A frequent component of derivative litigation resolution
is an award to the plaintiffs of the fees and expenses the plaintiffs incurred
in pursuing the suit. A contentious, recurring question is whether D&O
insurance covers fee awards to derivative litigation plaintiffs. This issue
received a through going over in a February 17, 2011 opinion from a five judge
panel of the New York Supreme Court, Appellate Division.
In the opinion (here), a
three-judge majority held, over the dissent of two judges, that a $8.8 million
derivative plaintiffs' fee award was covered under Loral Space &
Communications D&O insurance policy, but all five judges held unanimously
that the D&O policy did not cover the separate $10.7 million awarded for
plaintiffs' fees in a related action seeking damages for breach of fiduciary
The coverage suit arises out of litigation filed after
Loral agreed to enter a financing transaction with MHR Fund Management. In the
transaction, MHR agreed to provide Loral $300 million in exchange for
convertible preferred stock Loral was to issue to MHR.
Two lawsuits ensure. First, a BlackRock fund filed a
shareholders' derivative action seeking to rescind the deal. Second, Highland
Crusader Offshore Partners filed a damages action. Both actions alleged Loral
had breached its fiduciary duty because the value to MHR of the proposed deal
allegedly far exceeded $300 million.
The cases were consolidated. Following a trial, the
Delaware Chancery Court concluded that the transaction was unfair to Loral, and
reformed the deal terms so that MHR would receive nonvoting common stock rather
than convertible preferred stock. The court awarded no damages and made no
findings of fault.
Concluding that the plaintiffs' actions had produced a
substantial benefit for Loral, and applying the corporate benefit doctrine, the
Court entered a fee award to BlackRock of $8.8 million and entered a fee award
to Highland of $10.7 million. Loral paid these amounts and then sought coverage
under its D&O insurance policy for the payments.
Loral's D&O insurer denied coverage and commenced an
action seeking a judicial declaration that their policy did not cover the
plaintiffs' attorneys' fee awards. The trial court denied the insurer's motion
for summary judgment and granted summary judgment in Loral's favor. The
The February 18 Order
On appeal, the insurers argued that the Highland fee
award was not covered because the Highland action for damages was not a
"securities claim" and therefore there was no coverage under the
policy for any amount related to that action. The insurers argued that the
BlackRock fee award was not covered because the BlackRock litigation produced a
benefit for Loral and therefore the fee award did not represent covered
"Loss since it was a cost the company incurred as part of procuring the
The five-judge panel unanimously agreed that there was no
coverage for the $10.7 million Highland fee award, because the Highland damages
action was neither a derivative suit nor did it allege violation of any
securities law, and therefore it did not represent a securities claim as was
required to bring the claim within the Policy's coverage.
The panel split badly on the question whether or not the
fee award in the BlackRock derivative action was covered under the D&O
policy. The three-judge majority concluded that it was. Its reasoning turned it
part on the policy's definition of "Loss," which provides that
"Loss" includes "damages, judgments, settlements or other
amounts (including punitive or exemplary damages where insurable by law) and
Defense Expenses in excess of the Retention that the Insured is legally
obligated to pay."
The majority rejected the insurers' argument that because
the derivative suit produced a benefit for Loral, Loral had not suffered a
"Loss." The majority perceived this argument as essentially a
suggestion that the fee award should be offset against the nonmonetary benefit
Loral received as a result of the restructured transaction. The majority found
that while Loral received a benefit in that it no longer suffered the detriment
that would have followed from the transaction as originally structured "it
does not follow that Loral actually made a tangible profit."
The attorneys' fee award, the majority found,
"constitutes damages" and representing "other amounts" that
Loral has become "legally obligated to pay" and therefore comes
within the Policy's definition of "Loss." The majority also noted
that the Policy expressly covers derivative lawsuits and that "to declare
that Loral has no coverage for derivative plaintiffs' attorneys' fees would
deprive Loral of the coverage for derivative lawsuits that it paid for and
expected to receive."
The dissent objected to the majority's conclusion about
the derivative fee award. First, the dissent argued that the "legally
obligated to pay" language in the definition of Loss followed and referred
to "the Retention," not to "other amounts."
The dissent also argued that in order for the derivative
fee award to be covered, it would have to represent "an actual loss, not
an expense or the cost of doing business." The dissent reasoned that in
this case, Loral "did not sustain a loss but rather benefitted from the
A fee award a derivative suit, the dissent observed,
represents "the equitable entitlement of the successful derivative
plaintiff to recover the expenses of his/her attorneys' fees from all the
shareholders of the corporation on whose behalf the suit was brought." The
dissent observed that "if not spreading the cost of attorneys' fees sounds
in unjust enrichment, the obvious corollary is that shifting the cost to
shareholders as a group cannot be characterized as a loss."
The insurers in this case did not come away empty, as the
appellate court unanimously agreed that because there was no coverage under the
policy for the Highland damages claim, the $10.7 million Highland fee award was
not covered under the Policy.
This holding was not preordained as at least one court
has recently held that a fee award can represents damage for which there can be
coverage under a D&O policy even if there is no coverage under the policy
for the underlying litigation. In a February 9, 2010 ruling (here), the District
of Minnesota held that a derivative lawsuit fee award represented
"damages" and could be covered under a D&O insurance policy even
where the underlying claim itself was not covered under the policy.
With respect to the question of coverage for the
BlackRock derivative fee award, the insurers did manage to persuade two of
three judges that because of the nature of the outcome of the underlying case
and the nature of the derivative fee award, the award did not represent a loss
to Loral and therefore is not covered under the policy.
The narrowness of split between the majority and the
dissent on this issue suggests that this dispute is far from resolved. Even
just in this case, there seems a substantial likelihood for further appellate
proceedings in the New York Court of Appeals. And in general, given the close
split, the underlying issue is likely to continue to be debated in other cases.
The carriers assert their position on these
issues with conviction. Policyholders find the insurers' rationale on this
issue obscure and unpersuasive (those are among the milder adjectives,
actually) - although obviously the insurers were able to persuade two judges of
the appellate court of their position, so clearly there is something to their
position on this issue.
The danger for all involved is that this issue will
continue to come up over and over again. A colleague in the industry suggested
to me in a note about the Loral case that eventually this issue may have to be
addressed in the policy, along the lines of the way the industry developed a
policy solution to the contentious issue that Section 11 settlements were not
covered under the Policy. The way the industry addressed that issue is that it
became standard to include in public company D&O policies language stating
that the insurer would not take the position that a settlement of a '33 Act
case was not covered under the Policy. Perhaps, the colleague suggested, the
industry will adopt a similar approach on this derivative lawsuit fee award
I am interested in readers' thoughts on these issues. I
hope readers will add their observations to this post, using the blog's comment
Many thanks to the several readers who sent me a copy of
the Loral decision.
I am Word Power: In
a column in the February 28, 2011 issue of The New Yorker entitled "Who Am
Demetri Martin wrote "I am bravery. I am courage. I am valor. I am
daring. I am holding a thesaurus."
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
more information about LexisNexis products and solutions connect with us
through our corporate site.