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Dec 18, 2023

Why Delaware may be the best venue to resolve a D&O coverage dispute

Steve Raptis explains why Delaware companies may be missing advantages by litigating their D&O coverage claims elsewhere

No company wants to be involved in a coverage dispute with its insurer. But it happens. Many of these disputes can be resolved through negotiation or mediation but, in some cases, the company may have no practical choice but to sue its insurer.

One of the first decisions the company must make is where it should file its coverage action. Many companies assume they are limited to the jurisdiction where they principally operate or are headquartered, where their policies were ‘issued’ (often the same as their headquarters) or where the underlying matter is centered.

Although this may be a valid assumption for some policies, it is not for directors' and officers' (D&O) policies when the company is a Delaware corporation or other Delaware-formed entity, which many companies are. For Delaware companies, bringing their coverage action there is an additional strategic option they would be well advised to consider.

Why Delaware?
The decision of whether to choose Delaware poses a logical question. After all, a Delaware corporation principally operating elsewhere theoretically would be giving up its ‘home-field advantage’ and possibly incurring additional costs to litigate in a distant jurisdiction. The easy answer is that Delaware law, on several key D&O coverage issues, is simply more favorable for policyholders than many – if not most – other jurisdictions.

Depending on the facts of the claim at issue, the differences between Delaware D&O coverage law and the law of other jurisdictions may be outcome-determinative, as highlighted by the following.

Bump-up exclusion. D&O insurers regularly assert that this ‘exclusion’, which is in fact a carve-out from the definition of otherwise covered ‘loss’, applies to claims by shareholders that they received inadequate value for their shares when a company is sold. Unlike courts in several other jurisdictions, Delaware courts have held that certain forms of these exclusions are ambiguous and do not preclude coverage, most notably with respect to mergers.

Broad scope of insurable losses. Some jurisdictions limit or preclude coverage for certain types of losses – including restitution or disgorgement of allegedly ill-gotten gains, punitive damages and civil penalties – purportedly on the basis that they are uninsurable on public policy grounds. Delaware courts, on the other hand, have indicated that insuring these types of losses does not violate Delaware public policy.

Rules of insurance policy interpretation generally. Delaware courts have applied more policyholder-friendly standards in interpreting the language of insurance policies, including exclusions in D&O policies, than courts in other jurisdictions.

Allegations of fraudulent conduct. Claims covered by D&O policies often involve allegations of fraud against a corporation and/or its officers and directors. D&O insurers regularly assert that such claims are not covered by virtue of ‘conduct exclusions’ in their policies or because covering fraud would violate public policy. Delaware courts have made clear that settlement of a claim alleging fraud is not a ‘final adjudication’ as required by most conduct exclusions and that insuring against loss arising from fraudulent conduct does not violate Delaware public policy.

Larger settlement rule. Insurers often point to ‘allocation’ provisions in D&O policies as a basis for covering only a portion of settlements involving both insured and non-insured claims. At least one Delaware court has held that, even where the policy at issue contains an allocation provision, the insured’s entire settlement is covered where it ‘resolves, at least in part, insured claims’ and ‘the allocation provision does not provide for a specific allocation method’ as between covered and non-covered claims.

Governmental investigations. D&O insurers regularly assert that they are not required to cover the (often substantial) costs of responding to government subpoenas and civil investigation demands issued before formal proceedings are initiated against an insured. Delaware courts, on the other hand, have broadly interpreted D&O insurers’ obligations to cover the costs of pre-litigation subpoenas and civil investigative demands.

Although these examples highlight that Delaware courts generally have been friendlier to insureds in D&O coverage actions than courts in many other jurisdictions, the key facts and legal issues of every case are different. A Delaware company considering bringing a D&O coverage action would be well advised to research the law governing the key disputed coverage issues in each of the jurisdictions it is considering, including Delaware, before filing its action.

Why would Delaware law apply to companies or claims centered elsewhere?
In most cases, a company’s operations and the underlying dispute will be centered outside of Delaware and its only connection to the state may be that it is incorporated there. In that scenario, how realistic is it that Delaware law will be applied if it initiates its D&O coverage action there?

The simple answer is that, if the action is initially filed in Delaware state court, Delaware law likely will apply notwithstanding the lack of other contacts to the state. In conducting choice of law analyses, Delaware state courts have held repeatedly that a company’s place of incorporation is its ‘center of gravity’ for determining which jurisdiction’s law applies to a D&O coverage dispute because there is a strong nexus between Delaware law governing liability of directors and officers of Delaware-formed entities and the D&O policies purchased to protect them.

In Delaware state courts, therefore, Delaware law ordinarily applies to D&O coverage disputes where the insured is a Delaware-formed entity. These courts further hold that Delaware has a substantial public interest in application of Delaware law to such disputes so that directors and officers have a consistent body of case law on which they can rely to make informed decisions about protections available to them in performing their corporate functions.

What if the coverage action is removed or transferred before choice of law is determined?
As an initial matter, a Delaware state court is not likely to dismiss a coverage action filed in Delaware on forum non conveniens grounds due to Delaware’s stated public interest in having D&O coverage disputes involving Delaware-formed entities decided under Delaware law and, by implication, in Delaware courts. In most cases, this interest is likely to overcome considerations of convenience to the parties.

As to Delaware coverage actions filed in state court and removed to federal court, it may make little practical difference whether the action stays in Delaware state court as long as it is filed there initially. The federal Third Circuit, which includes Delaware, recognizes that the plaintiff’s choice of forum is a ‘paramount consideration’ in determining whether the defendant is entitled to have the action transferred to another jurisdiction after its removal to federal court.

But even if the insurer is successful in having the action transferred, federal case law is clear that the choice of law rules applied by the jurisdiction in which the action was initially filed, including its interpreting case law, apply to any choice of law determinations made by the transferee court. Delaware’s choice of law decisions strongly favor application of Delaware law to D&O coverage disputes, meaning that the transferee court is likely to be constrained to apply Delaware coverage law to the action.

Consider all the options
Delaware state courts have expressed a clear preference that D&O coverage cases involving Delaware corporate insureds be decided under Delaware law. As a result, Delaware courts have decided a substantial number of important D&O coverage issues in recent years, mostly in favor of insureds. When deciding where to file a D&O coverage action, therefore, a Delaware corporation should carefully consider all its options, with particular attention to the Delaware option.

Steve Raptis is an attorney in Reed Smith’s insurance recovery group, based in the firm’s Washington, DC office