M&A activity is making a comeback in 2023, according to Bloomberg Law (“M&A Roars Back in $40 Billion Surge Led by Miners, Storage” A. Kirchfeld and D. Nair, Feb. 6, 2023). The rise in transactions—and the likelihood of claims involving them—will no doubt lead to continued D&O insurance coverage disputes over the “bump up” exclusion.

Policyholders can navigate this speed bump, carriers waving the recent Seventh Circuit decision in Komatsu Mining Corp. v. Columbia Casualty Co., No. 21-2695 (7th Cir. Jan. 23, 2023), and the Final Statement of Decision After Phase One Court Trial entered in Onyx Pharmaceuticals, Inc. v. Old Republic Insurance Co., Case No. CIV 538248 (Cal. Super. Ct. San Mateo Cty. Dec. 30, 2022), notwithstanding. 

Rules for the Road to keep in mind:

1. Choice of law matters

Several courts have addressed the bump-up exclusion recently, and arrived at different results. Indeed, despite analyzing the same bump-up exclusion, the San Mateo County Court in California (applying California law) ruled in favor of insurers in Onyx whereas the Delaware Superior Court ruled in favor of the policyholders in Northrup Grumman Innovation Systems, Inc. v. Zurich American Insurance Co., 2021 Del. Super. LEXIS 92 (February 2, 2021) (the Delaware Supreme Court denied interlocutory appeal), and the Eastern District of Virginia Court (applying Virginia law) did as well in Towers Watson & Co. v. National Union Fire Insurance Co., 2021 U.S. Dist. LEXIS 192480 (E.D. Va. Oct. 5, 2021) (currently on appeal in the Fourth Circuit). The Seventh Circuit applied Wisconsin law in Komatsu, ruling in favor of insurers based on a different version of the exclusion. In short, Delaware and Virginia law remain favorable whereas policyholders have not fared as well thus far under California and Wisconsin law. 

2. Policy wording matters

Virtually all bump-up exclusions carve out coverage for defense costs and “Side A” claims (non-indemnifiable claims against insured persons). The issue presented by these cases is typically coverage for a settlement.

As mentioned above, Onyx, Northrup and Towers Watson had the same exclusion wording, yet Onyx reached a different result than Northrup and Towers Watson:

“In the event of a claim alleging that the price or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all of the ownership interest in or assets of an entity is inadequate, loss with respect to such claim shall not include any amount of any judgement or settlement representing the amount by which such price or consideration is effectively increased; provided, however, that this paragraph shall not apply to defense costs or to any non-indemnifiable loss in connection therewith.”

The exclusion in Komatsu differed from Onyx, Northrup, and Towers Watson. That exclusion precluded coverage for “any amount of any judgment or settlement of any inadequate consideration claim other than defense costs”, and defined an inadequate consideration claim as “that part of any claim alleging that the price or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all of the ownership interest in or assets of any entity is inadequate.”

Other policies reference ownership interest in or securities of another company, or the company’s purchase of “its” securities or assets. Exclusions may specify that they apply only when the company is the acquirer as opposed to when the claim is made against the company as the target. But even if such wording is not specified, courts may reach different outcomes because of policy construction principles and the specific facts of the transactions and claims at issue.

3. Policy interpretation matters

Presumptions and rules of construction make a difference. Although the bump-up language is an exception to the definition of loss, it is an exclusion. As such, it should be construed narrowly and the carrier has the burden of proof to show that it unambiguously applies.

Furthermore, ambiguities should be construed in favor of coverage. Undefined terms such as “acquisition,” the use of capitalized versus lower case terms for certain words like “entity” and “company”, the use of “an” versus “the,” and other terms in the policy read as a whole, may create ambiguities.  As Judge Easterbrook pointed out in Komatsu, referencing Northrup: “The state judge invoked what he understood to be a rule of Delaware insurance law that all conceivable ambiguities be construed against an insurer…[T]hat may be the law in Delaware but is not the law in Wisconsin.”

4. Facts matter

For the bump-up exclusion to apply, the carrier has the burden to show the transaction at issue is an acquisition (an undefined term). If it is a merger or not an acquisition, the exclusion does not apply. Other key inquiries are:

What does the claim allege? 

Many times the claim contains a myriad of alleged violations, non-disclosures and breaches of duty, which do not fall within the exclusion.

What is the relief sought?

Although the claim may allege the price was too low, the relief sought may be a measure of compensatory damages, which is a covered loss.

5. Policy negotiation matters

Shopping the market for the narrowest version of the exclusion is a worthwhile pursuit. The Onyx court made much of the broker’s awareness of alternative wording and the carrier’s unwillingness to provide that wording to the policyholder. Separate and apart from what policyholders believe is a flawed analysis in Onyx, brokers and policyholders should not be whip-sawed by asking for policy changes during renewal negotiations and then having the carrier’s denial of those requests used against the policyholder in a subsequent coverage dispute. 

To avoid these disputes, carriers should delete the bump-up exclusion and price and offer the full coverage sought. If it is true that the M&A market will continue to soar, innovative carriers should be responding with better products that foster partnership with their policyholders rather than costly and uncertain litigation.