Opinion ID: 220152
Heading Depth: 2
Heading Rank: 2

Heading: Derivative Litigation Coverage

Text: Turning to the insurers' second contention, the costs incurred by the SLC in terminating the derivative litigation were covered Defense Costs (or Securities Defense Costs) under the policies. The policies provide coverage (under Insuring Clauses 2 and/or 3) to MBIA and/or its directors for expenses incurred in defending or investigating claims (including Securities Claims). J.A. at 131, 158. A claim includes a lawsuit. Id. The insurers argue that the SLC-related costs are not covered for three main reasons. First, they say that the costs were incurred by the SLC (and not MBIA or any individual directors) and that the SLC is not an Insured Person. [4] Second, they focus on the nature of a derivative suit to say that granting MBIA coverage for the SLC's role would render the $200,000 sublimit for demand investigation costs superfluous. See supra note 1. Third, they rely on exclusions from the definition of Loss. We conclude that the costs are covered. We begin with the anatomy of a derivative action. Connecticut law applies here because the suits alleged state claims against MBIA, a Connecticut corporation. Halebian v. Berv, 590 F.3d 195, 206 (2d Cir.2009); May v. Coffey, 291 Conn. 106, 967 A.2d 495, 501 n. 6 (2009). In Connecticut, shareholders must perform two distinct steps to initiate a derivative suit. See Stutz v. Shepard, 279 Conn. 115, 901 A.2d 33, 36 n. 5 (2006). First, a disenchanted shareholder must make a demand on the corporation to take suitable action. [5] Conn. Gen.Stat. Ann. § 33-722. Then, after one of three events, the shareholder may commence a derivative suit: (1) the passing of ninety days without any action by the corporation, (2) notification that the shareholder's demand is rejected, or (3) a showing that irreparable injury would follow if the court waited for the ninety-day period to expire. Id. Connecticut law also provides that a corporation may form a committee of independent directors to determine whether maintaining a derivative action is in the best interests of the corporation. Id. §§ 33-605, 33-724; Frank v. LoVetere, 363 F.Supp.2d 327, 333 (D.Conn.2005). If that committee determines in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that maintaining the suit is not in the best interests of the corporation, it has the authority to move for dismissal. Conn. Gen.Stat. Ann. § 33-724(a). On such a motion, the court shall dismiss the lawsuit. Id. Here, both shareholders followed the two-step process and made a demand before filing suit. Ultimately, after the DIC performed its work, MBIA did not act within the ninety-day period provided by Connecticut law. Thereafter, the shareholders took the next step and filed lawsuits. MBIA formed the SLC to determine MBIA's response to this litigation, and the SLC decided to terminate the litigation. The SLC entered appearances for MBIA and filed motions to dismiss on its behalf in both the state and federal cases. The federal suit was voluntarily dismissed pursuant to Rule 41 of the Rules of Civil Procedure before the court could rule on it; the parties do not dispute that the state court action was also terminated, although the record does not indicate in precisely what manner. Connecticut law allows this procedure. The board may terminate derivative litigation by a majority vote of either of two sub-units of the board: (1) the independent directors if they constitute a quorum or (2) a committee composed of at least two independent directors. Id. §§ 33-605, 33-724(b). A corporation, possessing an identity only in a legal sense, can act only through its agents. In re Payroll Express Corp., 186 F.3d 196, 207 (2d Cir.1999). That Connecticut law permits the board to terminate a derivative suit is an extension of the fundamental principle that the management and ownership of a corporation are divided, with management undertaken by the board. Conn. Gen.Stat. Ann. § 33-735(b). In other words, corporate powers and management are exercised by agents under the authority of or under the direction of the board. Id. The SLC was one way MBIA exercised its powers. See, e.g., id. § 33-724(a); Zapata Corp. v. Maldonado, 430 A.2d 779, 785 (Del.1981) ([A]n independent committee possesses the corporate power to seek the termination of a derivative suit.); Revised Model Bus. Corp. Act § 7.44 official cmt. (citing Aronson v. Lewis, 473 A.2d 805, 813 (Del.1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000)). [6] Dismissal of the suits was MBIA's decision, undertaken pursuant to the powers granted to MBIA under Connecticut law, Conn. Gen.Stat. Ann. § 33-724(a), and exercised by the SLC as permitted under Connecticut law, id. § 33-724(b)(2). See also Aronson, 473 A.2d at 813 (stating that, ultimately, the board retains its ... managerial authority to make decisions regarding corporate litigation). We thus reject the insurers' suggestion that the SLC was not an Insured Person. To counter this reasoning, the insurers argue that the SLC was required to operate independently of MBIA. They postulate that this circumstance means that the SLC took on an identity and exercised powers separate and apart from those granted to MBIA. This is argument by sleight of hand. Connecticut law  and corporation law generally  requires that the decision to proceed with or terminate derivative litigation be made by independent directors to satisfy their fiduciary duties. Conn. Gen.Stat. Ann. § 33-724(a)-(b); see, e.g., Aronson, 473 A.2d at 811-12, 814. Independent in this context means independence of judgment  a lack of conflicts of interest. See Conn. Gen.Stat. Ann. § 33-605; Frank, 363 F.Supp.2d at 333; see also RMBCA § 1.43 official cmt. (stating that such directors must be disinterested and independent so as to avoid a likelihood that that director's objectivity will be impaired). Independence of judgment does not generate a new source of authority to terminate derivative litigation; that authority is still exercised by the corporation, which can act only through its agents. Aronson, 473 A.2d at 813; see Conn. Gen.Stat. Ann. § 33-724(a)-(b); Frank, 363 F.Supp.2d at 333, 335 ([A] corporation should be free to determine in its own business judgment whether litigation is in its best interest....). We do not agree with the insurers' characterization of the SLC's independence. The insurers' second argument relies on the nature of a derivative suit. Relying on the precept that an interpretation rendering a contract term superfluous is disfavor[ed], Int'l Multifoods Corp. v. Comm'l Union Ins. Co., 309 F.3d 76, 86 (2d Cir. 2002), the insurers say that because the SLC investigates whether to maintain a derivative suit, coverage of the SLC's costs would eviscerate the sublimit applicable to the investigation of shareholder demands. We disagree. The $200,000 sublimit provides that the insurers' maximum liability for all Investigation Costs covered under Insuring Clause 4 on account of all Shareholder Derivative Demands ... shall be $200,000. J.A. at 167. Insuring Clause 4 states: The [insurer] shall pay on behalf of [MBIA] all Investigation Costs which [MBIA] becomes legally obligated to pay on account of any Shareholder Derivative Demand first made during the Policy Period ... for a Wrongful Act committed, attempted, or allegedly committed or attempted, by an Insured Person before or during the Policy Period. Id. In this instance, the insurers' argument requires that the $200,000 sublimit operate as an exclusion of coverage. They therefore bear[] the burden of proving that the claim falls within the scope of an exclusion. Vill. of Sylvan Beach v. Travelers Indem. Co., 55 F.3d 114, 115 (2d Cir.1995) (citing Maurice Goldman & Sons, Inc. v. Hanover Ins. Co., 80 N.Y.2d 986, 592 N.Y.S.2d 645, 607 N.E.2d 792, 793 (1992)). To do so, the insurers must show that the policies, in clear and unmistakable language, exclude coverage. Id. (internal quotation marks omitted). Bearing in mind that we must read a contract as a whole and construe terms in context, Law Debenture Trust Co. of N.Y. v. Maverick Tube Corp., 595 F.3d 458, 467-68 (2d Cir. 2010), we conclude that the insurers do not meet this burden. The policies' structure and terms track the statutory shareholder grievance process. Insuring Clause 4, with its concomitant $200,000 sublimit, by its terms applies to costs related to investigating Shareholder Derivative Demands, which involves the first step in Connecticut's regime. But when a demand is rejected and the shareholders file a derivative suit in court, the application of Insuring Clause 4 to further investigative costs is less obvious. At best, to cover such costs, the language on account of any Shareholder Derivative Demand would have to be expanded to include the second stage of the Connecticut process, a lawsuit. At that stage, however, Insuring Clause 2 or 3 squarely applies because both provide coverage for costs incurred in ... investigating Claims or Securities Claims, respectively, each of which is defined expressly to include lawsuits. J.A. at 131, 158. Thus, either or both of Insuring Clauses 2 and/or 3 certainly provide coverage at the lawsuit stage. This view of the policies makes sense because their structure and terms mirror the two-stage shareholder grievance process of the Connecticut statute: Insuring Clause 4 specifically references a shareholder derivative demand, while Insuring Clauses 2 and 3 specifically reference lawsuits. [7] Irrespective of whether the language of Insuring Clause 4 bridges the gap between the demand stage and the litigation stage of a shareholder grievance  a question on which we take no view  we find certainty in saying only that the insurers have not met their heavy burden to show that the exclusion, as it operates here, applies. Finally, the insurers attempt to rely on the policies' exclusion of any amount incurred by [MBIA] (including its board of directors or any committee of the board of directors) in connection with the investigation or evaluation of any Claim or potential Claim by or on behalf of [MBIA] from the definition of Loss. J.A. at 144. Here, the insurers bear the burden to establish that the exclusion is stated in clear and unmistakable language, is subject to no other reasonable interpretation, and applies in the particular case. Cont'l Cas. Co. v. Rapid-Am. Corp., 80 N.Y.2d 640, 593 N.Y.S.2d 966, 609 N.E.2d 506, 512 (1993). The insurers do not carry this heavy burden in this case. To avail themselves of this exclusion, the insurers primarily rely on the procedural fact that MBIA is a plaintiff in the caption of the cases because the lawsuits, which are Claims, were filed on behalf of MBIA. But MBIA is named as a nominal defendant in the caption of these derivative actions as well. This situation is unsurprising because, in a derivative suit, the corporation is in an anomalous position of being both a defendant and a plaintiff in the same action. [8] Ma`Ayergi & Assocs., LLC v. Pro Search, Inc., 115 Conn.App. 662, 974 A.2d 724, 728 (2009). Thus, the insurers' reliance on the on behalf of language provides only equivocal support for their position. Moreover, we think that the exclusion in the definition of Loss is not clearly applicable to the costs incurred by the SLC because those costs were, at least to some extent, related to litigation, not investigation. In sum, we are not persuaded that the insurers have carried their burden to show that this exclusion applies. The costs incurred by the SLC are covered under the policies.