Reversing a district court holding to the contrary, the First Circuit has declared that Massachusetts public policy does not prohibit D&O carriers from insuring against damages allegedly incurred by one class of shareholders as a result of an unfair benefit conferred on another class of shareholders. Rather, the Court held that the terms of the policy had to be given their plain and ordinary meaning. The Court then remanded the case for an allocation proceeding. Genzyme Corp. v. Federal Insurance Company, No. 09-2485 (1st Cir. Oct. 13, 2010). A copy of the decision is available here.

The insured was a Massachusetts biotechnology firm that utilized three classes of “tracking” stock in its capital structure. Firm management allocated business performance across all three classes of the stock, each of which was separately registered with the SEC. In 2003, the insured invoked its right under the articles of incorporation to eliminate the “tracking” stocks; all outstanding common shares would be converted into a single stock class. The announcement was unpopular and led to the filing of a number of shareholder lawsuits.

In August 2007, the insured agreed to resolve all of the outstanding lawsuits for a single payment of $64 million to one group of tracking stock shareholders. The insured then demanded that its D&O carrier tender its $10 million limit. The carrier refused, contending that the settlement payment was uninsurable. In the subsequent coverage action, the district court agreed with the carrier, holding that the settlement payment was uninsurable as a matter of public policy because the claim was essentially that the insured’s management had decided to benefit one group of shareholders at the expense of another group. In the alternative, the district court ruled that the policy’s “bump-up” exclusion prohibited coverage for all claims in the underlying suits.

The First Circuit reversed on both theories. First, it held that no Massachusetts authority existed to support the proposition that damages paid to one group of shareholders because another group allegedly unfairly benefitted were uninsurable as a matter of public policy. Rather, the Court said, Massachusetts public policy prohibited indemnification only of acts committed with the specific intent to do what the law forbids. Such was not the case here.

Second, the Court carefully parsed the language of the “bump-up” exclusion and concluded that it barred coverage only to the extent that a claim was made against the corporate insured, and did not apply to the extent the claim was against the insured’s officers and directors. The Court remanded, directing the district court to conduct hearings on how the settlement payment was allocated between claims against the officers and directors (which would be covered) and claims against the corporate entity (which would not be covered). The Court was not insensitive to the complexity of the task, but noted that it was what the policy required.