When public companies are acquired by other public companies, the shareholders of the target company file suit to challenge the deal about 80% the time. The allegation is generally that the board has violated its fiduciary duty by selling the company for too low a price.
Directors and officers, of course, expect their D&O insurance policy to respond on their behalf when they are sued, including due to an M&A situation. As a practical matter, most M&A claims go away for not much more than a mootness fee. However, this is not always the case. Unfortunately, significant M&A settlements may not be covered by a company’s D&O insurance policy.
In Onyx Pharmaceuticals Inc. Shareholder Litigation, shareholders sued Onyx directors and officers for breaching their fiduciary duties during the company’s sale to Amgen in 2013 for $10.4 billion in cash (which, by reports at the time, was considered to be a good deal).
The shareholders pled the typical allegations: breaches of the duty of loyalty, good faith, and full disclosure. More specifically, the shareholder plaintiffs alleged a flawed sales process in which, instead of maximizing the sale price, the directors and officers of Onyx treated Amgen preferentially while suppressing other potential buyers.
Onyx believed that its D&O insurance policies (including the primary and excess layers) would cover all costs associated with the M&A securities class action, which is to say the costs of legal defense as well as the $30 million paid in settlement to the Onyx shareholder plaintiffs. However, the three insurers that provided excess coverage denied the claim.
Onyx sued its excess insurers in Onyx Pharm., Inc. v. Old Republic Ins. Co. for reimbursement of the $26 million it paid out of pocket to settle the class action against its directors. Onyx lost in a bench trial, making this California D&O insurance coverage case a cautionary tale.
In the case of Onyx Pharm., Inc. v. Old Republic Ins., the court found that the company that provided the primary D&O coverage for Onyx, National Union Fire Insurance Company, did not contest coverage. National Fire, in fact, paid $10 million to reimburse Onyx for its payment of defense fees for directors and officers, and to cover part of the settlement funds in Onyx Pharmaceuticals Inc. Shareholder Litigation.
Since the primary (first) layer paid its limit, the directors and officers of Onyx undoubtedly thought that the rest of the insurance tower would follow suit. After all, it is the primary layer of insurance that typically sets all the terms and conditions for the D&O insurance program.
The carriers above the primary layer of insurance, referred to as the “excess layers,” typically issue short insurance policies that say that they will “follow form,” meaning they are adopting the terms of the insurance policy contract provided by the primary carrier.
Why, then, did the three excess insurers deny the claim? They disagreed with National Union’s interpretation of its own policy contract, specifically the so-called “bump-up” exclusion.
The bump-up exclusion, a version of which is found in most D&O insurance policies, specifically excludes from coverage any payment that could be characterized as an increase (or “bump-up”) in the purchase price of a company.
The idea here is that while insurance carriers will defend directors accused of breaching their fiduciary duties, insurance carriers do not want to fund the purchase price of a company being purchased.
Some commentators have noted that bump-up exclusions were historically applied to situations in which an acquirer is being sued for having underpaid for a target. Most modern forms of bump-up exclusions can be easily applied to exclude coverage for settlements relating to a board having obtained too little in exchange for selling the company, as the Onyx directors learned.
The court in Onyx examined the bump-up exclusion language of the National Union policy:
In the event of a Claim alleging that the price or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all of the ownership or interest in or assets of an entity is inadequate, Loss with respect to such Claim shall not include any amount of any judgment or settlement representing the amount by which such price or consideration is effectively increased; provided, however, that this paragraph shall not apply to Defense Costs or to any Non-Indemnifiable Loss in connection therewith.
After its examination of the case, in October 2020, the court concluded that since the primary allegation against the Onyx board was that it “failed to obtain the highest price for sale of Onyx, particularly as there was another suitor willing to pay more,” the $30 million settlement was not covered.
The court goes on to note that:
It is reasonable that the insurance carriers did not want to have insurance proceeds be a means of funding the purchase of assets by a corporation – which, as pragmatic matter, would be the result of [sic] insurance funds paid to Onyx, which is now wholly owned by its acquirer Amgen.
The court seems bolstered by its observation that “the individual officers and directors, who were not required to pay for their own defense fees and costs and who were not required to pay any of the settlement of the lawsuit” as well as the fact that “the corporation Onyx was obligated to indemnify its directors and officers, and did so.”
As always, it is important to note that the outcome of this case turned on the specific policy language in the Onyx D&O policy. As the court noted, there were other versions of bump-up exclusions in the market that would have led to different outcomes.
Indeed, the court’s discussion of the broker’s efforts to improve the bump-up exclusion language was troubling. The court took the position that the broker’s efforts to improve the bump-up language, and carrier’s refusal to do so, as evidence that the broker knew the exclusion was broader than the client would have wanted. In doing so, the court does not seem to have considered the extent to which carriers may refuse to modify language for internal administrative or other reasons besides intentionally refraining from expanding the policy’s coverage.
Bump-up exclusions in D&O policies are common, and it’s useful for directors to examine the one in their D&O policy well before any M&A activity takes place. A company might direct its broker to attempt to negotiate more favorable language. The reality of the current carrier view of M&A litigation, not to mention the reality of the current D&O insurance environment, is that more insured-favorable bump-up language will be exceedingly hard to obtain.
Taking a step back, it is useful to remember that M&A litigation is so common that well-advised companies expect it. As a result, they take steps to ensure that the record of the board’s process was designed to maximize shareholder value, should their M&A transaction be challenged.
From a director’s defense perspective, there is no better use of money and time than the money and time spent on following the best possible M&A process. Good process, good corporate governance, and good board meeting notes and other documentation during M&A usually make this type of litigation go away for not very much money.
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