Second Circuit Requires D&O Insurers to Reimburse CEO for Settlement Even Without Their Consent

September 24, 2008

This past April McGuireWoods issued an alert on Bears Stearns losing insurance coverage when it settled a case without the insurers’ consent. Today’s alert provides an example going the other way.

Globalstar Telecommunications Ltd. declared bankruptcy in 2002, leaving a shareholder class action suit to proceed against its CEO, Bernard Schwartz. Schwartz was covered by $50 million in D&O insurance. During the two years preceding trial, the plaintiffs, Schwartz, and the primary and excess carriers participated in three mediations and other settlement negotiations. Plaintiffs offered to settle for $15 million, but warned the demand would increase to $20-$25 million once trial began. The primary insurer never offered more than $5 million, and the others refused to make up the difference.

The jury trial against the CEO was monitored by counsel for the excess insurers. After two weeks of trial the only remaining defense witnesses were Schwartz and a damages expert. Schwartz faced the prospect of a jury verdict in the hundreds of millions. At 10:00 p.m. on a Sunday, the day before Schwartz was set to testify, he wrote to the insurers seeking consent to settle for $20 million. The insurers refused to consent and Schwartz settled the case prior to testifying. Schwartz shortly thereafter provided personal funds for the entire amount.

Schwartz subsequently filed suit against the insurers for failing to settle the underlying action, including claims of bad faith. He won at trial against the insurers. On appeal the Second Circuit held the implied obligation of good faith and fair dealing requires an insurer to give the insured’s interests at least as much consideration as its own and requires the insurer to settle in an appropriate case even though the express terms of the policy do not impose such duty. The test applied to whether an insurer had given proper consideration was whether a prudent insurer without policy limits would have accepted the offer. The appellate court declined to disturb the jury verdict that found: 1) the excess insurers, Liberty and North American, had adequate opportunity to consider and evaluate the settlement opportunities; 2) $20 million settlement was reasonable; and, 3) Liberty and North American unreasonably withheld consent. The court also declined to find that Schwartz had breached the contract by failing to obtain consent prior to settling. Due to the insurers’ intimate involvement in the underlying trial, the court believed the insurers had sufficient notice and opportunity to evaluate the $20 million settlement request by Schwartz to avoid facing liability far exceeding that amount.

This case reminds us of the constant need to keep insurers informed of the status of litigation for which the policyholder believes there is coverage, and to closely follow conditions in the insurance policy.

Schwartz v. Liberty Mutual Insurance Co., Nos. 07-2794-cv, 07-2818-CV (2nd Cir. Aug. 19, 2008), 2008 BL 173327, 2008 U.S. App. Lexis 17680.