Directors are required to review and approve transformative M&A transactions. The power to approve, however, comes with the potential liability that could be asserted if the transactions do not turn out as projected. Directors, therefore, rely on existing D&O insurance coverage and in certain instances purchase additional insurance which is tailor-made to the contemplated transaction at hand.

Such was the case when Verizon contemplated the spin-off of its directories business to Idearc. To provide the directors and Verizon an adequate level of coverage, Verizon purchased primary and excess executive and organizational insurance policies as insurance for litigation risks and potential liability arising from the spin-off. So far, so good.

Unfortunately, Idearc did not do as well as expected and filed for chapter 11 two and a half years after the spin-off. U.S. Bank, as the litigation trustee formed under Idearc’s confirmed chapter 11 plan, sued Verizon, certain affiliates and a Verizon executive who was also Idearc’s sole director, for promoter liability and breach of fiduciary duties, unlawful dividends and fraudulent transfer, all in relation to the liabilities incurred by Idearc in connection with the spin-off. That litigation proved ultimately unsuccessful.

The insurers refused to reimburse Verizon for its defense costs arguing that the policies provided coverage only for “Securities Claims,” and the litigation trust’s complaint did not qualify as such. Securities Claim was defined in the policies as a claim “alleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities.” In essence, U.S. Bank’s complaint, as described by the Court, asserted that the spin-off involved the transfer of significantly inflated fraudulent consideration to Verizon. Does this constitute a Securities Claim?

The dispute boiled down to the interpretation of “rule … regulating securities.” As to “rule,” which was not defined in the policy, Verizon argued that it includes common law rules while the insurer countered that it includes only those that are issued by an administrative or regulatory agency, or a legislative body. As to “regulating securities,” Verizon argued that it captures any legal requirement that must be complied with such that a failure to do so may result in the transaction being enjoined or avoided. The insurer answered that the term includes legal requirements that specifically regulate securities, rather than laws with more general application that also may be applied to securities transactions.

Relying on (i) prior policy forms used by the insurer, (ii) prior determinations issued by the insurer that were inconsistent with the denial of coverage to Verizon, (iii) the legal principle that it is the insurer’s obligation to state clearly the terms of the policy and (iv) that the overall purpose of the policies was to protect the insureds from the exact transaction for which Verizon sought coverage, the Court held for Verizon, holding that the claims asserted by U.S. Bank constituted “Securities Claims” under the polices.

While this decision came out favorably for the D&Os and other insureds, vigilance is still required. The Court noted that the decision was not an easy one. Thus, other judges may go the other way. More to the point, however, as the decision is based on the policies’ language, insurers can easily revise their policies in line with it. As the Court stated: “The Court has no hesitation enforcing reasonable limitations on coverage, where the limiting language is clear and consistent with the terms of the policy. Unfortunately for Defendants, this was not the case with the Idearc Runoff Policies.”

Therefore, even if insurance is acquired for a particular purpose, the policy may include language gutting or limiting it; it is incumbent on the insured to carefully parse the policy’s language to ensure that it provides the sought for protection.

Verizon Comm. Inc. v. Illinois Nat. Ins. Co., Delaware Superior Court is available here.