Private Equity and M&A Insurance: Not Your Mother's D&O Policy Kim October 20, 2016 ABA Women In Insurance Conference

Overview M&A Litigation Overview Insurance Design Issues in M&A Context M&A Claim Handling Issues M&A Coverage Issues Settlement Considerations in Resolving M&A Claims

M&A Litigation Overview Shareholder Litigation Involving Acquisitions of Public Companies: Review of 2015 and 1H 2016 M&A Litigation, Cornerstone Research (2016) available at https://www.cornerstone.com/Publications/Reports/Shareholder- Litigation-Involving-Acquisitions-2016.pdf

M&A Litigation Overview (cont’d) Shareholder Litigation Involving Acquisitions of Public Companies: Review of 2015 and 1H 2016 M&A Litigation, Cornerstone Research (2016) available at https://www.cornerstone.com/Publications/Reports/Shareholder- Litigation-Involving-Acquisitions-2016.pdf

M&A Litigation Overview (Cont’d)

Meet ExoChem Company ExcoChem is a chemical manufacturer that owned a 300-acre chemical facility in Texas. Lewis Capital, through its Emergence Funds, controlled 88% of ExoChem’s voting power including 100% of its preferred shares which had a liquidation preference. In 2010, Lewis told its investors: The best way to maximize value would be to develop the largely underutilized Texas facility and other assets; and Selling ExoChem in 2011 would result in an unattractive price.

The Emergence Funds Liquidity Crisis In late 2010, the Emergence Funds suffered massive losses as a result of a failed credit default swap derivative trade and were facing a liquidity crisis. Redemption requests poured in. Investors called for Lewis to wrap up the Emergence Funds. As a result, despite its 2010 statements, in 2011 Lewis put ExoChem up for sale targeting a sale price in the $250M range.

The ExoChem Sale Process After the 2011 sale process went nowhere, Lewis appointed a close personal friend of its owner to the ExoChem board, who was charged with selling ExoChem, led the special board committee handling the sale and retained Marshall Company as the board’s financial advisor for the sale. The Lewis-appointed director thereafter tipped off Southland Chemical Company – a larger chemical company interested in the Texas facility – that Lewis had a strong desire to sell ExoChem and shared confidential information about Lewis’s motivations and minimum sales price. Marshall also met with Southland to discuss future work with the company despite knowing that ExoChem was in negotiations with Southland.

The ExoChem “Fire Sale” In 2012, Southland made a low-ball bid for ExoChem at $95M equity value, which the special committee negotiated up to $100M (enterprise value of $145M). The board approved the sale despite valuations of the company of: $129M to $375M excluding underutilized assets; and $314M to $595M including management estimated value of underutilized assets. Although the minority shareholders should have received nothing because Emergence had a liquidation preference of $115M, Emergence/Lewis agreed to allow a $2.50 per share payment to common shareholders (worth $7.1M) and the sale is approved.

Insurance Implications of Sale At time of transaction: ExoChem has a $25M D&O tower with a $15M primary layer, which also affords parent company/co- defendant coverage for the Emergence Funds and is subject to $500K SIR. Southland has a $50M D&O tower with a $10M primary layer subject to a $500K SIR and $25M in Side A DIC coverage. Lewis has a $50M General Partners Liability tower with a $5M primary policy subject to a $1M SIR.

And now come the claims… Minority shareholder plaintiffs file derivative litigation in Delaware Chancery Court asserting: Breach of fiduciary duty v. ExoChem board; and Aiding and abetting v. Southland, Marshall and the Emergence fund defendants Lewis Capital, its key principal (David Lewis), Emergence Asset Management I (EAMI) and Emergence Asset Management II (EAMII). Lead plaintiff in derivative case also files appraisal action against Southland.

D&O Insurers’ Coverage Positions ExoChem Run-off Policies Primary carrier agrees to reimburse board’s defense costs subject to satisfaction of the retention and ROR Primary carrier agrees to reimburse defense costs of only EAMI and David Lewis, but not the parent Lewis or sister company EAMII subject to an allocation with Lewis’s insurers. The parent coverage endorsement solely states “Emergence Asset Management” Primary carrier contends that underwriters only meant EAMI not the entire Emergence group. Emergence defendants contend coverage exists for all four defendants.

D&O Insurers’ Coverage Positions Southland Going Forward Policy Denies coverage based on run-off date and no securities claim against Southland Lewis Policies Primary carrier agrees to reimburse defense costs of Emergence defendants subject to the SIR, ROR and an allocation with the ExoChem primary policy. The SIR provision states: “Insurer shall be liable for Loss resulting from any Claim only in excess of the applicable retention . . . and such retention shall be borne by the Insured uninsured and at its own risk.”

Derivative Litigation Moves Along In ruling on motion to dismiss, the Vice Chancellor was troubled by allegations that: Lewis and its board appointees were highly motivated to sell at any price given liquidity crisis with Emergence funds and that a Lewis-appointee led the special committee; Marshall serving as board advisor at the same time as it is seeking work from the buyer, which it did not disclose to the board; and Southland aided and abetted board’s breaches by taking advantage of conflicts of interest. Parties have exchanged documents and are in the middle of depositions. Plaintiffs assert damages of $35M to $50M based on a valuation of ExoChem at $250M to $350M.

Status of Insurance The ExoChem primary policy limits are eroded by $5 M after satisfaction of SIR. The Lewis Primary Policy limit is intact. Insurer asserts there is still $500K left on the $1M SIR. The Emergence defendants maintain that $1M SIR is satisfied because it has incurred over $1M in defense costs (split 50-50 by Emergence defendants and ExoChem primary carrier).

Bump-Up Coverage Issue Bump-up exception to Loss definition of ExoChem Policies: “In the event of a Claim alleging that the price or consideration paid or proposed to be paid for the acquisition of all or substantially all the ownership interest in or assets of an entity is inadequate, Loss with respect to such Claim shall not include any amount of any judgment or settlement representing the amount by which such price or consideration is effectively increased; provided, however, that this paragraph shall not apply to Defense Costs or to any Non-Indemnifiable Loss. ExoChem primary carrier denies coverage for any indemnity amounts.

Settlement Considerations Timing Logistics Mediation v. informal discussions Mediator choice Excess carrier attendance Merits only or coverage issues as well Allocation issues between defendants and between funding parties