Recent Delaware Court Ruling Shows Path to D&O Coverage for Appraisal Action
Last week, the Delaware Superior Court ruled that a Delaware General Corporation Law (“DGCL”) § 262 appraisal action constituted a “Securities Claim” within the meaning of the insuring agreement of a directors and officers (D&O) liability insurance policy. See Solera Holdings, Inc. v. XL Specialty Ins. Co., No. N18C-08-315 AML CCLD, 2019 WL 3453232, — A.3d — (Del. Sup. Ct. July 31, 2019). This ruling is important for businesses considering actual and potential M&A litigation losses.
DGCL § 262 gives certain stockholders of a Delaware corporation the right to file an action in the Delaware Court of Chancery seeking an appraisal of the “fair value” of their shares when the corporation is involved in a merger. Based on the appraisal, § 262 also authorizes the Court of Chancery to “direct the payment of the fair value of the shares, together with interest, if any, by the surviving or resulting corporation to the stockholders entitled thereto.” Eligible stockholders pursuing a § 262 appraisal need not expressly allege any wrongdoing; the appraisal is available as a matter of right.
In Solera Holdings, the D&O insurer refused to provide coverage for an appraisal action. It maintained that the action did not constitute a “Securities Claim first made against the [insured] during the Policy Period for a Wrongful Act,” which insuring agreement of the D&O policy required. Specifically, the insurer asserted that the appraisal action did not involve a “violation” of any securities law, as required by the definition of “Securities Claim.” In contrast, the policyholder asserted that the appraisal action inherently alleged a “violation” of the duty to provide “fair value” in exchange for stock.
The court ruled in favor of the policyholder: “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.”
Why is this ruling important to businesses? Appraisal actions comprise a part of the M&A litigation explosion about which other commentators have written volumes. Directors and officers understand the litigation risks when undertaking these transactions. They rely on the possibility of insurance coverage in estimating and managing potential losses. Solera Holdings validates the possibility of defense cost coverage for appraisal actions. Moreover, for any business that has suffered a declination of D&O insurance coverage for an appraisal action, Solera Holdings highlights the insurer’s potential breach of the D&O policy and an opportunity to seek redress.
If your business has suffered a declination of D&O coverage for an appraisal action, you might revisit any previous decision to let the D&O insurer off the hook. Statutes of limitations applicable to an insurer’s wrongful declination of coverage, which vary by state, typically range from 5-10 years. So, the look-back period is long.
By way of tempering any undue enthusiasm, D&O policy language may differ from the language at issue in Solera Holdings, and the ruling was issued by a trial court. While the court indicated in a footnote that this particular ruling will not change, the case at large still remains pending. Until the case is resolved at the trial court level, there can’t be an appeal, let alone an affirming appellate opinion.