [Drugs] and the 384 SIC Code group [Surgical, Medical and Dental Instruments and Supplies]).These 15 new suits against life sciences companies represented 20% of all filing during the first half of 2013. (By way of comparison life sciences companies presented only about 17% of all 2012 filings).  

 

Only one other SIC Code category had as many as three new lawsuits – SIC Code category 1311 (Crude Petroleum and Natural Gas) had three new lawsuit filings during the year’s first six months.

 

The securities suit filings during the year’s first six months were filed in 25 different federal district courts. However, just three district courts accounted for a substantial proportion of the filings. There were 22 new cases filed in the Southern District of New York in the first six months of 2013, along with 13 in the Northern District of California and 6 in the Central District of California. No other federal district court had more than four new filings. The filings in just these three districts account for just about 43% of all first half filing activity.

 

Ten of the securities suits filed in the year’s first half involved companies domiciled or with their principle place of business located outside the United States, representing roughly 13.3% of first half filings. This level of filings against non-U.S. companies is well below the level in 2012 (when about 21% of all filings involved non-U.S. companies) and in 2011 (when about 30% of all filings involved non-U.S. companies), but above the average proportion of filings for the period 1997-2009 (about 9% of all filings).

 

The first half filings against non-U.S. companies involved firms from six different countries. The countries with the most companies sued were China (3) and Canada (3). Israel, Argentina, Bermuda and Mexico each had one company involved in a securities suit in the U.S. during the first half of 2013. (Note that I am counting the filing against Nam Tai Electronics as involving a Chinese company; the company is registered in the British Virgin Islands but has its operations in China.)

 

Please note that in counting securities class action lawsuit filings, I count each lawsuit filings only once, regardless of the number of separate complaints that may be filed. Other commentators counting securities suits count separate complaints filed in separate judicial districts as separate lawsuits unless the separate complaints are consolidated into a single proceeding. This different methodology may cause my securities lawsuit count to appear lower than other published tallies.

 

And All This Time, You Thought Monty Python Just Made the Whole Thing Up: In Marc Morris’s excellent recent book “The Norman Conquest: The Battle of Hastings and the Fall of Anglo-Saxon England ,” the author notes the following incident involving Exeter’s residents, as William the Conqueror besieged the city following the Norman Invasion: “According to William of Malmsbury, one of them staged something of a counter-demonstration by dropping his trousers and farting loudly in the king’s general direction.”

 

Public Service Announcement (Just in Time for the July Fourth Holiday): Since the dawn of time, man has struggled to find just the right wine to use in a wine spritzer. I am happy to report that after countless hours of research,  I have found the best wine for the purpose. The wine is a Vinho Verde, a light wine that originates in the Northern regions of Portugal.  Although the wine’s name literally means “green wine,” the name describes a young wine from the region that can be white, red or rose. Most of the wine that makes it to the U.S. is white.

 

The fermentation process used in making the wine results in a slight effervescence. The wine’s pétillance, light flavor and low alcohol level make it a refreshing ingredient for a wine spritzer. Although the optimal proportions are a matter of taste, I suggest poring over ice one part Vinho Verde to two parts fizzy mineral water. (I recommend using LaCroix water.)  For best results, serve the beverage on a backyard patio as twilight gathers and the lightening bugs come out. Repeat frequently as long as summer persists.

 

And Finally: How to make kebabs (because you like to stab things and to play with fire). Find it here.

 

On June 25, 2013, in a judicial development that may help ease the curse of multi-jurisdiction litigation, ChancellorLeo E. Strine, Jr. of the Delaware Court of Chancery held that forum selection bylaws adopted by Chevron and Federal Express are statutorily and contractually valid. The company’s by-laws designated Delaware as the sole forum for derivative lawsuits, lawsuits under the Delaware General Corporation Law and other lawsuit involving the “internal affairs” of the companies. A copy of the Chancellor’s opinion can be found here.

 

Whether or not the forum selection bylaw would be enforceable in any given future situation will depend on existing judicial standards for the enforcement of forum selection clauses. However, given that under the existing standards forum selection clauses are presumptively enforceable, a company adopting a foreign selection by-law will have a substantial chance of avoiding multi-jurisdiction litigation and ensuring that the corporate litigation will go forward in Delaware.

 

Because companies incorporated in one state often have their principal place of business in other states, and operations and shareholders in many other states, a corporate event or dispute can result in litigation involving a company can result in litigation in many different jurisdictions. This problem arises in many contexts but has been a particular curse in M&A related litigation.

 

As discussed here, in 2010, Vice Chancellor Laster in the Revlon Shareholder litigation endorsed the idea of corporation’s modifying their corporate charters to designate a forum for resolution of corporate litigation. The idea gained significant currency as it was advocated by leading academics and others.

 

According to Chancellor Strine’s opinion in the Chevron case, in the last three years over 250 publicly traded companies adopted forum selection bylaws. Chevron and Fed Ex were among the companies adopting this type of bylaw. Chancellor Strine recites in his opinion thatChevron’s board adopted the bylaw due to concerns about “the inefficient costs of defending the same claim in multiple jurisdictions” and in order to “minimize or eliminate the risk of what they view as wasteful duplicative litigation.” The bylaw essentially designates Delaware as the exclusive forum for derivative litigation, breach of fiduciary duty litigation, disputes under the DGCL, and disputes involving the companies’ internal affairs .Fed Ex’s bylaw is substantially similar.

 

The first judicial challenge to a forum selection bylalw resulted in a set back for the idea. As discussed here, in January 2011, a judge in the Northern District of California refused to enforce a forum selection by-law that had been adopted by Oracle, because it had not been made a part of the company’s corporate charter and adopted by shareholder, but rather had been adopted only by the company’s board of directors.

 

In February 2012, institutional plaintiffs, represented by the same law firm, filed a total of twelve separate lawsuits seeking to challenge the defendant companies’ adoption of a forum selection bylaw. Ten of the companies dropped their by-law and the plaintiffs dropped their suits against those companies. However, Chevron and Fed Ex declined to drop the bylaws and the cases against the two companies went forward.

 

The defendant companies moved for judgment on the pleadings as to the plaintiffs’ claims that the bylaws are beyond the board’s authority and that the bylaws are contractually invalid and therefore cannot be enforced like other contractual forum selection clauses because they were unilaterally adopted by the  companies’ boards.

 

In his June 25 Opinion, Chancellor Strine granted the defendants’ motion for judgment on the pleadings.First, he ruled that the by laws are valid under Delaware statutory law specifying that by-laws may contain any provision relating to “the business of the company, the conduct of its affairs, and its right or powers or the right or powers of its stockholders, directors officers and employees.” He noted that the bylaws related only to suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine. He found that the by-laws are “not facially invalid as a matter of statutory law.”

 

Chancellor Strine also held that the bylaws are valid and enforceable contractual forum selection clauses. He said that the Delaware Code allows directors to adopt and amend by-laws unilaterally. Thus, “when investors bought stock in Chevron and Fed Ext, they knew… the certificates of incorporate gave the board the power to adopt and amend bylaws unilaterally.” Strine rejected the argument that the bylaw was not enforceable because it had not been adopted by shareholders.  Chancellor Strine went on to hold that “a forum selection clause adopted by a board with the authority to adopt bylaws is valid and enforceable under Delaware law to the same extent as other contractual forum selection clauses.”

 

Finally Chancellor Strine rejected the plaintiffs efforts to undercut the by laws by reference to “purely hypothetical situtions” where the bylaws might not be enforceable or would result in unreasonable outcomes.

 

Chancellor Strine expressly noted that many other companies have adopted similar bylaws, and cited this fact as a reason to decide the defendants’ motion for judgment on the pleadings rather than, as the plaintiffs’ urged, to defer ruling. He specifically noted that “a decision as to the basic legal questions presented by the plaintiffs’ complaints will provide efficiency benefits to not only the defendants and their stockholders, but to other corporations and their investors.” In other words, Chancellor Strine’s opinion expressly assumes that his determinations will guide the determination of the validity of other companies’ bylaws – at least those with the characteristics of Chevron’s and Fed Ex’s by laws.

 

Of course, these plaintiffs have the right to appeal the Chancellor’s determination to the Delaware Supreme Court. Given the stakes involved for plaintiffs’ lawyers, it seems likely that the plaintiffs will appeal. There is of course the possibility that Chancellor’s rulings will be overturned on appeal.

 

Even if Chancellor Strine’s determinations are not overruled, there is s till the question of what will happen if a future plaintiff decides to disregard the bylaw and file a lawsuit in another jurisdiction. The defendant company will have to decide whether to invoke the bylaw and to seek to have the case dismissed because the suit was filed in the wrong court.

 

The bylaws will be subject to scrutiny under the principles of the U.S. Supreme Court’s decision in Bremen v. Zapata Off-Shore Co.which held that forum seleection claluses are valid provided that they are "uaffected by fraud, undue influence or overweenig bargaining power." The forum seleection clause "should be enforced unless enforcement is shown by the resisting party to be "unreasonable." In other words, the forum selection bylaws will be "presumptively, but not necessarily, situationally enforceable." ,

 

As the Wilson Sonsini firm noted in its June 25, 2013 memo about Chancellor Strine’s opinion (here), “Although the Delaware Supreme Court has yet to weigh in on the facial validity of forum selection bylaws (and an appeal is likely), the decision upholds a potentially powerful tool in responding to the problem of multi-forum litigation and protecting stockholders’ interests against duplicative litigation.”

 

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

 

In the latest in a series of decisions in which it has upheld the enforceability of arbitration agreements, the U.S. Supreme Court ruled on June 20, 2013 that an arbitration agreement with a class action waiver is enforceable even it meant that an individual’s cost of pursuing a claim exceeded the economic value of the individual’s potential recovery. A copy of the Court’s opinion in American Express Co. v. Italian Colors Restaurant can be found here.

 

Although the decision is consistent with other recent Supreme Court rulings, it has its own important implications – and it also raises question about just how far the principle of broad enforceability of arbitration agreements can be taken. In particular, it question whether the broad enforceability of arbitration agreements reaches far enough to include the enforceability of arbitration agreements and class action waivers in corporate articles of incorporation or by-laws.

 

The American Express case involved a purported antitrust class action filed by a group of vendors against American Express in which the vendors alleged that AmEx’s credit card policy constitutes an illegal tying arrangement because it forces the vendors to accept debit and credit cards at the same fee level. American Express sought to invoke the arbitration clause in its contractual agreement with the vendors.

 

The case has a long, tortuous procedural history and the specific decision on appeal to the Supreme Court represented the third separate opinion by the Second Circuit in the case. In what is known as the American Express III decision (here), the Second Circuit refused to enforce the class action waiver in the AmEx contractual agreement on the ground that it would effectively preclude the plaintiffs from prosecuting their federal antitrust claims, because the costs of economic experts would be far in excess of their individual damages.

 

In an opinion written by Justice Scalia for a 5-3 majority, the U.S. Supreme Court reversed the Second Circuit and held that the Federal Arbitration Act does not permit courts to invalidate a contractual waiver of class arbitration on the grounds that the plaintiff’s cost of individually arbitrating a federal statutory claim exceeds the potential recovery. The opinion also dramatically narrowed the “effective vindication” exception to the enforceability of arbitration agreements, stating that the exception, while valid, would apply only in the event of a provision “forbidding the assertion of certain statutory rights” or the inclusion of fees so high “as to make access to the forum impracticable.”

 

In light of the Court’s recent decisions supporting the enforceability of arbitration agreements, the outcome in the American Express case arguably comes as no surprise. Justice Scalia suggested as much in his opinion when he commented that “truth to tell, our decision in [AT&T Mobility v. Concepcion] all but resolves this case.”

 

The majority opinion was written over a spirited dissent written by Justice Kagan, in which Justices Ginsburg and Breyer joined. (Justice Sotomayor did not participate in the decision.) Justice Kagan characterized the outcome as holding that “the monopolist gets to use its monopoly power to insist on a contract effectively depriving its victims of all legal recourse.” She added “here is the nutshell version of today’s opinion, admirably flaunted rather than camouflaged: Too darn bad.”

 

Though the American Express decision follows a line of recent Supreme Court cases upholding the enforceability of arbitration agreements and class action waivers, it nevertheless also represents a significant development. The decision not only greatly narrowed the “effective vindication” exception. It also made it clear that courts will enforce arbitration agreements even if the agreement is not customer friendly and even if the individual’s cost of pursuing an individual arbitration claim is certain to exceed the potential recovery.

 

And though this case arose in the context of an antitrust claim, it obviously has broad applicability to a wide variety of claims. It clearly will be valuable in the employment context, as employers will be better able to count on the enforceability of arbitration clauses and class action waivers in employment agreements and thereby avert class-action litigation.

 

The decision obviously will have wide applicability to many other types of commercial and consumer agreements. Clearly, businesses that want to avoid class actions have wide latitude to include waivers of class actions in arbitration clauses.

 

An obvious question is exactly how far that latitude extends. Does the Supreme Court’s support for the enforceability of arbitration agreements extend far enough to include the enforcement of arbitration clauses in corporate charters?

 

The question of whether or not a company can impose an arbitration requirement through its articles of incorporation or its by-laws drew a great deal of attention when The Carlyle Group, which was preparing to go public at the time, specified in its partnership agreement that all limited partners would be required to submit any claims to binding arbitration. (I discussed Carlyle’s initiative in a prior blog post, here.) Ultimately, the SEC used its control of the registration process to prevent Carlyle from including this provision. But as illustrated in an April 22, 2012 article by Carl Schneider of the Ballard Spahr law firm on the Harvard Law School Forum on Corporate Governance and Financial Regulation (here), the idea continues to have its advocates and it seems likely that sooner or later there will be a case or circumstance testing the permissibility of arbitration provision in articles of incorporation or corporate by-laws.

 

As I am sure others will be quick to point out, it isn’t at all clear that the line of cases in which the Supreme Court has upheld the enforceability of arbitration agreements would support the enforcement of an arbitration agreement in a corporate charter. Among other things, the cases all relate to arbitration clauses in bi-lateral contractual agreements. A corporation’s charter documents represent a different type of legal instrument and involve a different kind of legal relationship.  And though the Supreme Court cases sweep broadly, the still allow room to raise arguments even about contractual arbitration agreements about contract formation and procedural unconscionability.

 

In any event, we certainly can expect to see arbitration clauses with class action waivers proliferating in commercial and consumer contracts of all kinds. In this environment, where it seems likely that businesses will actively be seeking to drive disputes out of the courts and into arbitration, it seems probable that there are going to be businesses that try to drive shareholder disputes into arbitration as well. The day may not be far off where court will have to address the question of enforceability of arbitration clauses and class action waivers in corporate charter documents.

 

Another FDIC Failed Bank Lawsuit: On June 18, 2013, the FDIC as receiver for the failed Southern Community Bank of Fayetteville, Georgia filed a lawsuit in the Northern District of Georgia against nine of the bank’s former directors and officers. The FDIC’s complaint, which can be found here, alleges that the individual defendants were negligent and grossly negligent by approving loans that violated the Bank’s internal policies, regulations and prudent lending practice, allegedly resulting in damages of $10.3 million. The bank failed on June 19, 2009, meaning that the FDIC did not initiate its suit until well after the third anniversary of the bank’s failure, and suggesting that the parties may have entered into some form of tolling agreement.

 

The latest lawsuit is the 68th that the FDIC has filed against former directors and officers of failed banks as part of the current bank failure wave. The agency has filed 24 so far in 2013, compared to only 26 in all of 2012.

 

How to Continue to Access The Content from One of the Internet’s Top Blogs: Readers of this site know that I am a huge fan of Alison Frankel’s On the Case blog. It is reliably interesting and well-written. Unfortunately for all of us, Alison’s blog has now been moved behind the Westlaw pay wall. (I have noted elsewhere the increasing and increasingly unfortunate encroachment of pay walls and toll booths into the previously free Internet.)

 

The good news is that we are not losing Alison’s great content entirely. One of her blog post per day will continue to be available at a free Reuters.com site, here. I have already changed the URL in the link on my blogroll. While I am sorry that we will not be able to follow Alison’s great content as completely as we have in the past, I am grateful that we will all be able to access at least one of her posts every day.

 

Whether overseas or in the heart of our Nation’s Capitol, whether at work or at play, The D&O Diary always fits right in, at least if the “mug shots” that readers have been sending in are any indication. 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.

 

We have shipped out nearly 150 mugs to readers (special thanks here to Mrs. D&O Diary for her assistance with the mug mailing). In a prior post (here), I published the  first round of readers’ pictures. The “mug shots” have continued to come in, presenting a broad array of sights and scenes. I have published a selection of the second round of mug shots below.

 

Long-time readers know that The D&O Diary’s reach is global, with a readership that spread far and wide around the world — even all the way to the antipodes. Jarrett Jeppesen of the Sydney, Australia office of Chubb sent along this photo of The D&O Diary Mug posing down under.

 

 

 

 

 

 

 

 

 

 

 

 

I guess because we mailed out the mugs during the spring and early summer, several readers have sent in baseball-related photos. The first picture below depicts “Slider,” the mascot of the “five-time Atlantic League Champion Somerset Patriots” of the minor league baseball Atlantic League.  The picture, sent in by Neil Waser of Everest Global Corporate Services, was taken at TD Bank Ballpark in Bridgewater, New Jersey, during a game between the Patriots and the Bridgewater Bluefish that was also a fundraiser for Special Olympics.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

This picture shows Judith Baum-Baron of the Simsbury, Connecticut Chubb office, who took her D&O Diary mug to a game at Fenway Park between the Red Sox and the Los Angeles Angels. She reports that she paid $18 for two beers. The mug, however, was free.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 Although The D&O Diary mug fits in well at sporting venues, it is also appropriate at scenes of power. John Mulligan and Joe Costello of ICI Mutual Insurance Company (a risk retention group), sent in this photo of their mugs taken at  the “White House Press Room.” Never under estimate the power of a blog.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

And to round out the Washington power scene mug shots, we have these pictures sent in by April Gassler of the Sperduto Thompson law firm, taken at the U.S. Supreme Court. Apparently, Gassler took her D&O Diary mug with her the day she was sworn in to the Supreme Court (seriously, who wouldn’t want to have a D&O Diary mug at hand for an appearance at the country’s highest court). The first picture shows Gassler on the Court’s steps. The second photo was taken during the photo opportunity following the swearing-in ceremony. If you look at the group of people across the room, you will see Justice Ruth Ginsburg at the center of the group. From the photo, it looks as if the Justice is not fully aware that she is in the presence of the mug. Too bad, I am sure it would have meant so much to her.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

Two readers sent me detailed photo studies of their cities that they assembled while roaming around town. First, Blaise Chow of the Ropers, Majeski, Kohn & Bentley law firm sent me a gallery of city views he assembled while jogging around New York city on a particularly picturesque day.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Finally, Justin Kudler of XL Professional assembled  a collection of photos while strolling around Boston. His city tour included the historical Freedom Trail and the original Cheers bar, each of which in their own way are particularly appropriate places to take a mug shot of a D&O Diary mug.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 My thanks to everyone who has sent in pictures. We are now down to our last few mugs, but if there is anyone else out there who still wants one, please let me know, we will send them out on a first-come, first-served basis. I hope to be able to publish many more mug shots.

 

My thanks to all of this blog’s readers for their loyal support. Cheers.

 

An insured’s guilty plea to criminal charges relieved his professional liability insurer of its duty under the policy to defend him against related civil claims, according to a June 18, 2013 Order by Southern District of Florida Judge Daniel Hurley. Judge Hurley’s decision is interesting because it addresses the question whether the court can consider extraneous matter (i.e., the guilty plea) in determining the insurer’s defense duty, and because it considers the degree of relationship between the criminal conviction and the separate civil claims required for the policy exclusion to be triggered.   A copy of Judge Hurley’s order can be found here.

 

Background

At the times relevant to this dispute, Steven Brasner was a life insurance agent who procured life insurance policies intending to sell the policies to third party investors. The life insurance company sought to avoid ths type of insurance actiivity to avoid issuing policies insuring the lives of persons who were strangers to the benficiaries. The life insurance company later alleged that Brasner had obtained the policies through misrepresentations in the certificates he provided to the life insurer. Among other things, he allegedly cerified that he did not intend to sell the policies in the secondary market. When the life insurer discovered the misrepresentations, it voided the policies.

 

In a criminal proceeding, Brasner pled guilty to grand theft and to participation in an organized scheme to defraud. Two civil actions were also filed against Brasner: the life insurer sued to recover over $1 million in commissions it had paid to Brasner; and an investor that had purchased policies that were voided sued to recover the amounts it lost..

 

Brasner submitted the two civil lawsuits as claims to his Professional Errors and Omissions Insurer. The E&O insurer denied that it had any duty to defend or indemnify Brasner for the claims, in reliance on the policy’s criminal misconduct exclusion, which states, inter alia, that “we will not defend any Claim … directly or indirectly relating to or in any way involving … conduct which is fraudulent, dishonest or criminal.” The E&O policy further states that the exclusion does not apply “unless there is a finding or adjudication in any proceeding of such conduct.”

 

The E&O insurer filed an action seeking a judicial declaration that it had no duty to defend or indemnify Brasner. The E&O insurer moved for partial summary judgment that it has no duty to defend Brasner in the two lawsuits. Brasner and the investor who had sued him (GIII) opposed the motion.

 

The June 18 Ruling

In his June 18 Opinion, Judge Hurley granted the E&O insurer’s motion for partial summary judgment, holding that Branser’s criminal conviction triggered the policy’s criminal misconduct exclusion, relieving the E&O insurer of a duty under its policy to defend Brasner.

 

The investor, GIII, had opposed the E&O insurer’s motion, arguing that it was improper for the court to consider facts that go beyond the allegations in the underlying civil actions in determining the duty to defend, and that even if the court considered the guilty pleas, the E&O insurer could not establish that the Brasner’s criminal conviction following his guilty pleas relate to the allegations against Branser in the civil actions.

 

With respect to the question whether or not the court could consider Branser’s guilty pleas in determining the E&O insurer’s defense duty, Judge Hurley said “The Court finds that when as in the instant case the duty to defend is contested based on facts that are (a) easily verified and (b) will not be resolved by the underlying litigation because they are irrelevant to the underlying claims, a court may consider facts outside of the underlying pleadings in determining whether an insurer is subject to a duty to defend.” Accordingly, Judge Hurley considered Branser’s guilty pleas and ensuing criminal conviction in determining the E&O insurer’s defense duty.

 

Judge Hurley then compared the criminal charges to the allegations underlying the civil claims in the two lawsuits against Brasner. He concluded that “the claims against Brasner in the underlying cases arise from the exact same misrepresentations that Bransner had been convicted of committing.”

 

He did note that though the investor’s separate lawsuit against Brasner pertained not to Branser’s misrepresentations to the life insurer (which had been the basis of the criminal conviction), but rather to Branser’s separate misrepresentations to the investor, the exclusion still applied to preclude a defense obligation for the investor’s lawsuit as well as the life insurer’s lawsuit.

 

Judge Hurley said “even though GIII’s claims are not the direct civil analogue of the criminal charges the way that [the life insurer’s] claims are, they plainly arise at least indirectly from Branser’s criminal conduct.”

 

Discussion

Many courts restrict the materials a court may consider in determining an insurer’s defense obligation under a liability insurance policy. Although the formulation differs from jurisdiction to jurisdiction, many courts will often say things such as that the court  may only consider the four corners of the underlying complaint and the four corners of the policy. (This principle is sometimes called the “eight corners rule.”) Had this rule been strictly applied here, the E&O insurer could well have been compelled to defend Brasner, notwithstanding his guilty pleas and ensuing conviction.

 

The criminal misconduct exclusion clearly contemplates that the insurer has no defense obligation in the event that the insured has engaged in criminal misconduct, if an adjudication has established that the misconduct occurred.  This exclusion would not be worth very much if the insurer were unable to rely on extrinsic evidence of a criminal conviction to context a defense duty under the policy. Judge Hurley’s pragmatic conclusion that the E&O insurer here could rely on the extrinsic evidence of Brasner’s conviction is interesting – you don’t often think about it, but it isn’t self-evident from the policy what the insurer may rely on to substantiate that an adjudication of preclusive conduct has occurred. Judge Hurley’s opinion provides at least some guidance in that regard.

 

Judge Hurley’s conclusions about the extent of the elationship between the criminal conviction and the underlying claims necessary in order for the exclusion to be triggered is also interesting, particularly his conclusion that the exclusion precluded coverage even for the investor’s claims against Brasner. The fact that the criminal conviction was based on misrepresentations to the life insurer but that the investor’s civil lawsuit was based on separate misrepresentations to the investor was not enough of a difference to avoid the exclusion’s preclusive effect. The exclusion’s use of the work “indirectly” was a critical aspect of Judge Hurley’s opinion in that regards, which is a reminder that the specific wording of policy exclusions can have a significant effect on coverage.

 

Though Judge Hurley found the relationship between the criminal conviction and the underlying claims was sufficient to preclude coverage, the fact that the question was asked and had to be answered is a reminder that the mere fact that an insured person had pled guilty to a criminal charge is not alone by itself enough to preclude coverage. There must be a connection between the criminal conviction and the separate allegations to preclude coverage for the separate claim. There must be a factual connection between the conviction and the separate allegation to preclude coverage. Judge Hurley did not consider how direct that connection must be in order to preclude coverage, he found only that the connection was sufficient here to trigger the exclusion. But the implication is that there could be circumstances where the connection was too tenuous for the exclusion to be triggered, even if there had been a criminal conviction.  

 

The Latest FDIC Failed Bank Lawsuit – With an Interesting Twist: On June 17, 2013, the FDIC, in its capacity as a receiver of the failed Advanta Bank, filed a lawsuit against Dennis Alter, the bank’s former Chairman, and William Rosoff, the bank’s former Vice Chairman. Even though the bank was chartered in Utah and had its headquarters in Draper, Utah, the FDIC filed its lawsuit in the Eastern District of Pennsylvania. The FDIC claimed that venue was proper in Philadelphia because, it alleges, that both Alter and Rosoff reside in the Eastern District of Pennsylvania. The Bank failed on March 19, 2010, so the parties must have entered some sort of a tolling agreement; otherwise the FDIC’s lawsuit was not filed until after the three-year statute of limitations had expired.

 

In its complaint, which can be found here, the FDIC asserts claims for both gross negligence and breach of fiduciary duty. The FDIC seeks damages of in excess of $219 million. The FDIC accuses the defendants of having driven off the Bank’s customer base by “increasing credit card interest rates to unprecedented levels.” The FDIC alleges that the two defendants were grossly negligent and breached their fiduciary duties by “failing to investigate or consider how their re-pricing campaigns would cost the Bank in terms of customer outrage, attrition, credit losses and governmental sanctions.” The FDIC alleges that the two ignored the bank’s own prior bad experience with re-pricing, as well as warning from others within the bank, from consultants, and from more than 35,000 customer complaints. The complaint further alleges that the re-pricing notices sent to customers were deficient and cost the bank $21 million in the form of a restitution order. The re-pricing allegedly caused many customers to leave the bank or to default on their accounts, which allegedly caused the bank millions in losses.

 

Alter and Rosoff apparently concluded that the best defense is an aggressive offense. On June 17, 2013, the same day as the FDIC filed its lawsuit, the two individuals filed a lawsuit against the FDIC in the Central District of Utah. A copy of the individuals’ complaint can be found here. The individuals allege that the bank “was destroyed by the actions” of the FDIC. They further allege that in an “effort to cover up its own wrongdoing that destroyed the bank and inflicted grievous losses on thousands of people and businesses … the FDIC has embarked on a campaign to blame” them for the bank’s failure. The two individuals allege that the FDIC “concocted” its claims against them despite an earlier settlement agreement and release between the FDIC and all of the bank’s directors and officers. The two individuals alleged they are being “scapegoated” for re-pricing efforts that were forced on the bank the deteriorating economic conditions. The two defendants assert claims against the FDIC for breach of contract, for violating the alleged settlement agreement, and to recover damages that the individuals assert that the FDIC caused the bank.

 

The two complaints frame what looks like what will be a spirited dispute. Whether or not the individuals’ complaint will succeed remains to be seen, but it is clear that they intend to put up a serious fight. These two cases could prove to be interesting to follow.

 

With the filing of this lawsuit against the two former Advanta bank officials, the FDIC has now filed a total of 67 lawsuits against former directors and officers of banks that failed during the current bank failure wave, including 23 so far during 2013, compared to 26 during all of 2012.

 

Special thanks to a loyal reader for sending me copies of both of the Advanta bank complaints.

 

In recent years, Stanford Law School Professor Michael Klausner has led research on several critical issues involved with class action securiteis litigation and SEC enforcement actions.In the guest post below, Professor Klausner and his colleague Jason Hegland describe the two databases they have built in support of their research efforts and detail some additional findings their research has produced. The authors also invite comments and inquirites regarding their research tools and their analysis. I would like to thank Professor Klausner and Jason Hegland for their willingness to publish their article on this site. Here is their guest blog post: 

 

            In two recent articles in the PLUS Journal, we presented some simple statistics from the database we have been building over the past few years. One article is on the extent to which D&O insurance proceeds are paid into settlements. The other is on the timing of settlements and dismissals. The two articles can be found on the PLUS website through their search bar or here and here. Our plan is to follow up with a series of more detailed and sophisticated statistical analysis of both securities class actions and SEC enforcement actions. In this post, we summarize some additional findings and invite comments from those of you who are involved in litigating, underwriting, brokering, and paying claims. We begin by describing two databases that we have built and which we intend to maintain going forward. One covers securities class actions and the other covers SEC enforcement actions.

 

The Securities Class Action Database

            This database covers all securities class actions since 2000 and includes over 50 categories of data. The basic data items include, for example:

 

·        Names and positions of all individual defendants

·        Names of third party defendants

·        Names of lead plaintiffs and lead counsel

·        Comprehensive case history, including details of all complaints filed, motions to dismiss and for motions summary judgment.

·        Settlements, including individual payments, third party payments, and attorneys’ fees

·        Courts and judges

 

In addition, we have some unique data points:

 

·        The amount that insurers paid into settlements

·        The stage of the proceedings at which a case settled (e.g. before the first motion to dismiss was ruled on, after the first motion was ruled on but before a later motion was finally denied)

·        The nature of the misstatement (e.g. financial or nonfinancial misstatement, restatement involved) 

·        Evidence of scienter alleged (e.g. insider sales, confidential witnesses, parallel regulatory actions)

 

 

The SEC Enforcement Action Database

            Our database on SEC enforcement actions covers civil and administrative actions involving public company misstatements filed from 2000 forward.  The following are some examples of the data we have collected:

 

·        Names of all individual, corporate and third party defendants

·        Specific violations alleged (e.g. Sections 10(b), 17, 13(b)(5)).

·        Allegations regarding evidence of scienter

·        Whether cases were tried, settled or dismissed

·        Case history

·        Timing of settlement (e.g. upon filing, following motion for summary judgment)

·        Penalties imposed on each defendant in settlement or following trial

·        Courts and judges

 

Some Findings Regarding Dismissals

            Dismissal rates range from 31% to 59% in any given year. Among cases filed in the years 2000 through 2005, 39% were dismissed, and among cases filed in the years 2006 through 2010, 45% of cases were dismissed. This difference, however, is not statistically significant.

 

Most cases (68%) were resolved on the basis of a single consolidated complaint. Thirty percent of cases were either dismissed with prejudice on the basis of the first consolidated complaint, or dismissed without prejudice and not refiled.  Nine percent of cases were voluntarily dropped before the motion to dismiss was made.  So a total of 37% of cases were dismissed or dropped without a second consolidated complaint being filed. Another 31% of cases were settled either before the ruling on the first motion to dismiss or after the ruling but before a second complaint was filed. 

 

Courts vary somewhat with respect to dismissals, but since the nature of cases varies geographically, it is difficult to separate the court from the nature of the case. Figure 1 below shows the distribution of final dismissals (with prejudice) across first, second and third consolidated complaints for the four high-volume courts and for the remainder of courts as a group. Of the courts with a relatively high volume of securities class actions, the Southern District of New York dismisses cases disproportionately on the basis of the first consolidated complaint, and it rarely allows a plaintiff to file a third consolidated complaint. The other three high-volume courts more frequently give plaintiffs more opportunities to file second or third complaints. In the remainder of the country, courts are similar to the SDNY.

 

Figure 1

 

Some Findings Regarding the Timing of Class Action Settlement

            Because the timing of settlements has a substantial impact on the cost of litigation, we collected detailed data on when settlements occur—at what stage of the litigation process and after how much time has passed. To simplify the presentation here, we divide the litigation process into three phases:

 

·        Early Pleading: Anytime prior to a ruling on the first motion to dismiss.

·        Late Pleading:   After the first motion to dismiss has been granted without prejudice but before a later motion has been denied. This is the period during which a plaintiff is filing a second or later consolidated complaint.

·        Discovery: Anytime after a motion to dismiss has been denied and a case heads into discovery. This phase includes cases settled soon after the motion has been denied and cases that settle on the eve of trial or even pending appeal.

 

Roughly half of all settlements occur in one of the two pleading stages—that is, before a court has finally denied a motion to dismiss and allowed a case to proceed to discovery. The other half of settlements occur after the motion has been denied and a case heads toward discovery. Among those cases, on average, settlement occurs 16 months after the motion was denied. 

 

            As shown in Figure 2, there is a slight difference in settlement timing across courts, with cases in the Central District of California settling in the Early Pleading Phase more often than cases in other court, and cases in the Northern District of California settling in the Discovery Phase more often than in other courts. These differences do not seem to be related to the patterns we see above with respect to differences in dismissals across courts.

 

Figure 2

           

D&O insurer payments into settlements also vary with settlement timing. This is shown in Figure 3, below. The lowest percentage paid is for settlements at the Early Pleading Stage, which is probably attributable to retentions. Earlier settlements tend to be lower than later settlements (though not across the board), and of course litigation expenses are lower for cases that settle early. An interesting finding, however, is that across settlements in all phases, insurer contributions to settlements were higher among cases filed in the second half of the past decade than in the first half. Figure 3 shows insurer contributions across the three phases for cases filed between 2000 and 2005 and cases filed from 2006 to 2010. (Many cases filed after 2010 are still ongoing, so we omit those).

 

Figure 3

 

Individual Liability in Class Actions and SEC Enforcement Actions

            Individual liability is obviously a concern of directors and officers. In earlier research, one of use showed that outside directors’ risk of liability is extremely low, in class actions or in any other type of suit.  Officers make made out-of-pocket contributions to class action settlements more often. In cases filed from 2006 to 2010, officers made payments into settlements in 2% of settlements (less than 1% of all cases filed).  It is difficult to say whether these were cases where evidence of misconduct was strong, but to get some perspective on whether individual liability is a danger in the absence of strong evidence, we look at officers’ payments in class actions with parallel SEC actions—cases presumably with relatively strong evidence of misconduct. As shown in Figure 4, among the 60 pairs of resolved cases filed between 2006 and 2010 in which the SEC imposed a serious penalty, there were only 5 class actions in which the officers made an out-of-pocket payment. This suggests that even when the merits are relatively strong in class actions, the likelihood of a personal payment is low.

 

Figure 4

 

            In class actions, the mean and median individual payments are $11.7 million and $600,000, respectively. In SEC actions, penalties against individuals involved in the 60 cases reflected in Figure 4 are shown in Figure 5, below.

 

Figure 5

 

Note: Frequencies refer to cases, which can involve multiple defendants. Means and medians refer to penalties per person.

 

 

Finally, we thought data on the duration of SEC actions, once filed, would be of interest. The mean and median duration of a case against an individual officer (as opposed to cases against the company, which settle more quickly) are 14 months and 8 months, respectively. This, however, includes a large number of cases that are settled simultaneously with filing or within a month of filing. Figure 6 provides a more detailed breakdown. Note, however, that these figures do not include the length of time that the SEC spends investigating a case.

 

 

Figure 6

           

          We have provided here a relatively small sampling of the sorts of basic information we can extract from our database. We would welcome comments, questions, and explanations on what we have described here as well as questions that D&O Diary readers think would be interesting to address with the data we are collecting. We would be happy to follow up with additional blog posts.