D&O IPO Litigation: Did the Other Shoe Just Drop?
Published September 4, 2020
We’ve been talking for a few years now about the scourge of class action lawsuits, such as Cyan, Inc. v. Beaver County Employees Retirement Fund, filed in state courts alleging violations of the Securities Act of 1933 (a federal law). While generally not an exposure for “mature” companies, such lawsuits have been a huge area of concern for companies within three years of a public offering. Indeed, heightened exposure to the state-court forum due to the Cyan decision has been one of the twin drivers (along with elevated levels of litigation across the board) of an explosive shift in the D&O marketplace over the last 2.5 years, which has seen D&O insurance premium levels and retentions (like deductibles) rise to previously unfathomable levels, particularly for IPO companies.
In the wake of the decision, many pre-IPO companies adopted federal forum provisions (provisions in Delaware corporations’ corporate documents requiring actions alleging violations of the federal Securities Act of 1933 to be filed in a federal court) as a means to redirect the cases back to federal court. As we previously discussed with Salzberg v. Sciabacucchi, perhaps the sole bit of good news to come out of the March 2020 decision is the Delaware Supreme Court gave insurance buyers a reason to hope when it unanimously ruled that the three federal forum provisions before it were facially valid under Delaware law. We cautioned at the time, however, that additional litigation was likely, and the insurance market was unlikely to immediately respond.
Well, the other shoe may have just dropped, as we now have a decision from another state giving force and effect to Delaware’s stance on the enforceability of federal forum provisions. For the last two months, all eyes in the industry have been focused on high-profile California state-court litigation involving Dropbox. Indeed, in a rare development, a handful of former Delaware judges filed an amicus brief supporting Dropbox’s argument that the court should dismiss the case due to Dropbox’s federal forum provision. Meanwhile, with all attention on Dropbox (and an entire industry awaiting an October hearing date on the motion to dismiss), a Judge quietly issued an explosive decision in a less-followed California state-court case that may ultimately be the catalyst that the market was looking for.
In a September 1, 2020 decision of first impression, Judge Weiner (the Complex Civil Litigation Judge of the San Mateo Superior Court – the hotbed of state-court Securities litigation over the last few years and a preferred venue for plaintiffs across the nation) ruled that a federal forum provision inserted in Restoration Robotics’ corporate documents prior to its IPO was “not illegal under California law and does not violate any California law or public policy.” In coming to this conclusion, Judge Weiner carefully considered many arguments put forth by the plaintiffs, but ultimately found none of them persuasive in light of existing controlling California authority and the Sciabacucchi decision.
While we don’t want to overemphasize the importance of a trial-court issued decision, particularly when additional litigation on the topic is likely (in the form of challenges under federal law, challenges in other states, and potential appeals), the reality is that this decision, from court, and judge (a judge who, to date, has shown a noted hesitancy to dismiss securities litigation cases) is a very big deal. While not controlling authority for other state courts, we think this ruling – from the court that has presided over more state-court securities litigation than any other – will be very persuasive authority for many judges considering the issues here.
So, what does this decision mean for D&O insurance?
Well, while we’re in the midst of an extremely fluid D&O insurance marketplace, unequivocally, a large driver of shift in the marketplace has been the state-court litigation exposure on the backside of the decision, and much of that litigation has been in San Mateo Superior Court before Judge Weiner. Consequently, this decision, seeming to express a willingness to close the preferred venue for plaintiffs (at least for Delaware corporations with enforceable federal forum provisions) and signaling the return of litigation to federal courts (with their: 1) heightened pleading standards; 2) more favorable procedural rules; and 3) significantly higher dismissal rates), would seem to be a great development and should help drive a favorable shift in the marketplace (e.g. lowered retentions and premiums).
We would be remiss, however, if we painted too rosy of a picture. To be sure, state-court litigation has had a massive detrimental impact on D&O insurers’ profitability and as a result the broader marketplace (manifested by less insurer capacity, higher prices, and higher retentions). Therefore, eliminating state-court exposure or minimizing it will undeniably be beneficial to the marketplace. We note though, that even absence of state-court litigation, all is not well in the public-company D&O insurance marketplace. The last few years have seen securities class action lawsuits (even excluding state-court filings) at near all-time high levels, derivative lawsuits are incredibly common (with a number of companies sued in the last few weeks around alleged Board diversity issues), and many of the largest recent losses are from litigation outside the state-court forum. These perils of the market will not go away in the wake of this decision, and neither will the challenges faced by insurers as they look to improve their performance. For these reasons, while we certainly welcome this decision, and while we do expect an improvement to the market as a result (most likely for IPO companies), we expect that the shift will generally be gradual and measured. We suggest insureds set their expectations accordingly.