In a case of first impression concerning the rights and duties of D&O insurers in settlement negotiations, the Delaware Supreme Court recently held that an excess insurer, Federal Insurance Company (“Federal”), was under no obligation to contribute to a settlement that it had not been permitted to negotiate and approve. As such, the court affirmed that Federal did not breach its duty of good faith by refusing to contribute to any such predetermined “done-deal pact” between the insureds and the underlying carrier. Hilco Capital LP, et al. v. Federal Insurance Co., No. 620-2008, 2009 WL 2426674 (Del. Aug. 10, 2009).

Background

In the underlying action, certain financial institution-plaintiffs, which provided loans to a residential construction supplier based on, and secured by, the inventory of the supplier, brought suit against the supplier’s directors and officers, contending that they manipulated and overstated its inventory and, thus, the company’s value. Such misrepresentations, the lenders contended, induced them to make loan advances they would not otherwise have made. The lenders eventually settled with the supplier and its primary D&O insurer, National Union. National Union provided the first of three $10 million layers of D&O coverage held by the insureds. Federal, which provided the second layer of D&O coverage, was invited to contribute toward the predetermined settlement “pact” negotiated by the insureds and National Union. Federal refused to accept the structure of this “pact,” contending instead that National Union must pay its full $10 million policy limit before any coverage under the Federal policy could be implicated. The insureds and National Union rejected Federal’s position and continued their negotiations with the lenders, eventually reaching an agreement without Federal. Federal continued to disagree with the terms of the settlement agreement and maintained its refusal to consent to any such agreement.

The Coverage Litigation

As part of the settlement agreement with the insureds and National Union, the lenders took an assignment of the insureds’ interest under the Federal policy and a purported bad faith claim against Federal. Initially, the lenders tried to collect under the Federal policy by bringing suit in Missouri. That action, however, was dismissed on jurisdictional grounds. At the same time, Federal initiated a declaratory judgment action in Delaware state court to resolve the parties’ rights and duties under the respective D&O policies. The insureds counterclaimed in the Delaware action, alleging, among other things, breach of contract and bad faith. Federal defended its position on the grounds that it was not provided with a fair opportunity to participate in negotiating any settlement and it did not consent to any such settlement. Thus, it was Federal’s contention that there could be no coverage or a claim for bad faith because the insureds breached the express terms of the insurance contract requiring Federal’s participation and consent for any settlement and, under the circumstances, it had a reasonable basis for refusing to consent to a settlement on such terms.

On cross-motions for summary judgment, the trial court held that: 1) Federal had no duty to negotiate with the insureds under Missouri’s implied covenant of good faith and fair dealing; and 2) the consentto- settlement provision in National

Union’s policy applied to Federal. The remaining issues — whether Federal unreasonably withheld its consent, and whether the settlement was reasonable and noncollusive — were tried to a jury. By special interrogatories, the jury found that: 1) the insureds breached the policy before Federal made any decision whether to consent to the settlement; 2) Federal did not unreasonably withhold its consent to the settlement; and 3) Federal had not been permitted to effectively associate in the negotiation of the settlement.

Appeal was taken to the Delaware Supreme Court, which affirmed. The court found that Federal never received any valid settlement offers, and that it rightly exercised its contractual rights to refuse to participate in a settlement that was hastily presented with a “pact” that, in effect, had been engineered by the insureds and National Union to put much of the financial burden on Federal. Based on those circumstances, the court held that Federal’s only practical option was to reject the settlement proposal. Thus, because Federal had a reasonable basis to reject the settlement, Federal could not have acted in bad faith.

Practical Implications

This decision illustrates the importance that insureds communicate with their insurers — not only primary insurers, but excess carriers as well — concerning any potential settlement that is likely to impact coverage. It also illustrates the importance of complying with all terms of coverage, including terms concerning the settlement of claims. For instance, where an insured is required to obtain consent from its insurer before accepting a settlement, it will not be enough for the insured to simply present the final negotiated terms of settlement. Rather, the Hilco decision illustrates that each insurer must be kept apprised of developments during the settlement negotiation and afforded an opportunity to fully participate in those negotiations.