United States: Delaware Court Adopts Pillsbury Theory That Shareholder Appraisal Actions Are Covered Securities Claims Under D&O Policies

Last Updated: September 30 2019
Article by Peter M. Gillon

Pillsbury secured an important victory for its client, Solera Holdings Inc., when Delaware Superior Court Judge Abigail LeGrow held—in a matter of first impression anywhere in the country—that a shareholder appraisal action challenging the price Solera obtained for its shares when it sold itself to private equity firm Vista Equity Partners was a "Securities Claim" within the meaning of Solera's directors and officers liability insurance policies. Last month's groundbreaking decision in Solera Holdings, Inc. v. XL Specialty Ins. Co., may be found here.

Solera sued its D&O insurers, seeking reimbursement for approximately $12 million in defense costs and $38 million in interest incurred in the appraisal proceeding. Solera's primary carrier, XL Specialty, settled, leaving a claim of approximately $39 million against the excess D&O carriers. The excess carriers sought summary judgment on three defenses, which the court addressed in three parts of the decision. This blog post focuses on the first of the court's rulings, denying summary judgment and holding as a matter of law that the Delaware appraisal action against Solera is covered as a Securities Claim within the meaning of the policies.

The carriers' principal argument was that they are not obligated to cover Solera's losses because an appraisal action is not a "Securities Claim" as defined in the primary policy. Public company D&O policies generally insure the company for its losses for "Securities Claims" only. The operative definition of "Securities Claims" broadly covered claims for a "violation" of any federal, state or local statute, regulation, rule, or common law regulating securities. The carriers did not contest that an appraisal action involves a state statute regulating securities but instead argued that there was no allegation of a "violation" of such laws. They insisted that the term "violation" implied that the policy required some allegation of wrongdoing on the part of the insured. Solera responded, and the court agreed, that the term "violation" does not require an allegation of wrongdoing; rather, it is satisfied by the allegation that Solera failed to meet its statutory obligation to its shareholders to secure "fair value" for their shares.

In ruling for Solera, the court explained:

[T]he Appraisal Action is a Securities Claim under the Policy because the appraisal petition necessarily alleges the violation of law or rule. Under Delaware law, shareholders have the right to receive "fair value" for their shares when they are cashed out of their positions through certain types of mergers or consolidations. By its very nature, a demand for appraisal is an allegation that the company contravened that right by not paying shareholders the fair value to which they are entitled. This interpretation corresponds with the general understanding that a "violation" is "the contravention of a right or duty" or a "breach of the law." Accordingly, the Appraisal Action is a claim against Solera for a violation of law and therefore is a Securities Claim under the Policy.)

The court based its analysis on an application of the "ordinary and usual meaning" of the policy language, concluding that "the Policy's language is unambiguous." The policy did not define the term "violation," and so the court accepted Solera's suggestion to apply the Black's Law Dictionary definition, which includes "the contravention of a legal right or duty." Nowhere in the policy language was there any requirement to prove wrongdoing or a legal state of mind to meet the definition of "violation." The court agreed with Solera's argument that this construction of the term comports with the reality that many indisputably covered Securities Claims, such as Section 11 claims, impose strict liability on issuers "without any showing of scienter or wrongdoing," and the same is true for claims based on the Responsible Corporate Officer doctrine, respondeat superior, and Blue Sky laws.

In assessing this ruling, insurers and their counsel may be inclined to view the court's decision as unfairly stretching the scope of their intended coverage in favor of policyholders. In this regard, it is worth considering that the court did not deem it necessary to address the second branch of Solera's argument on the "Securities Claim"/violation issue. As Solera explained, recent decisions by the Delaware Supreme Court reviewing appraisal decisions by the Chancery Court, including Dell, DFC and Aruba, made it clear that the Chancery Courts should adhere to the "deal price" negotiated by the policyholder if the sales process is fair. But conversely, if there is evidence of collusion, self-dealing, a rigged sales process, or if there is any other evidence that the alleged failure to obtain an accurate price for the company's shares was the result of a defective sales process, then the court may ignore the deal price and look at discounted cash flow and other factors. That was exactly what the petitioners alleged against Solera and attempted to prove at the appraisal trial. If she had addressed this second argument, Judge LeGrow would have had to consider the entirety of the record in the underlying dispute, including the extensive allegations of wrongdoing by Solera's executives. In that case, there would be no doubt that the petitioners alleged "wrongful" conduct by Solera sufficient to meet even the carriers' narrow construction of the term "violation." Having determined that Delaware appraisal proceedings inherently allege a "violation" of the obligation to obtain "fair value" for the petitioners' shares, the court did not find it necessary to reach this second argument.

Likewise, the court noted that it did not address one argument the carriers did not make (for the obvious reason that it was a weaker point): that an appraisal claim does not allege a "Wrongful Act" within the meaning of the policy's insuring agreement. The term "Wrongful Act" is a defined term under most D&O policies, and as was the case with XL's policy, includes "any actual or alleged act, error, omission" by the Insured. Courts have taken a plain meaning approach in interpreting the definition literally to include any "act," regardless of fault. For the very reason the court in Solera held that the term "violation" did not impose any requirement of culpability or wrongdoing—because appraisal actions are essentially like any other securities actions, inherently asserting the breach of a duty to shareholders—it likely would have held that appraisal claims meet the definition of an alleged "Wrongful Act" if the issue had been presented. Commenters from the insurance company side of the bar appear to agree with this assessment.

In a future blog post, we will address the Solera court's second and third rulings: (a) that $38.3 million in statutory interest awarded to petitioners is covered "Loss," even though there were no damages awarded to petitioners because Solera prevailed in the appraisal action; and (b) that there must be evidence of material prejudice to the carriers in order for them to avoid coverage for the defense costs incurred by Solera without the carriers' prior "consent" to the selection of counsel.

The key takeaway from the court's holding on the "Securities Claim" issue, though, is this: merger appraisal lawsuits fall within the scope of D&O insurance, so if your company is facing appraisal demands from dissenting shareholders, it would be wise to consult with coverage counsel about reporting the claim, and not to accept a denial at face value.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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