Directors and Officers Liability Insurance Coverage for Fee Awards

July 26, 2013

Insurance LawSettlements and judgments in securities fraud class actions and shareholders derivative suits typically include a sizeable award of attorney fees incurred in prosecuting the action. A NERA Economic Consulting Study recently found that plaintiffs’ attorneys recovered $653 million in attorney fees from defendants in securities and mergers and acquisition objection litigation in 2012 alone. NERA Economic Consulting Study, Recent Trends in Class Action Litigation: 2012 Full Year Review, January 29, 2013, http://www.nera.com/67_7992.htm.

Are Plaintiffs’ Attorney Fee Awards a Covered “Loss”?

Given the cost of prosecuting such actions, the question of whether directors & officers liability insurance covers plaintiffs’ attorney fees awards has tremendous practical significance. Cases addressing directors and officers insurance coverage for attorney fee awards in securities fraud class actions and shareholders derivative actions almost always focus on whether the award qualifies as a covered “loss” under the policy.

In arguing for coverage of fee awards or the fee component of a settlement, policyholders point out that directors and officers policies define “loss” broadly to include “settlements, judgments and defense costs”—and sometimes “damages” as well—without excluding plaintiffs’ attorney fees from the definition. They maintain that the policy is at best ambiguous regarding coverage for plaintiffs’ attorney fees, and, under accepted rules of policy interpretation, ambiguities should be resolved in favor of coverage. The New York Appellate Division recently adopted these arguments in XL Specialty Insurance Co. v. Loral Space & Communications, Inc., 82 A.D.3d 108, 918 N.Y.S.2d 57 (1st Dept. 2011). Accord, Safeway Stores, Inc. v. National Union Fire Insurance Co. of Pittsburg, PA., 64 F.3d 1282, 1286-87 (9th Cir. 1995).

Insurers, on the other hand, contend that, at least in the context of shareholders derivative litigation, attorney fee awards to the plaintiffs are not a “loss,” but a cost of doing business. The idea that the plaintiffs’ fees are a business expense for the corporation stems from the purpose of derivative litigation, which is to protect the corporation against the misconduct of its officers and directors. As the dissent in XL Specialty Insurance Co. v. Loral Space & Communications, Inc., supra, put it, “a fee award a derivative suit represents “the equitable entitlement of the successful derivative plaintiff to recover the expenses of his/her attorneys’ fees from all the shareholders of the corporation on whose behalf the suit was brought.” Id. at 122. The dissent observed that “if not spreading the cost of attorneys’ fees sounds in unjust enrichment, the obvious corollary is that shifting the cost to shareholders as a group cannot be characterized as a loss.” Id.

In the settlement context, insurers rely on the “American Rule” that the “loser” does not pay the prevailing party’s attorney fees to argue that an insured’s agreement to pay the pay plaintiffs’ attorney fees is a “voluntary” payment and, as such, not a “loss” within the meaning of the policy. Policyholders respond that the policy covers “settlements” and does not require the insured to allocate any portion of the settlement.

In the second half of this series we will look specifically at Applicable Exclusions.