07 Oct D&O Insurance Coverage: Insurance Provider Needs To Protect Later Securities Claims Associated With Earlier Claim
I have frequently written on this blog about relatedness issues and how they affect the availability of D&O insurance coverage for a series of lawsuits that have been filed over time against a company. D&O insurers frequently argue, in order to try to avoid coverage, that a later lawsuit is related to an earlier proceeding in order to try to argue that the subsequent suit is deemed made at the time of the earlier proceeding. In an interesting case in the Southern District of Texas, the insurer took the opposite position and tried to argue that two securities class action lawsuit complaints filed after the end of the policy period were unrelated to an earlier securities suit that had been filed during the policy period, in order to try to avoid coverage for the subsequent lawsuits.
In an October 4, 2018 decision (here), Magistrate Judge Nancy K. Johnson ruled that the later securities lawsuits filed against Nobilis Health were interrelated with the earlier lawsuit against the company, and therefore that the insurer was obligated to cover the costs the insured company incurred in defending all three lawsuits. The court’s decision underscores the breadth of the relatedness in D&O insurance policies and highlights the fact that relatedness issues can, depending on the circumstances, result in a coverage expansion and not only a narrowing of coverage.
Nobilis Health Corp. is a publicly-traded healthcare company located in Texas. On October 9, 2015, the company was the subject of an article on the Seeking Alpha website. The article suggested the company was “overvalued” and that its share price was likely to decline. Among other things the article noted “multiple accounting red flags” in the company’s financial statements. Following publication of the Seeking Alpha article, the company’s share price declined over 27%.
On October 21, 2015, a Nobilis shareholder filed a securities class action against the company and certain of its directors and officers (the “Hall lawsuit”). The Hall lawsuit was filed on behalf of Nobilis shareholders who had purchased their shares between April 2, 2015 and October 8, 2015. The Hall lawsuit raised allegations about the efficacy rate of one of the company’s procedures. The Hall lawsuit also alleged that the company had overstated its 2014 revenue and its 2014 revenue growth. The Hall complaint also referred to the Seeking Alpha post. The plaintiff voluntarily dismissed the Hall lawsuit on December 8, 2015.
On January 5, 2016, Nobilis filed a Form 8-K with the SEC in which the company said that its financial statements for its 2014 fiscal year and part of 2015 required restatement and could no longer be relied upon. The 8-K identified certain inaccuracies in the company’s previously filed financial statements. On January 13, 2016, the company filed amended financial statements with the SEC.
On January 19, 2016, another Nobilis shareholder filed a securities class action lawsuit against the company and certain of its directors and officers (the Schott lawsuit). The Schott lawsuit purported to be filed on behalf of Nobilis shareholders who purchased their shares between April 2, 2015 and January 6, 2016. The Schott complaint alleged that the company had overstated the value of its account receivables and of its net income for the 2014 fiscal year. The Schott complaint referenced the Seeking Alpha post and also the company’s amended financial disclosures. On September 29, 2016, the court dismissed the Schott complaint with leave to amend, and the following month the plaintiffs in the Schott lawsuit voluntarily dismissed the action.
In addition, on January 8, 2016, a different Nobilis shareholder filed a third securities class action complaint against the company and certain of its directors and officers (the Cappelli lawsuits). The Cappelli lawsuit purported to be filed on behalf of a Nobilis shareholders who had purchased their shares between March 23, 2015 and January 5, 2016, and held those shares at the close of trading on October 8, 2015 (the date of the Seeking Alpha post) or January 5, 2016 (the date of Nobilis filed its 8-K with the SEC). The Cappelli lawsuit alleged that the company’s financial statements had misled investors about the company’s revenue, expenses and general business operations. The Cappelli lawsuit discussed the Seeking Alpha post and the corrective SEC disclosures. The Cappelli lawsuit remains pending.
Nobilis’s D&O Insurance
Nobilis was insured under a D&O insurance policy with a policy period of October 30, 2014 to October 30, 2015. Nobilis submitted all three lawsuits as claims to its D&O insurer. The insurer accepted coverage for the Hall lawsuit, which was filed during the policy period. However, the D&O insurer denied coverage for the Schott and Cappelli lawsuit on the ground that the claims were made and noticed after the end of the policy period. Nobilis filed an action against the insurer for breach of contract and seeking a judicial declaration that the insurer was obligated to reimburse Nobilis for its costs incurred in defending the Schott and Cappelli lawsuits. The insurer filed a motion for judgment on the pleadings and Nobilis filed a cross-motion for summary judgment.
The Relevant Policy Language
The policy defines a “Wrongful Act” as “any actual or alleged act, omission, error, misstatement, misleading statement, neglect or breach of duty” by the “Insured Persons” or the “Insured Entity.” The term “Related Wrongful Acts” is broadly defined as “Wrongful Acts which are logically or causally connected by reason of any common fact, circumstance, situation, transaction, casualty, event or decision.”
The policy provides further that:
More than one Claim involving the same Wrongful Act or Related Wrongful Acts of one or more Insureds shall be considered a single Claim. All such Claims constituting a single Claim shall be deemed to have been made on the earlier of the following dates: (1) the earliest date on which any Claim was first made; or (2) the earliest date on which any such Wrongful Act or Related Wrongful Act was reported under this Policy or any other policy providing similar coverage.
The October 4, 2018 Opinion
In her October 4, 2018 opinion, Judge Johnson granted Nobilis’s motion for summary judgment and denied the insurer’s motion for judgment on the pleadings, holding that “under a plain reading” of the policy’s language, the three lawsuits “are a single claim that is deemed to have been made with the Policy’s period,” and therefore in denying coverage for the two later lawsuits the insurer had breached its obligations under the policy.
In concluding that the three lawsuits’ complaints “contained at least some allegations of the same ‘Wrongful Acts,’” Judge Johnson noted that “all three lawsuits contain allegations that Nobilis’ financial statements were misstated, false, misleading , and/or inaccurate.” All three complaints discuss the information revealed in the Seeking Alpha post.
Judge Johnson said further that even if the Wrongful Acts alleged in the three lawsuits are “not identical,” they are at least “Related Wrongful Acts” under the Policy. Judge Johnson noted that “all three complaints are allegations that Nobilis inflated its stock price by making various misstatements to the investing public.” Thus, she said, “at the very least,” the allegations in the three lawsuits “are united by common circumstance or situation such that the allegations are ‘Related Wrongful Acts’ under the policy.”
The insurer, Judge Johnson said, tried to argue that the allegations are different and unrelated “by focusing on minute differences in the complaints” – for example, that the Hall complaint refers to an overstatement of revenue and the Schott complaint refers to an overstatement of net income. Judge Johnson said the fact that the two complaints use different ways to describe “the same ‘Wrongful Act’ of overstating key financial information does not mean that the ‘Wrongful Act’ suddenly becomes two distinct ‘Wrongful Acts.’” And even if distinct, the two acts “would still meet the Policy’s broad definition of ‘Related Wrongful Act.’”
The insurer also tried to argue that the two later complaints differed from the Hall lawsuit because the two later complaints referred to the company’s January 2016 corrective disclosures, while the Hall complaint did not. Judge Johnson rejected this argument because the two later suits “sought damages for the same allegedly defective financial statements as the Hall lawsuit.” The January 2016 disclosure “was not itself a ‘Wrongful Act’”; the Wrongful Acts complained of in the three lawsuits “are primarily that Nobilis’ financial statements from 2014 and the first two quarters of 2015 contained misstated information.”
Judge Johnson concluded by noting that the insurer tried to rely on “other minor differences” between the three complaints” but “ignores the plain language of the Policy.” The fact that the complaints contain “some of the same ‘Wrongful Acts’ is enough to trigger coverage.”
Judge Johnson’s decision in this coverage dispute underscores the fact that the definition of Related Wrongful Acts in this policy, as is the case in most D&O insurance policies, is very broad. Alleged Wrongful Acts are related under the policy if they are “connected by reason of any common fact, circumstance, or situation.”
As I noted at the outset, more often than not, D&O insurers are trying to rely on this breadth of relatedness under the policy to try to argue that subsequent proceedings during the policy period are related to prior proceedings that were initiated prior to the policy period, in order to try to argue that there is no coverage under the policy for the subsequent proceedings. (Refer here and here for recent examples in which a D&O insurer made this kind of argument to successfully defeat coverage.) In this case, by interesting contrast, the insurer was trying to argue that the subsequent proceedings were unrelated to the prior claim and therefor outside of coverage under the policy.
Given the breadth of the policy’s definition of the term “Related Wrongful Acts” here, it was always going to be an uphill battle for the insurer to establish that the later lawsuits were unrelated to the earlier suit.
To be sure, there are differences between the three lawsuits. The complaints purported to be filed on behalf of investors who had purchased their shares during slightly different (although somewhat overlapping) lawsuits. Each of the lawsuits contained certain allegations that the others did not. And the two later lawsuits referred to the company’s 2016 corrective disclosure, which the Hall lawsuit had not due to the simple fact that the Hall lawsuit was filed and dismissed before the company made it 2016 corrective disclosures.
What Judge Johnson’s opinion establishes is that while there are differences between the complaints in the three lawsuits, the differences are, for purposes of determining the applicability of insurance coverage, relatively unimportant compared to the similarities and overlaps between the three complaints. As Judge Johnson noted, all three complaints alleged that the company’s 2014 and first two quarters of 2015 financial statements were misleading. All three complaints relied on the assertions in the Seeking Alpha post.
Judge Johnson characterized the differences on which the insurer sought to rely in order to try to argue that the two later complaints were not interrelated with the earlier lawsuit as “minute” and “minor.” Whether or not this characterization is fair, there is absolutely no doubt that there were – notwithstanding the differences between the complaints — significant areas of overlap between the three lawsuits. Given the extremely broad reach of the policy’s relatedness provision – requiring as it does only the existence of “any common fact, circumstance, or situation” – you do have to kind of wonder about the position the insurer took here.
The fact is that insurers are often relying on the breadth of relatedness provisions to argue that later claims during the policy period are interrelated with earlier claims first made prior to the policy period in order to try to disclaim coverage. But the breadth of the relatedness provisions can cut both ways, and in this instance the breadth of the relatedness provisions meant that the insured was entitled to coverage for all of the various proceedings, even those filed after the end of the policy period.
One thought I had while reading this decision was to wonder whether the company had replacement D&O insurance in place following the expiration of the policy at issue here. My guess it that the company did have replacement coverage in place, but that the insurer on the subsequent policy regarded the two later complaints as interrelated with the earlier lawsuit, and therefore not covered under its policy. Which is a reminder of the kinds of problems that can arise when a series of claims are filed over multiple policy periods. Which is in turn a reminder that changing carriers in subsequent policy periods is an action that should be undertaken with great care.
A Note About Counting Securities Lawsuits: It isn’t directly relevant to the court’s analysis of relatedness issues under the policy for purposes of determining the availability of coverage for the two subsequent lawsuits, however it is still interesting to note that at the time, both the Stanford Law School Securities Class Actions Clearinghouse and The D&O Diary, for purposes of tallying the number of securities class action lawsuits in 2016, counted the various lawsuits that were filed against Nobilis in 2015 and 2016 only once, in 2015. That is, in our respective counting efforts, we each concluded that the various complaints represented more or less the same lawsuit for purposes of our respective running lawsuit tallies.
The sequence of events here, and in particular the instance of three separate complaints, provides an interesting set of circumstance to consider lawsuit counting protocols. Under my counting methodology as well as under the methodology used by the Stanford Law School Securities Class Actions Clearinghouse, the claims filed against a single company are counted only once, regardless of the number of complaints actually filed, if the complaints more or less represent the same lawsuit. By contrast, NERA Economic Consulting counts the separate complaints separately unless or until the complaints are consolidated.
This case illustrates how the latter methodology would in this circumstance at least result in a higher claim tally. Here, the Hall lawsuit was filed and dismissed before the two later lawsuits were filed. The two later lawsuits would never be consolidated with the earlier lawsuit because the earlier lawsuit was already terminated before the later lawsuits were filed. The two later lawsuits were not going to be consolidated with each other, either, for a number of reasons including others beyond the scope of this post, and in any event the Schott lawsuit was dismissed and was not consolidated with the Cappelli lawsuit.
Because the lawsuits were not consolidated, under the alternative counting methodology, the three complaints are reckoned as three lawsuits, whereas under the methodology I use, the three complaints are counted only once. For me, the relevant question is whether or not different complaints involved the same or similar wrongful acts, not whether or not the complaints were consolidated – for me, the question of whether or not to count separate complaints should be a matter of the substance of what is alleged, and not upon the procedural happenstance of whether or not complaints are consolidated.
As Judge Johnson concluded, there was a great deal of overlap between these three complaints. She found the three complaints to be interrelated for purposes of determining insurance coverage. I had already concluded that the complaints were interrelated for purposes of determining whether or not to count the complaints separately or only once for purposes of my running tally of securities class action lawsuit filings.
All of which does make me wonder what the insurer was thinking here in trying to argue that these three lawsuits were not interrelated.
The post D&O Insurance: Insurer Must Defend Later Securities Lawsuits Related to Earlier Claim appeared first on The D&O Diary.