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When Your Merger Generates a Lawsuit, the Path to Coverage May Be Straighter than You Think

By: Carl L. Blumenstein

When mergers create lawsuits, corporations — as well as their officers and directors — typically seek help from directors’ and officers’ policies. Merger-generated lawsuits can give rise to a maze of corporate and securities law claims that must be evaluated in light of the policy terms to determine if there is coverage. A recent insurance coverage decision from the Ninth Circuit helps illuminate the road to coverage under D&O policies.

Pan Pacific Retail Properties, Inc. v. Western Properties Trust, 471 F.2d 961 (9th Cir. 2006) arose from a merger by which Pan Pacific stock was tendered to Western Properties shareholders. Those shareholders filed a class action lawsuit against both corporations and their officers and directors, asserting that the companies withheld material information and that the stock price was too low.

The state court granted summary adjudication on the derivative claims, but allowed the plaintiffs to proceed on their direct claims, i.e., claims based on their rights as shareholders, as distinguished from rights belonging to the corporation. The underlying case then settled for a little less than $1 million.

Both companies had timely tendered the lawsuit to their directors’ and officers’ insurers. Both insurers had denied coverage. After Pan Pacific, the merged entity, sued to recover under both policies, the federal district court granted summary judgment for the insurers. The policyholder persisted, appealing its case to the Ninth Circuit.

Restitution, Compensation, or Both?

In granting summary judgment of noncoverage against Pan Pacific, the acquiring company, the district court relied on the established principle that claims for restitution — seeking the return of money or property wrongfully withheld — are not insurable.

But the Ninth Circuit didn’t see it that way. It explained that some claims, while characterized as "restitutionary," also served to compensate for a loss and would therefore be covered. The court then analyzed whether the derivative and direct claims solely sought restitution or would also compensate for a loss. Two aspects of the court’s analysis are worth noting:

  • The Ninth Circuit evaluated whether there was coverage for the derivative claims that were no longer in the case at the time of the settlement. The court reasoned that, because the policyholder faced exposure if these claims were reversed on appeal, they could have factored into the settlement. This real-world approach is analytically sound and, importantly, permits policyholders to seek coverage based on the business realities of settlements without being constrained by pleading technicalities.
  • California law does not permit shareholders to sue management for decreases in stock value, so there would be no "loss," and no coverage if those were the only damages sought on the shareholders’ direct claims. In the coverage case, the policyholder argued that at least some of the settlement funds compensated the shareholders for the "value of the withheld information," a claim that was not even alleged in the underlying shareholder lawsuit. The Ninth Circuit held that counsel’s declarations were sufficient to raise an issue of fact on this basis, and reversed the trial court.

Coverage for the Acquired Company?

The acquired company, Western Properties Trust, was also named in the underlying lawsuit and had sued its D&O insurer in the same coverage action. The Ninth Circuit concluded, as had the district court, that Western Properties was not entitled to coverage under its policy.

  • Western was not entitled to coverage for reimbursing its officers and directors for indemnified claims because it hadn’t, in fact, reimbursed any such costs.
  • Turning to the insuring agreement that covered securities claims against the company itself, the Ninth Circuit reasoned that the underlying claims could have imposed liability on Western that would be covered by this insuring agreement. But in this case, Pan Pacific indemnified Western as part of the merger agreement. Permitting Western to recover under its policy would therefore give it an impermissible double recovery. Thus, the Ninth Circuit reminds us that the collateral source rule does not apply to insurance: A policyholder may only recover its actual loss, net of recovery from third party sources.

In order to optimize the value of their coverage, D&O policyholders and their coverage counsel should not accept the insurer’s initial denial. As here, obtaining policy benefits can take careful claims evaluation and persistent advocacy.

Carl L. Blumenstein, partner at Nossaman, specializes in insurance coverage and complex business litigation disputes. He can be reached at

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