Delaware Supreme court limits D&O coverage for appraisal actions
The Delaware Supreme Court recently issued a decision that has the potential to significantly limit the availability of Directors and Officers (“D&O”) coverage for actions brought under Section 262 of Delaware General Corporation Law. Section 262 actions allow minority shareholders who opposed a merger—but were outvoted by a majority of other shareholders—to invoke a statutory appraisal process if they believe the merger price undervalued the company. By doing so, such minority shareholders can obtain a judicial ruling establishing the “fair value” of their shares as of the date of the merger. Appraisal petitioners often also receive an interest award in order to provide restitution to the dissenting shareholders for the time value of their shares’ fair value. Section 262 appraisal actions have frequently followed merger transactions involving Delaware corporations. Unsurprisingly, policyholders have responded by seeking D&O coverage for these claims.
In In re Solera Ins. Coverage Appeals, 240 A.3d 1121 (Del. 2020) (“Solera”), the Delaware Supreme Court decided an interlocutory appeal from a summary judgment decision of the Superior Court (Matthew Ferguson and I previously discussed the Superior Court decision here). The merger underlying this claim was approved by a majority of shareholders of Solera Holdings, Inc., who accepted a merger offer valued at $55.85 per share. The dissenting shareholders sought an appraisal under Section 262, arguing that their shares were worth significantly more. The Delaware Court of Chancery, however, ruled that the company’s actual “fair value” had been $53.95 per share--$1.90 per share less than the actual deal price, and awarded the petitioners this amount, plus another $38 million in interest.
Solera Holdings, Inc. then sought coverage under its D&O policies and filed a coverage suit to recover the $38 million interest award and $13 million in defense costs. The company did not argue that it could recover the “fair value” awarded for the petitioners’ shares, apparently conceding that an amount spent to purchase stock could not be a compensable loss. The Delaware Superior Court denied the insurers’ motion for summary judgment, ruling that an appraisal action could be a Securities Claim potentially covered under a D&O policy. Recognizing that this presented an issue of first impression under Delaware law, the Superior Court certified its decision for a direct appeal to the Delaware Supreme Court.
Although several issues were raised on appeal, the Solera Court’s decision addressed only one: whether the Superior Court had correctly ruled that a Section 262 appraisal action involved a “violation” of law such that it qualified as a covered “Securities Claim” under the D&O policy at issue. The Solera Court first determined that the policy’s use of the term “violation” to define a potentially-covered Securities Claim necessarily implied some element of wrongdoing. The Solera Court then reviewed the historical purpose and text of Section 262 and determined that “appraisal actions are not designed to address breaches of fiduciary duty or other wrongdoing.” Instead, appraisal actions are uniquely “neutral” proceedings, in which both sides have the burden of proof and both sides bear some risk. The Solera Court thus concluded that “an appraisal under section 262 is a remedy that does not involve a determination of wrongdoing[;] [r]ather, it is a remedy limited to the determination of the fair value of the dissenters’ shares as of the effective date of the merger or consolidation.”
The Solera holding may dissuade policyholders from seeking D&O coverage for Section 262 appraisal actions to the extent that their Side-C coverage requires allegations of legal “violations.” It further remains to be seen whether the Solera decision will affect coverage even under policies with broader definitions of “Securities Claim.” Both the Superior Court and the Supreme Court in Solera carefully noted that they were not deciding the broader question of whether an appraisal action was “for a Wrongful Act,” a key requirement for most D&O policies. The Supreme Court’s reasoning in Solera, however, emphasized the unusual, “neutral” nature of an appraisal proceeding and repeatedly noted that it did not address questions of “wrongdoing” at all. In a footnote the Solera Court seemingly went out of its way to note that the definition of “wrongful conduct” involves the concept of a legal violation. This reasoning, therefore, suggests that the Delaware Supreme Court may be open to an argument that appraisal actions do not involve “wrongful” conduct at all, which could broadly preclude D&O coverage for Section 262 appraisal actions.