Uptick in Shareholder Derivative Lawsuits Challenging Large M&A Deals Calls for Greater Attention to D&O Insurance

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James R. Murray and Jared Zola  

James R. Murray is the professional development leader of Dickstein Shapiro LLP's Insurance Coverage Group, the leader of its Bankruptcy Insurance Practice, a member of the firm's Executive Committee, and is based in the firm's Washington office. Jared Zola is the northeast regional leader for Dickstein Shapiro's Insurance Coverage Group and is based in the firm's New York and Stamford offices. He also leads the group's Property & Business Interruption Practice.  

Recent trends highlight that shareholder derivative litigants will frequently challenge large merger, acquisition or going-private transactions involving a public corporation. On average, five shareholder derivative lawsuits are filed per transaction and dozens challenge the largest deals.

In 2013, shareholders challenged 94 percent of all mergers and acquisitions (M&A) transactions with a value greater than $100 million involving U.S. public corporation targets; the fourth consecutive year in which shareholders filed lawsuits challenging more than 90 percent of M&A deals valued over $100 million.1 Every one of 2013's top ten deals are valued at more than $10 billion, including: $130 billion deal in which Verizon Communications Inc. bought out Verizon Wireless stake from Vodafone Group Plc; $23 billion deal in which Berkshire Hathaway Inc. and private equity firm 3G Capital Partners, Ltd. bought H.J. Heinz Co.; $25 billion deal in which Michael Dell and private equity firm Silverlake bought Dell Inc.; $17 billion deal in which Comcast Corp. bought NBCUniversal Media from General Electric.2 These deals spawned significant shareholder derivative lawsuits. For example, on Feb. 5, 2013 Dell announced that it entered into a definitive merger agreement and by March 8, 2013, shareholders already filed 21 lawsuits in Delaware Court of Chancery, and three more in Texas state court.3 In total, Dell shareholders filed 26 lawsuits challenging the mega-deal in 2013.

To protect against losses incurred addressing shareholder complaints arising in connection with a proposed M&A transactions or any other of alleged wrongful conduct, corporations purchase directors and officers (“D&O”) liability insurance coverage. Addressing disgruntled shareholders' demands to remedy alleged damages done to the corporation by purportedly wayward directors and officers entering into corporate transactions are frequently expensive processes. Analogous to the increased number of shareholder derivative lawsuits relative to the deal's size, the size of a corporation's loss paid responding to shareholder derivative lawsuits greatly impacts D&O insurers' likelihood of disclaiming coverage. In particular, as shareholder derivative lawsuits continue to peak, insurers appear to be disclaiming with greater frequency two categories of losses under D&O policies: (1) Special Litigation Committee (“SLC”) fees and costs; and (2) the derivative plaintiffs' attorneys' fees. When seeking coverage for these losses, insured corporations should not readily take “no” for an answer because D&O policies frequently provide coverage for these types of losses.

A. D&O Insurance Coverage, in Broad Strokes

D&O policies typically contain several coverage grants. One grant, referred to as Side A coverage, provides coverage directly to directors or officers accused of wrongdoing when the corporation cannot indemnify them against such allegations. Side A coverage may be implicated, for example, if the corporation is unable to indemnify its directors and officers because the corporation is insolvent, or if state law precludes a corporation from indemnifying its directors and officers in connection with shareholder derivative suits.4

Under Side B coverage, by contrast, sometimes referred to as “reimbursement” coverage, the insurance company agrees to reimburse the corporate entity for all “loss” for which it is required to indemnify, or has legally indemnified, the directors or officers for a claim alleging a wrongful act. As with Coverage A, Coverage B does not provide insurance for claims asserted directly against the corporate policyholder. It reimburses the corporation for monies spent to protect the individual directors and officers.

Side C, often called “entity” or “organization” coverage, describes the insurance company's promises to reimburse the corporate insured for liability arising out of claims filed directly against the corporation. In other words, Side C coverage insures the corporation itself against certain types of claims, which are often brought in conjunction with claims against directors and officers.

Within these coverage grants, companies often purchased coverage for SLC fees and costs, and the derivative plaintiffs' attorneys' fees.

B. D&O Policies Should Provide Coverage for SLC Fees

In assessing and in response to shareholder derivative lawsuits, a corporation's board of directors frequently establishes and empowers an SLC, with the assistance of counsel. The SLC is tasked with engaging in an intensive evaluation and investigation of the derivative allegations to determine if the corporation's board will take over the litigation or oppose it.5 The SLC is charged with taking all actions as it deems appropriate and in the corporation's best interest with respect to the shareholder derivative lawsuit. The SLC's initial investigation and evaluation often is a costly undertaking, which may include, at least, the following:

(i) the collection and review of documents from current and former employees, officers, and directors;

(ii) interviews, by the SLC's counsel, of witnesses involved in the deal and its valuation;

(iii) the retention of an economic expert to assist and advise the SLC in its analysis; and

(iv) legal analysis of the derivative claims.


The SLC's fees and costs should be an insured “loss” under Side C coverage of many D&O policies providing “entity coverage” or “organization coverage.” A corporation must carefully review its coverages because language can vary significantly from policy to policy. But, D&O policies frequently provide Side C coverage that insures an organization's “loss” arising from a “securities claim” made against such organization for any actual or alleged “wrongful act” of such organization. D&O policies frequently define “loss” to include “defense costs,” which are the reasonable and necessary fees, costs and expenses that result solely from the investigation, adjustment, defense and/or appeal of a “claim” against an insured. These D&O policy terms cover as “loss” the full amount of reasonable SLC's fees and costs incurred to investigate, adjust and defend shareholder derivative lawsuits challenging corporation transactions.

Notwithstanding the policy language, D&O insurers often seek to avoid covering SLC costs and fees by asserting that SLC costs are “investigation costs,” for which D&O policies typically provide coverage subject to a sublimit of liability. Investigation costs sublimits are often hundreds of thousands of dollars, as opposed to the policy's multi-million dollar limit of liability for Side C “loss” including “defense costs.” In other words, D&O insurers assert that the insured's multi-million SLC loss is capped at, for example, $200,000 instead of the policy's $100 million per claim limit. Many D&O policies' language and facts typical to an SLC evaluation do not support D&O insurers' position in this regard.

Policies often narrowly define the term “investigation” to investigations conducted by or on behalf of the organization as to whether the organization should bring the civil proceeding demanded in the “shareholder derivative demand.” And, D&O policies frequently define “shareholder derivative demand” as a written demand by shareholders upon the board of directors (or equivalent management body) of an organization asking it to bring, on behalf of the organization, a civil proceeding in a court of law against any executive of the organization for a “wrongful act” of such executive. Meaning, this policy language does not limit coverage for the SLC fees and costs incurred in response to a shareholder derivative lawsuit. In response to shareholder derivative lawsuits challenging a corporate transaction, the corporation frequently does not receive, and the SLC does not investigate, a shareholder demand asking it to bring a lawsuit against a corporate executive--i.e., there was no “shareholder derivative demand.” Instead, shareholders file derivative lawsuits, which are not “shareholder derivative demands.”

In MBIA Inc. v. Federal Insurance Co.,6 the U.S. Court of Appeals for the Second Circuit highlighted the operative D&O policy language at issue in the “investigation costs” versus “defense costs” dispute. In MBIA, the Second Circuit rejected the D&O insurers' argument that the D&O policies' separate insuring agreement providing $200,000 in coverage for investigation costs applied to (and capped) the SLC costs that MBIA incurred in response to a shareholders' derivative litigation.7 The D&O policies at issue in MBIA state that “maximum liability for all Investigation Costs covered under Insuring Clause 4 on account of all Shareholder Derivative Demands … shall be $200,000.” The MBIA policies' Insuring Clause 4 states:

The [insurer] shall pay on behalf of [MBIA] all Investigation Costs which [MBIA] becomes legally obligated to pay on account of any Shareholder Derivative Demand first made during the Policy Period … for a Wrongful Act committed, attempted, or allegedly committed or attempted, by an Insured Person before or during the Policy Period.8  


In holding that MBIA's SLC costs constituted “defense costs” and not “investigative costs,” the Second Circuit found that the D&O insurers' argument improperly sought to expand the term “shareholder derivative demand” to include shareholder derivative lawsuits.9 Moreover, the court found that the “insurers' argument requires that the $200,000 sublimit operate as an exclusion of coverage” and, as such, the insurers “bear the burden of proving that the claim falls within the scope of an exclusion.”10 To meet their burden, the insurers must show that the policies, in “clear and unmistakable language,” exclude coverage.11 Bearing in mind that we must read a contract “as a whole” and construe terms in context, 12 we conclude that the insurers do not meet this burden.13

The D&O policy language discussed in this article covers as loss the SLC fees and costs that the corporation pays it to investigate, adjust and defend the shareholding derivative lawsuits as “defense costs,”’ not “investigation costs.” To apply a policy's “investigation cost” sublimit to the SLC fees and costs incurred in response to a shareholder derivative lawsuit would improperly rewrite a policy's “shareholder derivative demand” definition to include lawsuits, which it frequently does not. D&O insurers may not be able to overcome the steep burden they will face seeking to impose a policy's “investigation cost” sublimit as an exclusionary term to limit coverage for SLC fees and costs and, accordingly, an insured corporation should not accept the insurer's disclaimer without carefully reviewing the operative policy language and applicable facts.

The D&O policy language discussed in this article covers as loss the SLC fees and costs that the corporation pays it to investigate, adjust and defend the shareholding derivative lawsuits as “defense costs,”’ not “investigation costs.”

C. D&O Policies Frequently Provide Coverage for Derivative Plaintiffs’ Attorneys' Fees

If the insured corporation, through the SLC, settles a shareholder derivative lawsuit or loses a verdict, the court will likely either approve or award the insured corporation paying derivative plaintiffs' counsel's fees and expenses. Even if the parties enter into a settlement agreement, the court must approve and find reasonable the derivative plaintiffs' counsel's fees and expenses award by way of an order and final judgment.14 D&O insurers often find that providing coverage for the derivative plaintiffs' counsel's fees is a tough pill to swallow and the insurers frequently deny coverage for this portion of the insured corporation's loss. Notwithstanding, in most policies, D&O policy language provides coverage for this type of loss; moreover, case law from across the country further supports coverage.

D&O policies provide coverage for “loss,” which policies frequently define to include attorney fees awarded to a prevailing plaintiff's counsel pursuant to a covered judgment against an insured. Because the Federal Rules (and most state rules, including the Delaware Chancery Court) require that the court approve shareholder derivative lawsuit settlements, negotiated resolutions satisfy the “covered judgment” requirement. D&O policy language merely shores up prevailing case law from across the country holding that plaintiffs' counsel's fees are insured as “damages” or “loss.” Meaning that even if an insured corporation's D&O policy language does not explicitly states that “attorney fees awarded to a prevailing plaintiff's counsel” are covered “loss,” case law supports a finding that D&O policies provide coverage for plaintiffs' counsel's fees as “damages” or “loss.”15

Interested in This Topic?

For further analysis of legal issues that can arise in connection with director and officer insurance, see Paul F. Matousek et al., Indemnification and Insurance for Directors and Officers, Portfolio 54 in the Corporate Practice Series, available at Bloomberg BNA. Go to /indemnification-insurance-directors-officers-p6958/ for more information. For further analysis of legal issues that can arise in connection with derivative lawsuits, see R. Judson Scaggs, Jr. & Angela C. Whitesell, Derivative Lawsuits, Portfolio 101 in the Corporate Practice Series, available at Bloomberg BNA. Go to /derivative-lawsuits-no-p17179881904/ for more information.

D. Conclusion

Public companies entering into corporate transactions in today's economic environment face a significant likelihood of shareholder derivative lawsuits. The greater the deal's value, the more lawsuits a corporation can expect. In many instances the legal fees and costs that a corporation incurs addressing shareholder derivative lawsuits may be built into the deal price and chalked up to the cost of doing business in today's litigious environment. Notwithstanding, corporations facing shareholder derivative lawsuits should carefully evaluate their D&O insurance policies at the outset of any large corporate transaction to help protect corporate assets and maximize coverage. In many instances, D&O insurers will deny claims in hopes that the deal parties will not pursue coverage. Doing so, however, may leave millions of dollars on the table for covered SLC fees and costs and derivative plaintiffs' counsel's fees and expenses.

1 See Olga Koumrian, Shareholder Litigation Involving Mergers and Acquisitions--Review of 2013 M&A Litigation, CORNERSTONE RESEARCH, available athttp://www.cornerstone.com/getattachment/73882c85-ea7b-4b3c-a75f-40830eab34b6/Shareholder-Litigation-Involving-Mergers-and-Acqui.aspx (last visited April 29, 2014).

2 See Dan Burrows, Mergers and Acquisitions--The 10 Biggest Deals of 2013, INVESTORPLACE, http://investorplace.com/2013/12/mergers-and-acquisitions-biggest-deals-2013/2/#.U0Kke6hdX-s (last visited April 29, 2014). Recent reports suggest that only 2 percent of lawsuits filed in response to M&A deals that settled in 2013 produced monetary returns for shareholders, but more than a dozen resulted in eight-figure settlements. See Olga Koumrian, Settlements of Shareholder Litigation Involving Mergers and Acquisitions--Review of 2013 M&A Litigation, CORNERSTONE RESEARCH, available athttp://www.cornerstone.com/getattachment/7bd80347-124b-4b69-add5-575e33c3f61b/Settlements-of-Shareholder-Litigation-Involving-Me.aspx (last visited April 29, 2014).

3 See Steven M. Davidoff, Debating the Merits of the Boom in Merger Lawsuits, DEALBOOK (Mar. 8, 2013) available athttp://dealbook.nytimes.com/2013/03/08/debating-the-merits-of-the-boom-in-merger-lawsuits/ (last visited April 29, 2014).

4 See Section 145 of Title 8 of the Delaware Code, which governs indemnification of corporate directors and officers. Section 145(b) permits indemnification only for defense--not judgments or settlements. In other words, Delaware prohibits a corporation from indemnifying derivative suits' judgments or settlements.

5 If the board decides to take over the litigation, it may delegate control to an independent SLC. See Maldonado v. Flynn, 413 A.2d 1251, 1255-56 (Del. Ch. 1980). The board's decision to take over the lawsuit ends the shareholders' control of the suit and, in most jurisdictions, the board's decision is subject to the “business judgment rule” standard. See Kamen v. Kemper Fin. Servs., 500 U.S. 90, 101 (1991).

6 652 F.3d 152, 162-66 (2d Cir. 2011).

7 Id. at 162-66.

8 Id. at 165.

9 Id.  

10 Id. (citingVill. of Sylvan Beach v. Travelers Indem. Co., 55 F.3d 114, 115 (2d Cir. 1995) (citingMaurice Goldman & Sons, Inc. v. Hanover Ins. Co., 80 N.Y.2d 986, 592 N.Y.S.2d 645, 607 N.E.2d 792, 793 (1992))).

11 Id. (internal quotation marks omitted).

12 Law Debenture Trust Co. of N.Y. v. Maverick Tube Corp., 595 F.3d 458, 467-68 (2d Cir. 2010).

13 652 F.3d 152, 165 (emphasis added). D&O insurers frequently rely on Office Depot, Inc. v. Nat'l Union Fire Ins. Co., 734 F. Supp. 2d 1304 (S.D. Fla. 2010), 453 F. App'x 871, aff'd, 2011 U.S. App. LEXIS 20759 (11th Cir. 2011) for the misguided proposition that SLC costs are not covered. Office Depot is inapposite to this situation because it addresses Office Depot's use of an Audit Committee as part of its response to an SEC investigation, which spawned later derivative and securities lawsuits. The court found that the SEC investigation did not constitute a “claim” under the Office Depot policy's language addressing regulatory proceedings and subpoenas. Because the investigations did not meet the policy's claim definition, the court held that the policy did not respond to the Audit Committee's pre-litigation costs. Here, to the contrary, boards for an SLC in response to, and to protect the corporation's interests in connection with, a Claim--the Derivative Litigation.

14 Fed. R. Civ. Pro. Rule 23.1(c) (“A derivative action may be settled, voluntarily dismissed, or compromised only with the court's approval. Notice of a proposed settlement, voluntary dismissal, or compromise must be given to shareholders or members in the manner that the court orders.”).

15 See, e.g., XL Specialty Ins. Co. v. Loral Space & Comm., Inc., 918 N.Y.S.2d 57, 113, 82 A.D. 3d 108 (1st Dep't 2011) (“the attorneys' fees Loral had to pay constitute damages”), citingUnitedHealth Grp. Inc. v. Hiscox Dedicated Corp. Member Ltd., 2010 BL 27302, No. 09-cv-0210, at *23 (D. Minn. Feb. 9, 2010) (portion of settlement constituting plaintiff's attorneys' fee award constituted “damages” under the policy). See alsoNat'l Cas. Co. v. Coastal Dev. Servs. Found., 171 F. App'x 680, 686 (9th Cir. 2006) (holding claim for attorneys' fees constituted a claim for “damages”); City of Ypsilanti v. Appalachian Ins. Co., 547 F. Supp. 823, 827-28 (D.C. Mich. 1982), (“[A]n attorney fee award in a civil rights suit is a form of 'damage’ which the [insurer] contracted to cover. It would have been simple enough to exclude attorney fee awards had the parties so intended.”), aff'd, 725 F.2d 682 (6th Cir. 1983); Safeway Stores, Inc. v. Nat'l Union Fire Ins. Co. of Pittsburgh, PA, 64 F.3d 1282, 1287 (9th Cir. 1995) (attorney fees awarded to shareholders' class counsel in settlement were “actual out-of-pocket loss to [corporation] incurred in defense of its directors and officers . . . covered by the D&O policy”); Neal-Pettit v. Lahman, 125 Ohio St. 3d 327, 329-30 (2010) (“the jury may, in their estimate of compensatory damages, take into consideration and include reasonable fees of counsel employed by the plaintiff in the prosecution of his action.” Attorney fees therefore may “fall under the insurance policy's general coverage of 'damages’”); Hyatt Corp. v. Occidental Fire & Cas. Co., 801 S.W.2d 382, 393-94 (Mo. Ct. App. 1990) (“[A]n award of attorneys' fees [to the class action plaintiffs] is indistinguishable from a damages award for coverage purposes… . 'It is common class action practice for the defendants in a class action settlement to agree to pay such plaintiffs' attorneys' fees and expenses as the court may award.’”).

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