Misdeeds by directors may not void all cover: Court

PASADENA, Calif.--Both sides are finding something to like in a federal appeals court panel's decision in a California case involving what directors and officers liability insurance covers in a securities class action settlement.

In its Oct. 26 opinion in Pan Pacific Retail Properties Inc. and Western Properties Trust vs. Gulf Insurance Co. and Twin City Fire Insurance Co., the three-judge panel of the 9th U.S. Circuit Court of Appeals held that the district court erred in granting summary judgment to insurers without sufficiently examining the nature of the claims. The lower court viewed claims by San Diego-based Pan Pacific and Emeryville, Calif.-based Western Properties as restitutionary and therefore uninsurable under California law.

The case arose when Pan Pacific and Western Properties proposed an October 2000 merger in which Pan Pacific would acquire Western in a stock swap. A Western shareholder brought a class action, alleging that directors and officers of both companies engaged in misdeeds that included failing to negotiate the highest possible price for the Western shares.

The merger parties notified their insurers of the action, but the insurers denied coverage saying the claim was uninsurable under California law.

The shareholder case was settled by the merged companies for slightly under $1 million in February 2003. Pan Pacific and Western sued their insurers a month later in state court, arguing the insurers unjustifiably refused to recognize any coverage for the shareholder suit. The case was transferred to federal district court, which found the claims represented uninsurable restitutionary relief under state law and held that the insurers could deny such coverage.

The 9th Circuit, however, remanded the case to the lower court for reconsideration. It held that in California, it is "well-established that one may not insure against the risk of being ordered to return money or property that has been wrongfully acquired." But the appellate panel said the lower court needs to determine if the "settlement related entirely to restitutionary relief sought in derivative or direct claims" against the company.

The panel did uphold the summary judgment granted to Twin City because its client--Western Properties--had been compensated through Pan Pacific's indemnification agreement and should not obtain multiple recoveries.

"I think this represents a rebuff to the group of D&O insurers who have tried to deny coverage for certain types of securities class actions that are expressly covered under their policy wording, on the theory on that the underlying claim seeks disgorgement of 'ill-gotten gains,"' said Peter Gillon, a shareholder in Greenberg Traurig L.L.P. in Washington, who was not involved in the case. "If the insurers' theory were to prevail, their policies in essence include a hidden exclusion that could exclude a substantial number of claims."

"You need to look through the pleading and--despite how the insurers may posture the claims--the insured can create issues that give rise to coverage," said Michael Bruce Abelson, founding partner at Abelson Herron L.L.P. in Los Angeles, who represented Pan Pacific and Western. "It's not as quick and simple as the insurers would lead the insured to believe it is, where they can magically say it's all restitutionary and therefore no coverage."

He noted that it was the first time the 9th Circuit has addressed the issue that he called "a biggie" because of securities suits involving Silicon Valley companies.

The attorney for Gulf Insurance viewed the decision differently.

Although the case was remanded for further proceedings, "it does validate the concept that professional D&O policies are really not in the business of financing mergers, and that 'bump-ups' in merger considerations should not be funded by the insurance industry," said David T. DiBiase, managing partner with Anderson, McPharlin & Connors L.L.P. in Los Angeles. "Gulf didn't end up with a complete victory yet, but still I think it's largely a good case and I largely agree with it."

"It's a good decision from the insurer's standpoint," said Stephen H. Sutro, a partner in Philadelphia-based Duane Morris L.L.P.'s San Francisco office, who represented Twin City. "If there's a settlement payment made that seeks to compensate for increased consideration in the context of a merger, that payment is uninsurable as a matter of public policy and is not covered by directors and officers insurance," he said. "In the event there was such a suit, then the insurer is also not liable under this opinion to reimburse any defense costs spent defending those claims."