Business Litigation Reporter

As many readers will know, a government investigation can begin with something as seemingly innocuous as an email from a governmental agency to a company’s general counsel asking for information, or as attention-grabbing as a search warrant (or even arrests) executed at corporate headquarters. Regardless of how an investigation begins, it rapidly becomes a serious matter that any company must quickly mobilize in response to. Many questions will arise, concerning both the substance of the matter being investigated and how to deal with the government’s demands. Inevitably, though, a senior officer or director of the company will ask a question that may cause even the most seasoned in-house counsel to worry: does our company’s directors and officers (D&O) insurance cover this?

The answer to that question, of course, will depend on the specific coverage terms of your company’s D&O insurance program, as well as the facts and circumstances of the investigation. In this article, we take a close look at some of the key issues associated with D&O insurance coverage for government investigations and discuss how to maximize that coverage if an investigation arises.

Start By Having A Strong D&O Insurance Program Already In Place

The inescapable fact is that once an investigation or other type of claim arises, the insurance coverage is already “baked,” and the matter will be handled pursuant to the coverage terms then in existence. Accordingly, you should confirm that your company’s insurance program is ready and top-notch before an investigation or claim hits. The process is straightforward – start by making sure that your company has been working with an experienced insurance brokerage that has identified the right types of coverages and limits of insurance for your company. Your broker also should have carefully negotiated the terms and conditions of the coverage to ensure your company is getting the best terms the market currently has to offer. Such a review should be done in conjunction with outside counsel to confirm those terms offer the broadest possible coverage.

Know What Constitutes A “Claim” Under The Company’s D&O Coverage, Particularly As To Government Investigations

A threshold question to ask at the outset of a government investigation is whether any communication received from the government constitutes a “claim” as that term is defined under the D&O policy. To answer that question, first refer to the policy’s definition of claim (taking care also to review any policy endorsements that may modify the definition.) Many policies, especially for public companies, will distinguish between claims asserted against “insured persons” (typically directors and officers, and in some cases, employees) and claims against the company itself. The former category of claims may include an investigation of an insured person commenced by the service of subpoena on the person. Alternatively, it may involve the person being identified in writing (for example, through a Wells or target letter) as a subject of an investigation that may lead to a future proceeding. An arrest or extradition attempt may also constitute a claim against an insured person under many policies. Also bear in mind that, in addition to the presence of a claim, policies will often require an allegation of a “wrongful act” against an insured in order to trigger coverage.[1]

More D&O policies these days also contain an additional type of coverage, known as “pre-claim” or “inquiry” coverage, designed to provide enhanced protection to individuals facing a government inquiry. The intent of this coverage, among other things, is to provide coverage for individuals facing requests by a governmental body to appear at a meeting or an interview or to produce documents concerning the company’s business. Unlike a traditional claim, pre-claim coverage may not require that a wrongful act be alleged against an insured in order to trigger coverage.

Make Sure That The Company Understands And Fulfills Its Notice Obligations

Most policies require prompt notice of a claim as a prerequisite to coverage. The importance of this point cannot be understated. Failure to fulfill that obligation may be fatal to your coverage, even if the insurer has not been materially prejudiced. Further, failure to provide notice or providing late notice can potentially bar coverage for later-filed proceedings or other claims relating to the subject matter of the original claim. Even where the impact of late notice is not so drastic, the insurer’s obligation to pay defense costs for a covered claim typically does not start until the date of the claim notice, so prompt notice can also mean the difference between significant legal fees being covered by insurance, or disallowed because they were incurred prior to the notice date. When providing an insurance claim notice, you also must not forget about also providing notice under any “excess” policies that may sit above the “primary” policy.

Take The Time To Work Through And Respond To Any Issues Raised By The Insurer’s “Reservation Of Rights” Letter

If you have provided notice of a claim to your company’s D&O insurers, you will likely receive a “reservation of rights” letter from the insurer detailing the insurer’s view on coverage for the investigation. To preserve its rights (i.e., the right to limit or deny coverage), the insurer is required to identify every ground on which it believes the policy potentially may not cover the claim. Accordingly, a reservation of rights letter, even for a claim that likely will be covered in full, may at times seem voluminous and difficult to decipher. It is important to carefully read and understand the letter and, if necessary, respond in detail to the issues raised. Does the letter, for example, correctly identify the facts and legal allegations at play in the claim? Does it correctly identify and apply the relevant policy terms and coverages? Despite its reserved rights, does the insurer still agree to advance defense costs? While you would think that such issues would be correct as a matter of course, we often find that there are a number of areas in the typical reservation of rights letter which merit a written response in order to set the record straight and fully preserve the insured’s coverage rights. 

Cooperate With The Insurer, And Follow Through On The Company’s Claims Handling Obligations

Most policies require that the insured secure the insurer’s advance consent to the engagement of defense counsel. Likewise, the insurer’s consent typically is required before any defense costs or other loss covered under the policy can be incurred, and insurer consent also is needed before any settlement offers can be made. Failing to secure the insurer’s consent in advance on these kinds of issues could potentially lead to the insurer denying or limiting coverage. At best, it means a potentially difficult and time-consuming post hoc discussion with the insurer concerning why its advance approval was not sought, and why it should nevertheless agree to cover the costs incurred.

A Final Note: Be Prepared, Be Proactive

While our recommendations may seem straightforward, it can be surprisingly difficult for companies to follow through on them when caught up in the midst of responding to a government investigation. Nevertheless, at the end of that government investigation, a key factor in assessing how well the company fared will be what the investigation cost. Maximizing the D&O insurance recovery may play a critical role in allowing a company to get back on its feet and recover effectively. This requires having a strong D&O coverage program in place from the outset, knowing what your obligations are in the event of a claim, and having the right team in place to proactively manage the ongoing responsibilities associated with a complex D&O insurance claim.

[1] Of course, even without the presence of an identifiable “wrongful act” allegation, notice to an insurer of a particular matter may still be advisable under the policy terms

Goodwin Procter’s Business Litigation Reporter provides timely summaries of key cases and other developments within dedicated Business Litigation sessions and related courts throughout the country – courts within which Goodwin Procter’s Business Litigation attorneys are continually litigating. In addition, each issue of the Business Litigation Reporter provides a more thorough discussion of one topic of particular importance to the business community. In this issue, we take a close look at some of the key issues associated with D&O insurance coverage for government investigations and discuss how to maximize that coverage if an investigation arises.

California

Arbitrator to Decide if Employment Claim Can Be Pursued on Class Basis. In Universal Protection Service, LP v. Superior Court, No. C078557 (3d Dist. Ct. App. Aug. 18, 2015), the court of appeals held that under an agreement for the employment of security guards, it was up to the arbitrator to decide whether the plaintiffs could pursue their arbitrable claims on a classwide basis. In particular, the court held that the agreement incorporated the AAA’s National Rules for the Resolution of Employment Disputes and those rules provide that the arbitrability of class relief is for the arbitrator to decide. The California Supreme Court is currently reviewing whether the trial court or arbitrator should decide if an arbitration agreement permits classwide arbitration where the agreement itself is silent on the issue. Sandquist v. Lebo Automotive, Supreme Ct. Case No. S220812.

Data Disclosure to Authorized Account Users Does Not Violate Privacy Laws. In Mollett v. Netflix, Inc., No. 12-17045 (9th Cir. July 31, 2015), the Ninth Circuit held that Netflix’s display of viewing history (and recommendations based on viewing history) to third parties whom a subscriber permitted to access her account did not violate the federal Video Privacy Protection Act (“VPPA”), or the corresponding California statute, Civil Code § 1799.3. The VPPA is the law that Congress passed to protect video rental disclosure without consent after a newspaper published Judge Robert Bork’s video rental history in the 1980s. The plaintiffs in Mollett complained that their friends, family and guests could view information about their viewing history once a Netflix streaming account is registered on their television (or video game console, DVD player, etc.). The Ninth Circuit disagreed, holding that to the extent a subscriber permits others to access her account, disclosures to them are disclosures “to the consumer” that are lawful under the VPAA.

Insurance Anti-Assignment Provisions Invalidated. In Fluor Corporation v. Superior Court, No. S205889 (Aug. 20, 2015), the California Supreme Court held that enforcing an anti-assignment clause in a third-party liability insurance policy, where the assignment occurred after the coverage-triggering event, violated California Insurance Code § 520. Fluor overruled the Supreme Court’s decision just 12 years prior in Henkel Corp. v. Hartford Accident & Indemnity Co., 29 Cal. 4th 934 (2003). The court explained in Fluor that Section 520, despite being a statute dating back to 1872, had not been raised in Henkel.

Delaware

Amended Bylaw Allowing Stockholders To Remove Corporate Officers Held Invalid. In Gorman v. Salamone, No. 10183-VCN (Del. Ch. Ct. July 31, 2015), a Delaware corporation’s shareholders had adopted an amended bylaw that purported to authorize the stockholders to remove and replace corporate officers. The stockholders then tried to use this bylaw to oust the corporation’s CEO. The Court of Chancery held that the bylaw, and hence the CEO’s removal, were invalid under Delaware law. The Court observed that Section 141(a) of the Delaware General Corporation Law “establishes the bedrock statutory principle of director primacy” and that the ability of shareholders to amend bylaws “is limited by the board’s management prerogatives under Section 141(a).” The Court further found that the bylaw at issue question would interfere with the board of director’s ability to make “substantive business decisions,” which includes deciding who should serve as the company’s CEO.

Chancery Court Issues Discovery Guidance and Sanctions. Chancellor Bouchard recently issued a series of discovery rulings in Medicalgorithmics S.A. v. AMI Monitoring, Inc., No. 10946-CB (tr. July 15, 2015). First, he held that, absent a prior agreement, counsel producing documents must review each of them for responsiveness, rather than simply dump documents that have not been thus reviewed onto the opposing party. Second, he held that under Rule 33(d), which allows a party to respond to an interrogatory by pointing to documents in lieu of providing a narrative interrogatory response, the responding party must “identify by Bates numbers the specific documents” that contain the responsive information. Third, he held that, absent an agreement among counsel, a party withholding documents as privileged must prepare a fully compliant privilege log. Finally, he adhered to the default rule that when a plaintiff files suit in Delaware, it must make its officers available to be deposed in Delaware, absent an agreement between the parties. The Court also awarded costs and attorneys’ fees against the responding party that had not complied with its discovery obligations.

Massachusetts

Books and Records Claim Dismissed After Special Committee Investigation: In Chitwood v. Vertex Pharmaceuticals, Inc., No. 15-0854 (Mass. Super. Aug. 4, 2015), a corporation’s shareholder sued under the Massachusetts shareholder inspection statue seeking to examine the books and records of a special board committee’s investigation into the shareholder’s allegations of wrongdoing. After holding the first trial under this Massachusetts statute, the Court held that plaintiff failed to satisfy the statute’s requirements. In particular, the Court found that the plaintiff had failed to adduce evidence “calling into question the independence of the Special Committee or the diligence of its efforts.” And the Court explained that absent such evidence, “the Special Committee’s conclusion (ultimately accepted by the Board) would warrant dismissal of any derivative action the plaintiff might file.” The ruling strongly endorsed the process of using a Special Committee to investigate claims and reserving the final decision to the independent directors on the Board. [Disclosure: Goodwin Procter LLP served as counsel for the defendant.]

Nonsignatory Can Compel Arbitration: In Machado v. System4 LLC, 471 Mass. 204 (Apr. 13, 2015), a franchisee plaintiff sued a subfranchisor (NECCS) and master franchisor (System4), claiming, among other things, that NECCS and System4 had improperly classified the plaintiff and those like him as independent contractors. Id. at 405. The relevant franchise contracts were signed by the franchisee plaintiffs and NECCS, and contained a clause that required the arbitration of nearly all claims arising out of the franchise relationship. Id. at 405. At issue was whether System4, despite not being a party to the contracts, could compel the plaintiffs to arbitrate their claims against System4. The court held that System4 could compel arbitration both (1) because plaintiffs’ claims arose out of the franchise contracts and resolution of the dispute would require the fact-finder to analyze the contracts’ terms, and (2) because plaintiffs had alleged concerted misconduct by NECCS and System4.

New BLS Requirements for Partial Dispositive Motions. Effective July 1, 2015, the Business Litigation Session (“BLS”) of the Massachusetts Superior Court amended its procedural order governing partial dispositive motions. The order both reaffirms the basic requirements for such a motion and adds further provisions, including a Certificate of Compliance requirement. The order is motivated by the BLS’s concern that such motions often consume substantial resources without materially reducing the litigation.

New York

State Franchise Act Invalidates Pre-Agreement Non-Reliance Provision. In EV Scarsdale Corp. and Jonathan Lerner v. Engel & Voelkers North East LLC, 13 N.Y.S.3d 805 (Sup. Ct. June 5, 2015), the plaintiff franchise owners sued the defendants franchisors alleging violations of New York Franchise Sales Act (“NYFSA”), including alleged fraudulent representations in pre-agreement oral discussions. The defendants argued that a non-reliance disclaimer in the franchise agreement barred that claim. Justice Kornreich held, however, that New York intermediate state appellate court precedent required her to agree with the plaintiff that the NYFSA does not permit such a disclaimer, even though federal courts have disagreed with that intermediate state court authority. Justice Kornreich called on the state appellate courts to give the issue “serious consideration.”

Alleged Affirmative Misrepresentation in Response to Direct Inquiry May Be Sufficient to Plead Fraud. In ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043 (May 7, 2015), the Court of Appeals reversed an order granting a motion to dismiss a claim of fraudulent inducement brought by a company that had guaranteed a collateralized debt obligation. The Court held that, at the motion to dismiss stage, the plaintiff sufficiently alleged reliance by pleading that it had made express inquiries of the defendant, and the defendant had made affirmative misrepresentations in response to those inquiries, prior to the plaintiff entering into the transaction. The Court further held that, given those specific allegations, the plaintiff had no duty to insist on a “prophylactic provision” in the parties’ agreement, and in any event there was no written agreement into which such a provision could have been added.

New Commercial Division Rule Regarding Corporate Depositions. Beginning December 1, 2015, Commercial Division Rule 11-f will take effect, bringing practice ever more in line with federal court. Unlike in federal court, New York’s CPLR does not provide for a “30(b)(6)” deposition. Rather, historically, a litigant would specify the corporate officer or employee he/she wished to depose. Frequently, and at great expense and delay, that witness would not have the required information and had not done anything to prepare for the deposition. Under the new rule, litigants will be able to notice the deposition of a corporate entity and provide a list of deposition topics, and the onus will be on the entity to provide an appropriate witness to testify about “information known or reasonable available to the entity.” This rule change, along with other recent ones, should reduce discovery costs and streamline litigation in the Division.

For more information, contact Jordan Weiss at jweiss@goodwinlaw.com.