Section 11 Settlement Held Not Insurable "Loss"
In 2004, CNL was sued in a securities class action lawsuit (refer here) alleging violations of Section 11 of the Securities Act of 1933. The plaintiffs alleged that they had purchased their stock from CNL at an artificially inflated price of $20/share, based upon materially misleading statements in the offering documents. CNL settled the underlying action for $35 million.
CNL filed a declaratory judgment action against its D & O insurers seeking a determination of coverage for the settlement. CNL’s primary D & O carrier settled with the company. In his grant of partial summary judgment in the favor of CNL’s two excess insurers, Judge Presnell held that the underlying settlement represented a disgorgement of CNL’s ill-gotten gain, which he held did not constitute “loss” under the relevant policy language, and is therefore not insurable under applicable law.
The key to the court’s decision is his conclusion that the amount CNL agreed to pay by settling the Section 11 claim represented profits that CNL had wrongfully obtained. The insurers based their argument to that effect on evidence that:
shareholders in the underlying suit purchased their stock in secondary markets at a (split-adjusted) price of $20 per share, and that a planned public offering collapsed when an industry expert opined that the shares were only worth approximately $12 per share. The plaintiffs in the underlying suits sought to recover the $8 per share difference, attributing the inflated price to the use of “materially false and misleading” offering documents in violation of Section 11. CNL admitted to Landmark that the overwhelming majority of the shares had not been redeemed, traded, or sold in the market– in other words, that if the share price was inflated, CNL reaped the benefit…the Court concludes that the Settlement Amount represents CNL being compelled to return money that it wrongfully appropriated.
The Court’s ruling in this case is at one level not a surprise, as it arguably is just an extension of a case law trend recognizing that some types of settlements or payments do not constitute insurable loss. It is perhaps noteworthy that Judge Preswell’s opinion represents the first recognition by a federal court of the 2002 Indiana intermediate appellate court decision in the Conseco case that a Section 11 settlement was uninsurable.
From the judge’s perspective, based on his review of the case law, “if an insured is simply being forced to return money to which it was not entitled, the event is not a loss. It is simply not reasonable for an insured to assume otherwise.” With all due respect to Judge Presnell, his view about what an insured reasonably may assume to be insured may be unrelated to what a company in fact expects to be insured when the company buys a D & O policy. Therefore, even if the court’s ruling does arguably represent only an extension of an already developing case law trend, it also poses a challenge for the D & O insurance industry to address these issues in the policy itself.
In light of the developing case law trend, and now a federal court’s affirmation of the trend, it is going to be indispensable for D & O insurers to clarify within the language of their policy the coverage that policyholders can expect for amounts paid in resolution of Section 11 claims. In that regard, it is critical to note that Judge Presnell specifically stated that “Section 11 claims are not per se uninsurable.”
A good brief discussion of these issues written by the Edwards, Angell, Palmer & Dodge law firm can be found here. Special thanks to John McCarrick of that firm for the link.
Many thanks to the numerous alert readers who sent me copies of the CNL opinion and related materials.
A Big Bill: As the criminal trial of former Qwest Communications CEO Joseph Nacchio gets ready to start on Monday, March 19, 2007, the Rocky Mountain News took a look (here) at how much Qwest has spent defending itself and its directors and officers from civil and criminal allegations. The newspaper estimate that the company has spent over $1 billion in class action settlements, opt-out settlements, attorneys’ fees, and other related costs and expenses. Interesting, the newspaper also reports that “in a mediated settlement, Qwest agreed to pay $157.5 million to salvage $350 million worth of liability coverage for directors, officers, and [its] employee benefit plans.”