When “Substantially Similar” Means “Fundamentally Identical”: Delaware Court Enforces Related Claim Provision to Deny D&O Coverage for Securities Class Action
A company faces two class-action lawsuits—filed by different plaintiffs, complaining of different allegedly wrongful conduct, asserting different causes of action subject to different burdens of proof, and seeking different relief based on different time periods for the alleged harm. Those facts suggest the suits are not “fundamentally identical,” but that is what a Delaware Superior Court recently concluded in barring coverage for a policyholder seeking to recover for a suit the court deemed “related” to an earlier lawsuit first made outside the policy’s coverage period. First Solar Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa., No. N20C-10-156 MMJ CCLD (Del. Super. Ct. June 23, 2021). The decision, which is not on all fours with some of the authority upon which it relies, underscores the inherent unpredictability of “related” claim disputes and need for careful analysis of the policy language against the factual and legal bases of the underlying claims.
Underlying Shareholder Class Actions and D&O Claims
Shareholders of solar panel manufacturer First Solar sued the company and its directors and officers in a class-action lawsuit (the “Smilovits Action”) for the class period April 2008 to February 2012. The Smilovits Action asserted federal securities violations arising from First Solar’s alleged misrepresentations about the company’s business strategies, product design, financial strength, and ability to offer solar electricity at comparable rates to conventional energy producers (i.e., achieving “grid parity”), artificially inflated stock price, insider trading, manipulation of solar power metrics, and violations of GAAP accounting standards. First Solar submitted a claim to its D&O insurer, National Union, which provided coverage for the Smilovits Action and exhausted the policy.
Two years later, a different set of plaintiffs who had opted out of the Smilovits Action filed a separate class-action lawsuit against First Solar (the “Maverick Action”), asserting federal securities violations and claims for fraud, negligent misrepresentation, and violations of Arizona statutes. The Maverick Action, which covered the period May 2011 to December 2011, alleged that First Solar and its officers and directors had misrepresented how close it was to achieving grid parity, concealed defects in its products, manipulated and misrepresented financial data and project values, and issued financials in violation of GAAP.
First Solar provided notice of the Maverick Action to National Union and XL Specialty, the excess insurer above National Union, and later settled the Maverick Action for $19 million. National Union and XL denied coverage for the claim under their respective policies, however, on the grounds that the Maverick Action related back to the Smilovits Action and was a claim first made in 2012, which predated the inception of the policies and was excluded from coverage.
The policies provided that, if a claim is first made and reported under the policies’ reporting condition, then any “Related Claim” subsequently made against an insured reported to the insurer is deemed to have been first made at the time of the previously reported claim and that any claim made or deemed made prior to the inception date of the policy is not covered. “Related Claim” is defined as a claim “alleging, arising out of, based upon or attributable to any facts or Wrongful Acts that are the same as or related to those that were . . . alleged in a Claim made against an Insured.”
First Solar filed suit in Delaware, asserting claims for breach of contract and declaratory judgment. The parties filed competing motions on the “relatedness” of the two class actions and whether the D&O insurers were required to provide coverage for the Maverick Action.
First Solar argued that the two lawsuits are not related because they involved different operative facts, including different plaintiffs, different allegedly wrongful conduct, different causes of action, and different time periods for the alleged harm. The insurers contended that the Maverick Action was not covered by the policies because it was a “Related Claim” deemed first made at the time of the Smilovits Action in 2012, which was outside the policy period.
The “relatedness” issue turned on whether the Maverick Action was “a Claim alleging, arising out of, based upon or attributable to any facts or Wrongful Acts that are the same as or related to those that were . . . alleged in” the Smilovits Action. The court recognized that a number of Delaware cases had interpreted similar related-claim provisions under “factually similar” situations. Based on those cases, the court concluded that the operative test was whether the two lawsuits were “fundamentally identical.” Delaware courts look to the “subject” of the claims to see if they involve the “exact same subject” but need not credit the underlying claimant’s “unilateral characterizations” of the claims.
After rejecting the “series of differences” between the underlying actions identified by First Solar as “unilateral characterizations” that the need not be accepted, the court concluded that the two suits were related because they have “substantial similarities” in parties, class periods, causes of action, and relevant disclosures and generally involved the “same fraudulent scheme.” Because the Maverick Action was related to the Smilovits Action, the court decided the D&O policies did not provide coverage and granted the insurers’ motions to dismiss.
There are several interesting issues raised by the First Solar decision, the first of which is the manner in which the court applied Delaware’s “fundamentally identical” standard for related claims. The court cited the Northrop Grumman case as the most recent “applicable analysis” to determining relatedness under Delaware law. That case, however, applied the “fundamentally identical” standard to hold that two sets of securities claims were not related based on “[v]ariations in timing, breed of securities violation, mens rea, motive, and burden of proof, under each regulation,” all of which indicated that the claims do not involve the “exact same subject.” Northrop Grumman Innovation Sys., Inc. v. Zurich Am. Ins. Co., No. CV N18C-09-210, 2021 WL 347015, at *11 (Del. Super. Ct. Feb. 2, 2021).
Nearly all of those factors—divergent time periods, causes of action, mens rea, and burdens of proof—also were present in First Solar: the class periods were based on different time periods for the alleged harm; the different sets of plaintiffs alleged different causes of action, including separate and distinct common law and statutory violations only present in one action; and those claims involved varying burdens of proof and mens rea. For example, unlike in the Smilovits Action, the Maverick plaintiffs asserted tort claims, which impose different scienter and burdens of proof than the causes of action in the Smilovits Action based exclusively on alleged federal securities violations. As the court noted, the two actions in First Solar also had another “striking difference” in the type of damages sought in the Maverick Action, which claimed a much greater recovery.
Moreover, the court appeared to discredit completely the substantial differences between the two actions raised by First Solar, based on guidance in Northrop Grumman that “the underlying claimant’s ‘unilateral characterizations’ of the claims need not be credited” and instead, “the Court [must] draw reasonable inferences from the complaint as a whole.” Id. at *11. But First Solar was the policyholder seeking coverage, not the underlying claimant. First Solar simply identified a series of factual and legal dissimilarities in the litigation; it did not rely on the Maverick plaintiffs’ characterizations of their claims as a controlling factor on relatedness.
In fact, the “unilateral characterization” concept derived from Delaware courts’ reluctance to allow insurers to rely exclusively on how an underlying complaint characterized a defendant’s conduct, rather than the actual acts or omissions at issue in such claims, to deny coverage. See Northrop, 2021 WL 347015, at *11 (citing IDT Corp. v. U.S. Specialty Ins. Co., No. CVN18C-03-032 PRW CCLD, 2019 WL 413692, at *10 (Del. Super. Ct. Jan. 31, 2019) (“Although the Court looks to the allegations of the underlying complaint, the Court is not limited to the plaintiff’s unilateral characterization of the nature of [its] claims.”)). The court in First Solar appears to take the opposite approach, relying on broad-stroke similarities about the alleged “fraudulent scheme” in lieu of focusing on the concrete, material differences between the two lawsuits, which suggest that the two claims are, in fact, not fundamentally identical.
Regardless of the soundness of the court’s analysis in First Solar, the decision highlights the inherent unpredictability of relatedness disputes. Analysis is highly fact-specific and, while related claims provisions can differ materially in scope, it is very difficult to predict outcomes given the disparate standards applied and inconsistencies between outcomes. Case law is often mixed; thus, policyholders and insurers frequently will locate separate legal authorities supporting and undermining relatedness under a particular set of facts.