Long a feature of directors’ and officers’ (D&O) liability insurance policies, the so-called “Bump-Up” Exclusion has gotten significant attention over the last few years. Because of the recent escalation in securities litigation that follows a majority of mergers and acquisitions, the Bump-Up Exclusion is of critical importance to publicly traded policyholders. Bump-Up Exclusion provisions are often found in a D&O policy’s definition of “Loss” and purport to exclude the amount of a settlement or judgment that represents an increase in the price paid to acquire an entity, where such consideration was alleged to be inadequate. A recent decision out of the Delaware state courts affirms again that D&O insurers will be held to the specific terms of their Bump-Up Exclusions.
Insurers have sought to stretch the scope of the exclusion beyond its original purpose, to the detriment of policyholders. The Bump-Up Exclusion was originally written to apply only to acquisitions made by the policyholder, with the stated intention of preventing insureds from paying less than market value for an acquisition and having the insurer fill in the purchase price when the acquired entity’s stockholders sued for the shortfall. However, insurers later broadened the language to purportedly apply to acquisitions of the securities or assets of any entity, including the insured entity itself, even though the insured by definition would not have received the alleged additional consideration sought. And insurers continue to seek to push the application of the Bump-Up Exclusion even further, to include, for example, claims arising from transactions other than acquisitions, or claims for alleged breaches of fiduciary duty that seek damages other than increased consideration.
However, many courts, particularly Delaware courts, are holding insurers to the strict terms of their Bump-Up Exclusions. The August 2023 decision by the Delaware Superior Court in Viacom Inc. v. U.S. Specialty Insurance Company is a prime example.
In Viacom, the company sought coverage from its D&O insurers for claims brought by its stockholders concerning Viacom’s merger with CBS Corporation. In the 2019 transaction, all of Viacom’s “assets, rights, privileges, powers and franchises” were transferred to CBS, which was the surviving corporation. After the merger, the company was renamed CBSViacom Inc. In the merger process, all of Viacom’s common stock was converted into CBS common stock at an agreed exchange ratio and then cancelled, so that Viacom’s stockholders became stockholders in the newly merged CBSViacom.
Viacom stockholders sued Viacom and one of its directors alleging breach of fiduciary duty for negotiating a reduced purchase price for Viacom’s stock in exchange for governance concessions including the appointment of a CEO candidate preferred by one board member who was an indirect controlling shareholder. In exchange for the governance concession the ultimate price accepted for the merger was $1 billion less than had been bargained for during failed merger negotiations a year prior. The stockholders and Viacom parties ultimately settled the claims for $122.5 million. But several of Viacom’s excess D&O insurers refused to pay the settlement, denying coverage on the basis of the Bump-Up Exclusion in Viacom’s policies, which stated that covered Loss did not include:
any amount representing the amount by which the price of or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all of the ownership interest in, or assets of, an entity, including [Viacom], was inadequate or effectively increased.
The insurers argued that the Bump-Up Exclusion applied because all of Viacom’s securities were acquired by CBS in the merger. Viacom countered that the Bump-Up Exclusion applies only to “acquisitions”―an undefined term―and not “mergers.” Viacom’s policies included references to both, with “acquisitions” described using similar language as the Bump-Up Exclusion (i.e., “all or substantially all of the Company’s assets”), while “mergers” were described as “the merger or consolidation of the Company into or with another entity such that the Company is not the surviving entity.” This showed the insurers knew how to clearly refer to, and differentiate between, mergers and acquisitions, but chose not to do so in the Bump-Up Exclusion.
The Delaware Superior Court found that the Bump-Up Exclusion was ambiguous, as it was subject to two contrary but reasonable interpretations, i.e., that the Exclusion applies to acquisitions that are part of a broader transaction such as a merger, or that it only applies to “acquisition” transactions. As a result, the Court held that the Bump-Up Exclusion had to be interpreted in favor of coverage and that it did not apply to Viacom’s settlement of the CBS merger claims.
The Viacom decision is an important rejection of insurers’ improper expansions of the Bump-Up Exclusion. However, not all courts have been so diligent in applying these sound policy construction principles to similar terms. In March 2023, the Fourth Circuit Court of Appeals came to the opposite result in reversing a Virginia federal district court decision, applying Virginia law that (unlike Delaware law) finds no ambiguity where the court concludes one interpretation is more reasonable and relying on dictionary definitions of the term “acquisition” to conclude it applied to both an actual acquisition of stock and a merger.
Policyholders should take proactive steps to avoid losing coverage due to insurers’ application of a Bump-Up Exclusion. Review your current D&O policies and any terms offered on renewal to ensure you have the narrowest version of the Bump-Up Exclusion language available, particularly if you are anticipating any major corporate transactions. If you are sued in a lawsuit potentially implicating the Bump-Up Exclusion, or have a claim denied on that basis, consult with policyholder counsel regarding pursuit of the claim, including choice of law and jurisdiction.