What you need to know:

The United States Court of Appeals for the First Circuit has ruled in Genzyme Corp. v. Federal Ins. Co. that Massachusetts public policy does not prevent a corporation from recovering under a directors and officers liability policy for securities liabilities arising from the corporation’s exchange of different classes of its own stock.

What you need to do:

Insurers should consider the impact of the First Circuit’s decision in approaching demands by policyholders for indemnification under D&O policies.

Background

Genzyme Corp. sought coverage under a director, officer and corporate liability insurance policy issued by Federal Insurance Co. for settlement of securities claims arising out of the exchange of one series of Genzyme’s “tracking” stocks for another series of shares. Federal’s policy covered losses for which Genzyme indemnified its directors and officers, and losses by Genzyme itself relating to securities claims. The policy excluded from its corporate liability coverage (but not its D&O coverage) losses relating to “payment of . . . allegedly inadequate or excessive consideration in connection with its purchase of securities” issued by Genzyme (the “Bump-Up” exclusion). The policy also provided for allocation between covered and uncovered claims.

The US District Court dismissed the action, concluding that payment to one group of shareholders at the expense of another group was not an insurable “loss” under Massachusetts public policy because it merely shifted corporate assets among Genzyme’s shareholders. The court further held that the Bump-Up exclusion barred coverage for claims against Genzyme and its directors and officers, concluding that permitting coverage for the directors and officers “would encourage fraud by insured corporations.” The district court reasoned that because securities actions commonly name both the corporation and its directors and officers, policyholders might sidestep coverage limitations “through the simple expedient of claiming that a settlement payment was made to indemnify its directors and officers.” The First Circuit reversed in part, and remanded. See Genzyme Corp. v. Federal Ins. Co., No. 09-2485, 2010 WL 3991739 (1st Cir. Oct. 13, 2010).

The Court’s Ruling

The First Circuit held that:

  • Massachusetts public policy does not prevent Genzyme from recovering under a directors and officers liability policy for securities liabilities arising from the corporation’s exchange of different classes of its own stock. The court concluded that coverage for damages awards in routine securities litigation was “clearly contemplated” by the policy because “securities litigation is specifically mentioned in the policy and one class of claims arising from such litigation is specifically excluded by the Bump-Up clause.”
  • Genzyme’s settlement did not represent uninsurable “ill-gotten gains” because it merely reorganized its capital structure by issuing one series of stock and issuing additional shares of another series of stock, and acquired the right to cancel its tracking stock. In addition, Genzyme had no preexisting contractual obligation to pay the settlement, in which case its payment might not be an insurable loss, because the underlying claims alleged breach of fiduciary duties and breach of contract.
  • The policy’s Bump-Up clause barred recovery of settlement amounts paid to resolve claims against Genzyme itself, but not to resolve claims against its directors and officers. The court concluded that the Bump-Up exclusion expressly barred only coverage for liabilities of the corporation, not liabilities of the directors and officers, and that the policy’s allocation clause explicitly requires allocation of losses subject to the Bump-Up clause. The court concluded that it was required to “giv[e] effect to the plain language of the policy” and that there was “no basis in public policy” for applying the exclusion to the liabilities of the directors and officers.
  • The court remanded the case to the district court to determine whether any amounts paid in settlement were attributable to the indemnification of the named directors and officers, and if so, how much of the settlement should be allocated to those claims.

Conclusion

The First Circuit ruled that Massachusetts public policy does not prevent a corporation from recovering under a directors and officers liability policy for securities liabilities arising from the corporation’s exchange of different classes of its own stock.