The First Circuit's ruling in Genzyme Corp. v. Federal Ins. Co. represents a significant victory for policyholders seeking insurance coverage for securities cases. See 2010 U.S. App. LEXIS 21079 (1st Cir. Mass. Oct. 13, 2010). The Court of Appeals ruled there that public policy does not preclude insurance coverage for a settlement where a company is accused of supposedly favoring one class of its shareholders over another. Although Genzyme itself was unable to obtain entity coverage due to an express exclusion in its policy, the court found that amounts paid in settlement to indemnify its officers and directors were insurable and covered losses.

The coverage dispute between Genzyme and its insurer, Federal Insurance Company ("Federal"), arose out of a securities class action filed by former holders of the stock of Genzyme's Biosurgery Division. In 2003, Genzyme executed a share exchange transaction that required holders of Biosurgery Division stock to exchange their shares for Genzyme's General Division stock. 2010 U.S. App. LEXIS 21079, *4-5. Each holder of Biosurgery Division stock received 0.04914 shares of General Division stock for each Biosurgery Division share. Id. at *5. The share exchange was extremely unpopular and led to a number of shareholder lawsuits against Genzyme, its board of directors and officers. The gist of the allegations was that Genzyme and its board and officers had improperly favored General Division shareholders over Biosurgery Division shareholders in breach of their legal and fiduciary duties. Id. at *5-6.

Genzyme settled the class members' claims against the company, its officers and directors by making a single $64 million payment. Id. at *6. It then sought to recover $10 million of the settlement from its director and officer and corporate liability insurance policy with Federal. By its terms, Federal's policy provided coverage for losses suffered by Genzyme on account of securities claims. Nevertheless, Federal denied coverage arguing that the settlement was an uninsurable loss.

The United States District Court for the District of Massachusetts initially agreed with Federal, concluding that Genzyme's settlement was uninsurable as a matter of public policy. The District Court based its ruling on the Federal policy's definition of "loss," which excluded "matters uninsurable under the law pursuant to which [the policy] is construed." The First Circuit, however, saw the matter very differently.

The First Circuit found that the District Court's public policy ruling found no support in case law or statutes. Id. at *16. Massachusetts law contains a very narrow public policy exception for insurance coverage: Insurance coverage is impermissible as a matter of public policy for intentionally committed wrongful acts that are also done "deliberately or intentionally, in the sense that the actor knew the act was wrongful" or "with a specific intent to do what the law forbids." Id. In Genzyme's case, there were no allegations to support a finding of an intentionally and knowingly wrongful act. Thus, the First Circuit concluded that this limited public policy exception to coverage did not apply, and further held that courts cannot create a public policy bar to coverage not otherwise found in a state's law. Id. at *18-19.

The First Circuit also rejected Federal's argument that Genzyme's settlement was akin to a disgorgement of ill-gotten gains and thus uninsurable. Genzyme itself had received nothing in the share exchange transaction. Id. at *19-21. Genzyme merely issued additional shares of a certain category of stock, a transaction which the First Circuit found to have had no effect on Genzyme's assets or liabilities. Having received nothing, Genzyme could not be deemed to be disgorging anything. Id. at 21.

The First Circuit was equally unpersuaded by Federal's argument that Genzyme's settlement was not a covered loss because it was a payment of a pre-existing obligation. Instead, the First Circuit found that the loss was within the scope of insurance because "Genzyme had no concrete and identifiable pre-existing contractual obligation to pay the amount of the settlement." Id. at *24.

Despite these favorable policyholder findings, the First Circuit nevertheless concluded that Genzyme itself was not entitled to coverage for the settlement. It explained that an express clause in Federal's policy, a so-called "Bump-Up" clause, stated that Federal would not be liable for "that part of Loss, other than Defense Costs . . . which is based upon, arising from, or in consequence of the actual or proposed payment by any Insured Organization of allegedly inadequate or excessive consideration in connection with the purchase of securities issued by [Genzyme]." Id. at 24-25. The First Circuit found that this clause applied to the class action plaintiffs' claims against Genzyme because the share exchange involved a "purchase" of securities. Id. at 25-29.

According to the court, however, the Bump-Up clause did not bar coverage for those portions of the settlement payment made to settle claims against Genzyme's officers and directors. The court concluded that, by its plain terms, the Bump-Up clause applied only to claims against Genzyme itself. Id. at *29-32. The First Circuit therefore remanded the matter to the District Court so it could allocate the settlement amount between covered claims against the officers and directors and uncovered claims against Genzyme.

The Genzyme Corp. decision represents a decisive victory for policyholders facing securities claims. The First Circuit clearly found that public policy does not prohibit coverage where the alleged wrong is supposedly favoring one class of shareholders over another. The First Circuit also distinguished the settlement of such claims from an uninsurable "disgorgement" remedy. The Genzyme decision, however, offers an important cautionary note to corporate policyholders: clear and express clauses that limit the scope of securities coverage, such as Genzyme's Bump-Up provision, will be enforced as written.