In March last year, New York’s Appellate Division – First Department issued Xerox an important pro-policyholder decision in its D&O insurance recovery action against Travelers, arising from Xerox’s failed 2018 merger with Fujifilm. In a thoughtful order, the court issued three key pro-policyholder rulings that: (1) reinforce the rule that the words “arising from” when used in policy exclusions should be narrowly construed under New York law; (2) recognize that an insurer who shows bad faith indifference to its policyholder’s rights may be held liable for a breach of the duty of good faith and extracontractual damages under New York law; and (3) held that the reasonableness of an underlying settlement is an issue of fact that should go to the jury. A copy of the Court’s decision is available here.
Xerox’s coverage lawsuit against Travelers, its second excess D&O insurer, arose from Xerox’s failed 2018 merger with Fujifilm, which resulted in high profile lawsuits filed by Xerox shareholder Darwin Deason (funded in part by Carl Icahn), which resulted in an injunction of the proposed merger, a $28 million settlement, and over $34 million in defense costs related to the defense of Xerox and its Board members in numerous related lawsuits. Xerox’s total losses resulting from this litigation well exceed $60 million.
Xerox filed its insurance recovery lawsuit against Travelers, its second excess insurer, after Travelers refused to pay its $15 million limits toward Xerox’s losses, even though Xerox’s primary (Chubb) and first excess (XL) insurers paid their collective $30 million in underlying limits in full. Travelers purported to deny coverage principally on the ground that the primary policy’s Prior Acts Exclusion, which applies to claims “based upon, arising from, or in consequence of any fact, circumstance or Wrongful Act committed, attempted, or allegedly committed or attempted in whole or in part prior to January 1, 2017,” barred coverage. Travelers argued that because the underlying complaints challenging the proposed transaction also contained allegations related to joint venture agreements between Xerox and Fujifilm that were entered into decades earlier, it had no obligation to provide coverage. Travelers also claimed that the underlying settlement of the Deason lawsuits was unreasonable, even though it was aware of the settlement before it was finalized in 2018 and Travelers never told Xerox at the time that the settlement was unreasonable, or that it might deny coverage based on the Prior Acts Exclusion. In addition to its breach of contract claim, Xerox asserted negligent omission and bad faith claims against Travelers for concealing the Prior Acts Exclusion as a coverage defense until eight months after the underlying settlement was paid. After years of discovery and dueling summary judgment motions, the trial court, in an opinion issued by the now-retired Hon. Barry R. Ostrager, denied both parties’ motions, reasoning that material issues of fact precluded deciding any of the issues the parties had moved on, including the Prior Acts Exclusion and Xerox’s claim for breach of the duty of good faith and fair dealing. Travelers appealed, and Xerox cross appealed, seeking among other things a ruling that the Prior Acts Exclusion did not apply as a matter of law.
Following oral argument in January 2024, the First Department vacated the trial court’s decision on the Prior Acts Exclusion and held “as a matter of law that this exclusion is inapplicable to the facts of this case.” Consistent with New York case law holding that policy exclusions should be narrowly construed, the First Department explained that when interpreting “an ‘arising out of’ exclusion, such as the one at bar, the Court of Appeals has adopted a ‘but for’ test, meaning that ‘none of the causes of action that [the underlying plaintiff, i.e. Deason] asserts could exist but for the existence of the excluded activity.” The First Department relied on the position and case law that Xerox advocated for and rejected Travelers’ attempts to push for a broad “some causal relationship” or “link in the chain” interpretation of the “but for” test. Applying the correct standard, the First Department held that “Travelers failed to establish that the causes of action asserted in the underlying lawsuits could not exist but for the alleged wrongful acts preceding January 1, 2017,” reasoning that:
The acts giving rise to liability in the underlying cases consisted of the 2017-2018 negotiation and approval of an allegedly disadvantageous transaction with Fuji and Xerox’s 2018 denial of a request for a waiver of a deadline for advance notice of director nominations. The complaints in the two Deason actions allege that Xerox’s former CEO and certain directors breached fiduciary duties by agreeing to a rushed and unfavorable transaction in their own self-interest. These causes of action could be viable even if Xerox had not previously entered into the joint venture with Fuji (see Mount Vernon, 88 NY2d at 350; McGraw-Hill Educ., Inc. v Illinois Natl. Ins. Co., 178 AD3d 532, 532 [1st Dept 2019]).
This favorable decision by the First Department sets important pro-policyholder precedent confirming that “arising out of” exclusions should be interpreted narrowly.
The First Department also affirmed the trial court’s finding that Xerox’s bad faith claim would go to the jury. Specifically, the court held that the trial court “properly denied Travelers’ motion for summary judgment to the extent that it sought dismissal of plaintiff’s cause of action alleging breach of the covenant of good faith and fair dealing. Questions of fact exist as to whether Travelers acted in bad faith or with indifference towards Xerox’s rights.”
Finally, after confirming that the insurer would face a jury with regard to Xerox’s bad faith claims, the First Department handed Xerox another victory on Travelers’ reasonableness of the $28 million settlement defense, recognizing that the underlying settlement, which “resolved an attack on a multi-billion dollar transaction and resolved litigation against a large, publicly traded company by apparently well-financed plaintiffs,” “is not unreasonable on its face.” In doing so, the Court rejected Travelers attempt to second-guess the reasonableness of a settlement that Xerox entered six years ago, to which Travelers failed to object when it was entered.
Following the court’s favorable rulings, Travelers promptly agreed to enter a confidential settlement of all claims asserted in the coverage litigation.
