On August 28, 2009, Delta Financial Corp. (“Delta”) filed a Notice of Appeal to the United States Court of Appeals for the Third Circuit seeking to overturn the dismissal of its coverage action against Westchester Surplus Lines Insurance Co. (“Westchester”) and United States Fire Insurance Co. (“USFI”). The coverage action, which was filed as a part of an adversary proceeding with the United States Bankruptcy Court for the District of Delaware, sought coverage under two D&O policies issued by Westchester and USFI respectively. The Bankruptcy Court dismissed the action, ruling that the two insurers had properly relied upon an exclusion in the primary policy to deny coverage. The United States District Court for the District of Delaware agreed, affirming the Bankruptcy Court’s ruling on August 4, 2009. Delta now seeks to appeal those decisions.

At issue is an “inadequate consideration exclusion,” commonly referred to as a "bump up exclusion," that the insurers maintain precludes coverage for the underlying state court action against Delta and its directors and officers. That underlying action involved the transfer by Delta of excess “cash flow certificates” it said were worth $153 million in exchange for unsecured and senior secured notes with an outstanding balance of $153 million. The plaintiffs, who originally held the unsecured and senior secured notes, claim that the “cash flow certificates” were really only worth around $40 million. When Delta sought coverage for the action, the carriers cited the “inadequate consideration exclusion,” which precludes coverage for claims “based upon, arising out of, or attributable to the actual or proposed payment by [Delta] of the allegedly inadequate consideration in connection with [Delta’s] purchase of securities issued by any company.”

The Bankruptcy Court agreed with the insurers. Applying a “but for” test to the “inadequate consideration exclusion” because it contained the terms “based upon” and “arising out of”, the Bankruptcy Court concluded that the exclusion applied. In doing so, it went through a three-part analysis: (1) identifying first the specific harm at issue in the underlying action; (2) applying the “but for” test; and (3) “determin[ing] whether the operative act [was] explicitly covered by the exclusion.” The Bankruptcy Court concluded the alleged inadequate consideration at issue here caused the purported loss and was explicitly covered by the exclusion. A copy of the Bankruptcy Court’s decision is available here.

The District Court agreed and adopted the Bankruptcy Court’s decision in its entirety. A copy of the District Court’s decision is available here.