On October 5, 2012, in the latest in a series of decisions addressing the question whether or not corporate officers (as differentiated from corporate directors) are entitled under California law to rely on the protections of the business judgment rule, Central District of California Judge Dale Fischer held that former officers of the failed IndyMac bank cannot assert an affirmative defense based on the business judgment rule in the FDIC’s failed bank lawsuit pending against them. Judge Fischer also addressed the question whether the individual officer could assert a number of other affirmative defenses against the FDIC. A copy of Judge Fischer’s memorandum opinion can be found here.

 

Background

IndyMac Bank failed on July 11, 2008. As discussed in detail here, On July 2, 2010, in the first lawsuit against former directors and officers of a failed bank it filed as part of the current wave of bank failures, the FDIC, as receiver of IndyMac, filed a lawsuit in the Central District of California against four former officers of IndyMac’s Homebuilder Division (HBD). 

 

The lawsuit is filed against Scott Van Dellen, HBD’s former President and CEO, who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved at least 40 of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved at least 57 of the loans at issue; ;and William Rothman, who served as HBD’s Chief Lending Officer from mid-2006 and who is alleged to have approved at least 34 of the loans at issue. The lawsuit seeks to recover damages from the four individual defendants for "negligence and breach of fiduciary duties." 

 

In their answers to the FDIC’s complaint, the officer defendants asserted a number of affirmative defenses, including a defense based on their assertion that their actions were protected by the business judgment rule. The parties filed cross-motions for partial summary judgment on a number of issues, including the question of whether or not the defendants were entitled to rely on the protections of the business judgment rule, as well as the defendants’ other affirmative defenses.  

 

The October 5 Ruling

Judge Fischer began her October 5 opinion with a detailed choice of law analysis. The defendants had argued, in reliance on the holding company’s Delaware incorporation, that Delaware law applied. The FDIC argued that because the bank was locating in and conducted its operations in California, California law governed. Judge Fischer found that regardless of which choice of law principles were used to determine the question, California law governed.

 

Having determined that California law applied, Judge Fischer then turned to the question of the applicability of California’s Business Judgment Rule (BJR). Judge Fischer noted that under California law, the BJR has two components, an “immunization from liability” codified in Corporations Code Section 309, and a “judicial policy of deference to the exercise of good faith business judgment in management decisions.”

 

The officer defendants conceded that the protections codified in Section 309 were not available (undoubtedly because Section 309 refers only to “directors”). So the question for Judge Fischer was whether the common law element of the BJR applies to officers.

 

After reviewing California case law and also the work of the California Law Revision Commission, Judge Fischer determined that “the Court is left with only one reasonable conclusion” – that is, that “the state’s business judgment rule does not protect officers” and therefore the individual officer defendants “may not use the business judgment rule as an affirmative defense.” Judge Fischer granted the FDIC’s motion for partial summary judgment in that respect.

 

Judge Fischer then went on and considered several of the individual defendants’ other affirmative defenses. Among other things, Judge Fischer concluded that California’s four-year statute of limitations applied to the FDIC’s claims against the four individuals for breach of fiduciary duty, rather than either FIRREA’s three-year statute of limitations or other shorter California statutes of limitation on which the individual defendants sought to rely.

 

Judge Fischer also concluded that the defendants are barred from asserting against the FDIC (as Indy Mac’s receiver) affirmative defenses for failure to mitigate, unclean hands and ratification, based on the FDIC’s pre- and post-receivership conduct, because, as Judge Fischer concluded, under California law, equitable defenses that would have been good against the Bank could not be raised against the FDIC as receiver.

 

Discussion

In several instances, individual defendants have successfully argued that their conduct is protected by the business judgment rule and accordingly, that they cannot be held liable for ordinary negligence. The most significant holding is the August 14, 2012 decision in the Northern District of Georgia in the Haven Trust case, in which Judge Steve C. Jones dismissed the claims against both the director and officer defendants, because of his determination that under Georgia law the directors’ and officers’ conduct is protected by the business judgment rule. The Haven Trust case is discussed here. Earlier in August, a judge in the Middle District of Florida, ruled in the FDIC’s failed bank lawsuit relating to the failed Florida Community Bank of Immokalee, Florida, that under Florida law directors cannot be held liable for ordinary negligence, as discussed here. The ruling in that case did not reach the question of whether or not officers can be held liable for ordinary negligence under Florida law.

 

However, as California attorney Jon Joseph wrote in his April 11, 2012 guest post on this blog (here), courts applying California law on the issue and considering whether corporate officers as well as directors can rely on the business judgment rule have split on the issue. Most recently, on June 7, 2012, Eastern District of California Judge Lawrence O’Neill held that the defendant officers cannot rely on the statutorily codified business judgment rule under California Corporations Code Section 309, because the statute by its terms refers only to officers not directors. Judge O’Neill’s ruling is discussed here (second item).

 

The significance of Judge Fischer’s ruling in the Indy Mac case is that it was, by contrast to Judge O’Neill’s June 2012 decision, not solely with relationship to provisions of Section 309, which by its terms refers only to directors (a point conceded by the defendants in the Indy Mac case). Judge Fischer went on to hold that corporate officers may not rely on the protections of the common law business judgment rule, either.

 

Although Judge Fischer’s analysis in connection with her rulings regarding the defendants’ other affirmative defenses is not early as detailed as with respect to the business judgment rule, it is nevertheless significant that she determined as a matter of California law that the defendants cannot assert against the FDIC the affirmative defenses for failure to mitigate, unclean hands and ratification. As noted below, other courts, applying the laws of other jurisdictions, have reached contrary conclusions on the question of whether or not former Bank officers and directors can assert equitable defenses against the FDIC asserting claims as receiver as a failed bank.

 

Special thanks to a loyal reader for providing me with a copy of Judge Fischer’s October 5 opinion.

 

Under North Carolina Law, Failed Bank’s Former Directors and Officers Can Assert Equitable Defenses Against the FDIC: An October 2, 2012 ruling, applying North Carolina law, reached a different conclusion that Judge Fischer on the question of whether or not former directors and officers of a failed bank can assert equitable defenses against the FDIC. A copy of the October 2 opinion can be found here.

 

As discussed here, the FDIC had brought an action against nine former directors and officers of the failed Cooperative Bank of Wilmington, North Carolina. As detailed in the October 2 order, Eastern District of North Carolina Judge Terrence Boyle denied the defendants’ motion to dismiss.

 

The FDIC had also separately moved to strike the individual defendants’ affirmative defenses for avoidable consequence/failure to mitigate damages. The defendants contend that the terms of the loss-share agreement entered between the FDIC and Cooperative’s acquiring bank did not provide the acquiring bank with incentive to lessen the loan losses, which aggravated the losses or even cause the losses in connection with some loans. The FDIC moved to strike the defense, on the ground that it had “no duty” to the defendants.

 

The defendants argued in reliance on the U.S. Supreme Court’s 1994 ruling on O’Melveny & Myers v. FDIC that when the FDIC brings an action as receiver, it “steps into the shoes” of the failed bank and state common law governs questions of tort liability.

 

Judge Boyle noted that the courts are split on the question whether the “no duty” rule (on which the FDIC relied in its motion to strike) still applies after the O’Melveny decision. Citing an unpublished Fourth Circuit opinion, Judge Boyle concluded that state law governs what defenses are available against the FDIC. Judge Boyle found that under basic principles of North Carolina law, a plaintiff must take reasonable steps to mitigate damages. Accordingly Judge Boyle denied the FDIC’s motion to strike, allowing the defendants to assert the equitable defenses against the FDIC.

 

Although Judge Fischer reached a different conclusion in the Indy Mac case on the ability of individual defendants to assert equitable defenses against the FDIC as receiver of a failed bank, the difference in outcome in the two cases at least arguably can be explained by the difference in the two jurisdictions’ law that was applied. The two cases did at least conclude that the question of the availability of affirmative defenses is a question of state law.

 

Judge Boyle’s opinion not only ruled that the defendants can assert the equitable defenses but also implicitly rejected the FDIC’s “no duty” argument, one of several defendants to reach this conclusion.

 

For a detailed discussion of the issues surrounding the FDIC’s “no duty” argument, please refer to August 31, 2011 guest post, here.

 

Special thanks to a loyal reader for providing me with a copy of Judge Boyle’s opinion.

 

I am pleased to publish below a guest post from Rhonda Prussack, Executive Vice President and Product Manager, Fiduciary Liability, for Chartis, and her colleague at Chartis, Larry Fine, Global Head Professional Liability Claims, Financial Lines Claims. Rhonda’s and Larry’s guest post is written in response to a recent guest post on this blog about the scope of fiduciary liability insurance, written by Kim Melvin and John Howell of the Wiley Rein law firm. Kim and John’s prior guest post can be found here.

 

 

I would like to thank Rhonda and Larry for their willingness to publish their article on this site. I welcome guest posts from responsible commentators on topics of interest to readers of this blog. Any readers who are interested in publishing a guest post on this site are encourage to contact me directly. Here is Rhonda’s and Larry’s guest post:

 

In Ms. Melvin’s and Mr. Howell’s article on the IBM coverage denial decision posted here on September 19th, several good points were made, notably that plan fiduciaries typically wear “two hats” – one as settlor (i.e. the party making a business decision about a plan – for instance to terminate benefits or amend the terms of a plan) and the other as plan fiduciary (i.e. the party implementing the plan changes). However, Ms. Melvin and Mr. Howell then concluded that policyholders should not expect or necessarily want their policies to cover settlor capacity matters, even for an insured that wears two hats.

 

 

The IBM Case

In the plan participant class action against IBM, the plaintiffs alleged that IBM’s conversion of a traditional pension plan to a cash balance pension plan violated ERISA.  An excess fiduciary liability carrier denied having any coverage obligations on the grounds that the underlying suit related to “settlor capacity” acts as opposed to “fiduciary” acts.    A federal district court (and more recently a circuit court of appeals) upheld the carrier’s denial. As the authors correctly asserted, these decisions did not create a gap in coverage.  Nevertheless, they exposed an existing gap which carriers have been handling differently.

 

Is the Defendant a Fiduciary?

The question of whether a defendant is a fiduciary at all, or whether they were acting as a fiduciary when performing the acts in question, is often the main disputed question in an ERISA suit. For many years, certain carriers were narrowly interpreting their policies for clients that wore two hats and taking coverage positions based on opinions on the underlying merits of cases and defenses raised therein.  These carriers have presented a Hobson’s choice in which successful defenses based on lack of fiduciary status have led to the threat of lost coverage.  More customer-focused carriers, concerned that insureds get the benefit of their bargain, have been interpreting their policies more broadly, and some are now clarifying by means of endorsements.

 

Coverage Denials Based on Settlor Capacity

Ms. Melvin and Mr. Howell also pointed out that lawsuits “involving purely settlor issues are rare,” although in our experience, many carriers commonly reserve the right to deny coverage on that basis.  Often the result of these two facts is that insureds have to either fight with their carrier concerning allocation, or live in fear of future efforts by the carrier to recoup what it has paid, especially if the insureds are successful in a “settlor act” defense.

 

Coverage Not Traditionally Limited to Individuals   

The authors also made the point that fiduciary liability insurance arose at least in part from the desire to protect individuals against the personal liability imposed under ERISA for breaches of fiduciary duty. However, despite the individual fiduciary coverage at its core, fiduciary liability insurance for commercial insureds has traditionally included coverage for the organization sponsoring the plans, as well as for the plans themselves – even when individual fiduciaries are not named in a suit.  Yes, individual plan fiduciaries should definitely be concerned about their exposures (and the fact that they are expressly excluded from D&O policies). To address that concern, the most cutting-edge policies provide ample protections for individuals, including advancement of defense costs when the corporate sponsor fails to do so. However, the reality is that fiduciary liability policies cannot compete in today’s market if they limit their protections solely or even primarily to individual fiduciaries.

 

Costs in Settlor Matters Can Be Significant

It is true, as the authors maintained, that fiduciary policies do not step in to pay “benefits” owed pursuant to a plan, so that the coverage for “settlor act” claims, which some carriers provide, will generally be limited to defense costs.  It should be noted, however, that defense costs alone in purported “settlor act” cases can be in the substantial 8-figure range.   It is clear that carrying sufficient fiduciary liability insurance is eminently prudent and turning down broad coverage is ill-advised, since the product is still relatively inexpensive and offers substantial protection to corporate bottom lines.

 

Insureds have a right to expect that their fiduciary liability policies will protect all Insureds (including the plan itself and the corporate sponsor) from the various types of suits alleging breaches of ERISA and similar laws. 

 

The D&O Diary’s European itinerary continued this past weekend with a brief visit to Berlin, Germany’s capital and largest city. With a population of about 3.4 million within its city limits, Berlin is nearly as large as Los Angeles. It is, these days, a lively and dynamic city. It is also in many ways a surprisingly beautiful city, with a beautiful river — the River Spree follows a more or less east-west course across the city — and a beautiful big green heart — the Tiergarten, a 500-acre park built by the Hohenzollerns as a hunting preserve, is at the center of the city.

 

For all of its urban beauty and present dynamism, it is impossible to visit Berlin without encountering the city’s complex past. It was particularly well-timed to have visited Berlin during Germany’s annual reunification celebration, as there is no better place to contemplate reunification than standing on Pariser Platz facing the Brandenburg Gate. Following the Second World War, the Gate was located in the Soviet occupation zone, so when the Berlin Wall was built, the Gate stood just within East Berlin – a fact that underscores how the Wall cut through the city like a knife. At the same time, the celebrations at the Gate when the Wall came down may be among the most vivid and inspiring events of the last century. The Gate and The Wall — one way another, one of these, the Gate or the Wall, or sometimes the Gate and the Wall, played a part in many of the most important events in the 20th Century.

 

The Wall is almost completely gone now. Near my hotel in Potsdamer Platz a very short stretch of the Wall is preserved, together with a photographic display showing how the Platz had been laid to waste during the Second World War and left desolate during the Cold War because the Wall bisected its former location. Other than the special display, all traces of the Wall in the immediate area and of the Platz’s former desolation have been erased. After reunification, the Platz became “Europe’s largest construction site” and ranks of tall office towers and other commercial buildings now surround it. Directly across from my hotel is the Sony Center (pictured), a huge multi-structure facility with an enormous covered central courtyard and a mix of restaurants, theaters and shops. Standing in the Platz today, it is almost impossible to imagine that The Wall was ever there and even harder to believe that it was removed such a short time ago.

 

Following reunification, the forces of progress and change have moved quickly in Berlin and you can certainly understand how Berliners might have wanted to leave the past behind. However, Berliners have taken deliberate steps to preserve the memory of The Wall. The accompanying picture shows one of the sections of  Die Mauer (The Wall) that have been preserved. The area around Checkpoint Charlie  (the crossing point for entry into the American sector of occupied Berlin) includes a number of different memorials about The Wall. The Checkpoint Charlie museum affords an interesting overview of The Wall’s history – how events at the end of the war (including the Berlin airlift), and post-war events like the nuclear arms race, the Hungarian uprising and the Cuban Missile crisis, among many other things, led to the building of The Wall.

 

There are of course many other complications in Berlin’s recent history. Indeed, at times, the history can be almost overwhelming. I arrived in Berlin during a tremendous rain storm, which ordinarily would have meant lousy conditions for touristing. But the downpour proved entirely appropriate for a visit to the Holocaust Memorial, located a couple of blocks south of the Gate. The dark clouds and rain provided an appropriately somber atmosphere for the hundreds of stark black stele in the memorial.

 

As the Holocaust memorial shows, Berliners have not shrunk from confronting the city’s complex history. Just the same, there are some memories that are still too complicated even for Berlin. It took a fair amount of detective work for me to find the former location of Hitler’s Chancellery, on Wilhelmstrasse in what was East Berlin. The location is now an enormous construction site. I did my best to figure out the location of Hitler’s bunker. A small and obscure information sign acknowledges (at the very bottom, in the last sentence on the sign) that the bunker had been located nearby, without specifying the exact spot.

 

I guess I can understand why there hasn’t been any effort to highlight the site’s historical importance. The danger is that the spot could become a memorial for Hitler or even a pilgrimage site for a certain type of misguided soul (not meaning to suggest anything about myself with that latter comment). It could also attract completely inappropriate tourist operations. By way of illustration, the area around Checkpoint Charlie is full of tourist-oriented shops like “Checkpoint Currywurst” and “Die Mauer Souvenirs,” and display stands where you can have your picture taken with men wearing Soviet and American Army uniforms. If the location of Hitler’s Bunker were to be more openly recognized and the site started attracting tourists, there undoubtedly would soon be stores selling Third Reich tchotchkes and stage shows offering to let you relive the Nazi experience. It could also become a focal point for a very dangerous kinds of political action. For Berliners, history includes ghosts and demons for now too dangerous to admit even into a reunified city.

 

After a day spent confronting Berlin’s complicated 20th century history, it was a relief on Sunday morning to take the U-Bahn (subway) to the city’s West Side to visit Schloss Charlottenburg (Charlotte’s Palace). Sophie Charlotte, the wife of Friedrich III, the Elector of Brandenburg, built the palace in the late 17th and early 18th centuries as a summer retreat, but it became the preferred residence of subsequent Hohenzollern rulers, including Charlotte’s famous grandson, Frederick the Great. The structure itself was heavily damaged during the Second World War, but it has now been beautifully restored, and its gardens, which are open to the public as a park, provide a tranquil urban oasis.

 

After touring the Schloss and the gardens, I then went to get a better sense of the city itself, particularly two of its justly famous avenues. Kurfürstendamm, a broad avenue lined with plane trees, runs from just to the southwest of the Tiergarten to the western end of the city. The street is lined with stores and shops. It is often compared to the Champs-Élysées, because of the trees and street’s width, but the Berlin street lacks the Parisian boulevard’s drama (there is, for example, no Arc de Triomphe or Tuilleries at the ends of the street). I think the more apt comparison is the Magnificent Mile on Chicago’s Michigan Avenue. Both are commercial streets and stores lining both are almost identical – there is even a Nike Town on Kurfürstendamm. The Berlin street is visually interesting — but I am not much of a shopper, so I found it a little dull.

 

A more interesting place to visit is Unter den Linden, perhaps Berlin’s most famous street. The broad tree-lined boulevard runs east from the Brandenburg Gate across the River Spree. The middle stretch of the street is completely torn up for subway construction right now, but despite the construction the street was still a pleasant place to stroll on a sunny Sunday afternoon. Before reunification, Unter den Linden was entirely in East Berlin. The number of institutions and other important buildings along the avenue – including, for example, Humboldt University, the Berlin State Library, the Berlin State Opera, and the Berlin Cathedral – provides another reminder of what a devastating thing The Wall was for the city. It cut off access to the city’s historic heart.

 

On the day I visited, there was an art festival taking place on one of the walkways along the River Spree, at the point where the river intersects with Unter ten Linden. I sat at a sidewalk café along the walkway and watched the crowd and the river flow by while I enjoyed a plate of bratwurst, sauerkraut and mashed potatoes. I found myself thinking about how just a short time ago, many of the Sunday afternoon strollers would have been unable to see the art festival or walk along the river there. They are all just Berliners now, but as I studied the faces of the passersby who were old enough, I wondered – East Berliner or West Berliner? Was this one separated from a loved one by The Wall, was that one maybe a border guard who manned a watchtower? Maybe these questions don’t matter now, or at least shouldn’t matter now. But the thought did bring home to me what a great and challenging thing reunification has been.

 

These observations about Berlin left me with much to ponder. About the only thing I know for sure is that two days are not nearly enough to take in fully a city as big and complex and fascinating as Berlin. I feel that in some ways, I was very unfair to the city. I deliberately focused on the city’s past, and so came away with only just enough sense of the city’s present to know that there is so much more to see and do there. Berlin has been and is again one of the world’s great cities and deserves a longer visit.

 

For those of you who may not have seen it because I posted it on Columbus Day, my post about my recent visit to Munich can be found here.

 

Schloss Charlottenburg

 

 

 

 

 

 

 

 

 

 

 

 

River Spree

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bratwurst und Sauerkraut mit Kartoffeln

The D&O Diary was on assignment in Europe this past week, with the first stop in Munich for a series of meetings with my friends at Munich Re and their global insurance company clients. My visit to Munich not only coincided with Oktoberfest, but also with the Day of German Unity (Tag der Deutschen Einheit), the annual German holiday celebrating the country’s 1990 reunification. The annual holiday celebration is hosted in the German state presiding over the Bundesrat each year, and this year Munich, the state capital of Bavaria (or as the say in Germany, Bayern), hosted the celebration.

 

Munich is a prosperous and pleasant city and its population of about 1.4 million makes it the third largest city in Germany. The Isar River flows along the city’s east side, running northward from the Tyrolean Alps to a junction northeast of Munich with the Danube River. Munich itself is relatively flat, but one very clear day while I was there I was able to see the Alps — about fifty miles to the South of Munich — from the top of the Olympic Tower.

 

For the reunification day celebration, the main north-south street in the old city center was blocked to  traffic and lined with tents for each of Germany’s 16 länder (states), including the three stadtstaaten (city-states) of Berlin, Hamburg and Bremen. The tents featured products from each state, as well as food and beer characteristic of the region. I sampled an enormous variety of sausages, and in many cases I had absolutely no idea what I was eating — which is probably just as well, because when it comes to sausages, some things are better left unsaid. I did make sure to find out the name of the sausage I liked best – it was Thüringer Rostbratwurst,  a spicy sausage made with majoram, caraway and garlic. I also sampled some Currywurst, about which the less said the better, 

 

I was pleased that this year’s holiday celebrated the 22nd anniversary of reunification, because it allowed me to deploy my second most-favorite German phrase, which is zwei und zwanzig (twenty-two). Unfortunately it does mean that I will have to wait thirty-three years to use my most-favorite German phrase, fünf und fünfzig (fifty-five). My stock of German phrases admittedly is pretty limited. But zwei und zwanzig sure came in handy for the recent German holiday.

 

Many in the crowd at the holiday street festival were dressed in traditional Bavarian attire, with men wearing lederhosen and the women wearing dirndls. I was struck that those wearing the attire were not restricted to one age group – old and young alike were dressed up in the outfits. I was also struck the people wore the traditional attire with admirable nonchalance, as many people wearing costumes often are self-conscious about it. I found myself wondering who the people were who chose to dress up in the costumes for the day and I noticed that in general they seemed to be healthier and better looking than the crowd as a whole. It also occurred to me that the outfits may also reflect a certain level of prosperity, as a full Bavarian getup appears to be pretty costly. I will say that the women wearing the dirndls looked great, as the dresses are often worn in a way that, shall we say, emphasizes and flatters the feminine figure.

 

Munich has a reputation as one of the most livable cities in the world, and one of the main reasons for the reputation is the incredible amount of green space in the city. Just opposite the front door to Munich Re’s historic headquarters building is the main entrance to the Englischer Garten (English Garden), an enormous public park that is larger than New York’s Central Park. In the park’s center is the Chinesischer Turm  (Chinese Tower), a five-story wooden structure that at least in its basic shape is reminiscent of the Temple of Heaven in Beijing. Surrounding the tower is a large beer garden, and on a sunny fall afternoon, the beer garden’s more than 7,000 seats were full of people enjoying the dappled sunlight, talking, and drinking beer, while listening to an oompa oompa band playing music from the tower’s second story. Further north in the part is the Kleinhesseloher See, a man made-lake that in the early October sunshine reflected the leaves’ changing colors (pictured above at the top of the post).

 

At the southern end of the English Garden I saw something totally unexpected. There, at the mouth of the Eisbach, a man-made stream that runs through the park, people in wet suits were surfing the standing wave formed by the strongly flowing water. The river surfing was absolutely fascinating to watch, although I think anyone would have to be insane to even attempt it. The surfers I saw appeared to be quite skilled, but I suspect there are some serious injuries from time to time.

 

Early one morning before the first of my meetings in Munich, I took the U-bahn (subway) out to the city’s west end, to see more of the city’s green space at the Schloss Nymphenburg (“Nymph’s Castle”), a baroque palace that was the principal summer residence of the rulers of Bavaria. Behind the main palace building is a 490-acre park that includes both formal gardens and thick woodlands. (By way of comparison, the National Mall in Washington is about 309 acres). On a sunny fall morning, the castle’s grounds were quite beautiful. Alas, there are no beer gardens on the castle grounds, a rare city site that didn’t involve beer in some way.

 

On the other hand, this time of the year, another of the city’s large parks is entirely given over to beer. The city’s world-famous Oktoberfest celebration is staged in the city’s Theresienwiese, which is essentially turned over to the city’s brewers, and where each year the brewers construct what amounts to a beer-themed amusement park complete with carnival rides and swarming with crowds of people. Each of the major breweries hosts their own enormous “tent,” which is actually a large, enclosed wooden structure holding thousands of people. Every year the festival attracts nearly 7 million visitors, the vast majority of them from outside Bavaria. Each year, the thirsty visitors, many of them dressed in traditional Bavarian attire, drink about 7.5 million liters of beer – and they drink it one liter a time out of the enormous glass beer steins.

 

It is probably just as well that that the traditional serving size is measured in liters rather than ounces, because it is much easier to accept that you are drinking just one liter of beer rather to think about the fact that you are also drinking over 33 ounces of beer at a time. Inside the beer tents, a band plays a combination of contemporary music and traditional tunes. Periodically, the band calls out a chant that goes something like this

 

Ein Prosit, Ein Prosit, der Gemütlichkeit
Ein Prosit, Ein Prosit, der Gemütlichkeit
Eins, zwei, drei  g’suffa!

Zicke, zacke, zicke, zacke, hoi, hoi, hoi,
Zicke, zacke, zicke, zacke, hoi, hoi, hoi, Prosit!

 

With the final shout, everyone clinks their glasses together and takes a drink of beer. (All of this makes a lot more sense after the first stein). As the evening progressed, I found that I enjoyed singing along with many of the German drinking songs, despite knowing neither the lyrics nor the melody. As you might expect a crowd full of insurance professionals adapted to these circumstances effortlessly. Although one of our group did lose his glasses and another lost her cell phone. (In the interest of maintaining friendships, there are no pictures here of our group at Oktoberfest.)

 

The Oktoberfest celebration was great fun but I have to admit that I felt a little fragile for my presentation the next day. I will say that I grateful to have had the opportunity to visit Munich and to meet so many industry colleagues. I am very grateful Munich Re for inviting me to be a part of their event. Munich is a wonderful place, worthy of many return visits.

 

Surf Munich

 

 

 

 

 

 

 

 

 

 

Schloss Nymphenburg

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Alps (viewed from the Olympic Tower in Munich)

 

 

 

 

 

 

 

 

 

 

Do Your Worst: Currywurst und Pommes Frites mit Bier

 

 

 

 

 

 

 

 

 

 

A Sunny Fall Afternoon in the Beer Garden

 

 

 

 

 

 

 

 

 

 

 

The Walking Man Statue (Outside the New Main Entrance to Munich RE’s offices)

 

 

 

 

 

 

 

 

 

 

Isar River in Munich

 

 

 

 

 

 

 

 

 

 

In the English Garden

In what is by far the largest settlement of a credit crisis-related securities class action lawsuit, Bank of America has agreed to pay $2.43 billion to settle the suit filed against the company and certain of its directors and officers in connection with the bank’s financial crisis-driven acquisition of Merrill Lynch. The settlement is subject to court approval. Bank of America’s September 28, 2012 press release announcing the settlement can be found here.

 

The settlement is not only the eighth largest securities class action lawsuit settlement ever (refer here for the Stanford Law School Class Action Clearinghouse’s list of the top ten largest securities suit settlements), but according a September 28, 2012 press release from the Ohio Attorney General (whose office represented several Ohio pension funds that were among the lead plaintiffs in the case) it is the fourth largest settlement funded by a single defendant for violations of the federal securities laws, and it is largest securities class settlement ever resolving a Section 14(a) case (alleging misrepresentations in connection with the a proxy solicitation). According to the Ohio AG, the settlement is also the largest securities class action settlement where there were no criminal charges against company executives.

 

The three largest single-defendant securities class action settlements are Tyco’s $2.975 billion settlement in 2007; Cendant’s 1998 settlement ($2.83 billion); and Citigroup’s $2.65 billion contribution to the WorldCom case settlement. The total amount paid in settlement in each of these cases was larger than these amounts due to the contribution s of other defendants.

 

As discussed here, the BofA Merrill Lynch merger case had survived two rounds of dismissal motions, and according to press reports was scheduled to go to trial on October 22, 2012. In her On the Case blog (here), Alison Frankel has an interesting account of how the settlement came about and the various factors (including the looming trail date) that “forced” BofA to settle the case. Susan Beck has an interesting September 28, 20912 article on the Am Law Litigation Daily(here) in which she questions BofA’s decision to rely on the Wachtel Lipton firm (which had advised the bank in connection with the Merrill Lynch acquisition) for its defense in the securities suit. 

 

The case arises out of BofA’s agreement, reached in mid-September 2008, at the height of the global financial crisis, to acquire Merrill Lynch. In October and November 2008, while shareholder approval of the transaction was pending, Merrill suffered losses of over $15 billion and also took a $2 billion goodwill impairment charge. The Complaint alleges that BofA’s senior officials were aware of these losses as they occurred. The Complaint alleges that the losses were so significant that BofA management discussed terminating the transaction, prior to the December 5, 2008 shareholder vote on the merger, in which BofA shareholders approved the merger.

 

On December 17, 2008, BofA Chairman and CEO Kenneth Lewis called Treasury Secretary Henry Paulson to advise him that BofA was "strongly considering" invoking the “material adverse change” clause in the merger agreement, in order to terminate the deal prior to its scheduled January 1, 2009 close date.  At Paulson’s invitation, Lewis flew to Washington for a face-to-face meeting, at which Paulson and Federal Reserve Board Chair Ben Bernanke urged Lewis not to invoke the MAC clause.

 

In subsequent conversations, Lewis again advised the government officials that BofA intended to invoke the MAC clause. According to the plaintiffs’ allegations, BofA’s board voted on December 21, 2008 to invoke the MAC clause, but on the following day, the Board voted to approve the merger, apparently in part based on Lewis’s statement that he had received verbal assurances from Paulson that BofA would received a capital infusion and a guarantee against losses from risky assets if the merger concluded.

 

On January 16, 2010, BofA disclosed the fourth quarter losses of both BofA and Merrill and also revealed the federal funding package, which included $20 billion in capital and protection against further losses on $118 billion in assets. In following days, news reports revealed that in the days prior to the deal’s close, Merrill employees had been paid massive bonuses. 

 

In the two trading days following the January 16 disclosure, BofA’s market capitalization dropped over $20 billion, and shareholder litigation ensued. The plaintiffs alleged that the defendants misstated and concealed matters related to the Merrill bonuses, the losses that accrued in the Fourth Quarter of 2008 after the merger was announced, and the pressure to consummate the deal from government officials. After the securities and derivative lawsuits were consolidated, the defendants moved to dismiss.

 

In a lengthy August 27, 2010 opinion (about which refer here), Southern District of New York  Judge Kevin Castel denied in part and granted in part the defendants’ motions to dismiss. First, he denied the defendants’ dismissal motions with regard to the plaintiffs’ allegations concerning the disclosures of the Merrill bonuses. Next, he concluded that while the plaintiffs had also alleged that there were materially misleading misrepresentations or omissions about Merrill Lynch’s deteriorating 4Q08 financial condition and about the promised government financial inducements, the plaintiffs had not adequately alleged scienter as to these topics, and so he denied the defendants’ motion to dismiss as to these allegations.

 

Thereafter, the plaintiffs filed an amended complaint.The defendants renewed their motions to dismiss. . 

 

In a July 29, 2011ruling (about which refer here), Judge Castel denied the defendant’s  renewed dismissal motion as to the allegations surrounding Merrill’s declining 4Q08 financial condition, but granted the dismissal motion as to the allegations about the government bailout. He held that the plaintiffs’ amended complaint adequately alleged scienter as to the Merrill’s financial condition in the fourth quarter of 2008, but did not adequately allege a duty to update prior disclosures as to the financial support the government officials offered in order to facilitate the deal.

 

According to BofA’s September 28 press release about the settlement, the settlement is to be funded “by a combination of Bank of America’s existing litigation funding reserves and incremental litigation expense to be recorded in the third quarter of 2012.” The company estimates that its total third quarter litigation expense (including the incremental cost of the settlement) will be $1.6 billion. The company’s press release does not indicate that any portion of the settlement will be funded by insurance.

 

The settlement resolves not only the claims against the company but also those against the individual defendants as well. The individuals apparently will be making no personal contribution toward the settlement. According to Alison Frankel’s blog post, the plaintiffs attorneys intend to seek attorneys’ fees of $150 million

 

In addition to the monetary amount, BofA also agreed as part of the settlement to certain corporate governance reforms. Among other things, the bank agreed to institute or to continue certain corporate governance enhancements through January 1, 2015, “including those relating to majority voting in director elections, annual disclosure of noncompliance with stock ownership guidelines, policies for a board committee regarding future acquisitions, the independence of the board’s compensation committee and its compensation consultants, and conducting an annual ‘say-on-pay’ vote by shareholders.”

 

As I noted at the outset, this settlement eclipses by far any other settlement of a subprime meltdown or credit crisis-related securities class action lawsuit, far exceeding what had until now had been the largest of the financial crisis lawsuits, the $627 Wells Fargo/Wachoia Bondholders securities suit settlement (about which refer here).

 

Indeed, the $2.43 billion BofA settlement amounts to nearly half of the aggregate amount of all of the other credit crisis securities suit settlements. The 54 prior credit crisis related settlements together totaled about $5.5 billion. With the addition of the latest settlement, the total of all of the credit crisis securities suit settlements is now about $7.93 billion.

 

It is striking what a significant portion of the $7.93 billion total that BofA has had to fund due to its credit crisis era acquisitions of Merrill Lynch and Countrywide. As noted on the top ten list below, there have been a number of credit crisis securities class action lawsuit settlements involving these two companies. The total amount that BofA has had to pay in settling these cases (including the latest settlement) is just under $4 billion, representing slightly over half of all amounts that have been paid in settlement of credit crisis cases.

 

The ten largest credit crisis securities suits settlements are as follows:

 

Case

Amount

Links

BofA/Merrill Lynch Merger

$2.43 billion

 This Post

Wells Fargo/Wachovia Bondholders Action

$627 million

Here

Countrywide

$624 million

Here

Citigroup

$590 million

Here

Lehman Brothers (including offering underwriters’ settlement)

$507 million

Here

Merrill Lynch

$475 million

Here

Merrill Lynch Mortgage-Backed Securities

$315 million

Here

Bear Stearns

$275 million

Here

Charles Schwab

$235 million

Here

Washington Mutual

$208.5 million

Here

 

Though the BofA/Merrill Lynch merger securities suit was one of the highest  profile of the securities lawsuits from the financial crisis, there are other high profile cases yet to be resolved, including the one involving AIG and the Citigroup bondholders suit. The resolution of the cases filed as part of the credit crisis-related litigation wave still has much further to go.

 

I have updated my running tally of the subprime and credit crisis case resolutions to reflect this latest settlement. The tally can be accessed here.

 

Two Subprime-Related Securities Suits Dismissed: In addition to the BofA settlement, there were other developments last week in connection with high profile subprime and credit crisis-related securities suits. In separate decisions, the subprime related securities suits involving Freddie Mac and UBS were dismissed.

 

First, on September 24, 2012, Southern District of New York Judge John F. Keenan dismissed with prejudice the subprime-related securities class action lawsuit that had been filed against the Federal Home Loan Mortgage Corporation (Freddie Mac) and certain of its directors and officers. A copy of Judge Keenan’s order can be found here. As discussed here, Judge Keenan had previously granted the defendants’ motion to dismiss the case, but without prejudice. The plaintiffs filed an amended complaint and the defendants renewed their dismissal motions.

 

In a sharply worded opinion, Judge Keenan granted the defendants’ renewed motion to dismiss, saying, among other things, that “the bevy of truthful disclosures that Freddie Mac made throughout the Class Period, covering everything from detailed credit characteristics to extensive risk management also negates the inference of scienter. It defies logic to conclude that executives who are seeking to perpetrate fraudulent information upon the market would make such fulsome disclosure.” A September 27, 2012 Bloomberg article about the Freddie Mac dismissal can be found here.

 

Second, in a September 28, 2012 order (here), Southern District of New York Judge Richard Sullivan granted the defendants’ motion to dismiss in the subprime-related securities suit that had been filed against UBS and certain of its directors and officers. Among other things, Judge Sullivan said that “Although UBS made a series of bad bets with disastrous consequences for the company and its shareholders, those consequences alone are insufficient to establish scienter and support a claim for securities fraud.”

 

In granting the motion as to the individual defendants, Judge Sullivan concluded that the plaintiffs had failed to allege sufficiently specific misrepresentations as to each individual defendant, saying (in reliance on the Supreme Court’s opinion in the Janus Capital Group case) “"While it is true that Janus might not alter the well-established rule that a corporation can act only through its employees and agents, it is nonetheless also true that a theory of liability premised on treating corporate insiders as a group cannot survive a plain reading of the Janus decision.”

 

I have added these two dismissals to my running tally of subprime and credit crisis-related securities suits dismissal motion rulings, which can be accessed here.

 

Say-on-Pay Lawsuit Dismissed on the Merits: Though in many instances litigation has followed in the wake of a negative say-on-pay vote, the say-on-pay lawsuits generally have not fared particularly well, as I noted in a recent post (here). In general, however, these cases have generally faltered due to procedural shortcomings, such as a failure to make a pre-suit demand on the board of directors, rather than on the actual merits of the case. However a recent decision in a say on pay lawsuit out of Eastern District of North Carolina granted the defendants motion dismiss based on the merits.

 

On May 3, 2011, fifty two percent of Dex One shareholders rejected the company’s executive compensation plan. Afterwards, the board investigated shareholder concerns and ultimately decided not to amend its 2010 executive compensation plan. In September 2011, a Dex One shareholder initiated a derivative suit against Dex One, as nominal defendant, and against certain directors and executive officers of Dex One. The plaintiff alleged, among other things, that the defendants had misled the company’s shareholders about the executive compensation plan in the 2011 proxy statements and had breached their fiduciary duties in failing to amend or alter the 2010 executive compensation plan. The defendants moved to dismiss.

 

In a September 26, 2012 order (here), Eastern District of North Carolina Judge James C. Dever III granted the defendants’ motion to dismiss, concluding among other things that the 2011 proxy statement “did not contain false or misleading information.” Judge Dever also rejected the plaintiff’s claim that the defendants had breached their fiduciary duties by failing to alter or amend the executive compensation plan.

 

Judge Dever’s ruling in the Dex One case is very fact specific, and so it may be of limited applicability in other say-on-pay cases. It is, however, consistent with the outcome of many other say-on-pay cases, most of which have resulted in dismissals. But though the plaintiffs have fared poorly in these cases, that does not necessarily mean that they will stop being filed. In pursuing these cases, the plaintiffs are not motivated so much by a desire to try to secure any type of monetary recovery so much as they are trying to use the litigation as another means to try to pressure the board on executive compensation issues. Given the near certainty that disputes regarding executive compensation will continue to arise, it seems likely that we will continue to see these kinds of say-on-pay lawsuits, even though plaintiffs generally have not been very successful in these cases.

 

Special thanks to Alan Parry of the Smith Anderson law firm for sending me a copy of Judge Dever’s Order. The Smith Anderson represented the defendants in the Dex One say-on-pay lawsuit.

 

The Week Ahead: During the upcoming week, The D&O Diary will be traveling overseas on business so there may be some disruption in the publication schedule for the next few days. The publication schedule will return to "normal" after October 8.

 

Although the class action lawsuit is most often associated with the litigious legal culture in the United States, the fact is that in recent years class action and other group litigation procedures have been expanding around the world. Forces of globalization and the rise of organized groups of aggrieved claimants have encourage a host of countries to adopt class, collective or other representative action procedures, and still other countries are currently considering the adoption of these kinds of legal schemes.

 

The availability of these kinds of collective action procedures in many countries is an increasing concern for legal and insurance professionals around the world, as well as for their clients. However, even with the vast resources of the Internet only a mouse click away, it can be very challenging to determine whether any given country has adopted some form of collective action and how any given country’s collective action scheme compares to others.

 

Fortunately, there is now a terrific resource that collects and organizes this information in a single volume. The book, entitled World Class Actions: A Guide to Group and Representative Actions Around the Globe (about which refer here), was edited by Paul Karlsgodt, of the Baker & Hostetler law firm. (Karlsgodt may be familiar to many readers as the author of Classactionblawg.com.) The book consolidates the work of 53 different authors from around the world, whose contributions address the development of collective action procedures across the globe.

 

The book’s various chapters address the availability of class procedures not only in North America and Europe, but Latin America, Asia and even parts of Africa. Each chapter is written by a local attorney familiar with the laws, best practices, legal climate and culture of the jurisdiction. Each of the entries describes the relevant aspects of the country or countries civil court system and surveys the available collective action procedures. Each entry also includes relevant cultural considerations that pertain to the processes and remedies available in the relevant country’s courts.

 

The book also incorporates a separate section of essays on the issues concerning transnational law – that is, issue or actions that span geographic and political boundaries. This portion of the book addresses the challenges surrounding efforts to develop binding global solutions to private disputes. In addition, the book addresses the problems that can arise when  the claimants are not all located in a single country or when there are  parallel actions involving the same defendants proceeding in multiple jurisdictions.

 

This new book is provides a helpful introduction to the incredibly complex and varied topic of collective actions around the world. It will serve as a valuable resource for lawyers and other professionals as they attempt to navigate and develop strategies for litigation and risk management while doing business abroad. This book will be particularly valuable for those whose jobs require them to understand and manage the litigation risks their clients must attempt to manage in their operations around the world. I highly recommend this book.

 

The Class Action Playbook: And speaking of class actions, the same publisher that is responsible for World Class Actions has also recently published the second edition of The Class Action Playbook (about which refer here), a single volume class action litigation resource written by Brian Anderson of the O’Melveny & Myers law firm and Andrew Trask of the McGuire Woods law firm. (Trask may be familiar to readers of this blog as the author of the Class Action Countermeasures blog.)

 

The Playbook is intended as a guide for practitioners and others who must navigate the class action process in the U.S. courts, aiming to provide the requisite information to permit the participants to develop their strategies as the action progresses. The authors explain the importance of the issues at each stage in the process and the factors participants should consider in deciding what actions to take.

 

The publication of the second edition is particularly timely as there have a number of recent significant developments, including for example, the U.S. Supreme Court’s decisions in the Wal-Mart case, the Concepcion case, and the Matrixx Initiatives case. The updated version is a useful practical guide for anyone involved in class action litigation.

 

And Speaking of Collective Actions: A flock of starlings is called a “murmuration,” but that description hardly does justice to what starlings are capable of collectively. As described in a November 2011 post on Time.com (here):

 

No one knows why they do it. Yet each fall, thousands of starlings dance in the twilight above Gretna, Scotland. The birds gather in magical shape-shifting flocks called murmurations, having migrated in the millions from Russia and Scandinavia to escape winter’s bite. Scientists aren’t sure how they do it, either. Even complex algorithmic models haven’t yet explained the starlings’ acrobatics, which rely on the tiny bird’s quicksilver reaction time of under 100 milliseconds to avoid aerial collisions—and predators—in the giant flock. Despite their show of force in the dusky sky, starlings have declined significantly in the UK in recent years, perhaps because of a drop in nesting sites. The birds still roost in several of Britain’s rural pastures, however, settling down to sleep (and chatter) after the evening’s ballet.

 

I confess that until I had seen the video below, sent to me by an industry colleague, I had no idea that starlings were capable of anything remotely interesting. But I have to say that now that I am acquainted with the murmuration of starlings, I have an entirely new appreciation for the birds. Please give your self a treat and watch this video, embedded below.

 

A November 8, 2011 Wired Magazine article entitled “The Startling Science of Starling Murmurations” can be found here.

 

Murmuration from Islands & Rivers on Vimeo.

As I have previously noted (most recently here), the pace of filing of FDIC actions against directors and officers of failed banks has slowed considerably as 2012 has progressed. Indeed, there have only been two new FDIC failed bank lawsuits filed since May, and none at all since mid-July (even though the FDIC has each month continued to increase the number of authorized lawsuits, as reflected on the agency’s website, here).

 

While the FDIC has not filed any new failed bank lawsuits recently, that is not to say that the regulatory authorities have not been active. Specifically, on September 25, 2011, the SEC filed enforcement actions in the District of Nebraska against three former officers of the failed TierOne Bank of Lincoln, Nebraska, as well as against the son of one of the three officers. The SEC’s September 25, 2012 press release regarding the enforcement actions can be found here, and the SEC’s two complaints can be found here and here.

 

Banking regulators closed TierOne Bank on June 4, 2012 (refer here). The SEC alleges that prior to the closure, TierOne understated its loan losses  and misstated the value real estate the bank had repossessed. The SEC alleges that as a result of the bank’s expansion into “riskier types” of lending in Las Vegas and other high growth areas, and the resulting increase in problems loans, the Office of Thrift Supervision directed the bank to maintain higher capital ratios. The SEC alleges that in order to comply with these requirements, three TierOne officials – Gilbert Lundstrom, the bank’s Chairman and CEO; James Laphen, the bank’s President and COO; and Don Langford, the bank’s chief credit officer – disregarded information that collateral securing the bank’s loans and real estate the bank had repossessed were significantly overvalued. The SEC alleges that as a result the bank’s losses were understated by millions of dollars in multiple SEC filings.

 

The SEC further alleges that after the OTS required the bank to obtain new appraisals for the collateral and repossessed real estate, the bank disclosed more than $130 million in loan losses. The SEC alleges that had these losses been booked in the appropriate quarters, the bank would have missed the required capital ratios several quarters earlier. Following the announcement of the loan losses, its stock price dropped more than 70%

 

The SEC alleges that Lundstrom communicated inside information to his son about the bank’s intention to sell certain assets. With the benefit of this information, Lundstrom’s son was able to purchase TierOne stock and then later sell it at a profit.

 

The SEC has reached settlements with Lundstrom and with his son, and with Laphen. Lundstrom has agreed to pay a $500,921 penalty. Laphen has agreed to pay a $225,000 penalty. Lundstrom’s son has agreed to pay a $225,921 disgorgement plus a $225,921 penalty. The sole remaining defendant, Langfor, has not settled the charges and the case against him remains pending.

 

The SEC’s press release quotes SEC Enforcement Director Robert Khuzami as saying that the bank’s understatement of its loan losses had the effect of “concealing the bank’s deterioration from shareholders and regulators alike.” The SEC’s press release also expressly acknowledges the “cooperation” of the Office of the Comptroller of the Currency.

 

The SEC enforcement actions relating to TierOne Bank are not the first that the SEC has brought against in the wake of a bank closure as part of the current wave of bank failures. As noted here, in April 2012, the SEC filed a civil enforcement action against two former officers of the publicly traded holding company of the failed Franklin Bank. In addition, as noted previously (here, scroll down), in an October 11, 2011 complaint (here), the SEC filed a civil enforcement action against four former officers of UCBH Holdings, Inc., the holding company for United Commercial Bank, which failed in November 2009.

 

The SEC action against the former TierOne officials serve as a reminder that the former directors and officers of a failed bank face significant additional litigation threats beyond just the possibility of a civil action by the FDIC in its role as receiver of the failed bank. Where, as here, the failed institution or its holding company were publicly traded, the potential liability exposures include the possibility of an SEC enforcement action or even a securities class action lawsuit. Even though the penalty amounts the SEC sought in the enforcement actions would not be covered under a D&O policy, the costs associated with defending this type of enforcement action would likely be covered (assuming that D&O insurance coverage is in fact available). These costs erode the limits of liability of any applicable insurance, reducing the amount of insurance available for any other pending claims. All of which is a reminder of the strains that post-failure litigation can put on the D&O insurance resources of a failed bank.

 

Summary Judgment Denied in Failed Bank Coverage Suit: Readers may recall that in a prior post (here), I described an action that a D&O insurer had filed in the Eastern District of Michigan, seeking a judicial declaration that the policy the insurer had issued to the failed Michigan Heritage Bank did not provide coverage for the claims that the FDIC, as receiver for the failed bank, had filed against a former officer of the bank. The defendants in the insurer’s declaratory judgment action include both the FDIC and the former bank official that the FDIC has separately sued.

 

In its declaratory judgment action, the insurer contends that there is no coverage under its policy for the FDIC’s claim against the former bank officer, arguing that coverage is barred by the “insured vs. insured” exclusion” and that the financial loss alleged in the underling claim does not constitute loss under the policy. The insurer moved for summary judgment.

 

In a September 24, 2012 opinion and order (here), Eastern District of Michigan Judge Bernard Freidman denied without prejudice the insurer’s summary judgment motion. In opposing the summary judgment motion, the FDIC has argued that the motion was premature because the terms on which the carrier seeks to rely are ambiguous and because discovery is required to determine the meaning of the terms.

 

In denying the insurer’s motion, Judge Friedman said that “the FDIC has shown that some ambiguity exists in the insured vs. insured exemption [sic] due to the ‘security holder exception,’ the omission of a regulatory exclusion, and statements by plaintiff that regulatory suits, which might include the instant action are covered.”

 

Judge Friedman also found “the FDIC has shown that some ambiguity exists in the definition of ‘loss’ because the so-called ‘loan loss carve out’ does not clearly exemption tortious conduct.” Judge Friedman also cited the insurer’s marketing materials “which indicated that charged-off loan losses are covered not excluded.” Judge Friedman denied the summary judgment motion to permit discovery on specified issues.

 

Judge Friedman’s ruling in this case does not represent a determination on the merits. It does not represent a determination that the Insured vs. Insured exclusion does not apply to a claim by the FDIC as receiver of a failed bank against the former officials of the bank.

 

However, there may still be some significance to the fact that Judge Friedman did find “some ambiguity” in the provisions on which the insurer sought to rely to contest coverage. His determination in the regard depended in part on specific factual issues, pertaining in particular to the insurer’s marketing materials. Nevertheless, the ruling does represent to some extent a determination that the question of whether or not the Insured vs. Insured exclusion applies to an FDIC failed bank lawsuit may not be a strictly legal issue but could involve factual issues on which discovery is required. If this coverage question is a factual issue – if there is “some ambiguity” regarding the insured vs. insured exclusion — it could complicate insurer’s efforts to rely on the exclusion in order to contest coverage for FDIC failed bank claims.

 

To be sure, there will likely be another round on the issue of the exclusion’s applicability following discovery. But having to go on to that later round at a minimum could mean that obtaining  the coverage determination might turn out to be more involved than might have initially seemed like it would be.

 

FDIC, Bank Officials Settle Failed Bank Lawsuit: According to press reports, the FDIC and certain former directors and officers of Heritage Community Bank of Glenwood, Illinois have reached a settlement of the failed bank litigation that the FDIC, as receiver for the bank, had filed against the former bank officials. Background regarding the FDIC’s 2012 lawsuit can be found here. The press reports do not disclose the amount or terms of the settlement. The September 10, 2012 settlement stipulation that the parties filed with the court (a copy of which can be found here) does not disclose the terms or amount of the settlement.

 

A March 2012 memo by the Jones Day law firm  discussing the Heritage Community Bank case (among other things) can be found here.

 

FDIC Settles Failed Bank Insurance Coverage Action: A week after the parties to the Heritage Community Bank case filed their settlement stipulation, the parties tothe D&O insurance lawsuit pending in the DIstirct of Puerto Rico involving the failed Westernbank. also filed a stipulation of settlement. As discussed here (refer to the "Update" section in the body of the blog post), in January 2012, the FDIC intervened in an action that the holding company for Westernbank had filed against the bank’s D&O insurance carriers. According to the parties’ September 17, 2012 stipulation  (here), the FDIC and the carriers have reached a settlement. The terms of the settlement are not disclosed in the stipulation. UPDATE: A knowledgeable reader who wishes to remain anonymous advises as follow with respect to the Westerbank settlement: "That action actually hasn’t settled. The parties to a parallel proceeding involving fidelity bonds issues by [two insurers] (who also are parties to the Westernbank/FDIC D&O coverage action) did apparently settle, and was confirmed by the motion to dismiss referenced in  your blog post. Very similiar parties, and they involve some of the same underlying loans that assertedly led to the failure of the bank. But the fight goes on in the D&O coverage litigation." 

 

 

As the various forms of social media have become increasingly pervasive, employers have struggled with appropriate responses to employees’ use of the social media sites. One question in particular that has arisen is the extent to which employers can seek to regulate and even discipline employees’ use of social media to comment on the employer or their workplace. A recent decision by a three-judge panel of the National Relations Board, addressing the social media policies of Costco Wholesale Corp. held that the company’s social media policy violated its employees’ rights under the National Labor Relations Act. A copy of the NLRB’s September 7, 2012 Decision and Order can be found here.

 

I should note at the outset that this NLRB ruling was discussed by a panel at the Advisen Management Liability Insights Conference in New York last Thursday. In addition, a work colleague also forwarded me a copy of the Blank Rome law firm’s September 2012 memo about the NRLB’s ruling. I acknowledge here my indebtedness to the conference panel and to my work colleague for identifying this topic and suggesting many of the comments in this post.

 

The NLRB’s Costco ruling arose out of efforts at the company’s Milford, Connecticut facilities to organize the facilities’ meat department employees. In connection with these activities, the concerned union filed charges with NLRB alleging that the company had violated the employees’ rights under the National Labor Relations Act. Among other things, the Union alleged that the company had certain unlawful rules in its employee handbook. Among these rules is one stating that “any communication transmitted, stored or displayed electronically must comply with the policies outlined in the Costco Employment Agreement.”

 

The rule goes on to state that statements “posted electronically (such as [to] online message boards or discussion groups) that damage the Company, defame any individual or damage any person’s reputation, or violate the policies outlined in the Costco Employee Agreement may be subject to discipline, up to and including termination of employment.”

 

The Administrative Law Judge who heard the union’s charges upheld this rule, determining that employees would reasonably conclude that the company’s purpose in devising h the rule was to ensure a “civil and decent workplace.”

 

The NLRB rejected the ALJ’s determination, concluding to the contrary that the rule “allows employees to reasonably assume that it pertains to – among other things—certain protected concerted activities, such as communications that are critical to the Respondent’s treatment of its employees.” The Rule, the NLRB said, “clearly encompasses concerted communications protesting [Costco’s] treatment of its employees.” Costco’s maintenance of the rule therefore “has a reasonable tendency to inhibit employees’ protected activity” and as such “violates” the National Labor Relations Act.”

 

The Blank Rome law firm’s memo comments that the NLRB’s ruling, (the NLRB’s first binding decision on the issue) “serves as a reminder to employers to review the scope of their social media policies and to carefully analyze how they may be construed.”

 

As noted in a September 21, 2012 memorandum from the Franczek Radelet law firm about the ruling (here), the need to review social media policies applies to both union and non-union employers, adding that “now more than ever, all employers should continue to review and update all of their policies to ensure that they are specific, narrowly tailored to their business needs, and do not sweep so broadly so as to interfere with employee rights under federal labor law.”

 

In thinking about the potential EPL insurance implications of this development, it is important to note that many EPL policies have National Labor Relations Act exclusions, precluding coverage for claims based upon alleged violations of the NLRA or similar federal, state and local statutes. However, many insurers are willing upon request to amend this exclusion to provide a carve-back specifying that the NLRA exclusion does not apply to claims for retaliation.

 

A retaliation carve-back to the EPL policy’s NLRA exclusion would not preserve coverage for all claims asserting that a company’s social media policy violates the NLRA. However, Costco’s social media policy not only contemplated discipline for violation of the policy, but expressly allowed for employee termination. The retaliation claim coverage carve-back to the NLRA exclusion might preserve coverage for a claim by an employee that he or she was terminated in retaliation for engaging in activity that contravened a social media policy that violated the NLRA – or to put it more simply, in retaliation for engaging in activity protected by the NLRA. However, even among carriers who are willing to extend the carve-back to the NLRA exclusion, the carriers sometimes restrict the carve-back so that it does not extend to extend coverage to class or mass action claims.

 

Jay Rockefeller’s Cyber Security Letter: On September 19, 2012, John D. Rockefeller, IV, the Democratic Senator from West Virginia, sent a letter to the CEOs of all of the Fortune 500 companies, asking each CEO to voluntarily respond by October 19, 2012 to several broad questions pertaining to the company’s view on cybersecurity and to the federal government’s efforts to promulgate national cybersecurity standards. A copy of hte letter Senator Rockefeller sent to IBM’s CEO can be found here. ,  

 

As detailed in a September 19, 2012 memorandum from the Gibson Dunn law firm (here), Rockefeller’s letter follows his unsuccessful efforts earlier this year to pass legislation intended to impose heightened cybersecurity standards on a national level. (Indeed, a cynical reader might say that the letter is basically just one long gripe to the CEOs that the legislation failed to pass due to a filibuster and the efforts of business lobbyists.)   The law firm memo also points out that the letter follows other efforts Rockefeller has made to focus on cybersecurity outside of the legislative process, including his successful efforts last year to have the SEC provide guidance to pubic companies on what disclosures they should make concerning the companies’ cybersecurity risks and incidents.

 

The letters in and of themselves are unlikely to change anything. However, Rockefeller’s continuing efforts underscore the fact that cybersecuity is likely to remain both a high profile issue and a highly politicized issue. At the same time, other companies will find themselves, as Google recently did, under increased pressure to make disclosures regarding cybersecurity risks and incidents.

 

With increasing public scrutiny on companies’ cybersecurity preparedness and disclosure comes the increasing likelihood comes the increasing possibility that companies experiencing cybersecurity incidents —and their directors and officers — may face claims from shareholders and other constituencies that they failed to implement appropriate cybersecurity measures or made misrepresentations about their cybersecurity preparedness. As recently noted in Rick Bortnick’s Guest Post on this blog, potential D&O liability is one of the significant components of cyber risk. The high-profile nature of these issues and the level of scrutiny increase the likelihood that we will see claims against companies’ directors and officers based on cybersecurity preparedness and cyber disclosure.

 

Concerns About JOBS Act Fundraising:  Another topic that the Advisen conference in New York addressed last week was whole topic of concerns with fundraising activities enabled by the recently enacted JOBS Act. The Act’s provisions permitting crowdfunding and loosening restrictions on solicitation and advertising for exempted offerings at a minimum create a context within which liability claims could arise and also increase the possibility for fraud. The Act’s provision raising from 500 to 2,000 the number of shareholders a company may have before it takes on SEC reporting obligations not only increases the potential scale of these problems but also ramps up the number of prospective claimants that might object.

 

As the panel at the Advisen conference discussed, these concerns will pose a host of challenges not only for prospective investors but for private company D&O underwriters, as well. A September 22, 2012 Wall Street Journal article entitled “On Crowdfunding and Other Threats” (here) reviews the steps that prospective investors can take to try to avoid getting scammed in a JOBS Act offering. Though the list of steps in the article are addressed to the investors hoping to avoid getting defrauded, the list also provides a useful starting point for D&O underwriters trying to think about and to  underwrite these risks. At a minimum, it seems clear that caution is indicated here, both for investors and for insurance underwriters

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Readers interested in a more positive perspective on the possibilities of new forms of funding such as “crowdfunding” may want to take a look at the article in this week’s issue of Time Magazine entitled “The Kickstarter Economy” (here, subscription required). The article chronicles the successes of (and challenges for) the Kickstarter, the online fundraising portal. The article optimistically suggests that the online fundraising will support nascent enterprises that are well-intentioned and worthy. At the same time, the article also documents many initiatives that failed to live up to their own aspirations.

 

One of the panelists at the JOBS Act session at last week’s Advisen conference was Carl Metzger of the Goodwin Proctor firm, who pointed out that his firm has a page on its website devoted to JOBS Act- related concerns. The firm’s webpage, which can be found here, is a good one-stop resource on JOBS Act issues and developments.

 

German Court Dismisses Investors’ Porsche Suit: As I have discussed in numerous posts on this blog (most recently here),  aggrieved investors who lost money short-selling VW shares and who claim they were misled by Porsche’s management have been trying to pursue claims against Porsche and its senior officials in U.S. courts. (Background regarding the dispute can be found here.) After their initial U.S. federal court action was dismissed (about which refer here), some investors tried to pursue claims against Porches in Germany’s courts. Now, according to press reports (refer here), the first two of these German lawsuits to be considered have been dismissed.

 

According to the news reports, the Braunschweig regional court determined that the allegedly misleading statements on which the investor claimants sought to rely in support of their claims against Porsche did not amount to “vicious behavior” that would have misled investors A statement on the court’s website about the September 19, 2012 court determination (in German) can be found here. According to the news reports, three additional cases remain pending before the same German court.

 

The outcome of the two German cases highlights why the aggrieved investors tried first to assert their claims in the U.S., and why some investors are continuing to press the U.S. claims. The appeal of the dismissal of the original U.S. federal court lawsuit remains pending in the Second Circuit. In addition, other investors’ New York state court common law claims have survived an initial motion to dismiss (about which refer here). This long-running litigation saga continues to grind on, but the outcome of the two recent German court decisions seems to suggest that whether investors are to have any hope of relief will depend on further developments in the U.S. proceedings, particularly the pending appeal in the Second Circuit.

 

I am pleased to publish below a guest post from my good friend Kimberly M. Melvin and her colleague John E. Howell, both of the Wiley Rein LLP law firm. Kim and John’s article discusses a recent decision from New York’s high court and its implications for the scope of coverage under a fiduciary liability insurance policy. This article was first published by Advisen.

 

I would like to thank Kim and John for their willingness to publish their article on this site. I welcome guest posts from responsible commentators on topics of interest to readers of this blog. Any readers who are interested in publishing a guest post on this site are encourage to contact me directly. Here is Kim and John’s guest post:

 

The Employee Retirement Income Security Act (ERISA) virtually created the market for fiduciary liability insurance because it both expanded potential liabilities for fiduciaries of benefit plans and—crucially—extended liability to the personal assets of individual fiduciaries. The demand for fiduciary liability insurance largely grew out of a desire to protect fiduciaries from such personal liability. This insurance—focused on protecting individual fiduciaries—by design did not cover a plan sponsor’s non-fiduciary acts, such as making business decisions regarding its employee benefit plans. New York’s high court recently issued a decision that recognized and confirmed this basic limitation in Federal Insurance Co. v. International Business Machines Corp., 965 N.E.2d 934 (N.Y. 2012). 

 

Yet, commentators, carriers and insurance buyers alike continue to criticize the IBM decision as creating a new “gap” or marking a sea change in the scope of coverage. Such criticism does not hold up. The IBM decision is really nothing new. It reflects the traditional terms and function of fiduciary liability insurance—to protect fiduciaries. What’s more, the recent market trend toward expanding the scope of fiduciary liability coverage to plan sponsors may not ultimately serve the best interests of insurance buyers and the primary intended beneficiaries of the coverage—individual fiduciaries of employee benefit plans.

 

Settlor or Fiduciary: The Sponsor of an ERISA Plan May Wear Multiple Hats

A company that sponsors an employee benefits plan can “wear two hats: one as a fiduciary in administering or managing the plan for the benefit of participants and the other as employer in performing settlor functions such as establishing, funding, amending, and terminating the trust.”[1] A plan sponsor acts as a fiduciary when it exercises discretionary authority over the management of a plan or its assets or the administration of the plan. But when a plan sponsor makes business decisions regarding a plan, such as whether to create, fund or terminate a plan, it acts as a settlor, not a fiduciary. 

 

As a settlor, the plan sponsor may pursue the best interests of the company and its shareholders and is not subject to ERISA’s fiduciary duties. As a fiduciary, the sponsor’s overriding concern must be the best interests of the plan participants. Since ERISA does not impose breach of fiduciary duty liability on a plan sponsor acting as a settlor, it may be asked: why do these differing “hats” matter? Because a plan sponsor can—in rare cases—be liable under ERISA for non-fiduciary acts. For example, settlor acts like amending an ERISA plan may violate ERISA’s “anti-cutback” or anti-discrimination rules.

 

The IBM Decision: Fiduciary Liability Coverage for Liability as a Fiduciary

IBM was sued in a class action alleging age discrimination under ERISA in connection with amendments to IBM’s pension plan—a settlor function. IBM settled the litigation and then sought coverage from its fiduciary liability insurance carriers for the settlement. IBM’s first excess insurer, Federal Insurance Company, filed a lawsuit seeking a declaratory judgment that the settlement was not covered because the class action did not allege that IBM acted in a fiduciary capacity. The Federal policy afforded specified coverage in connection with a “Wrongful Act,” defined, in relevant part, as “any breach of the responsibilities, obligations or duties by an Insured which are imposed upon a fiduciary of a Benefit Program by [ERISA].” Because the class action undisputedly did not concern conduct by IBM in its fiduciary capacity under ERISA, Federal maintained that the class action did not involve a “Wrongful Act.” The Court of Appeals of New York agreed, finding that “[a] straightforward reading of . . . the ‘Wrongful Act‘ definition is that it covers violations of ERISA by an insured acting in its capacity as an ERISA fiduciary.”[2] Since “IBM was not acting as an ERISA fiduciary in taking the actions that gave rise to the allegations” in the class action, but instead was acting as a plan settlor, the New York high court held that there was no coverage for the settlement.[3]

 

Reactions to IBM: Separating Fact from Fiction

Despite its clear and straightforward holding, the IBM decision has generated unwarranted criticism from commentators, insurance carriers and insurance buyers:

 

The settlor capacity issue addressed by the IBM court is brand new, and now companies are suddenly left uninsured for something that always was covered.

 

The IBM decision does not create a so-called coverage gap. It recognizes the fundamental purpose of fiduciary liability insurance – to protect fiduciaries from liability for breaches of fiduciary duty under ERISA. Other courts uniformly have agreed that settlor liabilities are not covered by fiduciary liability insurance policies, and IBM cited no cases to the contrary. In fact, as the IBM court noted, IBM’s argument that the policy covered any violation of ERISA whether or not it implicated IBM’s fiduciary capacity, was “strained and implausible” and would expand fiduciary liability coverage to “almost every lawsuit imaginable” against a company that happened also to be an ERISA plan sponsor.[4] 

 

Claims often involve a settlor act where no breach of fiduciary duty is pled, and most fiduciary policies pick up such an exposure. 

 

ERISA plaintiffs can, in rare cases, sue a plan sponsor solely for acts in its settlor capacity. Typically, though, ERISA litigation concerns the plan sponsor’s acts as both a settlor and a fiduciary: for example, the sponsor’s amendment of a plan (a settlor function) and its disclosures about the amendment (a fiduciary function). Such a “mixed action” would trigger – at least – defense costs coverage. And under the policies at issue in IBM, such a mixed action likely would have been covered subject to other common coverage defenses. Virtually none of the fiduciary liability policies on the market would cover the rare case clearly involving only settlor allegations, because it would not allege a Wrongful Act necessary to trigger coverage. 

 

The primary carrier settled the claim with IBM and paid its entire policy limit toward defense costs and the settlement whereas the excess carrier took a different position and sued the insured.

 

In fact, the primary carrier did not acknowledge coverage for the underlying action or pay the full limits of the primary policy. Rather, the primary carrier advanced IBM’s defense costs subject to a reservation of rights and at all times disputed the availability of indemnity coverage. The primary carrier ultimately settled its coverage dispute with IBM in exchange for a payment that left over 30% of its policy limits untouched. 

 

The Landscape of Fiduciary Liability Insurance: Changing for the Better?

Even before the IBM decision, the fiduciary liability insurance marketplace has been moving toward providing limited coverage for settlor functions – limited to defense costs only or to particular types of settlor conduct. Whether such expansions of coverage will be beneficial for insurance buyers and viable in the long term for the carriers remains to be seen. It is not self-evident that such expansions will really benefit individual fiduciaries, whom the insurance was principally intended to protect. 

 

Costly investigations or litigation focused on settlor issues may drain or completely exhaust the insurance limits available to protect individual fiduciaries from personal liability. Limits adequacy therefore should be a paramount consideration for the insurance buyer in reviewing these newer policy forms. In addition, the settlor coverage afforded under these newer forms may frequently provide very little additional protection. First, claims involving purely settlor issues are rare and, as noted above, mixed cases likely would be covered already. Second, the additional coverage likely extends only to defense costs because the damages recoverable in pure settlor cases are likely to be benefits that would have been due but for the assertedly improper conduct. Such damages would be excluded from coverage by the policy’s “benefits due” exclusion or carved out from the definition of covered Loss. Thus, while insurance buyers often presume “the more coverage the better,” buyers should closely review these newer forms and consider the practical effects of the so-called extensions of coverage and the primary purpose of obtaining fiduciary liability insurance in the first place when selecting the appropriate coverage.

 

About the Authors

Kimberly M. Melvin is a partner in the Insurance Practice at Wiley Rein LLP in Washington, DC. She represents insurers in connection with coverage issues, including liability policies issued to directors and officers, financial institutions, mutual funds, investment advisors, Real Estate Investment Trusts (REITs), rating agencies, insurance companies, insurance brokers and lawyers. Ms. Melvin can be reached at 2.719.7403 or kmelvin@wileyrein.com.

 

John E. Howell is an associate in the Insurance Practice at Wiley Rein. He represents insurers in connection with coverage issues arising under directors and officers, financial institution, lawyers and other professional liability coverages. Mr. Howell can be reached at 202.719.7047 or jhowell@wileyrein.com.

* * *

[1] Hunter v. Caliber Sys., Inc., 220 F.3d 702, 718 (6th Cir. 2000) (citations omitted).

[2] Fed. Ins. Co. v. Int’l Business Machines Corp., 965 N.E.2d 934, 937 (N.Y. 2012). 

[3] Id.

[4] Id.

Two more courts have joined the growing line of cases holding that excess insurer’s payment obligations were not triggered where the policyholder funded part of the loss below the excess insurer’s limit.

 

First, on September 12, 2012, New York (New York County) Supreme Court Judge Melvin Schweitzer, applying New York law, ruled in favor of a top level excess insurer where the two underlying excess insurers had paid less then their full policy limits and Forest Laboratories, the policyholder, had funded the gap. A copy of Judge Schweitzer’s opinion can be found here.

 

Second, on September 17, 2012, the Sixth Circuit, applying Ohio law, affirmed the district court’s entry of summary judgment in favor of the excess insurer, holding that the excess insurer’s policy limit had not been triggered when the insured, Goodyear Tire and Rubber Company, had reached a compromise with the primary carrier in which the primary carrier had paid less than its full policy limit. The Sixth Circuit’s opinion can be found here.

 

The Forest Labs Case

Forest Laboratories had a $70 million D&O insurance tower, consisting of a primary $10 million layer and six excess layers of $10 million each. Forest Labs became involved in securities class action litigation, which it ultimately settled for $65 million. Defense and claims expense added several million dollars more of cost. Forest Labs’ primary insurer and the first three excess carriers paid their full policy limits. However the fourth and fifth level excess insurers reached compromises with the policyholder in which each paid only a part of its limit and Forest Labs “filled in the gaps.” Forest Labs then sought payment from the top level excess insurer.

 

The top level excess insurer contended that because of Forest Labs’ compromise with the underlying excess insurers, the payment obligations under its excess policy had not been triggered. In making this argument, the top level excess insurer relied on language in its policy specifying that it is obligated to pay only when the underlying coverage has been exhausted “solely as a result of actual payment of a Covered Claim pursuant to the terms conditions of the underlying insurance.” The top level excess insurer also sought to rely on exhaustion trigger language in one of the underlying excess policies, which the top level excess insurer argued was incorporated by reference into its excess policy.

 

Forest Labs relied on the venerable Second Circuit decision in Zeig v. Massachusetts Bonding & Insurance Company, arguing that the top level excess insurer’s policy language was ambiguous and therefore should not be interpreted to preclude coverage. In response to Forest Labs’ reliance on Zeig, the top level excess insurer relied on the growing list of cases in which  courts had found that excess insurer’s payment obligations had not been triggered where, like here, the policyholder had funded part of the underlying loss amounts out of pocket. Among other cases, the top level excess insurer relied on the Comerica case (about which refer here), the Qualcomm case (refer here), the Bally Total Fitness Case (here), and the J.P.Morgan case (refer here).

 

Judge Schweitzer said, referring to the many cases on which the top level insurer sought to rely, that “these examples,” along with the more specific trigger language in the underlying excess policies, “evince a clarity unfortunately missing from the [top level excess insurer’] policy language.” He added, however, that this “does not render [the top level excess insurer’s] policy ambiguous, as in Zeig.”

 

Citing the top level excess insurer’s policy language providing that its payment obligations are triggered only when the underlying insurance is exhausted “solely as a result of actual payment of a Covered Claim pursuant to the terms and conditions of the Underlying Insurance,” which Judge Schweitzer found is “not ambiguous,” Judge Schweitzer concluded that the top level excess insurer was obligated to pay “only after the insurance has been paid under the provisions of the underlying policies … which provisions necessarily include their term limits.” Thus, Judge Schweitzer added, the top level excess insurer “pays only after the underlying insurers pay up to their policy limits.”

 

Judge Schweitzer commented that while the top level excess insurer “certainly could have done a better job of drafting its policy, and has many examples of better language to refer to [sic] accomplish that, the language it chose still protects [the top level excess insurer] in the situation, as here where the underlying insurers never paid their full policy amounts, due to settlements with plaintiff.”

 

The Goodyear Case

In 2003, Goodyear, following a restatement of its previously released financial statements, became involved in securities class action litigation and related SEC investigation. The lawsuits ultimately were dismissed and the SEC terminated its investigation. Goodyear incurred about $30 million in legal and accounting costs in connection with these matters.

 

Goodyear carried $25 million in D&O insurance, consisting of a primary layer of $15 million and an excess layer of $10 million. The insurers disputed coverage for Goodyear’s $30 million in expenses, particularly the costs associated with the SEC investigation. Goodyear ultimately reached a compromise with the primary carrier, in which the primary carrier paid only $10 million of its $15 million limit. The excess carrier then contended that its payment obligations had not been triggered, relying on the language in its excess policy providing that “Coverage hereunder shall attach only after [the Underlying Insurer] shall have paid in legal currency the full amount of the [Underlying limit].”

 

The dispute over the excess insurer’s payment obligation ultimately wound up in litigation. The district court entered summary judgment in the excess insurer’s favor.

 

On September 17, 2012, in an opinion applying Ohio law and written by Judge Raymond Kethledge for a three-judge panel of the Sixth Circuit, affirmed the district court’s summary judgment grant. The Sixth Circuit’s opinion opens by observing that the parties’ dispute represents the “latest in a series of recent cases in which one corporation asks us to disregard the plain terms of an insurance agreement with another corporation.” (The Sixth Circuit opinion does not identify the other cases in the recent series to which it was referring.) The appellate court said that relevant provision in the excess carrier’s policy is “undisputedly clear and unambiguous.”

 

Goodyear had argued that, notwithstanding the provision, that the Court should enforce the excess insurer’s payment obligation, because of public policy favoring settlements and because the excess insurer had not been prejudiced by Goodyear’s compromise with the underlying insurer. The Sixth Circuit rejected both of these arguments.

 

In rejecting the public policy argument, the Sixth Circuit said that, by contrast to the uninsured motorist cases on which Goodyear relied, “what we have here, instead, is an insurance agreement into which sophisticated parties have freely entered,” adding that the Court “will enforce the agreement according to its terms.” 

 

In rejecting Goodyear’s argument that the excess insurer’s payment obligations should be enforced because Goodyear’s deal with the primary carrier had not prejudiced the excess carrier, the appellate court said that “this case does not concern a mere notice or cooperation requirement, which perhaps we could waive off without any harm to the insurer.” Rather, the court said, adding a note of supposed humor that I am sure Goodyear did not appreciate, “the provision at issue here is where the rubber hits the road,” adding that “the agreement’s Insuring Clause, under whose terms [the excess carrier] undisputedly did not agree to provide coverage that Goodyear now seeks.” Goodyear’s arguments, the Court concluded, are “meritless.”

 

Discussion

As I noted at the outset, and as the citations on which Forest Labs’ top level excess insurer relied demonstrate, there is a growing list of cases reaching the same conclusion that an excess D&O insurers payment obligations are not triggered where as here the underlying insurers paid less than their full policy limits and the policyholder funded the gap. The latest case in this line of cases can be found here.

 

There is a troubling aspect of this growing line of cases. If you take this line of cases as a whole, what you have are an awful lot of excess insurers walking away from their payment obligations. They agreed to take on the risk and they collected their premiums and in a disputed claims situation where losses clearly pierced their layer, they are successfully fighting off their payment obligations. This effort now apparently includes the possibility that an excess insurer can bootstrap the trigger language from an underlying insurance policy to avert its payment obligation.

 

To be sure, now that this growing line of cases has highlighted the issue, many insurance buyers are seeking, and many excess insurers are now granting, excess coverage trigger language that allows the amounts below the excess insurer’s attachment point to be funded by payment either by the underlying insurers or by the policyholder. With this type of alternative payment trigger language in place, excess insurers are much less likely to be able to avoid payment. However, the Forest Labs case underscores the fact that the language needs to be cleaned up all the way up the tower, to guard against the possibility that an upper level excess insurer might, like the top level excess insurer here, try to bootstrap trigger language from an underlying policy in order to try to avoid its payment obligation.

 

Nate Raymond has a good article on the On the Case blog, here, discussing the two decisions. Special thanks to a loyal reader for providing me with a copy of the Sizth Circuit opinion.