Coverage for Stockholder Suits Not Barred By Prior Acts Exclusion or Bump-Up Provision

Judge Paul Wallace of the Delaware Superior Court has held that a bump-up provision did not operate to preclude coverage for a settlement of a Section 14(a) cause of action.  Northrop Grumman Innovation Sys., Inc. v. Zurich Am. Ins. Co., 2021 WL 347015 (Del. Super. Ct. Feb. 2, 2021).  The court also held that a prior acts exclusion contained in a different set of D&O policies did not preclude coverage for Section 10(b) claims asserted in the same lawsuit.

Two defense contracting firms agreed to enter into a self-described “merger,” in which one contractor merged into a subsidiary of the second contractor.  After the transaction, stockholders filed a class action, alleging violations of Sections 10(b) and 14(a) of the Securities Exchange Act of 1934.  One set of stockholders alleged that, following the merger, the firm violated Section 10(b) when its executives disseminated false data about the firm’s financial health to mislead stockholders regarding the value of their investments.  A second set of stockholders alleged that, prior to the merger, one of the firms violated Section 14(a) when its executives made false and misleading statements in proxy solicitation materials distributed before the merger.  These stockholders alleged that the misleading statements allegedly caused that firm to be overvalued and affected the stockholders’ ownership split, depriving the stockholders of their right to a “fully informed vote” and inducing the stockholders to vote and “accept inadequate consideration.”  The parties to the underlying case settled the claims for $108 million.

The policyholder sought coverage under three towers of D&O insurance—two runoff towers issued to the companies involved in the transaction, and one going-forward tower issued to the entity after the transaction was complete.

In the ensuing coverage litigation, the insurers on the going-forward tower argued, among other things, that a prior acts exclusion precluded coverage for the Section 10(b) cause of action because it was related to the Section 14(a) cause of action, which alleged wrongful acts that predated the policy period.  The exclusion barred coverage for “any Claim made against [the surviving entity and its management] occurring prior to February 9, 2015 . . . .  Loss arising out of the same or related Wrongful Act shall be deemed to arise from the first such same or related Wrongful Act.”  The insurers on one of the runoff towers argued that a bump-up provision applied to the Section 14(a) claim.  That provision provided that, in the event of a claim alleging inadequate consideration, there would be no coverage for “any amount of any judgment or settlement representing the amount by which such price is effectively increased[.]”  Finally, the insurers on the second runoff tower argued that the law of the insured’s principal place of business, and not the law of the insured’s state of incorporation, governed interpretation of the policies, and that notice was late as a matter of law under that state’s common law.

The court rejected the insurers’ arguments.  First, the court held that the prior acts exclusion did not bar coverage for the Section 10(b) claim.  The court reasoned that the Section 10(b) and 14(a) claims were not related because the Section 14(a) claim was brought against personnel of the merging firms in their capacities as executives of those firms, not of the surviving entity, and alleged wrongful acts that occurred before the surviving entity was created.  The court further determined that the claims were not “fundamentally identical” so as to satisfy that purported Delaware law requirement for application of the exclusion.

Second, the court held that the bump-up provision did not bar coverage for the Section 14(a) claim under the first runoff tower.  Among other things, the court determined that the settlement of the Section 14(a) claim was not “solely” about an “unfair equity exchange,” and therefore did not effectively increase the merger consideration.  The court also determined that the provision barred coverage only for a “transaction which can only be called an ‘acquisition,’” and not a transaction that merely “involved” an acquisition.

Finally, the court held that the law of the insured’s state of incorporation, and not the law of the insured’s principal place of business, governed interpretation of the policies issued on the second runoff tower.  The court held that an issue of fact remained as to whether those insurers were “prejudiced” by the insured’s late notice under the law of the insured’s state of incorporation.