Does public policy prevent recovery for fraud under Delaware law?

Delaware state seal

An interesting recent Directors and Officers (D&O) decision of the Delaware Court challenges the tacit assumption that public policy necessarily prevents recovery from insurers in cases where fraud and deliberate misconduct is alleged.

The case concerns an action brought by former shareholders of Dole Food Company against two directors, one of whom was a major shareholder alleging they had manipulated Dole’s stock price to artificially deflate it prior to acquiring the remaining shares and taking the company private. In a Memorandum Opinion which had repeatedly cited “fraud” and “fraudulent activity,” the Delaware Court of Chancery assessed liability against the defendants for around $150 million.

The claim was then settled for that amount, plus interest, and the D&O insurers were asked to pay. They objected on the basis that the law didn’t permit indemnification on these facts. They also alleged the insureds had failed to obtain insurers’ written consent to settle and had failed to cooperate.

The indemnity and public policy point

Having first decided that the law of Delaware applied to the policy (in the absence of a specific choice of law clause), the Court went on to consider what Delaware public policy was with respect to indemnification for fraud. Its starting point was as follows:

“A court may not enforce an insurance provision that is contrary to Delaware public policy. A court will not void an otherwise valid contract provision based on public policy in the absence of clear indicia that such a policy actually exists”

Having reviewed what little authority it could find, the Court went on to conclude that:

“….Although it may strain public policy to allow a director to collect insurance on a fraud it does not appear explicitly prohibited by Delaware statutory law.”

It’s worth remembering that this was a motion to dismiss application which a court will only grant if no genuine issues of material fact exist and the party is entitled to judgment as a matter of law, i.e. a pretty high standard is applied. It will be open to insurers to argue the point further as the case develops. Nevertheless the decision may still come as something of a nasty surprise to insurers.

The consent to settle and failure to co-operate argument

One suspects, given the high threshold on motions to dismiss mentioned above, that insurers probably didn’t have too much faith in these arguments succeeding at this stage of the case, in the event their primary contention was unsuccessful. If so, they were right not to do so.

The Court had no difficulty in concluding that these policy requirements (as such they were) could only avail insurers in their non-observance by insureds to the extent that insurers were able to establish prejudice. On the question of failure to secure express consent to settle, insurers provided no evidence of prejudice. On the question of failure to cooperate, the Court found there were issues of fact between the parties as to whether or to what extent there had really been such failures.

Discussion and conclusion

The problem for insurers in this case I imagine was that the Memorandum Opinion in the underlying case didn’t amount to a “final adjudication” of the type needed to trigger the fraud and or conduct exclusions, which are likely to have existed under the D&O policy. Instead, there was a settlement of the claim which insurers were asked to honor. As indicated above, the story is not over yet though.

The finding of the court with respect to Delaware public policy remains something of a surprise. Maybe at a later point, if this case develops beyond the motion to dismiss stage, the Court will have an opportunity to re-examine this question.

Note that in the passage quoted above, the Court refers to “Delaware statutory law.” If the case had come before the English courts it would not simply be a question of statutory law. Insurers could also have availed themselves of the well-known common law principle known under the Latin maxim of “ex turpi causa…” i.e., that you cannot benefit from your own wrongdoing. Readers may recall that this was the basis on which insurers successfully defeated Safeways’ claim to be entitled to recover from its D&O insurers in a claim for breach of fiduciary duty brought against former board members.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Directors & Officers, Insurance and Risk Management | Tags: , , ,

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