What State Law Governs Disputes Over D&O Claims?

What State Law Governs Disputes Over D&O Claims?

The outcome of coverage disputes involving directors and officers (D&O) insurance can be greatly influenced by the state law applied in the case.

The outcome of coverage disputes involving directors and officers (D&O) insurance can be greatly influenced by the state law applied in the case. Therefore, it is important to understand any choice of law provisions in your insurance policy. In the absence of such provisions, courts will generally apply one of several choices of law tests to determine which jurisdiction’s substantive laws should govern interpretation of the insurance contract.

Recently, Delaware case law decisions are trending in favor of jurisdiction over D&O claims brought by insured involving Delaware incorporated entities. This is good news for Delaware corporations headquartered in New York or New Jersey because their directors and officers will likely fare better in claims brought before the Delaware courts.

Directors & Officers Insurance

D&O coverage is integral to shielding top management from personal liability and also allows businesses to pursue reimbursement when they do indemnify their executives. Therefore, it is important to understand the scope of protection your policy provides.

D&O policies vary widely by insurer. In essence, they generally contain two forms of coverage. One coverage provision provides company officials with insurance protection when indemnification is not otherwise available, i.e. the company is insolvent or legally prohibited from providing indemnification. The other primary coverage provision provides reimbursement of a business’s indemnification responsibilities. Because D&O policies are intended to compliment more general commercial liability insurance, they generally contain a wide number of exclusions and apply exclusively to insure against losses related to wrongful acts by the company officers in their official capacity.

Choice of Law in D&O Coverage Disputes

While some D&O policies specify which state’s laws apply to disputes arising out of the policies, many do not. As a result, when coverage disputes arise, the insurer and the insured each argue that the law most favorable to their position applies to the claim. If there is a material difference among those state laws regarding the insurance question at issue in the dispute, the court will generally apply the “conflict of law” rules of the state in which the suit is pending. 

In a recent decision, the Delaware Supreme Court held that Delaware law governed the interpretation of a D&O policy negotiated and issued in California to a Delaware corporation based in California. As described in the court’s opinion in RSUI Indemnity Company v. David H. Murdock & Dole Food Company, Dole Food Company, Inc. (Dole) holds a $15,000,000 directors, officers, and corporate liability insurance policy issued by AXIS Insurance Company (AXIS). RSUI Indemnity Company (RSUI), among other insurers, provides excess D&O policy coverage to Dole in policies that follow form to Dole’s policy with AXIS. 

Following a going private transaction, Dole stockholders filed a lawsuit in the Delaware Court of Chancery challenging the fairness of the transaction and alleging breach of fiduciary duty claims against Dole CEO David H. Murdock and Dole’s President, COO, and General Counsel, C. Michael Carter. While the parties were working to settle the suit, a separate group of shareholders filed a federal securities class-action lawsuit. The second suit ultimately settled as well. Thereafter, RSUI and several of Dole’s other excess policy insurers filed suit in the Delaware Superior Court to determine whether they were obligated to cover the settlements, specifically those related to fraud-based claims. The key threshold question in the suit was whether Delaware or California law should be used to interpret the D&O insurance contract.

The Superior Court, and later the Delaware Supreme Court, concluded that Delaware law governed. In reaching their decisions, both courts applied a “most significant relationship test” set forth in Restatement (Second) Conflict of Laws. They also looked to the Superior Court decision in Mills Ltd. Partnership v. Liberty Mutual Ins. Co. In Mills, the court held that “[w]hen the insured risk is the directors’ and officers’ ‘honesty and fidelity’ to the corporation, and the choice of law is between headquarters or the state of incorporation, the state of incorporation has the most significant relationship.”

The Delaware Supreme Court concluded that the state of incorporation is the center of gravity of the typical D&O policy. In support, it noted that, in the vast majority of cases, Delaware law governs the duties of the directors and officers of Delaware corporation to the corporation, its stockholders, and its investors. “As such, corporations must assess their need for D&O coverage with reference to Delaware law,” the court wrote.

Nonetheless, the court acknowledged that it was also required to consider whether the California contacts in the case were sufficient to tip the balance toward California. It determined that factors, such as Dole being headquartered in California and the Dole directors and officers living and working in California, did not alter its conclusion. According to the court, “the Insureds’ legal ties to Delaware are more significant—and therefore should be afforded greater weight—than their physical location in California.”

While every case will be subject to its own analysis, the decision strongly suggests Delaware law will apply to D&O coverage disputes involving fiduciaries of Delaware corporations in the absence of a choice of law provision. Both insurers and insured should take the decision into account when executing D&O policies going forward.

Key Takeaway

D&O policies are often subject to extensive negotiations. However, many insureds and their brokers neglect to consider the important question of what law will apply when interpreting and enforcing the policy. As a result, businesses must often expend significant time and money litigating choice of law issues. As a result, an express choice-of-law provision can have significant benefits, namely ensuring certainty and consistency when resolving coverage disputes.

If you have questions, please contact us

If you have any questions or if you would like to discuss these issues further,
please contact Dan Brecher or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.