In several posts (most recently here), I have tried to assess the continuing risks associated with what has been called The Banking Crisis of 2023. In my view, the risks continue, including in particular with respect to banks’ exposure to commercial real estate market. A May 28, 2024, paper by an economist at the Federal Reserve Bank of St. Louis entitled “Commercial Real Estate in Focus” (here) takes a detailed look at the current state of play in Commercial Real Estate (CRE) and examines the implications for banks and thrifts that hold CRE debt. Given the extent of the exposures of banks and thrifts to CRE debt, the author concludes, the CRE sector remains “a challenge for the banking system,” with significant concerns for the banks “if and when losses materialize.”

As the paper details, the CRE asset market is a huge part of the U.S. economy, representing over $22.5 trillion as of the end of 2023. Outstanding CRE debt totaled $5.9 trillion as of the end of 2023, with banks and thrifts holding 50% of that total (government-sponsored entities, insurance companies, and debt securities make up the other half). With such a large share of CRE debt held by banks and thrifts, “the potential weaknesses and risks associated with this sector have become top of mind for banking supervisors.” 

It is worth noting, as the paper shows, that banks’ exposure to CRE debt has grown enormously in the past decade, growing from about $1.2 trillion outstanding as of the first quarter of 2014 to about $3 trillion at the end of 2023. It is perhaps even more noteworthy that, as the paper notes, “a disproportionate share of this growth has occurred at regional and community banks, with roughly two-thirds of all CRE loans held by banks with assets under $100 billion.”

In other words, the health of the CRE market is of critical importance for the banking industry. As the author details in her paper, the CRE sector is currently “navigating several challenges.” The first of these challenges arises from the fact that much of the outstanding CRE debt will soon be maturing and will need to be re-financed at higher interest rates. The second is that these interest rate risks arise while certain market fundamentals continue to deteriorate.

With respect to the maturing debt, the author notes that roughly $1.7 trillion, or nearly 30% of the outstanding CRE debt “is expected to mature from 2024 to 2026.” This prospect is known as the “maturity wall.” The CRE sector has long relied on shorter-term debt durations, in expectation that the debt will be re-financed at maturity. During the many years that interest rates were low and stable, this arrangement made sense. However, in the current interest rate environment, borrowers looking to refinance maturing CRE debt “may face higher debt payments.” While higher debt obligations by themselves weigh on profitability, the weakening of the CRE market’s underlying fundamentals, especially for the office sector, “compounds the issue.”

The three underling fundamentals that are, according to the author, deteriorating are: net operating income (NOI); vacancy rates; and valuations.

The net operating income for the CRE market “has come under pressure of late, especially for office properties.” The office sector faces “not only cyclical headwinds from higher interest rates by also structural challenges from a reduction in office footprints as increased hybrid and remote work has reduced demand for office space.” Higher expenses as a result of sustained economic inflation have also raised operating costs. Overall, the author points out, “any erosion in NOI will have important implications for valuations” (about which see below).

Vacancy rates are obviously important as well, as higher vacancy rates indicate lower tenant demand, “which weighs on rental income and valuations.” U.S. office vacancy rates in the first quarter of 2024 reached 19%, surpassing previous highs reached during the Great Recession and the COVID-19 recession. The vacancy rate may even underestimate the overall level of vacant office space, as space that is leased but not being fully used runs the risk of turning into vacancies as leases expire.

As rates remain elevated, NOI declines, and vacancy rates rise, CRE valuations are under pressure. Because there have been relatively few transactions through early 2024, “price discovery” remains a challenge –meaning it is hard to gauge exactly how much valuations have declined. The reason there have been fewer transactions recently is that “building owners have delayed sales to avoid realizing losses.” By one measure the author cites, the office sector commercial property price index as of the first quarter of 2024 had decline 34% from its peak. The author suggests that “further pressure on valuations could occur as sales volumes return.”

The author concludes that the CRE market remains “a potential headwind for the U.S. economy in 2024,” as weakening fundamentals suggest “lower valuations and potential losses.” Stress in the CRE market is likely to “remain a key risk factor to watch in the near term as loans mature, building appraisals and sales resume, and price discovery occurs,” which will “determine the extent of losses for the market.”

Discussion

Some observers that follow the commercial real estate sector may say there is little new in the economist’s report, but I think the author deserves credit both for the concision of her summary and for marshaling key data to support her analysis and conclusions. The report, which is short, is worth reading in full.

The picture the author paints is indeed troubling. But notwithstanding the concerns, there are some things worth considering. For one thing, and for all of the gloom the author conjures up in her paper, there has still only been one failed bank so far in 2024, and here we are just weeks before the end of the year’s first half. To be sure, it could be that the real trouble is still ahead, as debts mature and as losses are realized. But in that regard, it is reassuring to note that, as the author observes, banks are now “increasing their allowances for loan losses on CRE portfolios,” and “stronger capital positions by U.S. banks provide added cushion against stress.” It is also probably worth noting that the author herself does not raise the specter of further possible bank failures ahead, but rather says only that there are key risk factors to watch in order to “determine the extent of losses for the market.”

There is one note in the author’s paper that is particularly troubling, and that is her observation that a “disproportionate share” of the growth in outstanding CRE debt during the past decade is concentrated at regional and community banks. The author specifically notes that CRE is a challenge to the banking sector overall, but that among banks with high CRE concentrations, “there is a potential for liquidity concerns and capital deterioration if and when losses materialize.”

The challenge that the CRE sector is facing is not helped by the fact that interest rate decreases, which many investors had assumed were on the calendar for later this year, likely will now be delayed. As long as interest rates remain elevated, the concerns surrounding the “maturity wall” will continue, with the likelihood that maturing debt will be rolled over at elevated interest rate levels – which will further weigh on landlords’ operating income and on valuations, which could contribute to and exacerbate losses.

One final note. All of these observations are disturbing enough by themselves, but they are even more alarming when the sheer size of the total CRE debt — $5.9 trillion — is taken into account, especially given that $1.7 trillion is due to mature during the 2024-2026 timeframe. That’s a lot of debt to roll over. It is also a lot of risk for creditors and lenders, particularly if interest rates continue to stay higher longer for longer.  

In numerous posts over the years (most recently here), I have noted that qui tam actions under the False Claims Act fit awkwardly with the typical D&O Insurance policy terms and conditions. Many of the related coverage problems arise from the fact that applicable procedures require a qui tam claimant to file his or her complaint under seal and to withhold service of process while the government decides whether or not it will intervene in the case. The upshot is that there sometimes can be a very long time lag between filing and service. This can make it challenging, for example, to determine when the claim was first made. It can also cause problems under the prior and pending litigation exclusion, as was the case in a recent bankruptcy-related proceeding.

As discussed below, the bankruptcy court judge granted a D&O insurer’s summary judgment motion, agreeing with the insurer that, by operation of the policy’s prior and pending litigation exclusion, coverage was precluded for a subsequent derivative suit that was based on the same operative facts as an earlier filed but not served qui tam lawsuit. As discussed below, as far as I am concerned, the upshot of this case (and other cases like it) is that the key policy terms should be modified so that the policy wording fits better with the qui tam procedures. A copy of the May 29, 2024, opinion in the Insys Therapeutics bankruptcy proceeding can be found here.

Background

In 2012, Insys Therapeutics, a pharmaceutical company, was sued in a qui tam action under the False Claims Act. The qui tam action was filed under seal and was dismissed before it was served on the directors and officers of Insys. At the time Insys purchased the D&O insurance at issue in the subsequent coverage action, the company was unaware of the existence of the qui tam action.

In 2016, the company’s directors and officers were sued in a shareholder derivative lawsuit. Both the qui tam action and the derivative action involved the same allegedly fraudulent scheme to market addictive opioid products. Insys submitted the derivative lawsuit to its D&O insurer as a claim under the policy. The insurer denied coverage for the claim in reliance on the policy’s Prior and Pending Litigation exclusion, which precluded coverage for actions “brought” prior to May 02, 2012. The insurer contended that the qui tam action, involving the same allegations, had been brought prior to May 02, 2013.

In 2019, Insys filed for bankruptcy. The trustee for the litigation trust in bankruptcy filed a coverage lawsuit in the bankruptcy proceeding seeking to recover defense expenses the estate had incurred in defending against the derivative suit. The insurer moved for summary judgment based on the Prior and Pending Litigation exclusion. The litigation trustee filed a cross-motion for summary judgment arguing first that the “unique procedural characteristics” of qui tam suits call for different treatment under the Prior and Pending Litigation exclusion, and second that the word “brought” in the exclusion is ambiguous in this context.

The Prior and Pending Litigation exclusion provides as follows:

In consideration of the premium charged, no coverage shall be available under this Policy for claims based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any fact circumstance, situation, transaction, event or wrongful act, underlying or alleged in any prior and/or pending litigation, or administrative or regulatory proceeding or arbitration was brought prior to May 02, 2013.

The May 29, 2024, Order

In a brief May 29, 2024, order, District of Delaware Bankruptcy Court Judge John T. Dorsey, applying Delaware law, granted the insurer’s motion for summary judgment, and denied the litigation trustee’s cross-motion, holding that coverage for the derivative suit defense fees was precluded by the policy’s Prior and Pending Litigation exclusion.

In reaching this conclusion, Judge Dorsey first rejected the litigation trustee’s argument that, in the context of a qui tam lawsuit, the word “brought” in the exclusion reasonably could be interpreted to mean both filed and served on the defendant. The court said that it is “commonly understood” that a litigation is “brought” when “a complaint is filed.” Delaware law, Judge Dorsey said, requires that insurance policies must be construed in a “common sense manner.” Accordingly, he found that under the Prior and Pending Litigation exclusion, litigation is “brought” when the complaint is filed with the court – which, in this case, was before the Prior and Pending Litigation date.

Judge Dorsey also rejected the litigation trustee’s argument that due to the “unique procedural characteristics” of the qui tam action, the action should be treated differently under the exclusion’s language. In so ruling, Judge Dorsey specifically cited and quoted with approval from the Pennsylvania Superior Court’s 2014 appellate opinion in the AmerisourceBergen Corp. case, in which a court held that a Prior and Pending litigation exclusion precluded coverage under an E&O policy for a subsequent claim based on similar facts as an earlier filed qui tam action. (I discussed the AmerisourceBergen decision at length in a blog post at the time, here.) Judge Dorsey concluded his analysis of this issue by saying that “Neither the arguments advanced by the Trustee, nor the relevant case law, indicate that the Qui Tam Action in this case should be treated any differently than other civil actions.”

Discussion

The litigation trustee may not have prevailed on the argument, but there is no doubt whatsoever that qui tam actions do indeed have “unique procedural characteristics.” And not only do qui tam actions have unique procedural characteristics, but these characteristics are such that over and over again they result in the preclusion of D&O insurance coverage for subsequent claims, owing to nothing other than the distinctive way that qui tam actions unfold.

 It may well be that, as Judge Dorsey said, under this policy and indeed under most conventional D&O insurance policies as written, there is no reason that qui tam actions should be treated differently than other civil actions. However, that does not mean that the policies themselves should not be written differently so as to treat qui tam actions differently and in a way that takes the unique procedural characteristics of qui tam actions into account.

There is one quick way to clean up this recurring problem involving qui tam actions, and that would be to amend the Prior and Pending Litigation exclusion to provide that for purposes of qui tam actions, the claim is “brought” (or “commenced” or whatever the operative word is in the exclusion) when the action is served, not when it is filed. Alternatively, the exclusion could be amended to specify that the exclusion does not apply to qui tam action complaints that were filed but not served before the prior litigation date.

For me, a particularly compelling solution here would be to line up the language between the Prior and Pending Litigation exclusion and the standard Definition of Claim, so that both require service of process. For me, this alternative has the appeal of having the policy’s various clauses operate consistently – as it is now, the inconsistency between the Prior and Pending Litigation exclusion, which does not require service of process, and the Definition of Claim, which does require service of process, is a jarring inconsistency that not only is dissonant but it produces harsh, unsatisfying outcomes like the one here.

As I said at the outset, qui tam actions fit awkwardly with the standard D&O insurance policy language. As an industry, we can just acknowledge that the standard policy language does not operate well in the context of qui tam actions, and that it is time to do something about it. I have proposed some possible solutions above. I hope that if others have suggestions they will add it to the dialog. The fact is this problem has been around for years. It should not be the case that there regularly are these situations where the D&O policy just doesn’t work well.

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

In recent months, much of the discussion of ESG issues has focused on the impact of the ESG backlash.  However, the predominance of the backlash movement in the current ESG discussion does not mean that interest in addressing ESG-related concerns has disappeared; in certain circles at least, ESG concerns remain on the agenda. The most interesting recent development along these lines is the May 9, 2024, issuance of a Request for Proposals (RFP) by the Michigan Department of Attorney General, in which the Department has solicited attorneys to act as Special Assistant Attorneys General (SAAG) to pursue climate change-related lawsuits against fossil fuel companies and others. The Department’s notice is reminder that for all of the noise surrounding the ESG backlash, the threat of ESG-related litigation is continuing.

Continue Reading Michigan AG Solicits Attorney Help for Climate Change Litigation

There is no doubt that, as I have previously noted on this site, the conversation about ESG has changed over time, particularly as ESG has faced a political backlash. These changes not only concern ESG itself but each of its three constituent pillars – and while ESG discussions frequently focus on the “E” pillar, and in particular on climate change, the changes in the ESG conversation also concern the “S” pillar as well. Of the recent changes surrounding the Social component of ESG, arguably none is more important that the U.S. Supreme Court’s 2023 decision in Students for Fair Admissions v. Harvard College, in which the Court ruled that race-based policies should not be used in university admissions. In a May 23, 2024, Law360 article entitled “The State of Play in DEI and ESG One Year After Harvard Ruling” (here), attorneys from the Crowell & Moring law firm review the ways that the Supreme Court’s decision in the Harvard case have changed the dialog surrounding Diversity, Equity and Inclusion (DEI) and ESG.

Continue Reading ESG, DEI, and the Supreme Court’s College Admissions Decision

One of the procedural innovations the PSLRA introduced was the requirement that plaintiffs’ counsel who file a securities class action lawsuit complaint must issue a press release announcing the complaint’s filing and notifying prospective class members of the opportunity to seek to become lead plaintiff. Plaintiffs’ lawyers quickly realized the potential publicity value for them from this exercise. Over time, related practices have developed, including the now commonplace practice in which plaintiffs’ lawyers issue a press release before they have filed a suit, announcing that they are “investigating potential claims.” While this practice is now familiar, it is still worth considering what the pre-suit communication tells us about the prospective lawsuit.

In a recent paper, four academics have examined this question; their article concludes that what the authors call “plaintiff’s attorney marketing” not only signals the likelihood of future litigation, but also may indicate severity of the litigation. The four authors are Steven E. Kaplan of Arizona State University, and Adi Masli, Matt Peterson, and Eric H. Weisbrod of the University of Kansas. Their article entitled “Corporate Ambulance Chasing? Plaintiff’s Attorney Marketing as a Signal of Corporate Litigation Risk,” can be found here. The authors’ May 23, 2024, post on The CLS Blue Sky Blog summarizing their article can be found here.

The authors evaluated a sample involving 4,500 public companies over the period from 2013-2020. The authors collected data on announcements (in the form of press releases and tweets) from the companies during the eight-year study period, in order to identify plaintiffs’ attorney investigation announcements. The authors examined a total of 167,357 investigation articles and 30,831 investigation tweets during the sample period.

Based on their analysis, the authors determined that overall, investigation announcements were “relatively rare,” occurring in only about 3 percent of company-months. But, the authors determined, when these announcements do occur, “subsequent litigation is much more likely.”

The authors determined that the “baseline probability” of a company in the sample getting sued in the next twelve months is about 18.7 percent. They further determined that in months in which an investigation tweet or press release appeared, the probability of future litigation jumps to 45 percent for investigation articles and 46 percent for investigation tweets. Moreover, the probability of future litigation continues to rise with greater numbers of press releases or tweets during the month. That is, not only does the presence of an investigation press release or tweet indicate an increased likelihood of future litigation, but the greater the number of press releases or tweets, the greater the likelihood of litigation.

The obvious objection to these observations is that of course companies that are the subject of the investigation press release or tweet are likelier to be sued, because obviously something happened to the company of sufficient importance to attract the plaintiffs’ lawyers’ attention. The authors themselves acknowledge that the marketing releases are often triggered by adverse corporate events, such as financial restatements, merger announcements, or signs of internal control weaknesses.

Based on their further analysis, the authors conclude that “even controlling for these potential triggers,” the plaintiffs’ lawyers’ marketing releases “remain incrementally informative about future litigation risk,” concluding further that “adding indicators for investigation articles and tweets to a litigation risk model increases the litigation risk model’s predictive power by 33 percent. The authors interpret these results as suggesting that “plaintiffs’ attorneys’ marketing efforts signal their judgment about a case’s potential viability.”

As a further test of these conclusions, the authors completed additional analysis with respect to financial restatement announcements, which the authors characterized as “a known trigger of shareholder lawsuits.” Even controlling for “restatement characteristics that speak to the potential merits of a case,” such as, for example, an indicated of fraud, the existence of plaintiffs’ attorney investigation articles or tweets in a three-day announcement window “remains strongly predictive of future litigation.”

The authors also considered the possibility that plaintiffs’ attorney marketing “may causally facilitate corporate litigation by connecting attorneys with potential plaintiffs.” The authors specifically found that due to an alteration in the algorithm that determines which tweets are displayed in a user’s Twitter feed, in which tweets most relevant to the user based on the user’s prior activity were displayed first, investigative tweets became incrementally more predictive of future litigation. The authors conjecture that this use of social media may have played a causal role in facilitating litigation by reducing the coordination costs between plaintiffs and law firms.

The authors acknowledge that courts and others have bemoaned that plaintiff marketing can “undermine regulations aimed at reducing frivolous lawsuits” and that some commentators go so far as to publicly label the attorneys putting out the press releases as “corporate ambulance chasers.”

However, whatever one may think of these marketing practices, the incorporation of plaintiff attorney marketing into litigation risk models “meaningfully increase(s) the predictive ability” of the model. Moreover, the authors conclude, the attorney marketing efforts are “not merely associated with the incidence of lawsuits but reflect value-relevant information about attorneys’ assessment of corporate liability.” The plaintiff’s attorneys’ marketing releases are “an informative, timely, and publicly available signal of the likelihood of corporate litigation, and, to a lesser extent, its potential severity.”

Discussion

On one level, it may be observed that the authors have merely concluded that when plaintiffs’ lawyers make a public statement that they have zeroed in on a specific company, it is likelier that the company is going to be sued. However, there is, in my view more to the authors’ analysis that this. For starters, the authors have quantified the probabilities, and demonstrated the general likelihood that companies that are the subject of one of these press releases are likelier to get sued.

Here is what I see as the value of these observations. Many times over the years I have found myself in conversation with management or counsel for a company that has been the subject of one of these attorney marketing press releases. My universal practice in these circumstances is to recommend that the company provide to its D&O insurer a notice of circumstances that may give rise to a claim. A surprisingly larger percentage of time, the company’s management or counsel will push back on the recommendation, usually on the ground that the prospective litigation would be frivolous or that the notice itself is just the product of ambulance chasers just trying to drum up business.

These kinds of observations may, at some level, be valid, but they don’t change the wisdom of providing a notice of circumstances to the company’s D&O insurers; as the authors’ analysis shows, a company that is the subject of an investigation press release is much likelier to get hit with a securities suit. Better for the company to conduct itself accordingly.

Another valuable observation in the authors’ paper is their conclusion these attorney marketing practices may serve a “causal role in facilitating litigation.” The authors’ analysis of this phenomenon was focused in particular with respect to the attorneys’ social media practices, but it is my observation that attorney marketing practices serve this role, whether the medium used is Twitter (or its current successor, X) or a more traditional press release.

The point is, the plaintiffs’ lawyers putting out the communication are trying to find plaintiffs to represent, preferably ones with a greater financial interest in the lawsuit who are therefore likelier to win the lead plaintiff derby. Indeed, the attorneys’ interest in using these communications to find clients to represent is so well understood that these kinds of attorney marketing efforts are universally referred to as “trolling press releases,” meaning that they attorney using the press release to troll for clients. While the reality of these practices are well-understood on a common sense basis, the authors’ research is helpful to identify, describe, and quantify these practices.

Long-time readers may recall that just a short time ago there was growing concern that New York’s courts might be becoming a preferred forum for aggrieved investors to pursue liability claims against non-U.S. companies’ executives, based on the companies’ home country laws. However, in early 2022, just as the alarm bells began to sound, New York courts issued a series of rulings dismissing various cases of this kind, suggesting that the furor might have been overblown. But even following these events, concern remained that New York’s courts might still prove to be available in at least certain circumstances for claims under home country law against non-U.S. companies and their executives.

A recent decision from a New York trial court, in which the court denied the defendants’ motion to dismiss a breach of fiduciary duty claim brought under Cayman law against former officers and directors of a Cayman company, confirms that, under some circumstances at least, New York courts may be an available forum for litigants to pursue these kinds of claims involving non-U.S. companies. The fact that the Court accepted the case, and the considerations that proved to be relevant to the court, are both instructive.

Continue Reading NY Court Keeps Cayman Law D&O Suit Involving a Cayman Company
Assen Koev

The resolution of many securities class action lawsuits would benefit from an economic assessment early in the case process. In the following guest post, Assen Koev argues in favor of a standardization of the initial economic assessment analysis as a way to provide the parties and concerned insurers with a clearer picture of the securities lawsuit at an earlier point in the case. Assen is an economic consultant and founder of SCA iPortal. A version of this article previously was published on Law360. I would like to thank Assen for allowing to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Assen’s article.

Continue Reading Guest Post: Standardizing Early Case Appraisal in Securities Class Actions

There is no doubt that ESG both as a concept and as a social, political, and litigation phenomenon has changed over time. Due to political backlash and changing investor priorities, ESG and ESG-related issues recently have featured less prominently in general economic and business dialog than even just a short time ago. An interesting and thought-provoking May 2, 2024, article (here) from the Rock Center for Corporate Governance asks the question whether the circumstances surrounding ESG are changing because ESG “is a luxury good”? (Hat Tip to Cydney Posner’s May 13, 2024, post on the Cooley law firm PubCo blog, here). The article raises some interesting questions and reflects interesting data and observations.

Continue Reading Is ESG a “Luxury Good”?
Brent Stevens

In the following guest post, Brent Stevens analyzes and summarizes the findings from the 2024 Claims Litigation Management Defense Counsel Study. Brent is a Senior Director at Consilio and leads Consilio’s Insurance Vertical, serving Consilio’s Insurance Industry clients, including carriers, brokers, and their law firms. I would like to thank Brent for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to the site’s readers. Please contact me directly if you would like to submit a guest post. Here is Brent’s article.

Continue Reading Guest Post: Navigating Key Insights from the 2024 CLM Study
Peter C. Fischer
Burkhard Fassbach

In the following guest post, Peter C. Fischer and Burkhard Fassbach explore the reasons why board members of German companies would be well-advised to negotiate a clause in their service agreements requiring their companies to procure D&O insurance, as well as the preferred terms and provisions that the D&O insurance should incorporate. Peter is a Professor of Law at the University of Applied Sciences Dusseldorf and Burkhard is a D&O lawyer in private practice in Germany. A version of this article in German previously was published in the law journal GWR. I would like to thank Burkhard and Peter for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.

Continue Reading Guest Post: The German D&O Procurement Clause Revisited