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Delaware Public Policy Does Not Preclude D&O Insurance Coverage for Fraud

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In Arch Insurance v. Murdock, (Del. Ch. Mar. 1, 2018), a D&O insurance coverage dispute, the state Superior Court’s complex commercial litigation division reasoned broadly to hold that, absent a contrary choice of law clause, Delaware law applies to Delaware corporations’ D&O insurance policies, and that Delaware public policy does not prohibit insuring losses from insureds’ breaching the fiduciary duty of loyalty through fraudulent conduct.

Background

The genesis for this coverage dispute was the Court of Chancery stockholder litigation against directors and officers of Dole Food Co. (See In re Dole Food Stockholder Litigation (Del. Ch. Aug. 27, 2015).) In Dole, the Court of Chancery reviewed a going-private transaction in which Dole’s 40 percent stockholder, David Murdock, who also was a director, acquired the remaining shares of Dole he did not already own. Stockholders brought suit against defendants including Murdock and David Carter, Dole’s president and CEO. In a post-trial opinion, the Court of Chancery held that Murdock and Carter breached the fiduciary duty of loyalty by inter alia manipulating Dole’s trading price downward prior to the transaction, conduct that the court described as fraudulent. After the opinion but before entry of a final order, the parties settled the dispute for the full amount for which the Court of Chancery found Murdock and Carter liable. The court approved the settlement. The defendants also settled a related federal securities lawsuit.

Dole’s D&O insurers then brought suit disputing coverage for the settlements. In a prior decision, the Superior Court dismissed the insurers’ claim that a coverage exclusion for any “deliberately fraudulent act … if established by a final and nonappealable adjudication adverse to such Insured” applied to prevent coverage here. The Superior Court reasoned that the Court of Chancery’s post-trial memorandum opinion was not a “final and nonappealable adjudication.” (See Arch Insurance v. Murdock (Del. Super. Dec. 21, 2016).) The insurers requested an interlocutory appeal, arguing that this was the first decision suggesting that corporate fiduciaries found at trial to have committed fraud may escape a fraud exclusion by settling. The Delaware Supreme Court refused the appeal. (See 155 A.3d 371 (2017) (Table).)

The Parties’ Arguments, and the Court’s Analysis

The Superior Court’s March 1 opinion addressed the insurers’ motion for summary judgment, which argued that California, not Delaware, law applied to interpret the policies, and in any event the public policy of both jurisdictions prohibited insurance coverage for fraud.

As the policies did not contain a choice of law provision, the Superior Court first considered the choice of law. The insurers argued that California law applied because Dole’s principal place of business was there, it was where David Murdock and Michael Carter resided and it was the situs of the fraud. The insureds claimed, by contrast, that Delaware law applied because the dispute concerned their conduct as fiduciaries of Dole, and Delaware law (8 Del. C. Section 145(g)) authorized Dole to obtain insurance for them.

The court in Arch Insurance followed precedent, reasoning that “where the insured risk is the directors’ and officers’ ‘honesty and fidelity’ to the corporation, and the choice of law is between the headquarters or the state of incorporation, the state of incorporation has the most significant relationship,” citing Mills Limited Partnership v. Liberty Mutual Insurance (Del. Super. Nov. 5, 2010).

The choice of law issue mattered greatly, because Section 533 of California’s Insurance Code provides that “an insurer is not liable for a loss caused by the willful act of the insured’s agents or others[]”—an exclusion implied into every insurance contract governed by California law.  Delaware has no similar statute, the court reasoned. By contrast, the court reasoned, Section 145(g) of the DGCL authorizes the purchase of D&O liability insurance “against any liability … whether or not the corporation would have the power to indemnify such person against such liability.”

The court continued to reason that Delaware will not void a contract provision on public policy grounds absent clear indicia that such a public policy exists. In their briefing, the insurers pointed to the significant body of Delaware case law (including Dole) evincing a remedial policy of ensuring that corporate fiduciaries do not profit from breaches of the duty of loyalty. The insureds responded that, just as no Delaware statute precluded coverage, no Delaware decisions hold that a corporation cannot obtain insurance that covers losses from a breach of the duty of loyalty based on fraud. Ultimately, the court reasoned that the Delaware Supreme Court has held that Delaware public policy does not prohibit insurance provisions that cover punitive damages. (See Whalen v. On-Deck, 514 A.2d 1072 (Del. 1986).) The court found that persuasive because—like corporate fiduciaries’ fraud—acts subject to punitive damages would also involve culpable misconduct, which similarly should not be encouraged. The court accordingly held that Delaware public policy does not preclude insurance coverage for directors’ and officers’ fraudulent misconduct.

Key Takeaways

In holding that Delaware has no public policy precluding coverage of for fraud, this opinion is a strong reminder of Delaware’s public policy in certain other respects. First, it is consonant with Delaware’s well-known public policy in favor of freedom of contract. As discussed, the Arch Insurance court’s prior decision held that the express fraud exclusion was not triggered by the post-trial settlement. Having so found, here the court declined to imply a fraud exclusion as a matter of Delaware law. The court’s decision also serves as a reminder that Section 145(g) of the DGCL expressly authorizes the purchase of insurance coverage for losses that a corporation is not permitted to indemnify, including for actions not taken “in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation.”  Section 145(g) ultimately defers to parties’ freedom of contract in obtaining insurance, while it helps implement Delaware’s longstanding public policy in favor of encouraging qualified persons to serve as corporate fiduciaries. (See “Delaware Supports Directors With a Three-Legged Stool of Limited Liability, Indemnification and Insurance,” by E. Norman Veasey, Jesse A. Finkelstein and C. Stephen Bigler, 42 Bus. Law. 399 (Feb. 1987) (discussing this issue).)

Delaware Business Court Insider  l  March 14, 2018