A federal court in California recently held that a D&O policy issued to Ceradyne, Inc. affords no coverage for an $11.3 million settlement of breach of fiduciary duty claims alleging that Ceradyne’s directors undervalued the company and agreed to sell it to 3M for an inadequate price. See Ceradyne, Inc. v. RLI Ins. Co., No. 2:21-cv-6373 JVS (KES), 2022 U.S. Dist. LEXIS 198217 (C.D. Cal. Oct. 31, 2022).
The court found that the policy’s Insuring Agreement B, which required the insurer to “pay the Loss of an Insured Organization” that arises from a claim “but only to the extent that such Organization has indemnified such Loss of, or paid such Loss on behalf of, the Insured Person,” did not apply to the settlement because “[t]he uncontroverted evidence in the record is that the source of funds used to pay the settlement came from 3M, not Ceradyne.” The court determined that the facts in Ceradyne were “nearly identical” to those in Pan Pacific Retail Properties, Inc. v. Gulf Insurance Company, 471 F.3d 961 (9th Cir. 2006), in which the Ninth Circuit held that a D&O policy issued to Western Properties did not afford coverage for the settlement of litigation arising out of the merger of Western Properties and Pan Pacific Properties because Pan Pacific, and not Western Properties, paid the settlement amount, so Western Properties did not suffer any “loss” covered by the policy.
The Ceradyne court also found that the subject policy’s Insuring Agreement A did not provide coverage for the settlement because “the settlement does not constitute ‘Loss’ contemplated by the policy as it falls under the ‘Bump-Up Exclusion,’” which stated:
In the event of a Claim alleging that the price or consideration paid… for the acquisition… of an entity is inadequate, Loss with respect to such Claim shall not include any amount of any judgment or settlement representing the amount by which such price or consideration is effectively increased[.]
As an initial matter, the court determined that 3M’s acquisition of Ceradyne could trigger the Bump-Up Exclusion, rejecting Ceradyne’s argument that the Exclusion was intended to apply only if Ceradyne were the acquiring entity and not when Ceradyne was acquired by another entity. Because the Exclusion’s “unambiguous language” expressly applies to “acquisitions,” the court found that it could not “narrow the term ‘acquisition’ to encompass only those transactions ‘where the insured was the party paying to acquire ownership of assets.’”
The court also found the underlying lawsuits plainly alleged inadequate consideration for the acquisition of an entity. According to the court, “the allegations are clear that the plaintiffs sought compensation for Ceradyne’s directors’ undervaluing how much Ceradyne was worth in the transaction with 3M, resulting in inadequate consideration paid for Ceradyne.” The court further determined that the settlement “effectively increased” the consideration paid for Ceradyne because “the entire settlement was intended to, and in actuality did, increase the consideration paid to shareholders in relation to Ceradyne’s acquisition.” Because all the elements of the Bump-Up Exclusion were met, the court ruled that it barred coverage for the settlement.