D&O Insurance: Liberalization Endorsement Allows Insureds to Rely on New Policy Form’s Enhanced Insured vs. Insured Exclusion Carve-Back

D&O Insurance: Liberalization Endorsement Allows Insureds to Rely on New Policy Form’s Enhanced Insured vs. Insured Exclusion Carve-Back

 On June 19, 2014, in a case involving so many unusual coverage issues that it seems more like a law school exam question than an actual coverage dispute, New York (New York County) Supreme Court Judge Melvin Schweitzer, applying New York law, granted summary judgment for the former directors of the bankrupt Lyondell Chemical Company who sought coverage from their company’s excess D&O insurers for their costs of defending themselves in an adversary action in the bankruptcy proceeding.

The follow-form excess insurers had denied coverage for the defense fees based on the primary policy’s Insured vs. Insured exclusion. The directors argued they were entitled to have their defense expenses paid based on a coverage carve-back in the exclusion – not a carve-back to the exclusion in the primary policy, but rather a carve-back to the exclusion in a new policy form the primary insurer had launched eighteen months after the expiration of the initial primary policy. In reliance on the Liberalization Endorsement in the primary policy, the directors argued that the language in the new policy form governed, rather than the language in the primary policy that had been issued to Lyondell. Judge Schweitzer agreed with the directors and concluded that the enhanced wording in the new policy form did not preclude coverage for the directors’ defense costs.

Background 

In December 2007, Basell AF S.C.A. acquired Lyondell Chemical Company and the combined companies became known as Lyondell-Basel Industries. In August 2007, prior to the merger, a shareholder filed an action in Delaware Chancery Court against the Lyondell board (the Ryan Litigation) alleging that the directors had breached their fiduciary duties because the merger consideration was “grossly insufficient.” (Judge Schweitzer’s opinion in the coverage lawsuit does not mention the outcome of the Ryan Lawsuit.)

The merged company went bankrupt in January 2009. Later in 2009, a creditors committee filed an adversary lawsuit in the bankruptcy proceeding (the Adversary Proceeding) against the former directors of Lyondell, alleging that the financing for the merger transaction had over-leveraged the company and forced it into bankruptcy. The creditors committee assigned the Adversary Proceeding to a litigation trust, which continued to pursue the Adversary Proceeding against the former directors.

The directors sought to have their costs of defending the Adversary Proceeding paid by Lyondell’s D&O insurers. For purposes of this coverage dispute, there are two relevant insurance programs, each arranged with a primary insurance policy and several layers of excess insurance. The policy period of the two towers were, respectively, 2006-2007 and 2007-2013. The primary carrier paid its full policy limit in payment of defense costs (Judge Schweitzer’s opinion does not say under which policy the primary carrier paid these costs). The directors sought to have the excess insurers pay  their continuing costs of litigation defense. The excess insurers’ policies provided follow form coverage, meaning that the terms and conditions of the primary policy determined whether or not there was coverage under the excess policies

The excess insurers denied coverage in reliance on the Insured vs. Insured exclusion in the primary policies and filed an action in New York state court seeking a judicial declaration that there was no coverage under their policies. The parties cross-moved for summary judgment.

Both the 2006-2007 primary policy and the 2007-2013 primary policy contain an exclusion (the Insured vs. Insured exclusion) precluding coverage for Loss arising from a claim “brought or maintained by or on behalf of the Company.”  The excess carriers contended that this exclusion precluded coverage for the directors’ defense expenses. 

Both the 2006-2007 primary policy and the 2007-2013 primary policy contained a Liberalization Endorsement, which provides that if the primary carrier issues a new policy form or a new standard endorsement then “the Company shall have the right to such new policy or such new coverage enhancement endorsement,” except that “any existing claims will be controlled by the existing policy form the claim was reported under.”

In April 2009, the primary carrier launched a new standard endorsement form (the Select Form). The Select Form provides a broad bankruptcy exception to the Insured vs. Insured Exclusion. The exception to the exclusion preserves coverage for Loss arising out of a claim “brought or maintained by or on behalf of a bankruptcy or insolvency trustee, examiner, receiver, similar official or creditors committee for such company, or assignee of such trustee, examiner, receiver or similar official or creditors committee.” The directors contended that by operation of the Liberalization Endorsement in the primary policies, this coverage carve back in the Insured vs. Insured exclusion in the Select Form controlled the question of coverage and preserved coverage for their defense expenses.

Both the 2006-2007 primary policy and the 2007-2013 primary policy include an Interrelated Wrongful Acts Provision, which stated that “all Loss arising out of the same Wrongful Acts and Interrelated Wrongful Acts of Insured Persons shall be deemed one Loss, and each Loss shall be deemed to have originated in the earliest Policy Period in which a Claim is first made against an Insured Person alleging any such Wrongful Act or Interrelated Wrongful Act.” Both of the primary policies defined the term “Interrelated Wrongful Acts to mean “all Wrongful Acts that have as a common nexus any fact, circumstance, situation, event, cause or series of causally connected facts, circumstances, situations, events, transactions or causes.”

The Court’s Opinion

The Court granted summary judgment for the directors based on its determination that by operation of the Liberalization Endorsement in the primary policies the enhanced bankruptcy coverage carve-back in the Select Form applied to preserve coverage for the directors’ defense expenses.

The insurers had tried to argue that the language in the Select Form did not apply because the Liberalization Endorsement specifies that it does not apply the language in new forms to “existing claims.” The carriers argued that because the Ryan Litigation and the Adversary Proceeding both alleged wrongdoing against the directors in connection with the Basell merger, the two claims were interrelated and therefore that they constitute one claim that was an “existing claim” at the time the Select Form was launched.

The Court rejected this argument, noting that the Interrelated Wrongful Act provision in the primary policy referred to “Loss,” not “Claims,” and provided only that all Loss from Interrelated Claims is “treated as ‘one Loss,’ triggering only one set of policy limits instead of two. It does not affect the separateness of the Claims.” The Court noted that the provision’s reference to “Loss” rather than to “Claims” differed from language found in Interrelated Wrongful Act provisions found in other D&O insurance policies. The language in the primary policies “treat related claims as ‘one Loss,’ not ‘one Claim,’” and therefore “although the Ryan Litigation and the Adversary Proceeding may be Interrelated Wrongful Acts, and therefore one Loss, they remain separate claims commenced on separate dates.”

The Court also said it didn’t matter that the Select Form had not been launched until 18 months after the end of the 2007-2007 policy period because (by contrast to language found in Liberalization Endorsement in other policies) “there is nothing in the plain language of the Liberalization Endorsement that prohibits liberalization by a form announced after the expiration of the policy period.”

Finally, the Court rejected the arguments of one of the excess carriers whose 2006-2007 policy did not include a liberalization provision. This excess carrier argued that because the Adversary Proceeding was Interrelated with the Ryan Litigation, the Adversary Proceeding would be deemed made in the 2006-2007 policy period in which its policy had no Liberalization Endorsement, and therefore that the enhanced wording in the Select Form did not apply to preserve coverage under its policy. The insurer argued that the two lawsuits were interrelated because they both related to the merger transaction.

The Court said “such a broad reading of Interrelated Wrongful Acts would encompass any Claim that is connected to the merger.” The Court found that in fact the two cases were “fundamentally inconsistent” with each other, that in the Adversary Proceeding the claimants alleged that the company had overleveraged itself to complete the transaction whereas the claimant in the Ryan litigation alleged that the company was getting inadequate consideration.

Discussion 

The outcome of this case depended on a couple of unusual features of the primary policy. Whereas the Interrelated Wrongful Acts provision in most policies provide for the interrelatedness of “Claims,” the Interrelated Wrongful Acts provision in these policies referred to and defined the interrelatedness of “Loss.” By the same token, again by contrast to the provisions found in many other D&O insurance policies, the Liberalization Endorsement in the primary policies had no time limitation on its applicability, and so the enhancements in a new policy form apply to the primary policy regardless of when the new form is released, even if it is released after the policy period of the policy.

The case does involve the rather unusual circumstances that a policy’s Liberalization Endorsement operated to define the availability of coverage. It is fairly standard for D&O insurance policies to include a Liberalization Endorsement, but at least in my experience it is relatively rare for the Liberalization Endorsement to actually affect the coverage analysis.  (Perhaps one reason it is relatively unusual for the Endorsement to be relevant is that most policies’ Endorsements, unlike the Endorsement here, specify that the liberalization applies only to new policy forms introduced during the policy period.) This case does underscore how the Liberalization Endorsement could be important for maximizing the availability of insurance for policyholders.

The purpose of a Liberalization Endorsement is to make sure that if the insurer launches a new form after it has issued a policy to a policyholder that the policyholder gets to the benefit of any coverage enhancements in the new form. It operates as a kind of fairness mechanism, by ensuring that the policyholder doesn’t have to do without the enhancement just because its policy was issued before the new form came out. It is fair to the insurer too, since the insurer is willing to offer the enhancement at all, it ought to provide the enhancement to present policyholders as well as future policyholders. This element of fairness to the insurer breaks down a little bit in this case, since the excess insurers that are being forced to honor the provisions of the new policy form are not the ones that issued the new policy form. Basically, by operation of the Liberalization Endorsement, the excess insurers must provide coverage for defense expenses that arguably would not have been covered under their policies, because the primary insurer – that wasn’t even a party to this coverage action – issued a new policy form after the excess insurers had agreed to provide follow form excess over the primary insurer’s former policy. The excess insurers may feel aggrieved by this, but they did agree to provide excess insurance over a primary policy that contained a Liberalization Endorsement, so there was always the risk that something like this might happen.

The case also highlights the importance of the wording of the bankruptcy carve-back in the Insured vs. Insured exclusion. Several specific features of the carve-back in the Select Form proved to be particularly important here. The carve-back preserved coverage for claims “brought or maintained” by the “creditors committee.” Not all carve-backs expressly refer to the “creditors committee.” Also the carve-back language in the Select form also referred to “any assignee of such trustee, examiner, receiver, or similar official or creditors committee.” Not all carve-backs expressly refer to an “assignee.” This reference was important here because the initial claimant against the Lyondell directors, the creditors committee, had assigned its claim to a litigation trust that continued to pursue the claim. Practitioners may want to note these coverage features and take them into account when reviewing policy wordings.

This case does present yet another instance of the elusiveness of Interrelated Wrongful Act provision interpretations. As I have noted before, the cases interpreting these provisions are all over the map. In my view, the Court’s conclusion on the interrelatedness question here is less than satisfying. Judge Schweitzer held that even though the Ryan Litigation and the Adversary Proceeding both related to alleged wrongful conduct by the directors in connection with the merger, the two claims were not related because in the Ryan Litigation the allegation was that the merger price was too low and in the Adversary Proceeding the directors had bankrupted the company by paying too much.

However, the definition of the term Interrelated Wrongful Acts in the primary policy refers only to “all Wrongful Acts that have as a common nexus any fact, situation, event, [or] transaction.” The definition does not add an additional requirement that the various Wrongful Acts must involve the same theory of wrongdoing or theory damages. The definition only requires that the various Wrongful Facts have a “common nexus” of “any transaction.”

Judge Schweitzer rejected the idea that because the two lawsuits related to the merger that they were interrelated because, he said, that would mean that any claim related to the merger would be interrelated. To which I say, well, yes, if the definition says that alleged wrongful acts that have as a common nexus any transaction are interrelated wrongful acts, then any wrongful acts related to the merger (which is, after all, a transaction) are interrelated.

I don’t know what the problem is with the interrelatedness question. It is not just the cases are all over the map, it is that so often courts’ analyses of interrelatedness issues are so unsatisfying.  (For a recent post in which I discuss another court’s unsatisfying interpretation of interrelatedness issues, refer here.)

There are also some details in the opinion that seem incomplete or that don’t add up. First, to me, it matters under which policy the primary insurer paid out its limit, as that will determine whether or not the underlying insurance has been exhausted.

Second, if the excess insurer paid its limit out under the 2006-2007 policy, it would likely have done so because it concluded that the Adversary Proceeding was interrelated to the Ryan Litigation. That seems like a relevant detail to me.

Third, Judge Schweitzer didn’t decide under which of the two programs the excess insurers’ obligations to pay defense expenses arose. That seems like an important detail to me. But instead, he prefaced his conclusion that the carve-back in the Liberalization Endorsement controlled the determination of the coverage issue by saying “Regardless of which policy (2006-2007 or 2007-2013) applies to the Adversary Proceeding, the Select Form’s terms apply.”

Fourth, I am confused by Judge Schweitzer’s conclusion that the Ryan Litigation and the Adversary Proceeding are not interrelated. In light of his earlier comments about the Interrelated Wrongful Acts provision in the primary policy, does his conclusion that the two lawsuits are not interrelated mean that the represent two losses rather than a single loss? That would seem to imply that each of the two insurance programs was triggered — the first by the Ryan Litigation and the second by the Adversary Proceeding.

As a final comment, I note that that this is yet another instance where insureds were forced to litigate with their excess insurers after the primary insurer had paid its limits in full. As I have noted elsewhere, the whole point of follow form excess insurance is so that every layer in the insurance program responds the same way to the same set of losses.

When the different insurers on the different layers of an insurance program respond differently to the same set of circumstances, the intent of the insurance acquisition process is frustrated. More to the point, no insured expects to have to fight their way through the various layers of the insurance program. The prospect of compulsory separate fights with separate carriers represents an undesirable burden and vexation for the policyholder – a burden that all too many insureds must face as fights with excess insurers become all too common. (For more on this theme, refer here.)

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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