Author: Susan Friedman, Esq.
In the race for companies to engage in mergers and acquisitions (M&A) activity, which often yields objections by shareholders claiming that they received inadequate consideration/payment for their shares, there have been a number of Directors and Officers (D&O) Liability insurance coverage disputes involving the often-overlooked Bump-Up Exclusion.
Historically, the Bump-Up Exclusion was created by insurers to block board directors and senior level officers (mostly on the buy-side, but occasionally on the sell-side of the transaction) from negotiating a below-market price for their M&A deals and then utilizing the D&O insurance proceeds to fill the delta sought by shareholders in the inescapable lawsuits that followed the transaction. Companies looking to D&O insurers as investment partners who would repay the frequently exorbitant shortfalls/settlements to plaintiff-shareholders were strongly encouraged to look elsewhere by virtue of this exclusion.1 Conceptually, however, the D&O policy is designed to provide coverage for allegations of breach of fiduciary duties, against board directors and C-Suite officers, which are typically asserted in lawsuits filed on the heels of M&A transactions and represent the traditional D&O Claim. Although purpose and tradition serve as backdrops for insureds and insurers, contract construction and language reign supreme in recent Bump-Up coverage disputes.
Policy language detour
The Bump-Up Exclusion is generally found in either the exclusion section of D&O policies or within the definition of "Loss" as an exception (excluded from coverage by that definition). The policy language used varies considerably among insurers. Sample exclusionary language within the definition of "Loss" provides that Loss shall not include:
"...any amount representing the amount by which the price of or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all of the ownership interest in, or assets of, an entity, including the Company (Insured), was inadequate or effectively increased. However this paragraph shall not apply to Defense Costs."2
Additionally, the vast majority of Bump-Up exclusionary language doesn't apply to Non-Indemnifiable (D&O Side A) claims against Insured Persons.
Moreover, insurers may make departures from the typical Bump-Up language which include:
- Exclusion applying only to claims arising from transactions where the Insured is the buyer/acquirer of another company
- Policies that refer to both M&As versus only referring to acquisitions or providing a list in the exclusionary language which reads: "acquisition, merger, business combination or other transaction."
- Specifically barring coverage in the exclusion for judgments and settlements that emanate from a Bump-Up claim and represent inadequate consideration paid
- Purposely leaving the term "acquisition" undefined or providing a vague definition of the term "transaction"
- Applying the exclusion to ownership interests in or securities of another company (which isn't the Insured)
Confronted with a myriad of novel business combinations (M&A transactions) and astronomical settlement or judgment dollars at stake from cases brought by aggrieved shareholders, in recent years insurers have sought to cast a wider net with Bump-Up Provisions to increase the applicability of the exclusionary language.3
As with all contracts, D&O policy language is subject to interpretation. It is well established that ambiguities in a contract are construed against the drafter. In this regard, several courts in different states have recently addressed the interpretation and applicability of the Bump-Up Provision in D&O coverage dispute cases.4 Judicial rulings have been inconsistent in interpretation of the Bump-Up exclusionary language even when interpreting the same exact policy provision in different cases.4 While insureds were victorious in Delaware and New York, they lost coverage battles in California and Wisconsin, but the coverage litigation continues across the United States.4
Another Bump-Up victory for insureds with a plot twist
The engines of excess D&O insurers were revved up in a recent coverage litigation in Delaware Superior Court. The plaintiff-insured sought coverage for a settlement arising out of a shareholder class action brought as a result of a merger.5 A number of the excess insurers had previously denied coverage for the underlying shareholder litigation on multiple grounds, including that coverage was barred by the D&O policy's Bump-Up Provision which was included within the primary D&O policy's definition of "Loss".5
The issue in this case, which was substantially similar to other recent cases4 was whether the merger transaction constituted an "acquisition" within the meaning of the Bump-Up Provision.5 The defendant-insurers argued that the merger qualified as an acquisition, because the Insured entity no longer existed when the merger was effectuated. The plaintiff-insured countered that the D&O policy's use of the term "acquisition" referred to a "takeover transaction" in which both entities survive and one entity simply owns the other. Here, however, the plaintiff-insured entity didn't survive.5
The plot twist in this particular case was references to mergers in two other insurance policy provisions that tracked the "acquisition" language in the Bump-Up Provision (which didn't include the word "merger"). First the Court highlighted the definition of "Merger Objection Claim:"
"...claim based upon, arising from, or in consequence of any proposed or actual acquisition of a Company, or all or substantially all of the Company's assets by another entity, or the merger or consolidation of the Company into or with another entity such that the Company is not the surviving entity.."5
Next the Court evaluated the language in the Material Changes in Conditions provision which also tracked the "acquisition" language in the Bump-Up Provision and specifically referenced acquisitions by merger plus it modified coverage based on certain wrongful acts. That provision read in pertinent part:
"...the acquisition of the Named Insured or of all or substantially all of its assets by another entity, or the merger or consolidation of the Named Insured into or with another entity such that the Named Insured is not the surviving entity..."5
The Court held that the Bump-Up Provision was ambiguous given the separate references to mergers in the other policy provisions that were not found in the Bump-Up Provision.5 In accordance with the rules of insurance policy construction the Court ruled that the insurance contract ambiguities were to be construed against the drafters.5 Plaintiff-insureds won, but it is highly likely that the excess D&O insurers will appeal considering the amount at stake in paying the settlement of the underlying shareholder litigation.
The road to the finish line
We may be far from the last stop on the Bump-Up Provision journey. Consider that insureds will continue to challenge the exclusionary language and insurers will aggressively push-back to shift the tide away from policyholder-friendly judicial decisions in an effort to increase pro-insurer legal precedent. Further, and notwithstanding the call for a remake of the old model Bump-Up Provision, insureds and insurers remain on opposite sides of the road with insureds seeking to delete or narrow the exclusion and insurers attempting to broaden its applicability.
To reach a better finish line we suggest:
- Carefully review the Bump-Up Provision and related sections of your D&O policy.
- Pro-actively seek to narrow insurance policy exclusionary language.
- Be aware of the Bump-Up Provision when considering M&A transactions.
- Avoid insurer choice of law provisions where possible.
- Remember that nuanced D&O policy distinctions can significantly impact coverage and may lead to coverage disputes.
En route to your final D&O policy destination, engage Gallagher's Management Liability Practice who always stands ready to assist.