I inhabit a world in which hotels loom unfortunately large. During many work weeks, I spend more nights in hotels than at home. Many of these hotel nights involve nondescript rooms in cookie-cutter chain hotels. These chain hotels are neither good nor bad, merely boring. They are so lacking in distinctiveness that often I am unable even to remember where I am when I first wake.

 

Fortunately for me, there are hotels I enjoy and that I even look forward to visiting. The purpose of this post is to share my list of favorite hotels, ranked according to my own admittedly quirky criteria. My hope is that readers will respond and offer their own favorite hotels, as a way to share information with others and perhaps enrich each others’ travel experiences.

 

Let my begin by relating an experience that sums up what I dislike about so many hotels, while at the same time identifying my hotel ranking criteria. Due to a weather-related flight cancellation, I recently spent an unplanned night in Philadelphia. Many other travelers were in the same fix, and so hotel rooms were scarce. Just at the point when I began to fear I would spend the night in the airport, I managed to find a room – at the Ritz-Carlton. For those of you who are thinking “Sweet!” –let me relate what I experienced.

 

First of all, the hotel stay itself cost over $550. What do you get for $550? You get a cavernous atrium echoing with over-amplified rock music that made it impossible to hear or to be heard. You get a hotel room bathroom with enough marble for the mausoleum of an eastern potentate and his entire entourage. And you get a bed with 13 pillows. I don’t need or even want any of those things.

 

But wait – there’s more.

 

When I tried to check in, I found myself in a line behind six other people also hoping to speak to the beleaguered clerk behind the desk. When I had finally been able to check in, I went to my room and found out that for $550, I earned the privilege of paying another $9.95 for Internet access. I also found that my room lacked a TV remote control. When I called about that, they brought me one, held together by duct tape. And when I went to check out next morning, there was no one at the reception desk.

 

To summarize, the hotel was ridiculously over-priced (particularly given the added Internet charge) and featured a lot of pointless and even worthless “amenities.” The overall effort reflected poor execution.  The experience was a total disappointment.

 

Let me contrast that with my all-time favorite hotel, the Base2Stay Hotel in London (pictured above). This small hotel is clean, quiet and inexpensive. The rooms and common areas are decorated in a simple Scandinavian style, which though perhaps austere to the point of severity, are practical and efficient. The location may not be fashionable, but it is functional – it is located a block from the Earl’s Court tube stop, on the Piccadilly Line (which also serves Heathrow), in an area with pubs, shops and cafes, and on a quiet street full of school kids and Moms pushing prams. The people who work at the hotel are friendly and helpful.

 

To be sure, many Americans would find the rooms small, perhaps too small. Personally, I find them a wonder of efficiency, the hotel room equivalent of a Swiss Army knife. They manage to include a small kitchenette (with refrigerator), an ultramodern bathroom with all sorts of nifty plumbing fixtures, and a satellite cable connection with a global TV channel selection and music. Oh, and by the way, a single occupancy room runs around £105 a night – including Internet access at no additional charge.

 

This hotel hits all of my important criteria. It is clean, quiet and inexpensive. It is in a convenient location. It includes everything that is indispensable but avoids pointless amenities that add only to the cost but not to the overall experience. And it has its own distinct charm and character.

 

Many of the hotels on my list of favorites and that meet these criteria are in Europe. This preference isn’t the product of some snooty Europhilic distemper. Rather, it is due to the fact that when I travel to Europe I am unwilling to pay a premium to stay at a hotel that lacks charm, character and distinctiveness. Both to keep costs down and to improve my travel experience, I am willing to go further afield. With TripAdvisor.com as my guide, I have had some terrific experiences.

 

My most recent discovery was the hotel in which I stayed in Amsterdam. (More about my Amsterdam travels here.) I was fortunate enough to stay in the Citizen M Hotel, a “concept hotel” located on Beethovenstraat in a quiet, leafy residential area on one of the main tram lines. The hotel is a way station for a surprisingly cosmopolitan clientele. The hotel is ultra modern, with simple décor, complicated lighting fixtures and a lobby full of flat screen TVs. All of the rooms and common areas are WiFi enabled (at no additional charge). The ground floor is built around a bar/lounge where people actually do congregate and converse for breakfast in the morning and for cocktails in the afternoon. The rooms themselves are small but efficient, with very space age-y plumbing fixtures. The beds are enormous. And the wall phone was Skype enabled. I made a bunch of International phone calls and the charges didn’t even amount to a euro. And the best part of all is that a single occupancy room costs around €95 a night.

 

Another favorite European hotel is the small hotel in which I stay while in Cologne, the Domstern. The hotel is just a few blocks from the central train station, but it is on the opposite side of the station from the Cathedral and the main tourist areas, so it is quiet. The rooms and the common areas are decorated in basic Ikea. The hotel is quiet and clean. The rooms have a pan-European cable connection and the fastest Internet connection I have ever had in any hotel anywhere. But the thing that sets this hotel apart is the breakfast service, which is included in the cost of the room. The menu includes fresh breads and pastries; homemade jams, jellies and honey; meats, sausages and cheeses; fresh fruit and various kinds of yogurt; and excellent coffee. I would travel hours to stay in this hotel just for the breakfast. And the best part of all is that a single room runs only about €60 a night.

 

My favorite hotel in Paris is the Hotel de Fleurie, which is located in the Sixth Arrondissement, just a block off of the Boulevard St. Germain des Pres. Even though it is in a very lively area, the hotel itself is quiet, because it is on a one-block long one-way street that doesn’t really go anywhere. The hotel is located in a restored 18th century building and the rooms are charming and comfortably decorated. The location is about perfect – it is just a block from the Odeon metro stop and a short walk from the Jardin de Luxembourg. The Seine River, Notre Dame Cathedral and the Louvre are all within walking distance. Breakfast is included in the room charge, and features freshly baked breads and excellent coffee. The rooms and common areas have ultrazippy WiFi service (at no additional charge). This hotel is more upscale than the others, but a single room runs only about €120 a night.

 

I have other European hotels I particularly like, but the others are sufficiently quirky that I hesitate to go too far overboard about them here.

 

Because of the predominance in the U.S. of the chain hotels, it is a challenge trying to find hotels that are both inexpensive and charming. There are of course innumerable bed and breakfasts, many of which are quite wonderful. The best ones tend to be out in the country or in locations that are not always well suited to my business purposes and requirements. They also tend to be too frou-frou and Laura Ashley-ish for my tastes. There are a few bed and breakfasts that I have been able to enjoy on business travel, including the White Swan Inn in San Francisco. Readers’ suggestions in this category are welcome, particularly for inns that provide the indispensable combination of lower cost, charming environment, and functional location.

 

One U.S. chain that I am happy to patronize is Club Quarters. I have stayed in Club Quarters hotels in New York, Philadelphia, Chicago and San Francisco. The rooms in these hotels are small and ascetic. (The first time I stayed in one, I was sure the room had been designed by an architect whose prior assignment had been designing airplane lavatories.) But the hotels are clean and quiet and they tend to be in very useful locations – for example, the Chicago hotel is in the Loop near Wacker Drive, the Philadelphia Hotel is on Chestnut, the New York hotel is mid-town, and the San Francisco hotel is in the financial district adjacent to the Embarcadero. The room charge includes Internet access, and most of the hotels have exercise facilities. These hotels are functional, not charming. But the room charges run significantly less than other business hotels located nearby.

 

Not all of my favorite U.S. hotels are austere. For example, my favorite hotel in Denver is the Oxford Hotel, which is a beautifully restored 19th century hotel located in the renovated Lower Downtown area. The rooms in the hotel have fine period-piece furniture. Hotel guests have access to a great nearby health club, and the area around the hotel, which is just blocks from Coors Field, is full of bars, book shops, cafes and restaurants.

 

In Washington, my favorite hotel is the Georgetown Inn. It is on Wisconsin Avenue, just a few blocks north of M Street, in Georgetown. When I visit Washington, I try to set up my meetings in the hotel restaurant, The Daily Grill, or at my favorite bar in DC, Martin’s Tavern, which is just a block away. The rooms in this hotel have a comfortable, old-fashioned feel. The best part is the access the hotel affords to the residential area of Georgetown.

 

One of my favorite hotels to visit is the Claremont Hotel, located in the hills of Berkeley, California. Admittedly, this hotel is by no means a bargain hotel. It is more of a resort destination, with one of the best health clubs and fitness centers of any hotel I have every stayed in. The décor is early 20th century country club. (Indeed, the look and feel is very similar to the clubhouse of my home golf course.) On a clear day, the views of the bay and of San Francisco are fantastic.

 

I could go on and on (perhaps unfortunately so, as it bespeaks my itinerant lifestyle), but for purposes of this post and for today, that is my list of hotels. I don’t feel nearly as passionate about my U.S. recommendations as I do about my European ones, in part because I have had far less success in the U.S. finding inexpensive, charming hotels in useful locations. I hope readers will respond with their favorite hotels, particularly if you have suggestions of great, inexpensive places to stay in the U.S.

 

I will freely admit that a big factor in many of my assessments may have been random good or bad experiences. For example, I am sure I just caught the Ritz-Carlton in Philadelphia on a bad night. I may have had an unusually fortunate experience at some of the hotels I have recommended. I certainly can’t ensure that others visiting those hotels will enjoy them as much as I did. But on the other hand, I find the hotel reviews on TripAdvisor.com remarkably accurate, which sugests that random hotel experiences often are representative.

 

I hope many readers will use the Comment feature of this blog to share with other readers their favorite hotels – or for that matter, their worst hotels, that is useful information too.

 

Securities class action lawsuit filings continued to accumulate during the third quarter of 2011, and the filing levels remain on pace for an above average year of securities class action litigation. As was the case in earlier quarters this year, the third quarter filing level was significantly buoyed by merger-related litigation and by lawsuits involving U.S.-listed Chinese companies, although to a lesser extent than prior quarters. There are some other interesting trends emerging as well.

 

By my count, there were 49 new securities class action lawsuits filed in the third quarter of 2011, bringing the year to date total through September 30 to 154. (Please see below for some note about “counting “and the reasons my count may differ from other published tallies.) The third quarter filing levels held steady with the number in the second quarter of 2011, when 49 lawsuits were also filed. The 154 filings year to date implies an annual filing total of about 205, which would be above the 1997-2009 average of 195.

 

The two most significant factors in the securities lawsuit filings during the first nine months of the year are merger-related lawsuits and lawsuits involving U.S.-listed Chinese companies. Of the 154 federal securities lawsuits filed through September 30, 47 (30.51%) were merger-related. Non-U.S. companies were named as defendants in 43 of the securities lawsuits (27.9%) filed during the first three quarters, of which 32 involved U.S. listed Chinese companies (20.79%).

 

Though the merger-related filings and lawsuits against U.S.-listed Chinese companies both continued to accumulate in the third quarter, both trends were diminished in the third quarter compared to the year’s first half. During the third quarter, 11 of the 49 lawsuit filings (22.54%) were merger-related, and 6 of the 49 filings (12.24%) involved U.S.-listed Chinese companies, both figures down compared to the year to date as a whole.  

 

The 154 YTD lawsuit filings involve a surprising diversity of companies. The companies named as defendants in the securities lawsuit filings during the year’s first nine months represented 91 different Standard Industrial Classification codes (SIC). Unlike recent years, in which filings against financially-related companies predominated, the SIC code categories with the largest number of filings during the first three quarters of 2011 reflect industries that historically have been the focus of securities litigation.

 

Thus, the SIC code categories with the largest number of securities lawsuit filings so far this year are SIC code categoies 3674 (Semiconductor and Related Devices) and 7372 (Prepackaged Software). The next largest SIC code category includes one industrial group that has also been a frequent target in the past, SIC Code category 2834 (Pharmaceutical Preparations), in which six companies have been sued year to date. Another category that has also had six new filings so far this year is a group that in the past has not seen the same level of litigation activity, SIC Code category 1311 (Crude Petroleum and Natural Gas).

 

The federal securities class action lawsuits during 2011’s first nine months have been filed in 45 different federal district courts, but just two courts have accounted for more than half of the filings. During the first three quarters of the year, there were 33 new securities class action lawsuit filing in the Southern District of New York, and 29 in the Central District of California. Both of these figures were significantly increased by filings involving U.S.-listed Chinese companies. In the Southern District of New York, 21 of the 33 filings through September 30 involved non-U.S. companies, of which 13 were U.S.-listed Chinese companies. In the Central District of California, 13 of the 29 lawsuits filed during the first nine months of the year involved U.S.-listed Chinese companies.

 

In the overall category of corporate and securities litigation, including litigation filed in state courts, the merger-related litigation has been and remains the predominant story. By my count, during the first three quarters, there was merger objection litigation filed involving at least 129 transactions, and accounting for at least 185 different lawsuits (counting lawsuits filed in both federal and state court). These figures only take account of the lawsuits of which I am aware and are almost certainly understated. In other words, if you are attempting to track corporate and securities litigation and you are only monitoring federal securities class action litigation, you are missing a great deal of the action. In fact, you could be missing the majority of the action.

 

As I noted at the outset, my lawsuit count may differ from other published accounts for a number of reasons. First, I include in my count class action lawsuits asserting violation of the federal securities laws but that are filed in state court. There were at least two of these during the third quarter of 2011. In addition, I may not always decide to include the same merger-objection lawsuits in my tally as do other sources that track securities lawsuit filings. I include the merger-related lawsuit if it is in federal court and if it alleges a violation of the federal securities laws.

 

The decision to include the above described categories of cases and other factors will likely cause my count to be slightly higher than other published tallies. I think the tallies will remain directionally consistent but the differences might be enough to lead to differences of opinion about, for example, whether or not the number of annual filings is increasing or declining, or how the annual filing levels compare with annual averages.

 

The Towers Watson 2011 D&O Insurance Survey Form Released: Towers Watson has released the 2011 survey form for its annual survey of D&O insurance buying patterns. Everyone in the industry benefits from Towers Watson’s annual survey, the summary report for which Tower Watson makes freely available. Because everyone benefits from it, we all have a stake in making sure that there are sufficient responses to ensure that the survey results are meaningful. I hope everyone will take the time to ensure that as many D&O insurance buyers as possible will complete the survey. The survey can be found here.

 

In an interesting October 14, 2011 post-trial opinion, Delaware Chancellor Leo Strine entered a $1.263 billion award in the Southern Peru Copper Corporation Shareholder Derivative Litigation. The lawsuit relates to Southern Peru’s April 2005 acquisition of Minerva México, a Mexican mining company, from Groupo México, Southern Peru’s controlling shareholder. Chancellor Strine concluded that as a result of a “manifestly unfair transaction,” Southern Peru overpaid for Minerva Mexico. A copy of Chancellor Strine’s 106-page opinion can be found here.

 

Background

Southern Peru is a NYSE company. (After the events involved in this lawsuit, Southern Peru changed its name to Southern Copper Corporation. Its shares trade on the NYSE under the symbol “SCCO.”) Groupo México is the controlling shareholder of Southern Peru. In 2004, Groupo México owned 54.17% of Southern Peru’s outstanding stock and 63% of the voting power. In February 2004, Groupo México proposed that Southern Peru buy its 99.15% share stake in Minerva in exchange for 72.3 shares of newly-issued Southern Peru stock. At market price of Southern Peru’s stock then, the proposed deal had an “indicative” value of $3.05 billion.

 

The Southern Peru board appointed a special committee to assess the proposed transaction. The special committee in turn hired numerous outside experts, including Goldman Sachs, to assist the committee in assessing the transaction. As Chancellor Strine later concluded, when it became clear that Minerva’s value was substantially less than the value of proposed amount of Southern Peru stock, “the special committee and its financial advisor instead took strenuous efforts to justify a transaction at the level originally demanded by the controller.”

 

As a result, “the controller got what it originally demanded: $3.1 billion in real value in exchange for something worth much, much less — hundreds of millions of millions of dollars less.” Even worse, the special committee agreed to a fixed exchange ratio. Because Southern Peru’s stock price rose between the date the parties entered the deal and the date the deal closed, the actual value of the transaction was $3.75 billion. Even though the special committee had the ability to rescind the deal, the special committee did not seek to update the fairness opinion or otherwise alter the transaction. The upshot was that “a focused, aggressive controller extracted a deal that was far better than market, and got real, market-tested value of over $3 billion for something no member of the special committee, none of its advisors, and no trial expert was willing to say was worth that amount of actual cash.”

 

Shareholders then filed a derivative lawsuit alleging that the transaction was unfair to Southern Peru and its minority shareholders. By the time of trial, the defendants remaining in the case were Group México and its eight affiliate directors who were on the Southern Peru board at the time of the transaction. The plaintiffs argued that the 67.2 million shares of Southern Peru stock that Groupo México received in the transaction were worth substantially more that the 99.15% interest in Minerva that Southern Peru received. 

 

The October 14 Opinion

Following trial, Chancellor Strine concluded that “the process by which the Merger was negotiated and approved was not fair and did not result in the payment of a fair price.” He found that “from inception, the Special Committee fell victim to a controlled mindset and allowed Groupo México to dictate its terms and structure of the Merger.”

 

Strine also concluded that the committee was “not ideally served by its financial advisors,” Goldman Sachs, which having concluded that the value of what Southern Peru would receive in the transaction was substantially less than the value of stock Groupo México was to receive, “helped its client rationalize the one strategic option available within the controlled mindset that pervaded the Special Committee’s process.” But, as Strine found, “Goldman and the Special Committee could not generate any responsible estimate of the value of Minerva that approached the value of what Southern Peru was asked to hand over.”

 

Strine found that as a result, the transaction was “unfair” to Southern Peru, because the special committee’s “cramped perspective” resulted in a “strange deal dynamic,” in which “a majority shareholder kept its eye on the ball – actual value benchmarked to cash – and a Special Committee lost sight of market reality in an attempt to rationalize doing a deal of the kind the majority stockholder proposed.” As a result of this “game of controlled mindset twister,” the committee “agreed to give away over $3 billion worth of actual cash value in exchange for something worth demonstrably less, and to do so on terms that by consummation made the value gap even worse, without using any of its contractual leverage to stop the deal or renegotiate its terms.” Because the deal was “unfair,” Strine concluded that “the defendants breached their fiduciary duty of loyalty.”

 

Since the time of the merger, Southern Peru’s share price has continued to climb. For that reason, and because of “the plaintiff’s delay in litigating the case,” Strine concluded that a rescission-based approach would be “inequitable.” Instead, Strine, utilizing a “panoply of equitable remedies,” crafted “a damage award that approximates the differences between the price that the Special Committee would have approved had the Merger been entirely fair (i.e., absent a breach of fiduciary duties) and the price that the Special Committee actually agreed to pay.” Strine noted that given the differences in values involved, the record arguably could support a damages award of $2 billion or more.”

 

However, taking into account the “imponderables” involved in many of the valuations, Strine took an approach he characterized as “more conservative.” His approach basically consisted of coming up with a value for Minerva based on an average of three possible valuation methodologies. This method came up with a valuation for Minerva of $2.409 billion. The 67.2 million shares Groupo México received were worth $3.672 billion.

 

Based on the difference between these two figures, Strine entered an award of $1.263 billion. Strine also awarded interest, without compounding, at the statutory rate from the merger date, and also from the date of judgment until payment. He also awarded plaintiffs’ attorneys’ fees, to come out of the award, in an amount he directed the parties to agree upon. Strine added that Groupo México could satisfy the judgment by agreeing to return to Southern Peru the number of shares necessary to satisfy the award.

 

Discussion

The addition of pre- and post-judgment interest could as much as another $100 million to the value of this award, meaning that the total value of this award is arguably as much as $1.36 billion (and counting). But as massive as this amount is, it does not represent the largest amount awarded in a shareholder derivative suit. As far as I am aware, that distinction belongs to the $2.876 billion awarded in the shareholder derivative lawsuit filed against former HealthSouth CEO Richard Scrushy, about which refer here. (Actually, the total amount of the damages in Scrushy case was $3.115 billion. It was only the application of $239 million credit for judgments entered against other defendants that brought the number down to the $2.876 billion.) The Southern Peru award does likely represent the largest award in a derivative suit in Delaware Chancery Court.

 

In light of the dollars involved, Groupo México has a strong incentive to appeal, although the accumulation of post-judgment interest could provide a reason to carefully assess the likelihood of success on appeal.

 

If it comes down to payment of the award, it looks to me like Groupo México’s best option would be to return the number of Southern Peru shares required to satisfy the award. The shares have dramatically escalated since the transaction closed (at current market valuations, and allowing for stock splits, the shares appear to be worth more then ten times what they were in April 2005). Paying the award with an inflated currency would appear to allow Groupo México to retain substantial benefits of this transaction.

 

There are at least a couple of important things to be drawn from the outcome of this case. First, this case represents a very substantial refutation to the many commentators who regularly complain that derivative litigation in Delaware courts provide shareholders’ with a toothless remedy. This case shows that the Delaware derivative litigation definitely can have bite.

 

Second, this case has some very important implications for board’s duties when considering a transaction proposed by a controlling shareholder. In particular, Chancellor Strine seemed particularly concerned that the special committee considered only the deal that the controlling shareholder proposed, suggesting that in these circumstances, boards and the committees must consider all alternatives and not just the one proposed by the controlling shareholder. More broadly, the board and its committee have a duty to consider more than just trying to figure out a way to complete the transaction that the controlling shareholder has proposed.

 

In view of the massive size of the award, the presence or absence of D&O insurance to pay part of the cost of this award is unlikely to be a material consideration. Were Groupo México to try to get its D&O insurer to pay a part of this award, it would face at lest a couple of likely objections from its carrier(s). First the carrier would contend that its policy provides coverage if at all for Groupo México itself only for “securities claims,” a term that is usually defined with reference to the insured company’s own securities. Since this transaction involved Southern Peru’s securities not Groupo México’s, the carrier would contend that there is no coverage for the award against Groupo México, because the award did not arise out a securities claim.

 

The carrier would likely also contend that in any event, because of the rescissionary nature of the award, there is no coverage under the policy, nor is there coverage under the policy for the return of amount for which the insured is not legally entitled.

 

This latter argument would likely also take care of any contentions by the individual defendants that they are entitled to coverage. An interesting issue though is the question of which company’s policy is the relevant policy. Though the individual defendants were affiliated with Groupo México, they were sued in their capacities as directors of Southern Peru. Accordingly, it would look as though the relevant policy for them to seek to access would be Southern Peru’s (although they might have also potentially have outside directorship liability coverage under Groupo México’s policy on an excess basis, a likelihood that is probably remote because that coverage is usually restricted to service on nonprofit boards).

 

The individuals’ prospects for obtaining coverage for the award under the Southern Peru policy would depend as an initial matter on their ability to overcome the carrier’s likely objections that there is no coverage under its policy for rescissionary damages. Those objections may well be insurmountable, but assuming for the sake of argument that that obstacle could be circumvented, the question would then be whether the policy’s Side A coverage would kick in, as providing coverage for nonindemifiable loss.

 

Given the size of the award and the hurdles the defendants would have to overcome in order to establish coverage, these insurance questions could all be more theoretical than real.

 

In any event, the eye-popping amount of the award here makes this case a noteworthy, and Chancellor Strine’s analysis makes these circumstances interesting. I suspect this decision will occasion a great deal of discussion, particularly around the duties boards’ face when forced to assess transactions that will benefit a controlling shareholder.

 

Special thanks to a loyal reader for providing me with a copy of this opinion. 

 

Alison Frankel has a very interesting October 17, 2011 commentary on this case on her blog on Thomson Reuters News & Insight (here). Professor Davidoff also has an interesting commentary about the case on the Dealbook blog (here).

 

One of the highest profile D&O insurance coverage decisions last year was the district court’s October 2010 opinion  holding that Office Depot’s D&O insurance policy does not cover defense expenses the company incurred in responding to an informal SEC investigation. The company’s appeal of the district court’s decision has been closely watched. On October 13, 2011, the Eleventh Circuit issued an unpublished per curium opinion affirming the district court, concluding that Office Depot did not have coverage under the language of the policy at issue for the defense expenses incurred in connection with the informal SEC investigation. A copy of the Eleventh Circuit opinion can be found here.

 

Background

In June 2007, Office Depot was the subject of news report suggesting the company had improperly disclosed material information to securities analysts in violation of SEC Regulation FD. In a July 17, 2007 letter, the SEC advised Office Depot it was "conducting an inquiry" to determine whether the securities laws had been violated, and requested certain information from Office Depot "on a voluntary basis." Office Depot provided documents and made its employees and officers available for sworn testimony. On July 31, 2007, the SEC requested that Office Depot preserve the records of numerous employees and offices. Office Depot forwarded the letter to its insurers. Office Depot’s primary insurer accepted the letter as a "Notice of Circumstances" that may give rise to a claim.

 

In addition, in July 2007, before it received the SEC’s informal inquiry, Office Depot received an internal whistleblower letter raising concerns relating to the timing of recognition of Office Depot’s vendor rebate funds. Office Depot self-reported the whistleblower allegations to the SEC, which expanded its inquiry to include the whistleblower allegations. The company’s audit committee conducted its own investigation of the allegations, retaining lawyers, accountants and consultants for those purposes. The internal investigation resulted in Office Depot’s restatement of its 2006 financial statements.

 

In November 2007, two shareholder derivative lawsuits and two securities class action lawsuits were filed against the company. The shareholder suits alleged misrepresentations in connection with the company’s financial reporting of vendor rebates. In January 2010, the defendants’ motions to dismiss the securities class action lawsuit were granted.The plaintiffs in the derivative lawsuits voluntarily dismissed those cases.

 

In January 2008, the SEC issued a formal "order directing private investigation" and during the course of 2008 subpoened the company and at least eight current and former Office Depot officers and directors, including several who previously voluntarily testified. The notice did not name any individuals as wrongdoers. In November and December 2009, the SEC issued Wells notices to three Office Depot officers. In December 2009, the company reached an undisclosed settlement with the SEC staff.

 

Office Depot requested reimbursement from its D&O insurers of the over $23 million the company had incurred in responding to the SEC, indemnifying individuals against defense expenses, and conducting an internal investigation of the whistleblower allegations.

 

The primary carrier acknowledged its obligation to reimburse Office Depot for defense costs incurred by officers and directors after having been served with SEC subpoenas and Wells notices, and for the costs incurred in the various securities lawsuits. However, the approximately $1.1 million of acknowledged expenses did not exceed the policy’s $2.5 million retention. The primary insurer denied coverage for the other expenses, and Office Depot filed an action alleging breach of contract and seeking a judicial declaration of coverage. Office Depot’s excess D&O insurer intervened in the action.

 

The parties filed cross motions for summary judgment. As discussed here, on October 15, 2011, Southern District of Florida Judge Kenneth Marra granted the insurers’ motions for summary judgment and denied Office Depot’s motion. Office Depot filed an appeal.

 

The Eleventh Circuit’s Opinion

In an October 13, 2011 unpublished per curiam, a three judge panel of the Eleventh Circuit affirmed the district court’s decision. Office Depot had sought to have the district court’s decision overturned on four separate grounds. The Eleventh Circuit rejected each of Office Depot’s four arguments.

 

First, Office Depot had argued that the insurers’ policies did not expressly exclude coverage for costs associated with SEC investigations, and that the “carve back” language in the definition of “Securities Claim” provided coverage for the costs. The “carve back” argument refers to language in the policy definition that, on the one hand said that a “Securities Claim” is a claim “other than an administrative or regulatory proceeding against, or investigation of an Organization,” but on the other hand also provided that the term “Securities Claim” shall “include an administrative or regulatory proceeding against an Organization, but only if and only during the time such proceeding is also commenced and continuously maintained against an Insured Person.”

 

The Eleventh Circuit noted that the first of these two definitional clauses eliminates coverage for two types of potential Securities Claims – that is, claims in the form of administrative or regulatory proceedings, and claims in the form of an administrative or regulatory investigation. The Court said that “the carve-back provision restores coverage for the former under certain circumstances. But it does not restore for the latter.” Accordingly, and “because the SEC’s requests for voluntary cooperation in furtherance of its pre-suit discovery constituted an ‘investigation’ rather than an ‘administrative or regulatory proceeding,’ Office’s Depot’s expenses incurred after the receipt of the SEC’s letters are excluded from coverage.”

 

Second, Office Depot argued that the SEC’s letters were sufficient to trigger a Claim under the policy because they were sufficient to constitute notice that insured persons could have proceedings commenced against them. In rejecting this argument, the Eleventh Circuit said that the SEC’s letters “do not allege that violations have occurred or identify specific individuals that could be charged in future proceedings,” and therefore do not trigger a “Claim” under the relevant policy definition.

 

Third, Office Depot argued that the district court had erred in concluding that the policy covered only defense expenses incurred after a “Claim” had been made. In essence, the company argued that the policy has no temporal limitation precluding policy coverage for pre-Claim expenses. The Eleventh Circuit concluded that the policies’ “text unambiguously limits Defense Costs to those costs incurred after a Claim has been made.”

 

Finally, Office Depot argued that the “relation back” language in the policy’s notice of circumstances provision provides coverage for costs incurred after it provided notice to the carrier of circumstances that could give rise to a claim and before the Claim actually was made. These notice provisions specify that if the policyholder gives the insurer notice of circumstances that could give rise to a claim, and if a claim subsequently arises, then determination of the date on which the claim was first made will relate back to the date on which notice of circumstance was provided.

 

The Eleventh Circuit rejected Office Depot’s “relation back” argument, finding that the notice of circumstances provision simply “create a notification process” that allows a determination of when claim are “considered made … rather than expand[ing] coverage to the costs incurred before Claim is actually made.”

 

The Eleventh Circuit concluded that “the policy does not cover the Defense Costs associated with the SEC investigation – which did not constitute a Claim against Office Depot until events such as the issuance of subpoenas and Wells Notices occurred.”

 

Discussion

The background circumstances of this coverage dispute dramatically highlight why the questions of coverage of expenses incurred in connection with informal SEC investigations is such a fraught issue. Office Max incurred tens of millions of dollars in defense expenses before the SEC commenced its formal investigative processes. Many other companies confronted with an informal SEC investigation similarly incur substantial costs voluntarily providing information. The sheer magnitude of these expenses ensures that policyholders will continue to try to argue that their D&O insurance covers these types of expenses, even after the Eleventh Circuit’s decision in the Office Depot case.

 

Insurers confronted with these coverage demands undoubtedly will seek to rely on the Eleventh Circuit’s opinion in taking the position that their policies do not cover costs incurred in connection with informal SEC investigations. In addition to arguable limitations arising from the fact that the opinion is designated “not for publication,” the insurers will also have to deal with the fact that the opinion is in many respects simply a reflection of the specific policy language at issue in the Office Depot case. In particular, the opinion rests heavily on the distinction in the relevant policy provisions between “proceedings” and “investigations.” Other policies do not contain these same distinctions or are otherwise worded differently, in reliance upon which other policyholders may attempt to distinguish their situation from the circumstances involved in the Office Depot case.

 

But while there may be grounds on which policyholders may attempt to argue that the Office Depot opinion is not absolutely determinative of questions whether or not there might be coverage under another D&O insurance policy for costs incurred in connection with an informal SEC investigation, the opinion nevertheless provides strong support for insurers taking the position that their policies do not cover these types of expenses.

 

One aspect of the opinion on which insurers are particularly likely to rely is the Eleventh Circuit’s holding that the D&O policy at issue only provides coverage for defense expenses incurred after a claim has been made. Policyholders seeking to establish coverage for costs incurred in connection with an informal investigation often try to argue that the insurer should cover the costs because the policyholder would have incurred all of the same costs after the investigation became formal if it had not voluntarily cooperated. The policyholders’ argument is the coverage for the expenses should not depend on a mere matter of timing and the policyholders should not be penalized for cooperating with the SEC. The insurers doubtlessly will argue that in reliance on the Eleventh Circuit’s opinion that its insurance obligations do not extend to pre-claim expenses.

 

There is the potentially troublesome issue of the fact that the Eleventh Circuit’s opinion is designated “Do Not Publish.” In the current era of Internet communication, this designation seems meaningless. Indeed, the Eleventh Circuit itself posted the opinion on its website. Clearly the opinion has been published despite the designation, even if the opinion will not appear in printed case reporters at some point in the future.

 

But beyond the question of whether or not this “unpublished” opinion in fact has been published, there is the question of whether or not the “Do Not Publish” designation could otherwise preclude carriers from relying on the opinion. While there was a time when attorneys were barred from citing unpublished opinions, revised Federal Rule of Appellate Procedure 32.1(a) specifically provides that a court may not prohibit or restrict citation to unpublished opinions dated after January 1, 2007. So there does not seem to be any problems for insurers attempting to rely on the Eleventh Circuit’s opinion, notwithstanding the fact that it is designated “Not for Publication.”

 

Given that the opinion is freely available on the Court’s website and given the fact that the opinion has every bit as much precedential value as if it were not designated “Do Not Publish,” you do kind of wonder what the point is of using the designation. I worry about what it implies about what the court itself thinks about the opinion. It is almost as if the court is saying “we don’t think enough of this opinion for it to be published,” as if they really didn’t give it enough of their focus to produce a publication worthy opinion.

 

In any event, it is worth noting that since the time that Office Depot purchased the policies at issue in this coverage dispute, the insurance marketplace has evolved. Recently, some carriers have been willing to provide coverage for costs individuals incur in connection with informal SEC investigations. In addition, at least one carrier now offers a separate insurance product that provides coverage for costs that the entity itself incurs in connection with an informal SEC investigation. Although this entity protection for informal SEC investigative costs is subject to a large self-insured retention and to coinsurance, the fact remains that if such a policy had been available to Office Depot and if Office Depot had had such a policy in place, at least a significant part of Office Depot’s costs of responding to the informal SEC investigation might have been covered.

 

The Wiley Rein law firm’s October 14, 2011 summary of the Eleventh Circuit’s opinion can be found here. Special thanks to a loyal reader for providing me with a copy of the Eleventh Circuit’s opinion.

 

SEC  Issues Disclosure Guidance on Cybersecurity: Based on the number of emails I received on the topic, I suspect that by now most readers are aware that on October 13, 2011, the SEC released Cybersecurity Disclosure Guidance, a copy of which can be found here. If you have not yet read the Cybersecurity Guidance, you may want to set aside a few minutes and read the document through. It makes for some very interesting reading.

 

First, the disclosure guidance is not just directed to those companies that have experienced a cyber attack. Rather, the guidance requires reporting companies to consider “on an ongoing basis, the adequacy of their disclosure relating to cybersecurity risks and cyber incidents.” The SEC also proposes that reporting companies include a discussion of these matters in the Management Discussion & Analysis (MD&A) if known incidents or the risk of potential incidents represent a material risk, trend or uncertainty.

 

Second, readers of this blog will find it particularly interesting that among the items the SEC suggests reporting companies include in their “ongoing disclosure” is “a description of relevant insurance coverage.”

 

Third, if a reporting company or any of its subsidiaries are party to material pending legal proceeding involving a cyber incident, the registrant may need to disclose information regarding this proceeding.

 

Fourth, reporting companies are also required to disclose conclusions on the effectiveness of cybersecurity controls and procedures.

 

Although the primary objective of these disclosure guidelines is to try to ensure that investors are better informed on reporting companies’ cyber vulnerabilities, one obvious consequence is cybersecurity matters are about to become a much higher profile item for all reporting companies. In addition, the requirements about disclosures regarding the effectiveness of cybersecurity controls and procedures potentially sets the stage for shareholder claimants to later contend that the companies’ disclosures about its controls and procedures were misleading.

 

Finally, the specific reference in the SEC disclosure guidelines to cybersecurity insurance undoubtedly will lead many companies who may not have purchased this insurance in the past to consider the need for this insurance, if only to allow the company to supplement its cybersecurity disclosures to show that its precautionary measures include the purchase of insurance designed to protect the company from the harm caused by cybersecurity risks.

 

Insurance professionals whose clients include reporting companies will undoubtedly refer to this suggested disclosure item as part of the professionals’ efforts to advise their clients with respect to insurance issues.

 

What to Watch Now in the World of D&O: In the latest issue of InSIghts, I examine the current hot topics in the world of D&O. As should be clear from this post, there is a lot going on now in the world of directors’ and officers’ liability, with many additional issues on the horizon. The latest InSights issue can be found here.

 

SciClone Settles FCPA Follow-on Derivative Suit : In a settlement that involves a company with significant Chinese operations — and that also may represent something of a template for the settlement of FCPA enforcement follow-on civil lawsuits — SciClone Pharmaceuticals and the individual defendant directors and officers have agreed to settle the consolidated derivative lawsuits that were filed following the company’s announcement that it was the target of SEC and DoJ investigations for possible FCPA violations.

 

According to the company’s October 12, 2011 press release (here), the parties have agreed, subject to court approval, to settle the consolidated cases based on the company’s agreement to adopt certain specified corporate governance reforms and the company’s agreement to pay $2.5 million in plaintiffs’ attorneys’ fees. The press release states that the payment of the plaintiffs’ attorneys’ fees is “to be paid by SciClone’s insurers under its director and officer insurance policy.” A copy of the parties’ stipulation of settlement can be found here.

 

The FCPA does not provide for a private right of action. However, as I have previously noted on this site, the advent of an FCPA investigation often triggers a follow-on civil lawsuit. In this case, multiple lawsuits were filed against the company, as nominal defendant, and certain of the company’s directors and officers, shortly after the company announced the existence of the investigation. The lawsuits, which were filed in San Mateo County (Calif.) Superior Court in September 2010, and which were later consolidated, alleged that “the Individual Defendants, by reason of their failure to implement and maintain internal controls and systems at the Company to assure compliance with the FCPA, breached their fiduciary duties and may be held liable for damages.”

 

As a result of mediation, the parties reached the settlement that the company announced in its press release. Among other thing, the settlement requires the company to adopt certain measures for three years, including the implementation of sanctions for employees violating the FCPA; the establishment of a compliance coordinator; the adoption of a compliance program and code; and the adoption of certain internal controls and compliance functions. The governance measures are described in detail in the parties’ settlement stipulation.

 

There are a number of interesting things to me about this settlement. The first is that it involves a company that, according to its own website, is a “China-centric” pharmaceutical company. Though the company has its headquarters in the U.S. its “strategy,” as described on the company’s website is to grow its sales in China.  The existence of the FCPA investigation underscores the challenges facing companies attempting to do business in China. Given the company’s business model, the compliance measures adopted in the settlement arguably are a good idea in any event, without regard to the fact that the company willingness to adopt the measures managed to resolve this consolidated litigation.

 

The D&O insurer’s payment of the plaintiffs’ attorneys’ fees shows how these kinds of lawsuits can contribute to insurers’ loss costs. Obviously, the D&O insurers also incurred the defense expenses as well, meaning that the total loss costs for this suit potentially represents a substantial figure. Moreover, depending on the nature and status of the government FCPA investigation, there could be additional covered loss costs as well. The company and certain of its directors and officers were also named as defendants in a related securities class action lawsuit (about which refer here), but that action was voluntarily dismissed without prejudice.

 

As antibribery enforcement activity is stepped up in this country and elsewhere, it seems likely that these types of lawsuits may become even more common. The likelihood is that this type of litigation could make a significant contribution toward insurers’ aggregate loss costs in the coming years. On the other hand, from an underwriting standpoint, it seems that companies that have already voluntarily adopted the kinds of compliance procedures that were the subject of this settlement should be view in a more favorable light, particularly with regard to those companies that might otherwise be viewed with caution owing to the countries in which they are doing business.

 

Dismissal Motion Denied in U.S.-Listed Chinese Company’s Securities Suit: In the second dismissal motion denial entered as part of the current wave of securities suits filed against U.S.-listed Chinese companies, on October 11, 2011, Central District of California Judge Christina Snyder denied the defendants’ motion to dismiss in the securities suit filed against China Education Alliance, Inc. (CEU) and  certain of its directors and officers. A copy of Judge Snyder’s opinion can be found here.

 

As discussed here, the plaintiffs first filed their action in December 2010. Among other things, the plaintiffs allege that the company overstated its revenue and profits by “exponential proportions.” The plaintiffs, in reliance on the report of an online securities analyst, alleged that the company maintained two sets of books, and that the revenue reported in the company’s Chinese regulatory filings was only a fraction of the revenue the company reported in its SEC filings. The complaint also alleges that the company’s educational website was not functional, and its education building allegedly is an empty building without classrooms.

 

The defendants moved to dismiss, arguing in part that the plaintiffs allegations, made in reliance on the online analyst report, merely repeated the unsubstantiated assertions of a professed short seller that was financially motivated to drive down the company’s share price. In rejecting the defendants’ argument in this regard, Judge Snyder relied on the earlier dismissal motion denial in the case involving another U.S.-listed Chinese company, Orient Paper (about which refer here). Judge Snyder found it was not appropriate to reject the allegations on that basis at this early stage.

 

Judge Snyder also found tat the plaintiffs had adequately alleged scienter, despite the absence of insider trading or other financially motivated conduct. Judge Snyder found that “additional facts” the plaintiff alleged “give rise to a strong inference of scienter.” Those alleged additional facts include the following:

 

That CEU has filed significantly disparate revenue figures in China and the United States: that plaintiffs’ own investigators toured CEU’s on-site “state of the art” facility in China only to find it an empty building; that witnesses told plaintiffs’ investigators that CEU was not the owner of the building; that CEU has had rapid turnover of its CFOs during the class period; and that many of the links on CEU’s website did not work properly despite its online segment purportedly deriving millions of dollars each year.

 

Judge Snyder said that “although each fact taken along might not give rise to an inference of fraudulent intent,” the allegations “taken together” establish that plaintiffs’ theory is at least as compelling as any opposing inference one could draw.

 

Judge Snyder’s dismissal motion denial suggests that in some cases at least the U.S.-listed Chinese companies draw into the wave of recent securities lawsuits may face difficulties evading these lawsuits, at least at the initial stages. Many of the cases, like this one, are based on the reports of financially motivated online analysts. Judge Snyder’s unwillingness to disregard the allegations based on the analyst’s report, notwithstanding the analysts admitted financial interest in driving down the value of the company’s stock, may represent a problem for the other companies tangled up in these cases as a result of negative reports by online analysts.

 

Moreover, Judge Snyder’s conclusion that the plaintiffs’ scienter allegations were sufficient, inter alia, on the discrepancies between the Chinese regulatory filings and SEC filings, may also suggest that a number of these cases could survive the initial pleading stages, as many of them are based on similar discrepancies between Chinese regulatory filings and SEC filings.

 

To be sure, some cases will nevertheless be dismissed, as was the case with the China North East Petroleum case, in which the dismissal motion was recently granted on loss causation grounds (about which refer here). But if Judge Snyder’s holding in the China Education Alliance case is any indication, other cases also will likely survive the initial dismissal motions.

 

Of course, it remains to be seen how valuable these cases ultimately prove to be for plaintiffs, even if they make it past the initial pleading hurdle. But the name of the game is making it past the dismissal motions, and at least in the China Education Alliance case, the plaintiffs have made it at least that far.

 

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

 

Fed Officials Pursue Actions Against Failed Bank Officials: In a significant development in the current wave of bank failures, that involves a failed bank that had significant ties to and operations in China, on October 11, 2011, federal officials concurrently filed a regulatory enforcement action and a criminal prosecution against certain former officers of the failed United Commercial Bank.

 

San Francisco based United Commercial Bank failed on November 9, 2009 (about which refer here). The bank had offices throughout the United States, as well as China and Taiwan. The bank grew rapidly. According to the SEC, it was the first U.S. bank to acquire a bank in the People’s Republic of China. However, during the economic crisis in late 2008 and early 2009, the bank experience significant difficulties in its loan portfolio, which regulators allege led to the bank’s failure, which in turn triggered the recently filed actions involving the bank’s former officers.

 

First, in an October 11, 2011 complaint (here), the SEC filed a civil enforcement action against four former officers of the bank. According to the SEC’s October 11, 2011 litigation release, the complaint alleges that the defendants “concealed losses on loans and other assets from the bank’s auditors, causing the bank’s holding company UCBH Holdings, Inc. (UCBH) to understate its 2008 operating losses by at least $65 million.” The complaint alleges that the further loan losses ultimately caused the bank to fail. The SEC action seeks permanent injunctive relief, an officer bar, and civil money penalties.

 

In addition, as reflected in the FBI’s October 11, 2011 press release (here), a grand jury has indicted two of these same former bank officials, for conspiracy to commit securities fraud, securities fraud, falsifying corporate books and records and lying to auditors.

 

Both the SEC’s litigation release and the FBI’s press release specifically reference the assistance they received in preparing their actions from the FDIC. The FDIC’s role in these actions is a reminder that as part of its failed bank post mortem, the FDIC is not only attempting to determine whether or not it has a valuable civil suit on its own as receiver, but is also looking to see whether or not wrongdoing has occurred that warrants referral to other authorities.

 

Both the SEC action and the indictment refer to securities fraud, which serves as a reminder that, by contrast to the institutions caught up in the S&L crisis a few years ago, many of these failed financial institutions in the current bank failure wave are publicly traded, a circumstance that has many ramifications.

 

It remains to be seen whether or not the FDIC will also file its own separate civil action against the former directors and officers of this bank. The bank’s former investors have in any event already filed their own class action lawsuit. As discussed here, the defendants’ initial motion to dismiss the class action lawsuit was granted, albeit with leave to amend.

 

Every now and then, I run across a case that makes me stop and say, “What?” I had that experience recently when I read the September 21, 2011 opinion of Middle District of Tennessee Judge John T. Nixon in an insurance coverage dispute involving Cracker Barrel Old Country Store, Inc. In the opinion, which can be found here, Judge Nixon held, applying Tennessee law and based on the policy language involved, that an EEOC lawsuit brought following employees’ discrimination charges was not a “Claim” within the meaning of the EPL insurance policy at issue.

 

Background

Between December 1999 and March 2001, ten of the company’s employees filed charges alleging sexual or racial discrimination against the company with the Illinois Department of Human Rights and the EEOC. The company later provided notice of these charges to its EPL insurer. Thereafter, the EEOC brought suit against the company for multiple alleged violations of federal civil rights laws. The EEOC’s lawsuit arose from allegations of harassment and discrimination against former and current employees of the company, including the original ten charging parties. The company provided its EPL insurer with notice of claim relating to the EEOC lawsuit. The company later entered into a settlement decree with the EEOC, which designated $2 million to be placed in a settlement fund. The company incurred over $700,000 in defending the EEOC lawsuit.

 

The company sought coverage from its EPL insurer in connection with the EEOC lawsuit, seeking inter alia, reimbursement for its defense expenses. The carrier — in reliance on the Policy’s definition of the term “claim” as “a civil administrative of arbitration proceeding commenced by service of a complaint or charge, which is brought by any past, present or prospective employee(s) of the ‘insured entity’ against any ‘insured’” – took the position that the policy did not cover the EEOC lawsuit. The company filed a declaratory judgment action and the parties filed cross-motions for summary judgment.

 

The September 21 Opinion

In his September 21 opinion, Judge Nixon granted the carrier’s summary judgment motion and denied that of the company. The carrier had argued that the EEOC lawsuit was not a “claim” within the meaning of the EPL policy because it was not brought by a past, present or prospective employee of the company. The company argued that the definition should be understood to mean that the proceeding must merely be commenced by a complaint or charge by an employee.

 

In ruling for the carrier, Judge Nixon found that the definition of “claim” in the carrier’s policy is
“not ambiguous” and that “the definition of a ‘claim’ has a clear meaning that a covered proceeding must be brought by an employee.” Even though the EEOC lawsuit followed from the employees filing of charges, the EEOC lawsuit “was not ‘commenced by the service of’ a charge, according to the plain meaning of that language, even though it may have arisen because of previous administrative charges.” The fact that “the EEOC charges on which the EEOC partially based its decision to bring a lawsuit were brought by Plaintiff’s employees is irrelevant.” Judge Nixon held that because “the EEOC lawsuit was not brought by an employee,” the lawsuit is “not a ‘claim’ under the Policies.” Accordingly, he ruled that the carrier did not have a duty to indemnify the company for the settlement amount or for the company’s costs of defense.

 

Discussion

I think most readers’ initial reaction to this ruling will be surprise (at a minimum). The general expectation would be that the possibility of an EEOC lawsuit is among the very reasons companies buy EPL insurance. Indeed, as Judge Nixon noted in his opinion, the plaintiffs in this case argued that the insurance companies position that an EEOC lawsuit is not a covered claim “flies in the face of common sense,” as the company had purchased the EPL insurance “to protect itself from exactly the type of liability that results from EEOC actions,” which is, the plaintiff contended the “very purpose” of the coverage.

 

But what may seem like a surprising outcome may be nothing more that a reflection of the unusual wording in this policy. In his opinion, Judge Nixon noted that he had reviewed the language of EPL policies involved in other cases and that he had “found no instances where the relevant definition restricted claims to those ‘brought by an employee.’”

 

Indeed, my own quick review of the EPL policies of several other carriers show that many policies do not, as Judge Nixon noted, limit who must bring an otherwise covered claim. Other policies specifically include actions brought by the EEOC within the definition of claim, while yet others include the EEOC within the definition of a “claimant” whose action represents a “claim” under the policy. Many policies also allow that a claim may be brought “by or on behalf of” an employee. Judge Nixon found that in the absence of these kinds of provisions in the policy here, he could not interpret the provision as if it included that type of language, and that he “cannot find ambiguity where none exists merely because plaintiffs did not bargain for coverage that is expected.”

 

If nothing else, this outcome underscores the critical importance of policy wording. Where coverage for something as basic to EPL insurance as an EEOC lawsuit depends on the presence or absence of crucial words, policyholders must take steps to protect themselves, and in particular policyholders must enlist in their acquisition of insurance knowledgeable and experienced insurance professionals capable of ensuring that the policy language is matched to the policyholders’ needs and expectations. And while you wouldn’t think it would be necessary, it looks as if one item that should be attended to with particular care is to make sure that the EPL policy’s terms encompass EEOC lawsuit within the scope of covered claims.

 

More than once, I have suggested that part of the obligation of those who counsel insurance buyers is to develop a sort of league table for carriers’ claims handling practices. The carriers’ awareness of the maintenance of league tables might possibly encourage the carriers — in considering whether or not to assert a particular coverage position — to consider not only whether or not a particular position is analytically justified, but also consider how it might look to the insurance marketplace if the carrier were to take that position. Insurance professionals that maintain a claims handling practices league table may find it highly relevant that the carrier in this case was willing to take the position it took in this case.

 

An October 2011 memo from the Lowenstein Sandler law firm discussing this case can be found here.

 

LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

Thank You for Your Support: The D&O Diary has been nominated as among the candidates for the LexisNexis Top 25 Business Blogs of 2011. The actual selection of the Top 25 blogs will take place at a later date. Among the considerations that will go into the selection will be the comments posted on the LexisNexis Corporate & Securities Law Communities site about the nominee blogs . Each comment is counted as a vote toward the supported blog. To submit a comment, visitors need to log on to their free LexisNexis Communities account.  If you haven’t previously registered, you can do so for free by following this link. The comment box is at the very bottom of the blog nomination page. The comment period for nominations ends on October 25, 2011. 

 

In what is as far as I know the first outright dismissal motion grant in the wave of cases filed against U.S.-Listed Chinese companies that began last year, on October 6, 2011, Southern District of New York Judge Miriam Goldman Cedarbaum granted the defendants’ motion to dismiss in the securities class action lawsuit filed against China North East Petroleum Holdings Ltd. and certain of its directors and officers. A copy of Judge Cedarbaum’s opinion can be found here.

 

As detailed here, the plaintiffs first filed their action in June 2010. According to their amended complaint, during the class period, the defendants inflated the amount of the company’s proven oil reserves, overstated reported earnings inflated profits and misrepresented the company’s internal controls. An allegedly “bizarre series of events” followed the company’s February 23, 2010 announcement that it would be restating prior financials, including “revelation of illicit bank transfers” made to company officials and “a dizzying number of resignations and replacements” of top executives. Over the next few months additional details were revealed regarding the transfers, ultimately resulting in the resignation of the CEO and several members of the board. The NYSE had halted trading on the company’s shares on May 25, 2010, but when trading resumed on September 9, 2010, the company’s share price “plunged.”

 

The defendants moved to dismiss the plaintiff’s complaint on loss causation grounds, arguing that the plaintiff had several opportunities to sell its shares at a profit following the allegedly corrective disclosure at the end of the class period, and contending that had the plaintiff “chosen to sell at those post-disclosure dates, it would have turned a profit.”

 

Judge Cedarbaum agreed. Even though the plaintiff ultimately sold its shares at a loss, she concluded that “that loss cannot be imputed to any of NEP’s alleged misrepresentations,” adding that “a plaintiff who forgoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure.” Because she found that the plaintiff “has not suffered any loss attributable to the misrepresentations alleged in the complaint,” she granted the defendants’ motion to dismiss.

 

The dismissal of the China North East Petroleum Holdings case may simply reflect the unusual movement of the company’s share price.. For whatever reason, the company’s share price quickly rebounded following the September 9, 2010 “plunge” – although the share price has steadily declined following that sharp, short rebound. The share prices of other U.S.-listed Chinese companies have not reflected this pattern. Particularly as the various accounting scandals have mounted, companies caught up in the scandals have seen their share prices drop down and stay down. (Indeed, the share prices of all U.S.-listed Chinese companies have been depressed as the scandals have spread.)

 

So the outcome of this particular lawsuit may be nothing more than a reflection of the rather atypical stock price movements that surrounded its various disclosures. Judge Cedarbaum’s ruling may have little bearing on other cases involving companies whose share price movements would not support the type of loss causation arguments that were successful in this case.

 

Nevertheless, Judge Cedarbaum’s ruling is a reminder that merely because a raft of lawsuits has been filed against U.S.-listed Chinese companies does not mean that the cases are meritorious or that the plaintiffs will be successful. The China North East Petroleum case was one of the first of these cases to be filed, as it was filed in June 2010, before the filings against U.S.-listed Chinese companies really began to pick up momentum in the second half of 2010. Because it was one of the first of these cases to be filed, it is among the first to reach the motion to dismiss stage. It remains to be seen how the other cases will fare .But the dismissal of this case shows that the plaintiffs in this cases face numerous obstacles in attempting to pursue these suits. (As I noted in an earlier post, here, there has also been at least one dismissal motion denial in a securities suit involving a U.S.-listed Chinese company.)

 

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

 

FDIC Files Suit Against Former Directors and Officers of Alpha Bank: On October 7, 2011, the FDIC filed a civil action in the Northern District of Georgia against 11 former directors and officers of the failed Alpha Bank & Trust of Alpharetta, Georgia. Scott Trubey’s October 7, 2011 Atlanta Journal Constitution article about the lawsuit can be found here. A copy of the FDIC’s complaint can be found here.

 

Alpha Bank failed on October 24, 2008, only about 30 months after it opened. The FDIC’s suit seeks damages of $23.9 million in connection with 13 specific loans that the suit contends were approved “despite plainly inadequate, incomplete, or outdated financials of the borrower and/or the guarantors” in the loans, resulting in loans to borrowers “with no apparent ability to repay or otherwise service the loans.”

 

The Alpha Bank lawsuit is the fifteenth lawsuit that the FDIC has filed as part of the current wave of bank failures, which began only shortly before the Alpha Bank failed. The Alpha Bank lawsuit is the fourth failed bank lawsuit that the FDIC has filed so far in Georgia, that state that has had more bank failures during the current bank failure wave than any other state. Many more lawsuits are likely to come, including many more lawsuits in Georgia.

 

This lawsuit is actually the first the FDIC has filed for several weeks. After the FDIC filed a total of five lawsuits in very quick succession in August, there was some speculation that the logjam in anticipated FDIC failed bank lawsuit filings had broken and that we were about to see a quick accumulation of additional suits. But after that flurry of August activity, new filing activity had dropped off until the filing of this Alpha Bank lawsuit on Friday. It will be interesting to see if the Alpha Bank filing is followed by another flurry of filing activity, as was the case in August.

 

It is worth noting that the FDIC has only now, nearly three years after Alpha Bank failed, gotten around to fling this lawsuit. This consistent in general with the lag time between the bank failure date and the initial lawsuit filing date that has characterized the lawsuits that the FDIC has filed so far. In view of this apparent timing pattern and the fact that the bank failure wave peaked during late 2009 and early 2010, the likelihood is that we may be in for increased numbers of new FDIC failed bank lawsuits in coming months and possibly for at least the next couple of years.

 

In addition to the FDIC lawsuit, the former directors and officers of Alpha Bank previously were the target of a lawsuit brought by shareholders of the bank, as I discussed in an earlier post, here.

 

Special thanks to a loyal reader for sending a copy of the FDIC’s complaint.

 

Unauthorized Reincarnations Will Be Punished to the Maximum Extent of the Law: According to an October 6, 2011 New York Times article (here), the Dalai Lama’s recent announcement that his successor “may be an emanation and not a reincarnation” has upset the Chinese government, which apparently contends that its authority extends even to matters involving reincarnation.

 

The article quotes a statement about the affair from the People’s Daily, described as the Communist Party’s “mouthpiece,” as having warned that: 

 

All reincarnation applications must be submitted to the religious affairs department of the provincial-level government, the provincial-level government, the State Administration for Religious Affairs and the State Council, respectively, for approval.

 

Hannah Arendt had something like this in mind when she coined the expression “the banality of evil.”

 

Travel Journal: The Köln Concert: The D&O Diary’s European sojourn continued in Cologne this week, after a three-hour train ride from Amsterdam. Fortunately for me, the glorious weather I enjoyed in Amsterdam followed me to Cologne. After arrival at the Hauptbonhof (central train station) in Cologne and dropping my bags at the hotel, I emerged into a city swathed in October sunshine (quite a contrast to my prior visits to the city, which were uniformly water-logged).

 

For a visitor to the city, the three most distinctive things about Cologne are a river, a church and a beer. The river is the Rhine, which surges through the city on its way toward the North Sea. The church is the city’s great cathedral, or “Dom” as it is known locally, which looms large from its strategic perch along the river.  And the beer is kölsch, a light beer that according to convention and regulation can only be brewed in the Cologne region.

 

My visit to Cologne (or Köln as it is known in German) was quite a bit different than my trip to Amsterdam, owing to the fact that unlike my visit to Amsterdam, my trip to Cologne was business related. Due to meetings and other commitments, I had less opportunity for frolics and detours, alas..

 

Nevertheless, I did still manage to find ways  to enjoy some of Cologne’s distinctive features, including the city’s famous local brew, kölsch. It is a light and refreshing beer that is traditionally served in tall, thin cylindrical 0.2 liter glasses. The waiters in the brew pubs carry around trays full of the glasses, and in a smooth single motion they remove your empty glass at the same time as they provide a fresh one. They mark the number of glasses consumed with pencil marks on a coaster. First timers learn the hard way that the waiters will continue to bring fresh glasses unless you take your coaster and put it over top of your glass.

 

As special as the warm afternoon sunshine was on the day of my arrival in Cologne, my best opportunity to enjoy the city’s riverine location came later in the week, when I took a lunch break bike ride along the river. I pedaled my rental bike across the river to the east side and headed south along the paved bike path. (I was heading upstream, as the Rhine flows generally northward.)

 

Within minutes, I was away from the city center, and shortly thereafter, it was just me and the crickets and the birds. The riverside is flat and the bike path smooth, and the kilometers just rolled away. The serene countryside, softened in soothing autumnal tones of brown and gold, drew my on and on. I had intended to ride for only a short while,  but at each curve of the river, a church steeple ahead or a flock of birds in the river lured me to keep going. I am quite sure I traveled at least 30 miles roundtrip before I was done.

 

To be able to escape from a city into the countryside in less than 15 minutes on a bicycle is a very fine thing. It is a privilege we lack in most of the U.S., with our sprawling urban areas and our autocentric culture. In Europe, the urban density and the accessibility to the countryside are interrelated, and provide both a more vibrant city life and greater ease of access to rural areas. In the U.S., urban sprawl means many cities that are empty at night, and are surrounded by endless suburbs that blur into the countryside even far from city centers.

 

During my European trip, I had some very pleasant experiences, including my lunchtime bike ride on the Rhine. These kinds of experiences are available at home, too, but they occur less frequently. I think that when you are in a new place, you are more open to the possibilities, particularly in a foreign country. How frequently do any of us in our day to day lives at home drive further down the road just to see what is around the next bend? But in my all too brief European visit, every time I yielded to curiosity, I was rewarded with something novel, something interesting, something worth seeing.

 

If I bring anything home with me from my European visit, it is a renewed appreciation for the possibilities of the moment, where just ahead there are always new things to discover.

 

Janus Distinguished: In an interesting opinion that distinguishes the U.S. Supreme Court’s decision in Janus, on September 30, 2011 Southern District of New York Judge John Koetl granted in part and denied in part the defendants’ motion to dismiss in the EnergySolutions securities class action lawsuit. Judge Koetl’s opinion can be found here.

 

As discussed here, in October 2009, plaintiff shareholders filed a securities suit against the company, certain of its directors and officers, and its offering underwriters in connection with the company’s November 14, 2007 IPO and July 24, 2008 secondary offering. The plaintiffs also named as a defendant the parent company of Energysolutions (ES), ENV Holdings. The plaintiffs alleged that the company’s offering documents misrepresented the company’s financial opportunities in the nuclear energy decommissioning business, as well certain of its regulatory constraints.

 

ES had been formed by several sponsor institutional investors that had purchased several individual businesses through ENV Holdings. At the time of the IPO ENV owned 100% of the shares of ES. ENV was also a selling shareholder in the secondary offering.

 

The defendants moved to dismiss the plaintiffs’ complaint. Although the defendants’ motion was granted as to certain of the alleged misstatements, it was denied in other material respects.Among the more interesting aspects of Judge Koetl’s opinion is his analysis of the question whether the plaintiffs had stated a cognizable claim against ENV, which had been ES’s 100% owner prior to the IPO. ENV had moved to dismiss based on the U.S. Supreme Court’s holding in the Janus case, arguing that like the mutual fund management company in that case, it was a legally distinct entity lacking “ultimate authority” over the statement of its related entity, and therefore because it had not “made” the alleged misstatements, it could not be held liable under the securities laws.  

 

Despite the apparent parallels between the cases, Judge Koetl nevertheless held that the claim against ENV could go forward. Judge Koetl found that there are “significant differences” between EMV and the fund management company in the Janus case. Among the critical differences that Judge Koetl found were “ENV’s owndership of ES, its direct control over all corporate transactions, and its authority to determine when and whether to sell the shares beings sold.”

 

Judge Koetl went on to note that even though the individual directors and officers signed the registration statements in their capacities as directors and officers of ES, that did not “preclude attribution” to ENV as well. He added that Janus itself even said that attribution “could be implied from the surrounding circumstances.” A reasonable jury, Judge Koetl found, could conclude that ENV’s role went far beyond a “speechwriter drafting a speech,” because “ENV had control over the message, the underlying subject matter of the message, and the ultimate decision whether to communicate the message.”

 

Judge Koetl’s decision adds an interesting new layer to the evolving analysis of the question of when alleged misrepresentations made by one party can be attributed to another party. Under Judge Koetl’s analysis, there are times when the second party’s alleged control is so complete that notwithstanding the legal separation between the two parties, the controlling party can be said to have “made” the misstatement delivered by the other party – almost as if the controlling party were using the other party as its mouthpiece. The critical element in Judge Koetl’s analysis seems to have been ENV’s complete ownership and consequent complete ability to dictate its actions. (I would certainly be interested in hearing a panel of informed securities law specialists discuss the question of whether or not the differences Judge Koetl cites are or are not distinctions without a difference between this case and Janus.)

 

It is worth noting that the EnegySolutions case is one of the so-called “backlog" cases that were filed in late 2009 and early 2010 (the name refers to the fact that the cases were filed more than a year after the proposed class period cutoff date). As the time, some commentators speculated that the plaintiffs were filing the belated cases because they were out of fresh ideas and they were scraping the bottom of the barrel. But as this case’s dismissal motion survival shows, merely because the cases were belated does not necessarily mean they are not meritorious. Indeed, a number of the so-called belated cases have survived their initial dismissal motions (refer for example here).

 

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

 

Eleventh Circuit on Loss Causation: On September 30, 2011, the Eleventh Circuit affirmed in part and reversed in part the district court’s partial dismissal and later entry of summary judgment on the defendants’ behalf in the FindWhat.com securities class action lawsuit.   The opinion, which can be found here, has a number of interesting features.

 

Among the more interesting aspects of the Eleventh Circuit’s opinion is its reversal of the district’s summary judgment grant on loss causation issues. The Eleventh Circuit observed that the district court’s reasoning “misapprehends” the relation of misstatements, the company’s share price, and the plaintiffs’ allegations.

 

The district court had rejected the plaintiffs’ loss causation arguments because the plaintiffs’ expert had found that the stock price inflation predated the alleged misstatements, and that the subsequent alleged misrepresentations had not increased the amount of price inflation.  The district concluded that the misstatements could not have caused the price inflation and therefore the misstatements could not have caused the alleged financial harm.

 

The Eleventh Circuit, declining to follow prior Fifth Circuit case law, and looking at the nature of the plaintiffs’ allegations, reversed the district court’s loss causation ruling, holding that “fraudulent statements that prevent a stock price from falling can cause harm by prolonging the period during which the stock price traded at inflated prices,” adding that “confirmatory information that wrongfully prolongs a period of inflation – even without increasing the level of inflation—may be actionable.”

 

In an interesting footnote (fn.32), the Eleventh Circuit also observed that the district court had also improperly conflated the “loss causation” and “reliance” issues. The Eleventh Circuit directed the parties on remand to clarify their reliance and loss causation arguments, particularly with respect to the defendants’ reliance-related arguments that the alleged misstatements had not caused the price inflation (as opposed to the defendants’ loss causation-related arguments that the alleged inflation had not caused the plaintiffs’ financial loss).

 

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

The D&O Diary is on assignment in Europe this week. The first stop on the Continental itinerary was Amsterdam.I had never been to Amsterdam before, but I have traveled to Northern Europe quite a bit, so when I packed I made sure to load up on sweatshirts and a fleece. And an umbrella. As it turned out, I could have used some shorts and a tee shirt. The weather was absolutely gorgeous, with temperatures in the upper 70s and not a cloud in the sky. I don’t know what Amsterdam is like the rest of the year, but in early October it is spectacular.

 

Here’s the single most important thing about Amsterdam — bicycles rule. Bicycles outnumber people. Bicycles are  the prevailing physical force and predominant spirit. The bicyclists ride without regard for public order or their personal safety. The Dutch bicyclists seem to think that a bike ride is a good time to catch up with their friends, as almost every cyclist is talking on their cell phone. Or texting, using both hands. The prize-winning multitasking bicyclist I saw was a young mother, riding along with her kid straddling the back fender, talking on her cell phone and smoking. And wearing sun glasses. At night.

 

I saw a one-legged policeman riding a bike. I saw a guy cruising along on his Schwinn, with a beagle draped across his shoulders, its ears and tongue flapping in the breeze. I saw another woman, who apparently had never thought of wearing her dog, who was pedaling along with her terrier trotting, well, doggedly, along beside her. She was talking on her cell phone of course. (Her dog must have left his cell phone at home.) I also saw a very large black man riding a bike wearing only an orange wig and what looked like women’s panties. He lacked only a beagle to complete his ensemble.

 

It turns out, there actually is a dam in Amsterdam. Or there was, on the Amstel River. Now it is just a big public square adjacent to the Royal Palace, full of street musicians and American college kids on their semester abroad, learning about Dutch culture by smoking pot. (Legally! What a novelty!). Informed sources advise that the town originally was called Aemstelerdam, and somehow it became Amsterdam rather than Amsteldam. 

 

It also turns out that in Amsterdam, the natives speak Dutch, which sort of sounds like German and English being spoken simultaneously.  I don’t speak Dutch, but Ich spreche ein bisschen Deutsch, so I tried to a few words of my best Berlitz German. I got a look as if I were from Mars. (No, Cleveland actually).  The funniest thing I heard was when some young Dutch toughs tried to Talk American: “Yo, Joe, you bin kommen from da hoood?” (accompanied by gang member hand signs, performed with a Dutch accent).

 

I understand there are many fine museums in Amsterdam. I didn’t visit any of them. The weather was so glorious that I spent the better part of Saturday afternoon inVondelpark, which is sort of like Central Park but without the roads or the surrounding tall buildings. While I was in the park, I was exposed to something so unexpected that I will remember it even after I am dead. I was walking along admiring the fall foliage, when I was distracted by a young woman bending over and apparently looking for something on the ground. Though I was in Amsterdam, I immediately thought of the childhood rhyme, “I see England, I see France” – except she wasn’t wearing any underpants. I spontaneously blurted something improbably ascribing divine qualities to excrement. I wonder whether the guy with the wig misappropriated her panties?

 

(I wanted to insert a joke here about a “Dutch treat” but I couldn’t quite work it out. You get the point.)

 

On a warm fall evening, Amsterdam is a rocking place. Party Central is Leidseplein, which is an open area ringed with bars and cafes and full of American college kids learning about Dutch culture by studying the dynamic relationship between numbers of euros and liters of beer. (Turns out, they are directly proportionate, as is the case with dollars and ounces.) The kids were also texting, perhaps to their parents (“Please send money,” which translated from the vernacular means “Beer is expensive here.”) There was one street musician there who did a fantastic impression of Joe Cocker. While the faux Joe was singing, a man in a cow suit walked up and started dancing along to the music. He also performed a fairly impressive moonwalk.

 

A Moonwalking Man Cow – that was pretty special, but what happened next was truly awesome. Nine guys gathered in a semicircle and starting singing “Country Road,” a capella. When they reached the part about “West Virginia, Mountain Mama,” several hundred people gathered in the square spontaneously joined in. It was so cool it gave me goosebumps.  

 

The most distinctive feature of Amsterdam is its canals. The canals form a semicircle around the center city, and are lined with classic seventeenth century houses with their ornate four-story facades. The Canal District represents the distilled essence of civilized urban living. On a beautiful fall day, walking along the canals is a calm, peaceful, even sublime experience.

 

I found myself contemplating the vast Dutch trade armadas that gathered the wealth that built all of those beautiful houses. It is pretty amazing that a country about as big as Massachusetts became a global power for a time. But while the Dutch were clever enough to build an empire, they were not strong enough to keep it. So what is left now are a whole bunch on Indonesian restaurants and a museum city of beautiful houses. Sort of like Venice. Or when you come right down to it, sort of like Madrid. Or Paris. Or London, for that matter. Or, when you come right down to it, Rome. Or for that matter, Egypt.

 

There are innumerable cross streets spanning the canals on gently curving bridges. At many of the corners where the cross streets and the canals meet there are cafes and coffee shops.  If I could drop one moment in amber and have it with me always to warm my spirits when the January winds howl, it would be 4 o’clock on Saturday at a sidewalk café overlooking the Princengracht (Princes’ Canal). A nearby church rang the hour by chiming out the first few bars of Bach’s Passacaglia and Fugue in C Minor. It might have been the glass of Grolsch I was enjoying at that moment, but the warm sunlit glow – and the gentle voices of all of those cute Dutch people speaking German and English at the same time (perhaps discussing their underwear, or lack thereof) – will be something I will treasure for a long time.

 

On Sunday, I decided it was time to step off the sidelines and jump into the fray. I went out and rented a bicycle. Within the first minutes, I realized what an idiot I had been walking around the city the prior day. The only way to see Amsterdam is on a bicycle (sort of like the only way to see Los Angeles is in a car.) The other thing I quickly figured out is that Amsterdam is basically flat, so once you get rolling, you can just cruise, as long as you watch out for crazed people on motor scooters. After just a short time, I had an urge to make a cell phone call. Clearly I had tapped into the essential zeitgeist.

 

I biked along for more than six hours. I rode out in the suburbs. I pedaled along the Amstel River. I went out to the waterfront and rode along the docklands. What I found there was as deeply disturbing as the Canal District was uplifting. Over the past several years, developers have invested hundreds of millions of euros building a new residential area along the shipping canal. The area, called Oosterdokseiland, is as ugly and sterile and empty and dispiriting of a place as I have ever seen. Row upon row upon row of featureless, dead buildings. I have been in livelier cemeteries. The area is the exact urban opposite of the Canal District. I can understand the Dutch people wanting to move beyond their past, but how could they have completely forgotten everything they learned, especially when the best of it is so close at hand? Understand, this isn’t some urban renewal project for people with nowhere else to go, this is a very high end residential real estate development. I decided that the thousands of poor souls condemned by unforgivably poor judgment to live there are like the prisoners on Alcatraz, so close to paradise that you can see it and hear it, but living in hell just the same, with no one to blame but themselves.  

 

Fortunately for me, I could just turn around and head back to the warm, human, vibrant center of a real city – a city that is what a city was meant to be. After I returned my bike, I was thirsty and hungry, so I sat right down at the restaurant next to the bike shop. I had a plate of gnocchi in olive oil and a glass of wine. While I was eating, there was a sort of family reunion going on at the next tables. There was one group of six young men in their late 20s. At the next table, were several older men and women, obviously the parents of the men. Running between the tables were a bunch of little blond kids, flittering around like a flock of birds. It was obvious everyone knew and loved everyone else. (I have no idea where the children’s mothers were, but it didn’t seem to matter.) I thought to myself, this is what cities are for, for people to come together and to celebrate a warm sunny fall afternoon with a bottle of wine in the kindly glow of the brotherhood of man.

 

Amsterdam, I hereby apply for honorary citizenship. If I go back, I hope to see more of that attractive young woman in the park. Wait a minute, I already did. All the more reason to hurry back.

 

Disclaimer: For those readers whose only thoughts about Amsterdam are that pot and prostitution are legal there, let me just say that I did not visit the red light district or go in a smoke shop. Mrs. D&O Diary would staple my private parts to the back fence if I so much as thought of doing either of those things.

 

The Dutch, these are my people.

 

The Amstel River, still only 90 calories

 

The classic Amsterdam bicycle (rental version)

 

The essence of Amsterdam, bicycles and canals

 

In a case involving multiple ghosts of long lost companies, a judge in federal court in Manhattan has held that excess D&O insurers do not have a duty to “drop down” to fill the gaps in coverage caused by the insolvency of underlying insurers. The court also held, based on the language of the excess policies at issue, that the excess insurers’ coverage obligations were not triggered merely because the insureds’ losses exceeded the amount of the underlying insurance, where the underlying insurance has not been exhausted by actual payment.

 

A copy of the Southern District of New York Judge Richard Sullivan’s September 28, 2011 opinion can be found here.

 

Background

This insurance coverage case arises out of the bankruptcy of Commodore International Limited (the manufacturer of the classic Commodore 64 personal computer, pictured above). In connection with the bankruptcy proceedings, numerous lawsuits were filed against the company’s former directors and officers. Most of these actions have been resolved, save only one proceeding remaining in the Bahamas where the claimants seek to recover $100 million. The defendants have so far incurred a total of $14 million in losses as a result of the various actions.

 

At the time of the bankruptcy, Commodore carried a total of $51 million of D&O insurance arranged in eight layers and involving six insurers. Unfortunately for the company’s former directors and officers, the first and fourth excess layers were provided by Reliance Insurance Company, and the third and sixth level excess insurance was provided by The Home Insurance Company. In 2001, Reliance went into a regulatory liquidation, and in 2003 so did The Home.

 

The primary layer of insurance was exhausted by payment of losses. However, due to Reliance’s insolvency, the individuals were unable to obtain insurance for losses that went into the next layer of insurance. The individuals then turned to the solvent upper level excess insurers, seeking to have them provide coverage for the individuals’ continuing defense fees and other losses. The solvent excess insurer that provided the second and fifth level excess insurance agreed to advance defense fees pursuant to an interim funding agreement and later filed an action (in which the other solvent excess  insurers joined) seeking a judicial declaration that there was no coverage under its excess policies as a result of the insolvent underlying insurers’ unpaid gaps. The individual directors and officers sought to establish that there was coverage under the solvent excess insurers’ policies, claiming that the excess insurers’ payment obligations had been triggered because osses exceeded the amount of the underlying insurance.

 

The policies of the solvent excess insurers all contained a similar provision essentially providing that “the Underlying Policies shall be maintained during the Policy Period ….Failure to comply with the foregoing will not invalidate this policy but the [excess insurance carrier] shall not be liable to a greater extent that if this condition had been complied with.” In addition, the excess policies all have provisions essentially providing that their policies are triggered only “in the event of exhaustion of all of the limit(s) of liability of such Underlying Insurance solely as a result of payment of losses thereunder.”

 

The September 28 Opinion

In his September 28 opinion, Judge Sullivan agreed with the excess insurers that they had no obligation to “drop down” to fill the insolvent insurers’ gaps, and he also concluded that the excess insurers’ obligations under their policies had not been triggered merely because the individuals’ losses exceeded the amount of the underlying insurance.

 

Judge Sullivan found that the laws of New York and Pennsylvania “clearly provide” that “an excess insurer is not required to fill gaps in coverage created by the insolvency of the underlying insurer.” He went on to note that

 

The Insurance Contracts themselves make no mention whatsoever of such an obligation. To the contrary, the policies expressly state that, in the event that Defendants fail to maintain underlying insurance, the insurers “shall not be liable to a greater extent than if this condition had been complied with.” This language expressly demonstrates that the coverage provided by the Excess Insurers will not be enlarged to compensate for gaps in underlying coverage.

 

In rejecting the individuals’ argument that the excess insurers’ payment obligations were triggered because the amount of the individuals’ losses exceeded the amount of underlying insurance, Judge Sullivan found that the “express language” in the excess insurers’ policies requiring exhaustion of the underlying limits by actual payment of loss in order to trigger coverage “establishes a clear condition precedent to the attachment of the Excess Policies,” and therefore it is “clear from plain language of the Excess Policies…that the excess coverage will not be triggered solely by the aggregation of Defendants’ covered losses. Rather the Excess Policies expressly state that coverage does not attach until there is payment of the underlying losses.”

 

In reaching this latter conclusoin, Judge Sullivan rejected the applicability of the 1928 Zeig v. Massachusetts Bonding & Insuance Co. casae, and similar cases. Judge Sullivan said these cases "provide not guidance because they involved circumstances where the insured had accepted partial insurance from the underlying carriers while making up the shorfall themselves. In this case and unike in Zeig, the carriers "have a clear bargained for interest in assuring that the underlying policies are exhausted by actual payment." 

 

Discussion

This case provides a sharp reminder that though insurance carriers fail infrequently, when they do it is a real mess. This reminder highlights the all-too-often overlooked importance of carrier solvency – and not just when coverage is bound but also at the time when a claim must be paid.

 

The mess created by the carriers’ insolvency, compounded by the excess carriers’ ability to avoid dropping down to fill the gap, leaves these individuals uninsured for their continuing expenses and exposures. Which in turn provides a vivid illustration of the value of a so-called Excess Side A/DIC policy, which  by its terms would drop down and provide coverage in the event of the insolvency of an underlying carrier.

 

Excess Side A/DIC policies were available at the time that Commodore procured its D&O insurance, but they were not nearly as pervasive as they are now. (The policies that were available at that time were somewhat more restrictive than those available today.) If Commodore’s insurance program had included an Excess Side A/DIC policy, the individual defendants might have been able to rely on that policy to defend themselves notwithstanding the gaps caused by the insurers’ insolvency

 

Judge Sullivan’s holding that the excess insurers’ payment obligations were not triggered even though the individuals’ losses exceed the amount of the underlying insurance is consistent with other recent decisions in which the courts have interpreted the excess insurer’s trigger language to require exhaustion of the underlying insurance by the actual payment of loss (refer for example here and here).

 

This case may also represent the first occasion on which a court applying New York law expressly declined to follow Zeig. However, the court never conclusively stated whether it was applying New York law; rather, Judge Sullivan said only that the outcome was the same whether New York or Pennsylvania law applied. He also distinguished Zeig rather than overtly declining to follow it.

 

It is worth noting that in the current D&O insurance marketplace excess insurance policies are available with trigger language that allows the amount of the underlying limits of liability to be paid either by the insurer or the insured, in order for the excess insurer’s payment obligation to be triggered. How this language would have affected the outcome of this case is not entirely clear, because it does not appear from the record whether or not the individuals have actually funded the shortfall themselves. (My impression is they did not.)

 

It is astonishing to note that ten full years after Reliance failed, problems from its failure continue to arise. It somehow seems appropriate that all of these ghosts from an earlier era have all gathered in this one locale, presided over by the specter of the late lamented Commodore 64. Clearly, the former directors and officers continue to be haunted by their former company’s remarkably unlucky choice of carriers. (This company doubled down on its bad luck, by managing to slot both of the eventually insolvent carriers in two different layers each in Commodore’s insurance program.)

 

One final note. Commodore’s primary insurance carrier has a name that would have been completely unknown to all concerned at the time Commodore procured its coverage. The primary insurer is a company now known as “Chartis” – a company that in that bygone era was known by a different name altogether.

 

Yes, there are all kinds of ghosts roaming around on the set of this production.

 

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

 

“As of Now, I am in Control”: There is at least one more ghost to mention here. Among Commodore’s former directors and officers was the late Alexander Haig, Jr. who among other things served as Secretary of State under Ronald Regan. Haig had a distinguished career of public service, but he will be most remembered for his unfortunate statements shortly after Reagan had been shot: “Constitutionally gentlemen, you have the president, the vice president and the secretary of state, in that order, and should the president decide he wants to transfer the helm to the vice president, he will do so. As for now, I’m in control here, in the White House, pending the return of the vice president and in close touch with him. If something came up, I would check with him, of course.”

 

Unfortunate News for Former Directors and Officers in Failed Bank Litigation: There’s some bad news for former directors and officers of failed banks defending themselves in FDIC litigation. On September 27, 2011, in the case the FDIC filed in the Central District of California against four former officers of IndyMac bank (in what was the first lawsuit the FDIC filed in the current round of bank failures, as discussed here), Judge Dale Fischer granted in part the FDIC’s motion for judgment on the pleadings as to certain of the defendants’ affirmative defenses.  A copy of Judge Fischer’s opinion can be found here.

 

Judge Fischer held that because the FDIC as receiver stands in the shoes of the failed bank, the defendants could not assert defenses based on the FDIC’s pre-receivership actions or omissions. Accordingly, she granted the FDIC’s motion for judgment on the pleadings as to the individual defendants’ defenses of unclean hands, failure to mitigate and ratification. She did deny the FDIC’s motion as to other affirmative defenses, including the business judgment rule.

 

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