Summary
Delaware’s Supreme Court recently clarified the difference between derivative and direct claims in the context of a dispute over whether creditors’ fraudulent transfer claims were covered by insurance policies applicable to derivative securities claims, but not to direct ones. Ruling unanimously, the court held such claims are direct, not derivative, and are therefore not covered by the policies, and that the issue is determined by the state and federal securities laws, not bankruptcy law.
In 2008, Verizon Communications, Inc., transferred assets to a wholly owned subsidiary (Spinco) in exchange for cash, stock, and Spinco debt. Spinco then was spun off through a merger and the debt was sold to the public. Spinco later filed for bankruptcy under Chapter 11. Under the reorganization plan, a litigation trust was established giving creditor-beneficiaries the right to pursue claims arising from the transaction. The Trust sued Verizon alleging fraudulent transfer, which Verizon ultimately settled for $95 million.
Verizon’s insurers denied coverage under policies insuring against “Losses” from “Securities Claims” that are “brought derivatively on behalf of an Organization by a security holder of such Organization.” The Delaware Superior Court held bankruptcy law defined the nature of the claim and permitted creditors to assert fraudulent transfer claims derivatively.
The Supreme Court agreed the Trust stated Securities Claims, but overruled the holding that the claims were derivative and not direct. In doing so, it found bankruptcy law merely establishes that pre-bankruptcy contractual rights do not change post-bankruptcy. The Delaware Supreme Court analyzed the nature of the claim under the two-part test enunciated in Tooley v. Donaldson, Lufkin & Jenrette, Inc., which examines (a) “who suffered the alleged harm” and (b) “who would receive the benefit of any recovery or other remedy.” The court ruled on December 15, 2023, that the Trust’s fraudulent transfer claims were “direct, not derivative, because the creditors suffered the harm caused by the fraudulent transfer, and the remedy benefits the creditors, not the business entity.”
Practice Tips
Ballard Spahr can help clients review insurance policies to determine what claims are and are not covered. In the event of claims leading to claimed “Losses,” we can work with clients to understand coverage issues and to maximize the probability of a favorable outcome.
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