Seventh Circuit Affirms that “Inadequate Consideration” Provision Bars Coverage for Securities Fraud Settlements

In a win for Wiley’s client, the United States Court of Appeals for the Seventh Circuit held, under Wisconsin law, that an exception for settlements of “Inadequate Consideration Claims” barred coverage for the insured’s settlement of securities litigation alleging that its misleading proxy statement induced shareholders to accept inadequate consideration in the sale of the company. Joy Global Inc. v. Columbia Cas. Co., No. 21-2695 (7th Cir. Jan. 23, 2023).

Shareholders alleged that the insured violated Section 14(a) of the Securities Exchange Act of 1934 by not disclosing internal projections of future growth that could have been used to negotiate for a higher price in the sale of the company. The insured settled for roughly $21 million and sought coverage from its D&O insurers. The primary insurer agreed to reimburse defense costs but denied coverage for the settlements because the definition of covered “Loss” did not include “any amount of any judgment or settlement of any Inadequate Consideration Claim.” The policy defined “Inadequate Consideration Claim” as “that part of any Claim alleging that the price or consideration paid . . . for the acquisition . . . of all or substantially all of . . . an entity is inadequate.”

Judge Frank Easterbrook wrote for the court: “Suppose Company X is worth $100 million. Company Y agrees to buy X for $80 million and promises that X’s shareholders will be made whole. The shareholders sue, contending that X has withheld the “fact” that the company is worth $100 million. X and Y settle that claim for $20 million and turn to their insurer for indemnity. The shareholders get their $100 million, but if this maneuver works, Y completes the purchase for only $80 million, with the rest coming from insurance. Insurers use clauses about inadequate consideration to protect themselves from this moral hazard.”

The court held that, although the underlying litigation alleged that the insured made inadequate disclosures, “the reason disclosure was inadequate, according to the complaints, is that [the insured] failed to reveal that the price too low.” The litigation therefore was an “Inadequate Consideration Claim” under the policy terms, and the settlement amounts were not covered.  

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