"Inadequate Consideration” Provision Bars Coverage for Securities Fraud Settlements

In a win for Wiley’s client, the United States District Court for the Eastern District of Wisconsin, applying Wisconsin law, has held that settlements of shareholder class actions alleging that the insured issued a misleading proxy report that induced its shareholders to accept inadequate consideration in an acquisition were not covered “Loss” under the insured company’s D&O policy due to a carve-out for settlements of “Inadequate Consideration Claims.”  Joy Global Inc. v. Columbia Cas. Co., 2021 WL 3667077 (E.D. Wis. Aug. 18, 2021).  The court rejected, as a “non-starter,” the insured’s argument that coverage should be available because the class actions could be read to allege liability arising from misrepresentations as well as from the inadequate share price because even those claims alleged that an inadequate share price had resulted.

After announcing a potential agreement to be acquired in 2016, the insured manufacturer of mining equipment was the target of numerous securities suits alleging that misrepresentations were made in the proxy statement presented to shareholders to approve the transaction.  All but one suit settled before the transaction closed.  The remaining suit was amended after the transaction closed to allege that the misleading proxy statement had induced the shareholders to approve the acquisition for inadequate consideration.  The final suit was eventually settled for $20 million, and the insured sought coverage from its D&O insurers.  The primary insurer agreed to reimburse defense costs but denied coverage for the settlements because the definition of covered “Loss” did not include “any amount of any judgment or settlement of any Inadequate Consideration Claim.”

The policy defined “Inadequate Consideration Claim” as “that part of any Claim alleging that the price or consideration paid … for the acquisition … of all or substantially all of … an entity is inadequate.”  The court found that “each cause of action within [all of] the [underlying] suits relied on … allegations of inadequate consideration” and therefore the entirety of each of the underlying suits were “part of [a] Claim alleging … inadequate consideration.”  Finding the policy language “clear and unambiguous, and its effect … not uncertain,” the court rejected the insured’s argument that it had a reasonable expectation of coverage.  The court determined that an insured’s reasonable expectations may not, under Wisconsin law, be based on an interpretation contrary to the plain effect of the policy language.  The insured argued further that an expectation of coverage was reasonable because the primary insurer was aware, when it renewed the policy at issue, of the pending acquisition and the related risk of shareholder suits challenging the transaction.  The court found that this further argument could not overcome the plain language of the policy.

The insured also argued that the settlement should be covered to the extent that it was not actually paid to the shareholders, but rather was awarded as plaintiffs’ attorneys’ fees, because the portion that did not reach the shareholders was no longer “part of” a “Claim” alleging “inadequate consideration.”  The court rejected this argument, finding that the policy language unambiguously required that “[o]nce a part of a claim alleging inadequate consideration is settled, the entire settlement is … not covered.”

The court next addressed Northrop Grumman Innovation Systems, Inc. v. Zurich American Insurance. Co., No. N18C-09-210, 2021 WL 347015 (Del. Super. Ct. Feb. 2, 2021), in which a Delaware trial court found similar policy language  to require that a suit allege only inadequate consideration and “nothing else” to fall outside coverage.  Because the underlying suit considered in Northrop had included allegations of misrepresentations by the directors in tandem with the allegations that the share price was too low, the Delaware court found the relevant carve-out from covered “Loss” to be inapplicable.  The Joy Global court found the Delaware court’s reasoning “unpersuasive” because the limitation that a claim must “only” allege inadequate consideration—and nothing else—to fall into the carve-out did not appear in the policy provision.  The Joy Global court observed that Wisconsin law did not permit it to rewrite unambiguous policy language.