When corporate transactions engender shareholder litigation, Directors’ and Officers’ liability insurers all too often invoke the so-called “bump-up” exclusion to bar coverage of such claims. These provisions, common in D&O policies, purport to exclude coverage for settlements or judgments that effectively increase the deal price in acquisitions, the theory being that D&O insurance was not intended to act as a backstop to the share price obtained by management in selling a company. D&O insurers have for years tried to expand the application of these provisions in attempts to narrow Side B/C coverage for M&A transaction-related losses.
In a win for policyholders, the Delaware Supreme Court recently issued a decision limiting insurers’ ability to broadly invoke the “bump-up” exclusion to bar coverage for post-transaction settlements. In the closely watched case Illinois National Insurance Co. v. Harman International Industries, Inc., the court held that a $28 million settlement of federal securities claims arising from Samsung’s acquisition of Harman was not excluded from coverage under the policies’ bump-up exclusion.
The Harman decision is a victory for policyholders because it reinforces the rule that bump-up exclusions are not a per se bar to coverage of acquisition-related claims and should curtail insurers’ ability to assert the provision, though some key D&O insurance providers are also changing their bump-up exclusion language to avoid the impact of decisions like in Harman. This decision is an important reminder that the application of bump-up exclusions turns on policy language and the real-world substance of the underlying settlement. Because this fact-intensive approach leaves the door open for future litigation around bump-up exclusions, policyholders should carefully tailor their settlements of post-transaction lawsuits to reflect the parties’ intention and to avoid the inappropriate application of bump-up exclusions.
Background: The Harman–Samsung Transaction and Coverage Dispute
Harman International Industries merged with a subsidiary of Samsung Electronics Co., Ltd. in 2017. Following the transaction, former Harman shareholders brought a federal securities class action alleging that disclosures made in connection with the merger were misleading and violated Section 14(a) of the Securities Exchange Act. The action ultimately settled for $28 million. Harman sought coverage for the settlement under its D&O insurance program, but its insurers denied coverage on the basis that the settlement represented an effective increase in merger consideration and therefore fell within the policies’ bump-up exclusions. The Delaware Superior Court rejected the insurers’ theory, and the Delaware Supreme Court confirmed that outcome with some adjustment in the analysis.
A Two-Step Test—and a Narrower Exclusion
The Delaware Supreme Court focused on the language of the bump-up exclusion and emphasized that not all such exclusions are created equal. For the common bump-up exclusion language at issue in Harman, the Delaware Supreme Court required the insurers make a two-step showing. First, the insurers must prove that there is (i) a Claim; (ii) alleging inadequate price or consideration; (iii) arising from an acquisition. If so, as a second showing, the burden is on the insurers to prove that the settlement or judgment has the “real result” of increasing the consideration paid to shareholders.
In Harman, the Delaware Supreme Court looked first at the nature of the damages claimed and found that the underlying securities claim may in fact have alleged inadequate consideration. While the underlying action was styled as a disclosure claim under Section 14(a), the court found that with respect to damages the plaintiffs solely alleged they were deprived of the “full and fair value” of their shares and sustained losses of the difference between the deal price and the shares’ purported “true value.”
However, the court held that the insurers failed to establish the second—and dispositive—requirement of proving that the settlement functioned as a real increase in deal consideration. Several factors drove that conclusion:
- Settlement class composition. The settlement class included shareholders who held Harman stock at any time during a defined period before closing, not only those who received merger consideration. Class membership did not depend on whether a shareholder held shares through the transaction or received any consideration at all.
- No evidence tying the settlement to “true value.” The record contained no analysis of Harman’s “true value,” and the insurers offered no evidence that the settlement amount was calculated to compensate shareholders for an alleged underpayment of such value in the transaction.
- Litigation-driven settlement dynamics. The court accepted that the settlement amount was more plausibly driven by the cost and risk of continued litigation rather than an effort to retroactively increase the deal price, based on settlement language, the amount of the settlement compared to the alleged damages, and testimony by the policyholder.
Because insurers had not met their burden to show that the “real result” of the settlement was to increase merger consideration, the bump-up exclusion did not apply.
Practical Implications for Policyholders
For years, carriers have often treated the bump-up exclusion as an automatic bar to coverage for acquisition-related claims, arguing that any claim that sought pro rata damages for shareholders after a transaction must be a bump-up claim. Harman makes clear that this approach overreaches. The decision confirms that application of the exclusion depends on policy language and facts—including how settlements are structured and supported in the record.
The securities bar, when resolving post-transaction claims, should consult with experienced coverage counsel for guidance on how to ensure settlement agreements accurately reflect the parties’ intent. Thoughtful and accurate settlement drafting and a clear record explaining what a settlement represents—and what it does not—may prove critical in preserving coverage and avoiding the improper application of bump-up exclusions.
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