In Verizon Decision Careful Review of Insurance Policies Expands Coverage

Farella Braun + Martel LLP
Contact

Farella Braun + Martel LLP

In Verizon Communications Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pa.[1] the Delaware Superior Court ruled that Verizon was entitled to a defense under its D&O policy for fraudulent transfer claims. Although the decision relies on unique facts and specific policy language, it provides guidance on how to exploit minor but critical differences in policy language to expand the company’s coverage beyond claims involving securities fraud.

The opinion also rejected the insurers’ efforts to limit coverage under a separate policy, based on their contention that the subsidiary out of which the liabilities arose was not a subsidiary when the policy was purchased. And finally, it handed policyholders a practical and valuable gift of universal application, holding that an insurer who wrongfully refuses to defend a claim cannot contest the reasonableness of the fees incurred by the policyholder to defend the case.

Whether or not it is successfully challenged on appeal, the Verizon decision is an important reminder not to make assumptions as to what is or isn’t covered under any type of insurance policy. Coverage depends on the particular language of the policy under review and the particular facts for which claims are sought.

The Transaction and FairPoint Action

  • The underlying case arose out of a multi-step transaction by which Verizon transferred a set of failing assets (landlines) to FairPoint (the “Transaction”). Though the steps of the transaction were complex, the result was relatively simple: FairPoint acquired a telecommunications portfolio in exchange for corporate debt originally issued by a former wholly-owned Verizon subsidiary (Spinco, and the “Spinco notes”), which was converted to “new” FairPoint stock after FairPoint and Spinco merged.[2] Verizon sold that debt to investment banks, which then sold it to third-party investors. FairPoint’s balance sheet was left with landline assets it had acquired from Verizon (through Spinco), the debt on the former Spinco (now FairPoint) notes, and the additional liabilities incurred to capitalize the new Spinco-FairPoint company.
  • Following this series of transactions, FairPoint immediately faced financial hardship. It filed for bankruptcy in 2009.
  • The bankruptcy appointed a trustee, who brought claims against Verizon seeking to avoid alleged fraudulent transfers related to the Transaction (the “FairPoint Action”). The trustee brought the claims as “a successor to [FairPoint] and a representative of [its] estate[.]” The Trustee differentiated between Spinco, the original FairPoint, and the post-Transaction FairPoint.[3]

The Policies

  • Verizon sought coverage under two D&O policies,[4] both of which provided coverage for “securities claims,” and the terms of which were nearly identical. The first was issued to Verizon for the period from October 31, 2009 to October 31, 2010 and defined “Organization” to include Verizon and its subsidiaries existing on or before the Policy period (the “Verizon Policy”). The second was a policy on which both Verizon and FairPoint were named insureds, which covered the period from March 31, 2008 to March 31, 2014 (the “FairPoint Policy”). The “Organization” included Verizon, FairPoint, and subsidiaries existing “on or before” the policy period.[5]
  • While the Policies excluded claims brought against an Insured by or on behalf of an Organization or security holder of an Organization, it contained a carve-back for claims brought in any bankruptcy proceeding or by the trustee of an Organization. A related provision stated that an Organization’s bankruptcy would not relieve the Insurers of their obligations under the Policies.[6]
  • The Policies defined a “Securities Claim” in two parts. The first part was a more traditional definition of a securities claim and included claims alleging violations of securities regulations. The second broadly referenced claims “brought derivatively on the behalf of an Organization by a security holder of such Organization.”

The Court’s Ruling

The FairPoint Action Was a Securities Claim

The court focused on this second portion of the Securities Claim definition. It noted that, unlike the policy at issue in an earlier Verizon case decided by the Delaware Supreme Court (which found that there was no coverage for a fraudulent transfer claim)[7], the provision here was not limited to derivative claims “relating to a Securities Claim as defined in [the first part of the definition,]” and thus did not incorporate a “regulating-securities element.”[8] In other words, a derivative suit brought by a shareholder need not implicate conduct in violation of any securities laws.[9]

After noting this distinction, the court rigorously compared the allegations in the FairPoint Action to the FairPoint Policy and concluded that the FairPoint Action was a covered securities claim. It found the Spinco notes were “securities” – they were investments and not merely loans. It found that the Trustee was a “security holder” of FairPoint – the trustee was appointed pursuant to the plan of reorganization and had the sole power to pursue claims on behalf of FairPoint’s debt security holders, who could not pursue those claims by operation of the bankruptcy process.[10] (The court rejected the Insurer’s argument that the Trustee was not a “holder” of the securities because a contrary reading would relieve the Insurers of their obligations in any bankruptcy, contrary to the terms of the policy.)

The Superior Court held that the FairPoint Action was brought “derivatively” – the claim predated the bankruptcy and was brought to inure to the benefit of the estate and all creditors by increasing the assets of the debtor’s estate as a whole, not merely to benefit an individual creditor. It also found that the FairPoint Action was brought “on the behalf of” FairPoint – the trustee represents the estate and has the authority to bring the claim on its behalf, not on the behalf of creditors, as the debt security holders’ claims are converted into the debtor’s estate’s property in bankruptcy. The court noted that this conclusion fit with the nature of fraudulent transfer claims in a bankruptcy, which belong to the debtor, are brought to remedy injury to the debtor, and which benefit the estate by increasing the pool of assets for distribution to its creditors.

While the Superior Court’s analysis is consistent with the recent wave of policyholder-friendly (and sometimes ground-breaking) decisions coming out of Delaware courts, it is based on well-settled principles of Delaware insurance law providing that coverage must be determined by the policy language, with any ambiguities to be construed against the insurer.[11] It also determined that because fraudulent transfer claims serve to benefit all creditors of the estate, they are derivative as a matter of federal bankruptcy law.[12]

Spinco’s Status as a Former Subsidiary Did Not Necessarily Defeat Coverage

The Insurers separately moved for summary judgment under the Verizon Policy, asserting that Verizon had no coverage for Spinco securities liabilities because Spinco had ceased being a “Subsidiary” over which Verizon had “Management Control” (as those terms were defined in the Verizon Policy) before the Policy was purchased. The Superior Court rejected this argument based on two provisions in the Verizon Policy. It first noted that the Verizon Policy provided coverage if Verizon had Management Control of the Subsidiary “on” or “before” the Policy Period. The use of the word “before” established that the Subsidiary did not have to be a subsidiary as of the date of the policy. Secondly, the Verizon Policy included an endorsement that explicitly provided coverage for liabilities arising out of the Transaction. Denying coverage for the claims would render these policy provisions illusory.

Coverage for Defense Costs

After the Superior Court found coverage for a defense under the FairPoint Policy, the Insurers contended that the Court should audit the Insureds’ bills to determine whether their fees were “reasonable and necessary.” The court exhibited an extreme distaste for this onerous task. It justified its refusal to do so by pointing out that the Insurers had denied coverage six years ago and had copies of those bills over that same period of time, but only reviewed and challenged those bills once they faced a dispositive motion on their defense obligations. Responding to the Insurers’ assertion that they had reserved their rights to do so, the court stated:

It certainly was [the Insurers’] “right” not to participate. But it also was Insureds’ “right” to assume their Defense Costs were reasonable in the face of the Insurers’ silence. The Insurers cannot have it both ways. 2021 WL 710816 at *__.

In this case, the Superior Court combined a careful reading of the policies with a thorough understanding of the bankruptcy law upon which the liabilities were based. It threw in a dose of common sense in deciding that Insurers who denied coverage for a defense lost their right to complain about fees incurred by the Insureds. The result—the Insureds obtained the benefit of the coverage they purchased under their policy.

 

[1] Verizon Commc’ns Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa, No. CVN18C08086EMDCCLD, 2021 WL 710816 (Del. Super. Ct. Feb. 23, 2021).

[2] Roughly speaking, that transaction went as follows: Verizon created an entity, SpinCo, and sold it the landlines in exchange for corporate debt notes. Verizon then spun out these corporate debt notes to Verizon’s shareholders. SpinCo and FairPoint merged, with FairPoint surviving, and FairPoint issued new stock to replace stock in the now-defunct SpinCo.

[3] 2021 WL 710816 at *3.

[4] In its summary judgment motion, Verizon sought coverage only under the FairPoint Policy. The insurers’ motion sought a determination that there was no coverage under either policy. Id. at *15.

[5] Id. at *2.

[6] Id.

[7] In re Verizon Ins. Coverage Appeals, 222 A.3d 566 (Del. 2019).

[8] 2021 WL 710816 at *7.

[9] This is consistent with the fact that derivative actions can be based on claims of director and officer misconduct other than securities fraud, and that directors and officers would expect coverage for such actions under a D&O policy. Public company coverage, however, typically is limited to claims falling within the “Securities Claim” definition in the company’s policy.

[10] 2021 WL 710816 at *9.

[11] 2021 WL 710816 at *__, citing to Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376, 388, 390 (D.Del. 2002).

[12] 2021 WL 710816 at *___, citing to Artesania Hacienda Real S.A. DE C.V. v. North Mill Cap., LLC (In re Wilton Armetale, Inc.), 968 F.3d 273, 280 (3d Cir. 2020).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Farella Braun + Martel LLP | Attorney Advertising

Written by:

Farella Braun + Martel LLP
Contact
more
less

Farella Braun + Martel LLP on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.