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Intro: Hello, and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at insuredsuccess@reedsmith.com. We'll be happy to assist. 

Carolyn: Welcome to our Insured Success podcast, the bump-up exclusion. I'm Carolyn Rosenberg. I'm a partner in our insurance recovery group on behalf of policyholders here in Chicago. With me today are my colleagues, Jalen Brown, also in Chicago, and Steve Raptis in our Washington, DC office. We'll get right into it. We've talked about the bump-up exclusion, which is a name. Jalen, can you start us off and tell us what do we mean when we say a bump-up exclusion? 

Jalen: Yes, thank you, Caroline. So bump-up exclusions have become a hot issue for D&O insurance coverage. Insurers have begun raising these issues regularly in claims involving corporate mergers and acquisitions, insurers assert these bump-up exclusion claims whenever consideration paid in an acquisition is alleged to be too low. And so while a bump-up exclusion is referred to as an exclusion, we won't find a bump-up exclusion in exclusion sections. There is a carve-out for the definition of an otherwise covered loss. And so a bump-up exclusion provisions are often found within a D&O policy's definition of loss, and attempts to exclude the amount of a settlement or judgment that represents an increase in the price paid to acquire an entity where such consideration was alleged to be inadequate. There are a few exceptions to the bump-up exclusion. Virtually all bump-up exclusions carve out coverage for defense costs and side A claims, and I know Steve is going to tell us a little bit more about what side A claims are. 

Stephen: Just as a little bit of history, D&O policies were originally put into the marketplace largely to protect the directors and officers from non-indemnified claims, the kind of claims that the company will not indemnify them for or can't indemnify them for legally. Those are side A claims. Many D&O policies also include side B and side C coverage that protects the company. But the side A claims are the non-indemnified claims against the officers and the directors. 

Carolyn: So, Jalen had mentioned that these come into play in acquisition situations and transactions. Steve, tell us, where do you think the bump-up exclusions come into play most? What kinds of cases or situations should you be on the lookout for? 

Stephen: In my experience, I've been seeing insurers assert that bump-up exclusions apply to really all types of corporate transactions. They haven't limited it to one type. It's become sort of a go-to generic defense anytime there's an allegation in a case that inadequate consideration was paid and consideration with a transaction. And that includes both public and private companies. And we have seen sort of a morphing of these exclusions. It used to be traditionally they would apply to, they would contain language that made them applicable to acquisitions. That was a key word, and often it would be accompanied with acquisitions of all or substantially all of the assets of some other entity, and that was where the exclusion applied. But more contemporary versions we're seeing have really gotten away from that acquisition language. We might call it a restriction. And we know that with most public company transactions, they will be challenged. It's the nature of the beast. And when I say challenged, one side, one set of shareholders or another will claim that either their side paid too much or the other side will claim that they didn't receive enough. And sometimes there are both of those allegations in a single transaction. They can't both be right, but we'll see both sides actually have to deal with those kinds of shareholder suits. The good news is if you're a public company, these are securities claims. These are exactly the kinds of claims that are likely to be covered if you have side C coverage. So that's the good news. And one other thing that policy holders should be aware of with respect to these bump up exclusions is they really are, even in the states where they've been interpreted in favor of the insurers, they are still limited to the language of the exclusion. And that is damages or loss where it is claimed that inadequate consideration was paid. So if the loss or the damages at issue are of a different nature, those should not fall under the bump-up exclusion. And that's something that we should all be mindful of when we're looking at these often long securities complaints that may be 150 pages long. You really need to separate out what falls under the exclusion and what doesn't, because if it doesn't fall under the exclusion, it should still be covered regardless of how the bump-up exclusion is interpreted. 

Carolyn: And as you said, Steve, and as Jalen alluded to, even though this is in the definition of loss, it's an exception to the definition of loss, and therefore it is construed as an exclusion. And as we know, applying basic sort of black letter law principles, exclusions have to unambiguously apply, and the insurer has the burden to show that. So, you've told us sort of theoretically and practically speaking what's covered, but let's get into the nitty-gritty. Jalen, you know, who's been winning the coverage disputes in regard to the bump-up exclusion? 

Jalen: At this point, Delaware seems to be the only jurisdiction that is scrutinizing these exclusions rigorously. Two examples of this is in February 2021, the Delaware court presented the Northrop Grumman decision, and in this case, the policyholder prevailed under Delaware law. Some of the key facts for this case was that both sets of shareholders voted, neither merging entity survived, and that neither entity obtained substantially all of the assets of the others. The court noted in Northrop that the shareholder claims did not allege inadequate consideration exclusively, and the court construed the bump-up provision, which the court deemed an exclusion, and narrowly and strictly under Delaware law, the court concluded that it applied to a lawsuit claim that alleges only the consideration exchanged, nothing else, as part of only one specific control transaction was inadequate. The court held that the exclusion was inapplicable to the merger because the lawsuit involves more than just inadequate consideration. And also more recently, we have the Viacom decision that just came down a few months ago in August of 2023. And. Again, the court applied Delaware law, and this case involved a merger between Viacom and CBS, and this was a transfer of all of Viacom's assets. The shareholders of Viacom brought a claim against Viacom due to the merger. And in this case, the shareholders and Viacom ultimately settled their claim for $122.5 million, and the insurers refused to pay the settlement because of the bump-up exclusion provision. In this case, Viacom countered the insurers and stated that the bump-up exclusion applied only to acquisitions, and acquisitions was an unidentified term within the policy and was not considered a merger. The Delaware Superior Court found that the bump-up exclusion was ambiguous as it was subject to contrary but reasonable interpretations, that the exclusion applied to acquisitions that are part of a broader transaction, such as a merger, or that it only applied to acquisition transaction. As a result of this case, the court held that the bump-up exclusion had to be interpreted in favor of coverage and that it did not apply to Viacom's settlement of the CBS merger claims. Therefore, Delaware has been the only state so far that has been rigorously construing bump-up exclusions in favor of policyholders. 

Carolyn: So it sounds like, Jalen, that Delaware law is favorable, at least at this point, and scrutinizing the specific language and the particular facts are critical. What about the cases where policyholders have not fared as well? What about the cases that have been lost? 

Jalen: For the cases that have been lost, those have been found in jurisdictions that have not been applying Delaware law, such as Wisconsin, Virginia, and California. An example of this case would be the Komatsu Mining Corporation decision, which was a Seventh Circuit decision in January of 2023 that applied Wisconsin law. In this case, the transaction at issue was a merger, but the extent to which the merger is an acquisition was not particularly analyzed by the court. The court held that the exclusion applied solely based on the inadequate consideration language and the bump-up exclusion policy. While the court acknowledged the Northrop decision in Delaware, it noted that the exclusion at issue was different and that Delaware law applies more policyholder-friendly rules of policy construction than the Wisconsin courts. 

Carolyn: I know there was one other case as well, the Towers-Watson case, right, where the appeal was recently in the Fourth circuit, and that didn't go quite as well as policyholders had hoped. 

Jalen: Yes, the Towers-Watson decision came down from the fourth circuit on May 9, 2023. The fourth circuit reversed the district court's decision and applied Virginia law instead of Delaware law. The fourth circuit relied on the dictionary definitions of the term acquisition to conclude that the term applied both both to the actual acquisition of a stock and to mergers. The Fourth Circuit then remanded the case to the District Court to determine whether the bump-up exclusion applied, given these new parameters. The District Court's decision came out on March 6, 2024, and consistent with the Fourth Circuit's opinion, the District Court determined that the contract interpretation in Virginia was distinct and different from Delaware, and that under Virginia law, the bump-up exclusion applied. 

Stephen: One thing that I found interesting about the Wisconsin case and the Towers-Watson case were the fact that they found the Delaware law actually applies more policyholder-friendly rules of policy interpretation than the states, Wisconsin and Virginia, whose laws they were applying. That was interesting to me because we normally think of that body of law as universal. In fact, we often refer to it as universal rules of policy interpretation. But I thought in both cases, it was interesting that those courts distinguished the Delaware cases by saying, well, Delaware has a different set of rules of policy interpretation, which was a little bit new to me. 

Carolyn: Yeah. And Delaware makes some sense because many corporations are incorporated in Delaware. Delaware seemed to have a body of law where the jurists are quite familiar with. Corporate law, indemnification, bylaws, and also the roles of directors and officers and the ability to look at transactions, look at the various damages alleged, and be able to parse through both the exclusions and elements of loss that would be covered. And although we've been talking about the cases themselves and the very helpful analysis that you both have shared, the real question too is, are there really lessons learned from either successful, partial success, or not success if you're a policyholder that could be applied when you're purchasing insurance or renewing your D&O policy or structuring a transaction or considering it. Steve, can you share some of your thoughts on those issues? 

Stephen: Yeah, I guess the first thing that I would say is that this is an evolving issue because this is not an exclusion that has been interpreted in average state, or not even close to it yet, this is a book that's still being written in terms of the ability of policyholders to really effectively be able to recover under their policies with respect to transactions. But there are a few things that I think that we can take away from where we are on the current state of the law. The first thing, and just to sort of go one level higher, is that D&O policies for people who have not negotiated them, they aren't written on a standard policy form like you might have with your general liability policy or your property policy. There's not much room to negotiate those policies because the insurance industry has a form that everybody uses. D&O policies aren't like that, which means that each insurer has its own version of policy. There's a lot of similarities between those versions, but they're not the same. And as a result, depending on how the market conditions are at the time, certain provisions within your D&O policy may be negotiable. And we have no reason to believe, given that There really is no typical bump-up exclusion. That language has really evolved over time and continues to evolve over time. We don't have any reason to believe that that's not one of the provisions that may be more on the negotiable side than the non-negotiable side. But regardless, when the policyholder at renewal or if they're buying a new policy altogether, they really need to look at that language, whether it be in the specimen policy, if they're buying it from that carrier for the first time, or whether it's in their current language that they would renew. new. They really need to review that language carefully at renewal so that if adjustments need to be made, that can happen. That's the right time to do it. A couple of the things that they can look for that we've highlighted already today, if you can find, if it's still available, a version of the exclusion, it still has the traditional acquisition language in it. We mentioned earlier that that might be thought of as a limitation. That's a good thing with exclusions. If you can still get a version of that bump-up exclusion, that's a good place to start. As Jalen mentioned earlier, bump-up exclusions traditionally always carved out defense costs expressly. Now we don't always see them carved out expressly. If you can get a version of the policy that carves them out expressly, that's better than relying on certain language that may be within the exclusion that can be interpreted as carving out defense costs. We want to make sure that language is expressed. And then finally, you want to make sure that that side A carve out, which should be in every bump up exclusion, is stated very expressly. In your exclusion, maybe it says that the side A claims are carved out. Maybe it says it only applies to side B and C coverage. Either way, you would be well advised to make sure that that carve out is in there. The final thing that I would say is that a lot of times in structuring transactions. One of the last considerations that the negotiating or the transacting parties have is insurance. What we might propose is under certain circumstances, insurance maybe should be more of a driver than an afterthought. And especially, say, for a public company, it's highly likely because of the visibility of the transaction that it will be challenged on one side or both. So maybe since you know you're going into the transaction with a high likelihood that it will be challenged, maybe D&O insurance and the recoverability of D&O insurance should really be more at the forefront of the thinking. Can you structure your transaction in a way that preserves the D&O coverage if the transaction is ultimately challenged? And as we talked about a little while ago, Jalen talked about the fact that Delaware has shown itself to be a friendly place. Two different types of burgers have been held by Delaware courts not to be subject to the exclusion. So, if all other things are equal, why not structure your transaction in a way that takes you outside the bump-up exclusion, at least arguably, by structuring it, if you're a Delaware corporation, in a way that's consistent with the case's finding coverage? Anyway, we don't want to suggest that the tail should wag the dog, but D&O proceeds in these transactions, like Jalen talked about with Viacom, $122 million in D&O insurance proceeds. That's a lot. And so it's something to take into account when potentially when you're structuring a transaction, especially if you're a public company, especially if you're a Delaware corporation. 

Jalen: That's a great point that you mentioned that an insurer should really consider the language of the policy that they purchased. That's exactly what the Onyx decision focused on, where the court held that and relied on the assumption that there was more favorable policy language available in the marketplace, and that was not purchased by the policyholder when finding that the bump-up exclusion did apply. 

Carolyn: And clearly, bump-up exclusions are not going away anytime soon, at least not for the short term. So it's really important to both know what jurisdiction you're in, do what you can on the negotiating front and structuring the transaction, and of course, understand where the case law is and is going and really get into the facts to be able to make the arguments that put you in the best place to overcome the exclusion if and when it is raised. I want to thank both Steve and Jalen for elucidating the topic for us today and would invite you to tune in to additional episodes of Insured Success. Thanks so much. 

Stephen: Thank you, Carolyn. Thank you, Jalen. 

Jalen: Yeah, thank you both. It was great talking. 

Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact insuredsuccess@reedsmith.com. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

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