M&A Reps and Warranties Insurance to Cost More in 2021
In a recent podcast posted by Liberty GTS, one of the leading insurers that offers representations and warranties insurance (RWI) policies to protect against breach of representation in acquisition agreements, Rowan Bamford, President, and Gareth Rees, Chief Underwriting Officer, spoke about the factors that are likely to drive rate increases for RWI in 2021.
Based on the claims data Liberty GTS had collected, generally one in five policies received claim notifications, which is in line with data previously seen in the RWI market. While the majority of those claim notifications were precautionary, 25 percent of them resulted in real claims. The interesting part was that Liberty GTS saw an increase in the number of claims coming out of smaller deals. This is likely due to the fact that more sophisticated diligence teams are employed for larger deals and more funds are spent on diligence for the larger deals, uncovering most of the skeletons in the closet. For smaller deals, typically those under $50 million in enterprise value, diligence budgets are smaller and not as much effort is put towards looking for possible issues. These findings will likely cause insurers like Liberty GTS to refuse to take on as many smaller deals as they had in the past and to increase their minimum retention and premium requirements for the smaller deals.
Other interesting trends noted in the podcast and that I have generally observed in the market is the continuation in the increase of premium rates for RWI policies. Initially the market saw increased rates in November and December of 2020 when it experienced a surge in demand for coverage. Many companies that slow-walked their deals through the COVID-19 pandemic in 2020 or waited out the November presidential election, rushed to close those deals prior to year-end fearful of change in political outlook. This resulted in an overload experienced across the RWI industry among insurers and insurance brokers alike. As a result, insurers either increased rates or declined to quote many of the deals, prompting the general RWI rates to go up by about 20 percent. This rate increase has generally been holding in the market through February 2021 and is unlikely to dissipate.
An interesting point made in the Liberty GTS podcast centered on the fact that insurance rates across other lines such as management liability, cyber, E&O, etc. had grown dramatically in 2020 to compensate for increased risk that was partially due to COVID-19 and partially to increased number of claims. Considering that insurers need to balance their books and capacity among various insurance lines to maintain harmony with their reinsurers, in 2021 they may need to pull more capacity towards lines that are more profitable than RWI, which will, in turn, drive an additional RWI rate increase. The podcast speakers threw out 10 percent as the potential number for this additional increase but considering the ongoing competition among over 20 insurers in the current RWI market, it remains to be seen whether the actual rate increase will prove to be that drastic.
Second Circuit Upholds District Court’s Decision Regarding GE Turbine Flaw
By Dixon Babb
On February 3, 2021, the United States Court of Appeals for the Second Circuit (the “Court”) affirmed the judgment of the United States District Court for the Southern District of New York (the “District Court”), which found that the Teachers’ Retirement System of Oklahoma (“TRS”), investors of General Electric Co., a multinational conglomerate focusing on the power, renewable energy, aviation and healthcare industries (“GE”), failed to state a claim under Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, as amended, relating to GE’s alleged concealment of a defective gas turbine and a delayed $22 billion goodwill impairment charge.
The initial complaint relates back to GE’s 2015 acquisition of the power assets of Alstom SA, a French multinational rolling stock manufacturer (“Alstom”), and the initial suit alleged that GE had hidden a defect in its H-class gas turbine while inflating the value associated with the Alstom deal’s goodwill. On appeal, the TRS challenged the District Court’s decision with respect to eight public statements made by GE in 2017 and 2018 relating to GE’s new HA turbine, which the District Court found were either too general to constitute a representation that an investor would reasonably rely on, or were not actionable because they were statements of opinion. The TRS contended that these statements were materially misleading because GE made positive statements regarding the turbine’s performance and omitted important information regarding a blade defect. The TRS claimed that Item 303 of Regulation S-K obligated GE to disclose the information regarding the blade defect.
However, the Court did not address the substance underlying the alleged misstatements and omissions, because the TRS did not successfully plead scienter. In an attempt to establish scienter, the TRS alleged that “GE made statements praising the HA turbine, even though they knew when making the statements that the turbines suffered from a significant blade defect, that the defect harmed the turbine’s performance, and that GE’s proposed solution to the defect ‘could not be implemented effectively’ and would ‘have a material financial impact’ on GE.” The TRS argued that these allegations could support an inference of scienter because they “strongly suggest [GE] sought to use those disclosures to express optimism and underrepresent the extent of those very problems.”
In affirming the District Court’s decision, the Court noted “these statements did not amount to a ‘sufficiently extreme departure from the standards of ordinary care’ to support an inference of recklessness.”
Superior Court of Delaware Rules on Motions for Summary Judgment in Case Involving Insurance Policy Coverage in the Orbital Sciences Corporation – Alliant Techsystems, Inc. Merger
By Courtney Black
On February 2, 2021, the Superior Court of the State of Delaware (the “Court”) decided a case arising out of the 2015 reverse triangular stock-for-stock merger between Orbital Sciences Corporation, an aerospace supplier (“Orbital Sciences”), and Alliant Techsystems, Inc., an aerospace and defense company (“Alliant”), which led to the creation of Orbital ATK, Inc., a space and defense contractor (“OATK”). Northrop Grumman Innovation Systems, Inc., an aerospace and defense technology company (“Plaintiff”), later acquired OATK and sued the insurance companies of Orbital Sciences, Alliant, and OATK (“Defendants”), who provided merger-related insurance policies. Plaintiff alleged Defendants wrongfully denied coverage for defense fees and settlement costs incurred in a class action suit challenging the merger (the “Knurr Litigation”). The class action had two claims: a challenge to the merger’s proxy solicitation (the “14(a) Claim”) and a challenge to the value of OATK in the post-closing financial reports (the “10(b) Claim”). The Court decided motions for summary judgment filed by Plaintiff and Defendants.
The Court began with the OATK insurance companies. First, the Court held the OATK policies cover the 10(b) Claim. The Court rejected Defendants’ argument that a “prior acts exclusion” in the policy barred coverage because the 10(b) Claim was related to the 14(a) Claim, which occurred outside the policy period. Here, the plain language stated the policy-defined insured must make the wrongful act to trigger the exclusion. The OATK policies defined OATK as the insured, but the 14(a) Claim was brought against Alliant and Orbital Sciences. The Court then rejected the argument that the 14(a) Claim was an interrelated wrongful act. Delaware law on interrelated wrongful acts states coverage is excluded when the underlying claims are fundamentally identical, i.e. of the exact same subject. The Court found the 14(a) and 10(b) Claims were not fundamentally identical due to variations in timing, type of securities violation and burdens of proof, among other factors. Second, the Court held Defendants did not meet their burden of showing certain investigation fees were not defense costs. Defendants argued Plaintiff incurred certain investigation fees before the Knurr Litigation claims were filed. However, the Court found a material issue of genuine fact regarding if pre-Knurr insight was used to defend the claim.
The Court then turned to the Orbital Sciences insurance companies and held the Orbital Sciences policies may cover the 14(a) Claim. The Court looked at policy language where coverage extended to insured persons solely in their capacity as successor to the policyholder. Here, the Court established OATK’s successor status because the alleged facts of the 14(a) Claim, proxy statement wrongdoings, occurred when OATK did not yet exist. The Court also examined a policy term on losses, which included amounts when Orbital Sciences granted indemnification to insured persons. The Court emphasized how a policy re-negotiation covered liabilities arising from the transaction, so construing the term as Defendants argued would frustrate the parties’ intent at the time of contracting.
Lastly, the Court turned to the Alliant insurance companies and held the Alliant policies cover the 14(a) Claim. Before reaching the coverage issue, the Court took a plain reading approach to the term at issue and interpreted it as an exclusion rather than a provision, which invoked a narrow construction. The Court then found the exclusion applied when three elements exist: 1) the suit only alleges inadequate consideration, 2) the transaction is only an acquisition of all the entity’s assets or ownership, and 3) the loss only represents an effective increase of the claimant’s inadequate consideration. Here, the elements were not met. The 14(a) Claim was primarily about the false and misleading proxy statement, the parties consistently understood the deal as a merger, and the shareholders sought compensatory damages to decrease what they over-paid. The Court’s final Alliant holding was to deny Defendants’ motion regarding two defenses costs – the use of private counsel in the Knurr Litigation and the policy addition of two Orbital Sciences managers. The Court found a genuine issue of material fact regarding if the private counsel fees were jointly incurred by Knurr Defendants. For the Orbital Sciences managers, the Court found as a matter of law, Defendants did not show they were not liable as insured persons, and their Orbital Sciences status alone was insufficient to read them out of coverage.
Delaware Court of Chancery Finds for Defendants in Breach Contract Case Arising from Energy Transfer Partners L.P. - Regency Energy Partners LP Merger
By Courtney Black
On February 15, 2021, the Court of Chancery of the State of Delaware (“the Court”) decided two breach of contract claims arising out of the 2015 unit-for-unit merger (“the Merger”) where Energy Transfer Partners L.P., a midstream energy company, acquired Regency Energy Partners LP, an oil and gas midstream services provider (with its general partner Regency GP LLC, the “Defendants”). The Court, using a preponderance of the evidence standard, entered judgment in favor of Defendants.
The Court held Defendants breached an implied covenant of good faith and fair dealing in the Limited Partnership Agreement’s (“LPA”) safe harbors, which meant the general partner could not shield its Merger approval from judicial review. First, the Court held the special approval safe harbor was not met. This safe harbor would preclude judicial review if a majority of the general partner’s Conflicts Committee members approved the Merger. Here, the LPA had a provision that Conflicts Committee members could not simultaneously serve as directors of the general partner and its affiliates, and one director was a director of a general partner affiliate when he accepted his Conflicts Committee role. The Court thus found the requisite Conflicts Committee vote was not obtained. The Court then held the unitholder approval safe harbor was not met. This safe harbor would preclude judicial review if a majority of common units approved the Merger. Here, the lack of independence with the above-mentioned director made two disclosures in the Merger proxy false, which meant the requisite common unit vote was not obtained.
The Court then held Defendants did not breach an express provision of the LPA. The Court first held judicial review of the Merger was governed by Section 7.9(a) of the LPA’s fair and reasonable standard, not Section 7.9(b)’s subjective good faith standard. The Court used a plain language approach, also used in Delaware precedent, to find that Section 7.9(b) applied, “unless another express standard is provided for in this Agreement,” and Section 7.9(a) referred to standards when a conflict of interest existed between the general partner and partnership. Additionally, Section 7.10(b)’s conclusive presumption of good faith did not apply to the Merger approval. The Court agreed with Plaintiff’s reliance on Morris v. Spectra Energy Partners (DE) GP, LP and its use of the specific-over-general rule of contract interpretation. Section 7.10(b), titled “Other Matters,” applied when other sections did not address the matter, while Section 7.9(a) explicitly addressed conflicted transactions. The Court also invoked an investor’s reasonable expectations standard and concluded investors would reasonably expect a provision addressing conflicted transactions to govern over a more general provision.
Applying the fair and reasonable standard, using a totality of the circumstances approach, the Court held the Merger was fair and reasonable. The Court looked at fair dealing and considered the limited nature of prior director relationships, the limited amounts of units owned, and director experience. The Court also examined fair price and considered the positive opinions of JP Morgan, proxy advisory firms, and market reaction.
Lastly, the Court held Defendants were not liable for damages under Section 7.8(a) of the LPA, which required a judicial finding of bad faith, fraud, or willful misconduct. Using Delaware law definitions, which focus on intent and knowledge, the Court could not make such judicial findings given the case facts. Further, even if Defendant was liable for damages, damages would not be warranted because the valuation calculations deemed proper by the Court would yield no damages.
Double-Derivative Suit against Tableau Software Dismissed for Failure to Make a Demand on the Salesforce Board
By Kolby A. Boyd
On February 10, 2021, the United States District Court for the District of Delaware (the “Court”) dismissed a shareholder suit against Tableau Software Inc., an interactive data visualization company focused on business intelligence (“Tableau”), that was brought by Abdullah Ansary (the “Plaintiff”), who was a shareholder of Tableau prior to the Tableau’s 2019 merger with Salesforce.com, Inc., a cloud-based software company (“Salesforce”).
This lawsuit stemmed from actions taken by Tableau’s directors and officers prior to the merger, where in 2016 they made public statements that the company’s prospects were good and allegedly sold their shares while stock prices were high, even as the company was facing pressures from increased competition in the business-analytics marketplace. Near the end of 2016, the company released a statement saying that growth was slowing, and stock prices dropped nearly 50% that day.
The Plaintiff brought suit after the merger, alleging under Delaware law that Tableau’s directors and officers breached their fiduciary duty and unjustly enriched themselves. According to the Court, because the suit was brought after the merger with Salesforce, the claims would actually belong to Salesforce, meaning the Plaintiff had actually brought a double-derivative suit on behalf of Salesforce.
The decision to dismiss the suit hinged on whether the Plaintiff had made a demand on Salesforce’s board or shown the demand would have been futile, as required under Federal Rule of Civil Procedure 23.1. Because the Plaintiff had made no such demand, he was required to plead particularized facts to create a reasonable doubt that “at least half of the Salesforce board could not have properly exercised its independent and disinterested business judgment in responding to his demand.”
According to the Court, the Plaintiff failed to plead such particularized facts and so the Court did not excuse the lack of the required demand. The Plaintiff had simply made “broad allegations” that Salesforce was able to get a discounted price for Tableau because they approved an indemnification and hold-harmless clause in the merger agreement as part of a scheme meant to protect Tableau’s directors and officers while entering into the merger in bad faith. Further, the Court held the Plaintiff failed to create a reasonable doubt as to whether Salesforce’s board was disinterested or independent. The indemnification clause was routine and standard with no substantial likelihood that Salesforce’s board would be held personally liable for acting in bad faith, and the Plaintiff did not plead any facts to suggest that Salesforce’s board was under the influence of Tableau’s directors and officers.
The Court dismissed the suit under Rule 23.1 without prejudice and granted the Plaintiff 30 days to cure the defects.