Companies facing shareholder derivative suits should be wary of their directors’ and officers’ liability (“D&O”) insurers attempting to avoid providing coverage for settlements or judgments based on “bump-up” or “inadequate consideration” exclusions. The historic purpose of the exclusion is to prevent insureds from negotiating an unfairly-low price when purchasing another entity or completing intracompany transactions and then using insurance proceeds to supplement that price to come up with the fair market value.
Insurers may seek to contravene the exclusion’s intended purpose, and plain language, by invoking it to bar coverage for claims by an acquired company in a corporate transaction. The U.S. District Court for the Eastern District of Pennsylvania’s recent decision in Gardner Denver, Inc. v. Arch Ins. Co., Civ. No. 16-0159 (E.D. Pa. December 16, 2016) rejected the insurers’ early exit on a motion to dismiss that largely centered on the bump-up exclusion.
As with many other D&O provisions, the language insurers use to impose bump-up exclusions varies considerably. In some policies, the exclusion is a standalone “Inadequate Consideration Exclusion,” and in other policies it appears as exclusionary language in the definition of “Loss.” In the Gardner Denver case, an endorsement amended the definition of Loss to exclude any:
amount representing, or substantially equivalent to, an increase in consideration paid or proposed to be paid in connection with any purchase of securities or assets of a Corporation or any plaintiffs’ counsel fees in any Claim alleging inadequate or unfair consideration. . . .
The policyholder asserted that the exclusionary language bars coverage only in connection with a very narrow type of loss representing an increase in the purchase price paid by the policyholder when purchasing securities or assets. It focused on the insurers’ use of the word “a” to modify the term “Company,” which was defined as the policyholder and its subsidiaries. The policyholder noted that throughout the policy when the insurers intended to reference it, they used the terms “the Company” or “the Named Company.” But, in the bump-up exclusion, the insurers wrote “a” Company. The policyholder asserted that its interpretation was, at minimum, reasonable and, accordingly, the insurers failed to meet their burden of proving the exclusion.
The court agreed. It held that “a reasonable person could construe the use of the phrase ‘a Corporation’ as meaning an entity other than Plaintiff.” In addition to the policy language, the court quoted a Senior Vice President and Global D&O Project Manager of Chubb Group of Insurance Companies, who explained at a D&O insurance industry presentation in 2012, as follows:
[t]ypically the bump-up exclusion has been designed to apply to additional considerations paid by acquiring companies that they pay above and beyond the initial offer. . . . [By contrast] most of the claims we’re seeing today are characterized as breach of fiduciary duty claims against the acquiree’s board of directors [i.e. claims such as the Underlying Litigation]. And so therefore the bump-up exclusion doesn’t really get the kind of use it used to with these claims that have been taking place in the last couple of years.
Insurers could offer D&O policies that explicitly barred coverage for inadequate consideration losses that an acquired company pays to its former shareholders post-acquisition. Perhaps recognizing that such policies may not be marketable in the present litigious world of shareholder lawsuits filed in connection with almost every major acquisition, D&O insurers have instead continued to sell policies with bump-up exclusions not intended to address such claims. Insureds should therefore push back on insurers if they attempt to interpret existing inapplicable (and, at best, ambiguous) exclusionary language to claims where the insured corporation is the acquiring entity.