Delaware court suggests D&O coverage may be available for appraisal actions
For several years now, D&O insurers and their policyholders have sparred over the potential for coverage of statutory appraisal actions under Section 262 of Delaware’s General Corporation Laws, or similar statutory appraisal rights in other jurisdictions. Until very recently there has been a dearth of caselaw addressing such claims. A recent decision in the Delaware Superior Court, Solera Holdings, Inc. v. XL Specialty Ins. Co. et al., ____ A.3d ___, 2019 WL 3453232 (Del. Super. July 31, 2019), may provide insight into how courts are likely to approach these claims. The issues not addressed by the Solera Court, however, may prove more important in the long run.
The Nature of Section 262 Appraisal Actions
Corporate transactions and mergers are fertile ground for D&O claims as shareholders frequently claim that directors and officers have improperly handled merger proposals. Such claims can be asserted in merger objection suits, breach of fiduciary duty or fraud claims, whether by way of derivative claims or class actions. Like many other states, Delaware law also provides an alternative protection for minority shareholders from unfair treatment in a merger by providing statutory appraisal rights – Section 262 – if they believe that a majority of their fellow shareholders have approved a cash merger that undervalues the company. By invoking Section 262 rights, such minority shareholders can obtain a judicial ruling establishing the “fair value” of their shares as of the date of the merger. Once fair value has been determined by way of a Section 262 proceeding, Section 262 also provides that the shareholders are entitled to interest in the amount of five percent over the Federal Reserve discount rate in order to provide restitution to the dissenting shareholders for the time value of their shares’ fair value. See Finkelstein v. Liberty Digital, Inc., No. Civ. A. 19598, 2005 WL 1074364, at *26 (Del. Ch. April 25, 2005).
Unlike breach of fiduciary duty claims, a Section 262 proceeding does not turn on the culpability or negligence of any person or entity because “the only litigable issue is the determination of the value of the appraisal petitioners’ shares on the date of the merger, the only party defendant is the surviving corporation and the only relief available is a judgment against the surviving corporation for the fair value of the dissenters’ shares.” Cede & Co. v. Technicolor, 542 A.2d 1182, 1187 (Del. 1988). Put another way, a Section 262 proceeding does not examine whether the surviving corporation’s is liable to the outvoted minority shareholders, but rather determines how much the surviving corporation must pay to those dissenting shareholders based on a judicial appraisal of “fair value.” This fair value can be higher or lower than the per-share price paid to the majority that approved the merger. The appraisal function of a Section 262 proceeding is so much part of the normal process of a cash merger that merger proxy statements must detail how shareholders can perfect their appraisal rights under Section 262 or similar appraisal laws. See 17 CFR § 240.14a-101.
The Solera Appraisal Action and the Coverage Dispute
In 2016, a majority of shareholders of Solera Holdings, Inc. (“Solera”) approved a merger offer at $55.85 per share. Shortly after the merger was consummated, dissenting shareholders filed petitions for a Section 262 appraisal, arguing that this deal price significantly undervalued Solera. At the end of the Section 262 process, the Delaware Court of Chancery disagreed and ruled that Solera’s actual “fair value” had been $53.95 per share, i.e., $1.90 per share less than the actual deal price. The dissenting shareholders were therefore awarded $215 million for their shares’ value as of the merger date, plus $38 million in interest.
Despite waiting nearly two years after the initiation of the Section 262 action to give notice to its D&O insurers, Solera sought to recover the $38 million interest award plus $13 million in defense costs from them by filing a coverage action in Delaware Superior Court.
As described by the Solera Court, the D&O policies at issue agreed to indemnify Solera for “Loss resulting solely from any Securities Claim first made during the Policy Period for a Wrongful Act.” “Loss” was defined as “damages, judgments, settlements, pre-judgment and post-judgment interest or other amounts … that any Insured is legally obligated to pay and Defense Expenses.” “Securities Claim” meant a claim “made against any Insured for any actual or alleged violation of any federal, state or local statute, regulation, or rule or common law regulating securities, including but not limited to the purchase or sale of, or offer to purchase or sell, securities.” “Wrongful Act” included “any actual or alleged act, error, omission, misstatement, misleading statement, neglect or breach of duty by the Company.” Solera’s polices also contained a Consent Clause requiring the insurer’s consent to the expenditures of defense costs.
Most of Solera’s D&O insurers moved for summary judgment, arguing that:
- a Section 262 action was not a “Securities Action” because it was not brought for a “violation” of law, which they argued would require proof of wrongdoing;
- the interest Solera paid on the purchased shares’ fair value was not a covered Loss; and
- Solera’s claims for Defense Expenses should be disallowed because it failed to properly notice the appraisal action until nearly all of the Defense Expenses had been incurred.
The Solera Court’s Decision
On July 31, 2019, the Solera Court issued its decision, denying the insurers’ motion for summary judgment, as well as the insured’s request at oral argument for summary judgment in its favor. First, the Solera Court dismissed the insurers’ argument that the “Securities Claim” requirement required Solera to prove that the Section 262 action was based on wrongdoing because the plain meaning of “violation” carried no necessary implication of wrongdoing. Interestingly, while dismissing the possibility that a “Securities Claim” must involve wrongdoing, the Solera Court recognized in a footnote that “[f]or reasons that are not clear,” the insurers had not raised the separate issue of whether a Section 262 action was “for a Wrongful Act.” Accordingly, the Court specifically reserved the issue of whether the “Wrongful Act” element might turn on whether a Section 262 action involved wrongdoing. The Court therefore declined to issue a definitive ruling as to whether or not coverage was actually owed because “factual disputes remain … including whether other Policy provisions preclude coverage.”
Next, the Solera Court ruled that the interest award in the Section 262 action was unambiguously “Loss” given the inclusion of “pre-judgment and post-judgment interest ... that [Solera] is legally obligated to pay” in the policies’ definition of Loss. The Solera Court dismissed without any analysis the insurers’ argument that the interest award should not be covered because all parties agreed that the underlying fair value award was not a covered “Loss.” By doing so, however, the Court ignored the difficulty of making a principled distinction between the award of fair value for the dissenting shareholders’ shares on the merger date and the statutory interest award for the time value of that same amount between the merger date and the date of the award in the appraisal action. The addition of interest to a “fair value” award does not reflect a separate legislative purpose or a distinct cause of action, it merely serves to update the fair value award – which has to be calculated as of the merger date – by compensating the dissenting shareholders for lost time value of their shares’ value. Thus, in a Section 262 action, the fair value award and the interest award are merely different components of a merger deal price that the surviving corporation’s new owners agreed to pay, even if the ultimate dollar amount could not be identified until Section 262’s appraisal process was final. Understood in that light, the Court’s ruling that interest was potentially covered Loss was particularly odd because it would allow Solera’s new owners to recover from Solera’s insurers $38 million dollars – 15% of the total amount – that they paid to acquire the shares of Solera’s former owners. But the Solera Court neither acknowledged nor analyzed the economic reality that Solera was seeking to characterize an anticipated part of a voluntary deal cost as a “Loss” in order to trigger insurance coverage. Cf. Merion Capital, L.P. v. 3M Cogent, Inc., No. CV 6247-VCP, 2013 WL 3793896, at *25 (Del. Ch. July 8, 2013) (Section 262 statutory interest was intended to “avoid an undeserved windfall to the respondent in an appraisal action”).
Moreover, the policies at issue appeared to exclude from the definition of Loss “any amount which represents or is substantially equivalent to an increase in the consideration paid, or proposed to be paid, by the Company in connection with its purchase of any securities or assets of any person, group of persons, or entity.” On its face, this carve-out for “bump-up” awards could apply to Section 262 interest, which increases the amount of consideration paid to the dissenting shareholders by the post-merger corporation. The Solera Court, for reasons not apparent in its opinion, did not consider the potential impact of this language.
Finally, the Solera Court ruled that, while Solera had failed to give its D&O insurers’ timely notice of the Section 262 action, Delaware law would imply a prejudice requirement into the policies’ Consent Clause. Finding that it lacked evidence concerning the possibility of prejudice, the Court therefore refused to grant summary judgment to either side as to whether the Consent Clause might bar coverage.
The Solera Court thus found for the policyholder on several issues. But the issues that the Solera Court either did not reach – the meaning of Wrongful Act or the existence of prejudice – or did not recognize – the bump-up exclusion or the basic incongruity of seeking insurance coverage for an anticipated component of a merger’s deal cost – suggest that the disagreements between D&O insurers and their policyholders over appraisal actions are far from settled.