Under “Law Most Favorable” Provision, Delaware Law Applies and Does Not Prohibit Coverage for Settlement of Alleged Ill-Gotten Gains

Upholding a “law most favorable” provision with respect to the insurability of ill-gotten gains, the Delaware Superior Court has concluded that Delaware law, rather than New York law, applies to a coverage dispute regarding coverage for settlement amounts allegedly constituting ill-gotten gains. Sycamore Partners Mgmt., L.P. v. Endurance Am. Ins. Co., 2021 WL 761639 (Del. Super. Ct. Feb. 26, 2021). Because such amounts are insurable as a matter of Delaware public policy, the amounts at issue constituted covered Loss.

Three Delaware-organized private equity firms and their managers were sued by a corporation’s bankruptcy estate, alleging that the firms acquired the bankrupt company, raided its high-performing assets, and left the remainder of the company as an overly leveraged shell. The estate asserted claims for fraudulent conveyance, breach of fiduciary duty and related business torts. The parties ultimately settled.

The firms sought coverage for the settlement under a fiduciary liability insurance program providing both D&O and E&O coverage. After the insurers denied coverage, the firms filed suit in Delaware, seeking a declaration that the settlement constituted covered “Loss” under the policies. In response, the insurers asserted certain affirmative defenses, including a defense that the settlement was uninsurable as a matter of public policy because it represented disgorgement of, or restitution for, ill-gotten gains.

The firms moved for judgment on the pleadings on the “uninsurability defense,” asserting that with respect to the insurability of ill-gotten gains, the policies expressly allowed for the application of the “law most favorable . . . to insurability.” The firms asserted that Delaware law and public policy, rather than New York law and public policy, should apply, because Delaware law is more favorable to the insurability of such Loss. The firms asserted that because Delaware law and public policy permit the insurability of disgorgement and ill-gotten gains, the settlement amounts constituted covered Loss.

In response, the insurers asserted that New York law, which prohibits coverage of disgorgement and ill-gotten gains as a matter of public policy, should apply to the dispute rather than Delaware law. The insurers argued that the “law most favorable” provision is not a choice of law provision, and, even if construed as a choice of law provision, the clause should be invalidated as unreasonable under the Restatement (Second) Conflict of Laws § 187(2)(b), which required the insurers to show that but for the choice of law provision, New York law would apply under a traditional conflict of law analysis, rather than Delaware law.

The trial court granted the firms’ motion with respect to the “uninsurability defense,” finding the “law most favorable provision” valid and enforceable. Because the provision was enforceable, the firms had discretion within reason to select a forum for determining whether a Loss is uninsurable. The trial court further rejected the insurers’ claims that the application of Delaware law would be unreasonable and that New York law would apply under a traditional choice of law analysis. The court noted that Delaware takes a superseding interest in coverage disputes for fiduciary management claims of Delaware organizations, despite the fact that the firms were headquartered in New York, the policies were issued and brokered in New York, and the underlying misconduct and resulting litigation occurred in New York.