Delaware Supreme Court expands the application of Delaware law in D&O coverage disputes
On March 3, 2021, the Delaware Supreme Court issued an important opinion in RSUI Indem. Co. v. Murdock, 2021 WL 803867 (Del. Mar. 3, 2021), a Directors and Officers’ (D&O) liability insurance coverage dispute. The Murdock decision:
- Endorsed the view that Delaware has a special, and potentially dispositive, interest in having its own law apply to D&O insurance disputes for Delaware-incorporated corporations, even if other choice-of-law analysis factors – corporate headquarters, location of directors and officers, place of negotiation and delivery of policy – would point towards another state.
- Held that Delaware public policy permitted insurance coverage for liability arising from fraud and that a judicial finding of fraud in one underlying action did not trigger policy exclusions for fraud with respect to liability for a second underlying action even if the two actions arose out of the same factual circumstances.
- Established that Delaware will apply the “larger settlement rule” for allocation of indemnity coverage where the policy language did not provide for an express method of allocation in case of disagreement.
Especially given the large number of Delaware-incorporated insureds, D&O insurers should carefully review the Murdock decision and consider whether their existing policy forms should be revised in light of the increased potential for insureds to litigate their coverage arguments under Delaware law by commencing actions in the Delaware courts.
Dole Food Company, Inc. (“Dole”) is a California-based food company. RSUI Indemnity Company (“RSUI”) issued a high-excess D&O policy to Dole. The RSUI policy contained an exclusion providing that the insurer was not liable for “Loss on account of any Claim… based upon, arising out of, or attributable to… any profit, remuneration or financial advantage to which the Insured was not legally entitled,” or “any willful violation of a statute of regulation or any deliberately criminal or fraudulent act, error or omission by the Insured…” (“the Fraud Exclusion”).
In November 2013, Dole CEO David H. Murdock completed a private transaction in which he purchased all outstanding Dole stock he did not already own via a holding company he controlled, DFC Holdings, LLC (“DFC”). Dole stockholders then brought two underlying lawsuits against Murdock, DFC and Dole’s General Counsel, Michael Carter, in the Delaware Court of Chancery, alleging breach of fiduciary and challenging the fairness of the deal (“the Stockholder Action”). The Chancery Court ultimately determined that Murdock and Carter had breached their duties of loyalty through several intentional, unfair and fraudulent actions that reduced Dole’s pre-merger stock price. The Chancery Court specifically found that Murdock and Carter had engaged in fraud in the negotiations for the Murdock-Dole stock deal, which had the effect of reducing the transaction price. Both were found jointly and severally liable for $148 million in damages. RSUI reserved the right to disclaim indemnity coverage based upon several exclusions, including the Fraud Exclusion. Dole and the plaintiffs then settled the Stockholder Action without involving RSUI for the full amount of damages awarded by the Chancery Court. Murdock paid the full amount of the settlement.
While the Stockholder Action settlement was pending court approval, another group of Dole stockholders – those who had sold Dole stock in 2013 prior to the November 2013 Murdock-Dole transaction – filed a second federal securities class action in the District of Delaware against Dole, Murdock and Carter (“the San Antonio Action”). They cited the Chancery Court’s findings of fraud, etc. in the Stockholder Action and alleged that all three Defendants had violated the Securities Exchange Act. Dole reported the San Antonio Action to RSUI and noted a potential mediation and settlement of this second action. RSUI elected to treat the San Antonio Action and the Stockholder Action as a single Claim under its policy and issued similar coverage reservations. Dole then settled the San Antonio Action without any insurer’s consent for $74 million plus interest. One of Dole’s other D&O insurers paid $7 million of that settlement; Dole paid the remaining $66 million.
The Coverage Litigation
RSUI and several other insurers then commenced the instant declaratory judgment action in Delaware state court against Murdock and Dole. Murdock and Dole counterclaimed for breach of contract, bad faith, and fraud in the inducement. All of the insurers except for RSUI eventually paid or settled, leaving RSUI as the sole plaintiff insurer. The trial court ultimately entered judgment in favor of Dole and Murdock and against RSUI for its policy limit of $10M plus interest. RSUI appealed.
1. The Choice of Law Analysis
RSUI first argued that the trial court incorrectly determined that Delaware law, and not California law, governed its policy. RSUI argued that the trial court incorrectly attached too much weight to the fact that Dole was a Delaware corporation when applying the “most-significant relationship” choice-of-law test, which essentially transformed the test into requiring the application of Delaware law to all Delaware corporations, regardless of the other factors. RSUI pointed to the worldwide coverage offered by its policy and its California amendatory endorsements, the fact that Dole’s directors and officers lived and worked in California, and the fact that Dole negotiated and obtained the policy at its California headquarters through a California insurance broker.
The Supreme Court rejected this argument. First, the Court explained that the choice-of-law balancing of factors does not have to be conducted uniformly for all insurance policies because it can permissibly yield different results on different facts. Second, the Court explained that “when the insured risk is the directors and officers honesty and fidelity to the corporation – and… to its stockholders and investors – and the choice of law is between headquarters or state of incorporation, the state of incorporation has the most significant interest.” Murdock, 2021 WL 803867, at *8. Third, the Court noted that Delaware has specific statutory policies implicating the subject matter of D&O insurance policies, such as the authorization of Delaware corporations to procure D&O insurance and the fact that Delaware law would govern the duties owed by directors and officers. The Murdock Court reasoned that since Delaware corporations would therefore purchase their D&O insurance policies in light of Delaware law, “the state of incorporation is the center of gravity of the typical D&O policy,” id. at *9, unless another state’s contacts were sufficient to tip the balance away from Delaware in a particular case. The Supreme Court concluded California’s contacts were not sufficient in this case, and therefore approved the trial court’s application of Delaware law.
2. Coverage for Fraud
The Supreme Court next rejected RSUI’s argument that Delaware public policy prohibited indemnity insurance coverage for Murdock and Carter’s breach of loyalty based upon fraud. The Court began by noting that the Insuring Agreement and the definition of “Loss” did not expressly exclude fraud. While acknowledging that Delaware did not approve of fraud, the Supreme Court framed the issue as whether Delaware had “a public policy against the insurability of losses occasioned by fraud so strong as to vitiate the parties’ freedom of contract?” Noting that the Delaware Legislature had authorized corporations to obtain D&O insurance “against any liability” asserted against directors and officers, the Supreme Court held that this provision “expressed the opposite of the [public] policy RSUI asks us to adopt.” The Supreme Court then concluded that Delaware does not have a public policy against the insurability of loss caused by fraud.
The Supreme Court also determined that the Fraud Exclusion noted above did not bar coverage for the underlying settlements because the Fraud Exclusion’s requirement that the fraud be established “in the underlying action” did not allow fraud to be established in a different litigation, even one based upon the same conduct. The Court held that “in the underlying litigation” in the settlement context means “the litigation in… which the Insureds became legally obligated to pay on account of a claim.” Id. at *14. The adjudication of fraud in the original Stockholder Action was therefore irrelevant to whether there was a final adjudication of fraud in the San Antonio Action. Because the settlement of the San Antonio Action was sufficient to reach and exhaust the RSUI policy, the Court ruled that the Fraud Exclusion did not eliminate indemnity coverage for the underlying settlements.
3. The Larger Settlement Rule
Finally, the Supreme Court rejected RSUI’s suggested application of the allocation provision of the RSUI policy by adopting the “larger settlement rule” as the default rule in Delaware. The RSUI policy contained an allocation provision stating that if “the Insureds who are afforded coverage… incur Loss jointly with others… who are not afforded coverage for such Claim, [or incur both covered and uncovered Loss], the Insureds and the Insurer agree to use their best efforts to determine a fair and proper allocation of covered Loss…. In making such determination, the parties shall take into account the relative legal and financial exposures of the Insureds in connection with the defense and/or settlement of the Claim.” (“the Allocation Provision”). Id. at *15. RSUI contended that the trial court erred in applying “the larger settlement rule” instead of conducting the relative exposure analysis required by the policy’s wording. The “larger settlement rule” provides that “loss is fully recoverable unless the insurer can show that the liability for non-covered conduct increased the insurer’s liability.” Id. at *16. RSUI argued that under a “relative exposure rule,” its eighth-layer excess policy would not be reached because Murdock’s holding company in the Murdock-Dole transaction, DFC, had significant liability and was not insured under the RSUI policy, and because some of Murdock and Carter’s actions were taken in uninsured capacities (as shareholders and as General Counsel).
The Supreme Court agreed with the trial court that the Allocation Provision was “unhelpful” because it did not establish an allocation mechanism where there is no agreement between the parties. The Court further agreed with the trial court’s observation that the insuring agreements contemplated broad coverage that “implies… a complete indemnity for Loss regardless of who else might be at fault for similar actions,” and that “[t]he Policies do not limit coverage because of the activities of others that might overlap the claims against the Insureds. Any type of pro rata or relative exposure analysis seems contrary to the language of the Policies.” Id. The Court therefore rejected the relative exposure analysis and adopted the larger settlement rule: “responsibility for any portion of a settlement should be allocated away from the insured party only if the acts of the uninsured party are determined to have increased the settlement.” Id. (quoting Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, 1432 (9th Cir. 1995) (emphasis in original)).
Applying this new rule, the Supreme Court determined that RSUI had not argued that the acts of DFC (an uninsured) or the acts of Murdock or Carter in their uninsured capacities increased the amount of the Stockholder Action settlement. The Supreme Court further noted that RSUI had not alleged that the San Antonio Action settlement resolved both covered and non-covered losses. RSUI had also failed to explain how a “relative exposure analysis” would have reduced the coverage available. The Court therefore affirmed the trial court’s allocation decision.
Implications for Insurers
The Murdock decision strongly suggests that in most D&O coverage disputes brought in Delaware courts, Delaware law will govern the interpretation of D&O policies issued to Delaware corporations, even if their principal places of business, operations, and officers are located outside of Delaware and even if the policy was procured elsewhere. As of February 2021, approximately 67.8% of all Fortune 500 companies were incorporated in Delaware, and nearly 1.5 million legal entities have been incorporated in Delaware since 2019. Many D&O policies do not contain explicit choice-of-law provisions. The Supreme Court’s choice-of-law analysis in Murdock is therefore likely to affect a substantial number of existent D&O policies issued in the U.S. Insurers writing D&O coverage in the U.S. should accordingly be mindful of the likelihood that any coverage disputes arising under D&O policies issued to Delaware corporations could be decided under Delaware law.
Insurers might be able to avoid this outcome by including express choice-of-law provisions in newly-issued D&O policies. For disputes that have arisen from policies already issued, an insurer may wish to consider pre-emptively filing a declaratory judgment action in another appropriate jurisdiction that would apply different choice-of-law rules. Because state and federal courts apply the choice-of-law rules of the state in which they are located, this may increase the chance that the court would conclude that the legal precedent of a jurisdiction other than Delaware governs policy interpretation.
The Supreme Court’s interpretation of “in the underlying action” in the Fraud Exclusion at issue further clarifies that insurers may not necessarily be able to disclaim indemnity coverage under Delaware law for excluded conduct that has not been established in the specific action for which coverage is sought, even if the excluded conduct under the same circumstances has been established in another action already. Insurers will accordingly want to read carefully policy exclusions requiring the establishment of certain facts and/or potentially excluded conduct of the insured where the such facts and/or conduct have been determined outside of the underlying action for which the insured seeks coverage. Under Delaware law, insurers can also proactively move to intervene in underlying actions to protect their interests to ensure the court makes specific findings of fact. See e.g., Hercules Inc. v. AIG Aviation, Inc., 776 A.2d 550, 568 (Del. Super. Ct. 2000), aff'd, 760 A.2d 162 (Del. 2000).
The Murdock Court’s application of “the larger settlement rule” follows similar decisions issued by the Seventh and Ninth Circuit Courts of Appeal, at least where a D&O policy does not explicitly provide for a concrete allocation method when the parties cannot reach a compromise. Under this rule, an insurer has the burden to show that causes of action against non-insureds or uncovered causes of action increased the settlement figure. See e.g., Caterpillar, Inc. v. Great Am. Ins. Co., 62 F.3d 955, 963 (7th Cir. 1995) (liability incurred by the company as a result of direct action against it which increased settlement figure was not covered); Safeway Stores, Inc. v. Nat'l Union Fire Ins. Co. of Pittsburgh, Pa., 64 F.3d 1282, 1288 (9th Cir. 1995) (insurer failed to show that company may have incurred liability that was not concurrent with the insured directors and officers). An insurer who wishes to avoid this rule might consider including an allocation provision in the policy to resolve disagreements.
Murdock showcases the strong inclination of the current Delaware Supreme Court to provide D&O insurance coverage protection for officers of Delaware corporations. The Supreme Court’s choice-of-law analysis virtually guarantees that Delaware law will govern the interpretation of D&O insurance policies issued to Delaware corporations – of which there are many – in all but the most limited circumstances. The Court’s additional conclusion that Delaware has no public policy forbidding D&O coverage for actual fraud committed by a corporation’s officers further demonstrates the broad approach to expansive D&O coverage taken by the Delaware courts. This conclusion, however, raises the interesting prospect that another jurisdiction’s strong public policy against the insurability of established fraudulent conduct by corporate officers might be sufficient to tip the D&O choice-of-law analysis in favor of applying another jurisdiction’s insurance coverage law if suit was brought in that jurisdiction. (California, for example, has a statute – Insurance Code § 533 – that prohibits insurance coverage for willful acts by the insured.) Finally, Murdock also suggests the current Delaware Supreme Court’s deference to novel approaches taken by Delaware trial courts, as borne out by the Court’s agreement with the trial court’s rejection of the Allocation Provision in favor of the larger settlement rule.