Are Special Litigation Committee Expenses Covered Costs?

A Recurring D&O Coverage Issue Heats Up

Among perennial directors and officers insurance issues are questions whether policy coverage is available for the costs associated with special litigation committees. A Dec. 30, 2009 decision in the coverage lawsuit brought by MBIA against its D&O insurers, in which the court held that the company’s special litigation committee counsel expense was covered under its D&O policies, has brought renewed focus to these recurring issues.

When allegations arise that a company’s directors or officers have engaged in wrongdoing, the company’s board will generally form a special litigation committee (SLC), composed of individuals who were not involved in the alleged misconduct, to investigate the allegations. The SLC can decide whether to pursue claims on the company’s behalf against the alleged wrongdoers. If the SLC concludes that the alleged allegations are not well-founded, the company can rely on that conclusion to move to dismiss any related shareholder derivative litigation.

D&O insurers take the position that SLC expenses are not covered costs because they are not part of the defense of a claim against an insured party and are not incurred “in connection with” a claim. Policyholders argue the SLC costs should be covered because they benefit the defense.

MBIA had been the target of both the U.S. Securities and Exchange Commission and New York attorney general investigations concerning the company’s “finite insurance” products. Shareholders initiated a derivative lawsuit against the company, as nominal defendant, and certain of its officials, alleging wrongdoing in connection the company’s “nontraditional products.”

MBIA’s board appointed an SLC to investigate the allegations, and the SLC hired outside counsel to conduct the investigation. The SLC concluded that the allegations were not meritorious. The company successfully moved to dismiss the derivative lawsuit, in reliance on the SLC report.

The company then sought to have its D&O carriers cover its costs, including the SLC’s counsel expenses. The insurers denied coverage for the SLC expenses. MBIA filed an action against its D&O insurers alleging breach of contract and seeking a judicial declaration that the carriers were obligated to reimburse the company for the SLC expenses and other costs. The parties filed cross motions for summary judgment.

In a Dec. 30, 2009 order, Southern District of New York Judge Richard M. Berman held the SLC’s costs were covered because they were incurred “in connection with” the shareholder derivative litigation. He emphasized that the SLC’s counsel had actually appeared and filed motions in the shareholder derivative on behalf of MBIA.

Judge Berman also found that even if the SLC’s law firm represented only the SCL and not MBIA itself, there would still be coverage, because the SLC was composed of individual members of MBIA’s board who were acting pursuant to delegated authority for the board. Judge Berman noted that “the SLC could readily reach independent decisions without being independent of [MBIA].”

Judge Berman’s decision in the MBIA coverage lawsuit that the company’s D&O insurance policies cover SLC expenses has proven to be controversial. Policyholders seeking coverage for similar expenses have immediately demanded reimbursement for their costs in reliance on Judge Berman’s decision, while the carriers have in turn sought to minimize or distinguish the ruling.

Carriers’ counsel have taken the position that Judge Berman’s ruling is limited to the facts presented, which involve the somewhat unusual circumstances in which the SLC’s counsel actually appeared and filed motions in the shareholders’ derivative litigation. The carriers also have argued that the ruling does not in any event represent a blanket ruling that SLC expenses are always covered costs.

The D&O insurers also contend that the policyholders’ argument that the SLC’s actions are part of the defense could undermine the independence of the SLC.

Finally, the insurers argue that the characterization of the SLC expenses as “defense costs” potentially opens the door to all sorts of operational and administrative costs that might prove helpful in defending a claim.

The carriers in the MBIA case have filed an appeal of Judge Berman’s ruling. Unless and until the Second Circuit overturns the ruling, policyholders’ representative will seek to rely on the decision to try, as one leading carrier-side law firm phrased it, “to significantly expand the scope of coverage for these kinds of legal expenses.” At a minimum, the question of D&O insurance coverage for SLC costs seems likely to remain a source of contention for some time to come.

Topics Lawsuits Carriers