In an August 10, 2009 decision, the Delaware Supreme Court held that under certain circumstances, a D&O insurer may reasonably withhold its consent to settle a Claim. Hilco Capital, LP, et al. v. Federal Insurance Co., No. 620, 2008 (Del. August 10, 2009).

In 2003, Hilco Capital, LP and Congress Financial Corporation (collectively “Hilco”) sued Payless Cashways, Inc.’s officers and directors (the "Insureds") alleging that the defendants misrepresented the value of Payless’s inventory in connection with certain loans Hilco made to Payless. According to the Delaware Supreme Court's summary of the relevant facts, the parties agreed to mediate before trial. The Insureds' counsel and National Union Fire Insurance Company, the primary insurer, valued the case to be within National Union’s $10 million limit of liability. The Insureds' counsel conveyed to Federal Insurance Company, the first excess insurer, that he would rather try the case than settle the case for more than $10 million. All parties agreed that Federal should not attend the mediation.

At the mediation, Payless and Hilco agreed to have the mediator address a single issue in the case. In addition, the parties agreed to a “high-low” outcome – National Union would pay Hilco $5 million immediately and if Hilco was successful on the single issue that the parties agreed to mediate, Hilco would receive the amounts remaining under National Union’s policy (approximately $3.7 million) and $7 million under the Federal policy. If Hilco was not successful on the single issue that the parties agreed to mediate, Hilco would keep the $5 million and receive no further payments. The parties executed a Memorandum of Unerstanding (“MOU”) at the mediation, without having obtained Federal’s consent. As part of the MOU, the parties agreed that the Insureds would not be held personally liable for the settlement and would assign their rights under the first excess policy to Hilco.

Subsequent to the mediation, and while the settlement was in the process of being finalized, Hilco first asked Federal to consent to the settlement. Federal rejected the proposed settlement, recommending a “straight” settlement instead and asking the parties to refrain from finalizing the MOU. The parties ignored the request. The Insureds later arbitrated the single issue and lost. Federal then filed a declaratory judgment action, denying coverage for the settlement based on a breach of the National Union policy’s consent to settlement requirement, which Federal asserted was incorporated into its policy as a follow-form policy.

On a motion for summary judgment, the trial court found in favor of Federal. The trial court held that Federal had no duty to negotiate with the Insureds under Missouri’s implied covenant of good faith and fair dealing and that the Federal policy incorporated the consent to settlement provision in National Union’s policy. The remainder of the case proceeded to trial. The jury returned a verdict in favor of Federal and found that the Insureds breached the consent to settlement provision before Federal made its decision whether to consent to the settlement. In addition, the jury determined that Federal did not unreasonably withhold its consent to the settlement and that Federal was not given the opportunity to associate in the negotiation of the settlement. Hilco appealed the decision.

The Delaware Supreme Court agreed with Hilco that the trial court erred in its analysis of the covenant of good faith and fair dealing but affirmed the trial court’s ruling on alternative grounds including the ground that there was no support for the argument that Federal breached the covenant by failing to attend the mediation because all agreed that Federal should not attend. The Court also noted that while the settlement was being finalized, Federal had indicated that it was willing to negotiate a settlement, but that it wanted to pursue a “straight” settlement as opposed to the “high-low” proposal agreed upon by the parties. The Court also affirmed the trial court’s ruling that the Federal policy incorporated the consent to settle provision from the National Union policy and that the trial court correctly instructed the jury to consider all of the facts and circumstances in deciding whether Federal had a reasonable basis to withhold its consent.

 A copy of the Court’s opinion can be found here.