Enterasys v. Gulf Insurance, et al. CV-04-027-SM 03/29/05 P UNITED STATES DISTRICT COURT
DISTRICT OF NEW HAMPSHIRE
Enterasys Networks, Inc., Plaintiff
v. Civil No. 04-27-SM Opinion No. 2005 DNH 050P Gulf Insurance Company and Clarendon National Insurance Company, Defendants
O R D E R
After settling a securities class action by agreeing to pay
the class members a combination of cash and stock, Enterasys
Networks, Inc. ("Enterasys") filed suit1 against various
insurance carriers seeking a declaratory judgment of coverage
(Count I) and damages for breach of contract (Count II), breach
of the duty of good faith and fair dealing (Count III), and
violation of the New Hampshire Consumer Protection Act (Count
IV). Before the court are: defendants' motion for judgment on
the pleadings on Counts I and IV (document no. 15);2 Enterasys'
1 This suit was removed from the New Hampshire Superior Court.
2 Defendants move for judgment on the pleadings on Count I on grounds that plaintiff's petition for declaratory judgment is motion for partial summary judgment (document no. 21);3 Gulf's
cross-motion for summary judgment (document no. 29);4 and
Clarendon's motion for partial summary judgment (document no.
30) .5
Discussion
Review of the extensive memoranda filed by the parties
discloses that although they raise a number of secondary issues,
they engage, primarily, on one major issue. The critical issue
presented in the cross-motions for summary judgment is whether,
under Gulf's and Clarendon's excess insurance policies, Enterasys
suffered a loss when it committed to issue Enterasys shares to
untimely under N.H. R e v . S t a t . A n n . (RSA) § 4 91:22 and move for judgment on Count IV on grounds that the insurance trade is categorically exempt from the Consumer Protection Act's reguirements.
3 Enterasys moves for summary judgment with respect to insurance coverage for that part of the settlement in the underlying securities class action that will be satisfied by transfer of Enterasys stock.
4 Gulf moves for summary judgment on the issue of loss, claiming Enterasys did not suffer an insurable loss, within the meaning of the policy it issued, when Enterasys transferred (or transfers) stock to the settling plaintiffs in the securities class action.
5 Clarendon moves for partial summary judgment on the issues of loss, exhaustion, and consent.
2 the class plaintiffs valued (by a formula agreed upon by the
class plaintiffs and Enterasys) at $33 million, as part of the
overall class action settlement. Among the secondary issues
presented are whether plaintiff's state law declaratory judgment
action was filed timely (it matters because plaintiff expects an
award of attorneys fees under that claim if it prevails on the
coverage issues), whether plaintiff's failure to obtain
Clarendon's written consent to the class action settlement, as
reguired, precludes coverage under its policy, and whether
coverage under the excess policies has been triggered. Of
course, the parties also derive and discuss a host of subordinate
issues, but most are either not pertinent in light of the record
as currently developed, or moot given the disposition described
below.
A. Policies Triggered?
The basic point of this litigation is to determine whether
the Gulf and Clarendon excess insurance policies provide coverage
to Enterasys for any part of the underlying class action
settlement. Because these are "excess" policies, they follow the
primary coverage and are triggered only after the underlying
3 insurance policies have been exhausted. The parties agree that
Gulf's policy provides "fourth layer" coverage and Clarendon's
"fifth layer" - Gulf provides $10 million in coverage after
losses of $40 million and Clarendon provides $10 million in
coverage after losses of $50 million.
It cannot be determined on this record whether either policy
has been triggered. Enterasys says it paid $17 million in cash
and $33 million in its stock to settle the class action, for a
sub-total of $50 million in covered losses (several times in its
pleadings Enterasys adds those figures and gets $55 million,
which presumably represents typographical errors). In addition,
it says it incurred legal expenses in defending the class action
of "more than $27 million," for which it also claims coverage.
"More than $27 million" might be a big number. If it was, say,
$40 million, then each excess policy would be triggered, without
regard to whether the $33 million in stock counts as a loss under
the respective policies. On the other hand, if it were a smaller
number, say $27.01 million, then only the Gulf policy would be
triggered (unless more than $5.9 of the $33 million in stock it
issued (or will issue) counts as a loss) . Defendants counter
4 that "less than one half of the more than $27 million" in claimed
defense costs "may be deemed reimbursable costs" covered by the
terms of the policies. Again, that equally ambiguous number
could be outcome determinative of the trigger issue, but the
record, as currently developed, does not allow a definitive
ruling.
B. The $33 Million in Stock
With respect to Enterasys' claims for reimbursement of the
"loss" associated with paying the class members with company
stock, the parties identify what appears to be a somewhat novel
question. It is simple to pose but more complicated to answer:
Has Enterasys incurred a loss within the meaning of the excess
insurance policies6 by committing to deliver 8,727,851 shares of
its stock, valued by the litigants at $33 million, to settle the
underlying class action suit? Having carefully considered the
opposing memoranda and materials, the court is of the view that
Enterasys' distribution and/or issuance of stock to the class
6 For purposes of these excess policies, the term "loss" means "damages, judgments, settlements. Costs, Charges and Expenses . . . incurred by any of the [insureds]." (Defs.' Joint Mem. (document no. 34) at 7 (quoting Edwards Aff., Ex. 3 (Primary Policy, Endorsement No. 5)).
5 plaintiffs is not a loss within the meaning of that term as used
in the policies.
Enterasys' asserted theory of loss is not persuasive. It
argues, perhaps tongue-in-cheek, that no distinction can be made
between a corporation and its shareholders, and, thus, if the
shareholders suffer some economic detriment as a result of the
issuance of stock to settle a potential corporate liability, then
that loss is suffered by the corporation as well, at least for
purposes of obtaining insurance coverage. Extensive discussion
of that theory is not reguired. It is fundamental that a duly
organized corporation enjoys a legal identity separate and apart
from its shareholders, directors and officers." 1 Fletcher
C y c l o p e d i a of the La w of P ri v a t e C o r p o r a t i o n s § 25 at 476 (1999 rev.
vol.); Terry Apts. Assocs. v. Associated-East Mtg. Co., 37 3 A. 2d
585, 588 (Del. Ch. 1977) ("Certainly in the normal course of
events a corporate entity must be regarded as more than a mere
formality. It is an entity distinct from its stockholders . . .
."). Enterasys' shareholders, by the way, are not named insureds
under either excess policy at issue; the corporation is the named
insured.
6 When a corporation issues new shares (up to the maximum
authorized number ) , the value of its assets are not diminished.
If corporate assets are worth $100, and 100 new shares are issued
and sold, doubling the number of issued and outstanding shares,
corporate assets after issuance would still be worth $100 (plus
the cash raised from the sale). No loss to the corporation
occurs. The new stock issue will dilute the outstanding shares
in terms of the percentage of ownership interest each represents,
and may dilute those shares in terms of book (but not necessarily
market) value (although the corporation's assets would also be
enhanced by the sale receipts), but that is a "loss," if at all,
experienced by the shareholders, not the corporation.
Generally, shareholders necessarily understand that a
corporation may issue shares up to the maximum number authorized
by its certificate of incorporation. Shareholders would be hard
pressed to complain when that occurs in furtherance of legitimate
corporate purposes, such as the settlement of a lawsuit
representing a potential corporate liability. More specifically,
under the corporate law of Delaware, Enterasys' state of
incorporation, the directors are authorized to distribute
7 treasury stock and issue new stock (up to the limit authorized by
the certificate of incorporation) at their discretion, for
consideration determined by them. See D e l . C o d e A n n . tit. 8, § §
152, 153(b) and (c), and 161.
It would make no substantive difference whether Enterasys
issued and sold new shares into the market and handed over the
proceeds to the class plaintiffs, or issued and handed over the
stock directly. In either case, the corporation suffers no
economic harm - it resolves a potential liability without
diminishing its asset value, or worth - its asset-pie remains the
same, there are just more (and smaller) slices. And, because the
issuance of stock allows Enterasys to benefit the settling class
plaintiffs without significant cost to itself, deeming the
issuance of stock in settlement to be an insurable "loss" would
actually result in an inappropriate windfall for the company. It
could hand the stock over to settle the claims, then obtain a
cash reimbursement from its insurance company up to the policy
limits, in effect forcing the insurance company to underwrite a
new stock placement. Under such circumstances the company's
irresistible incentive would always be to settle with stock - stock that costs the company very little beyond paper and ink to
issue, but which would amount to a guaranteed source of new
capital and resolution of a potential liability.7
In short, the corporation is a named insured, the
shareholders are not; shareholders' losses are not covered by the
policies at issue, and the corporation did not suffer any harm,
economic or otherwise, when it committed to deliver its own
shares to settle the underlying claim, or when it actually
delivered some shares, and it will not suffer harm when it
completes the agreed-upon delivery.
Some of the stock used to settle the class action was (and
apparently will be) treasury shares held by Enterasys. As
discussed during the hearing on the pending motions, an
interesting argument might be made that treasury shares are of a
7 As a practical matter, insurers would not agree to such a proposed settlement, but the potential for mischief illustrates an important point. Most policies, including those at issue here, include a "no action clause," which reguires approval by the insurer of any settlement, or a judgment entered against the insured, as a condition of the insurer's obligation to cover any loss. The obvious purpose of such clauses is to protect the insurer from collusive or overly-generous, or unnecessary settlements by an insured at the insurer's expense. UNR at 1106. different character than newly issued shares (having likely been
bought back from the market by the company using otherwise
distributable profits) , and perhaps transfer of those shares
might be said to constitute an insured loss.
But, for most regulatory and accounting purposes, treasury
shares are functionally eguivalent to shares that are authorized
but unissued. Dividends are not paid on shares held in the
treasury, the company cannot vote them, and they are not carried
on the corporate books as assets. See 11 F l e t c h e r §5080.80
("[treasury shares go into something like a state of 'suspended
animation' in that the corporation, although nominally the owner,
cannot exercise certain rights of ownership, such as the right to
vote or to receive dividends") (citing Public Inv. Ltd. v.
Bandeirante Corp., 740 F.2d 1222, 1227 (D.C. Cir. 1984);
Kirschenbaum v. Comm'r, 155 F.2d 23, 25 (2d Cir. 1946)); III Cox
& Ha z e n on C o r p o r a t i o n s § 21.09 (2d ed. 2003); "Treasury shares are
indeed a masterpiece of legal magic, the creation of something
out of nothing. . . . Treasury shares carry neither voting
rights nor rights to dividends or other distributions. Their
existence as "issued shares" is pure fiction."); 18A A m . J u r . 2 d
10 Corporations § 367 (2004) ("Treasury stock is generally regarded
as not an outstanding obligation of the corporation As
the Bankruptcy Appellate Panel for the First Circuit has
explained:
The purchase by the corporation of its own stock is a form of shareholder distribution from which the corporation receives nothing. B. Manning, A Concise Textbook on Legal Capital, at 130 ( 1 9 7 7 ) . . . .
. . . Regardless of whether Edward's ownership interest had any tangible value to him, the stock was worthless to the corporation. "Treasury stock is not generally considered an asset, because it is widely held that a corporation cannot own a part of itself." M. Miller, Comprehensive GAAP Guide, at 38.04 (1979).
Consove v. Cohen (In re Rocco Corp.), 21 B.R. 429, 434 (B.A.P.
1st Cir. 1982). Finally, under Delaware law, "[s]hares of its
own capital stock belonging to the corporation . . . shall
neither be entitled to vote nor be counted for guorum purposes."
In re Best Lock Corp. Shareholder Litig., 845 A. 2d 1057, 1085
(Del. Ch. 2001) (guoting D e l . C o d e A n n . tit. 8, § 160(c)).8
8 The corporate law statutes of Delaware appear to be silent on the guestion of whether treasury shares are entitled to dividends.
11 So, for purposes of determining whether Enterasys suffered
an insurable loss by transferring stock to the injured
plaintiffs, treasury shares are substantively no different from
and are treated identically as newly issued shares. Technically,
it does not actually matter here, one way or the other, for
Enterasys, no doubt aware of the accepted attributes of treasury
shares, firmly takes the position that "[T]he distinction between
treasury shares and newly issued shares is irrelevant to
determining the value of the shares issued to the Class
Plaintiffs, and therefore immaterial to the adjudication of
Enterasys' motion for summary judgment." (Reply Br. (document
no. 39), at 4 n.2.) To be sure, Enterasys makes that comment in
the context of its erroneous proposition that harm to the
shareholders (eguity dilution) is harm to the corporation
(insured loss) , so too much probably cannot be made of it as a
concession. But the point is well taken even outside the context
in which it was made, and Enterasys does not argue or suggest
that the distribution of treasury shares might constitute a loss,
even if the issuance of new shares does not.
12 Enterasys does rely heavily upon UNR Industries, Inc. v.
Continental Casualty Company, 942 F.2d 1101 (7th Cir. 1991) to
support its basic claim that its issuance of stock to resolve a
potential liability qualifies as a cognizable loss to the
corporation. But UNR does not support Enterasys' position at
all.
UNR involved a rather unique situation. Facing thousands of
asbestos-related personal injury claims, UNR sought protection
under the bankruptcy laws. I d . at 1104. In that bankruptcy
context, an "innovative" reorganization plan was formulated, and
approved by the court, under the terms of which the company's
assets were used to pay both unsecured creditors and the class of
injured plaintiffs. Id.
[T]he firm and its creditors agreed on a plan of reorganization. The reorganized firm ("New UNR") endowed an Asbestos Disease Trust, which received approximately 63% of the firm's stock to supply additional income. Other creditors received the bulk of the remaining shares in lieu of cash payment. Shareholders retained only 8% of the stock.
In re UNR Indus., Inc., 20 F.3d 766, 768 (7th Cir. 1994). UNR's
unsecured creditors' claims were valued at $112 million and the
13 injured plaintiffs' claims at $254 million (or 2.27 times greater
than the creditors'). 942 F.2d at 1105. That valuation was
deemed both reliable, as the product of arms-length negotiations,
and reasonable, given the bankruptcy court's approval. I d . at
1105-06. Based upon that valuation of the respective claims on
the estate, 63% of the stock in the reorganized UNR was
distributed to a trust for the benefit of the asbestos-claimants
(representing a market value of $150 million), and 37% went to
the unsecured creditors (about 29%) and former shareholders
(about 8%). I d . at 1104.
At issue in UNR was whether the company's excess insurance
carrier was reguired to cover the "loss" associated with the
payment of stock to the injured class. Id. The insurer,
pointing out that the policy in guestion "define[d] 'loss' as
'the sums paid as damages in settlement of a claim or in
satisfaction of a judgment,'" i d ., argued that the bankruptcy
reorganization constituted neither a judgment nor a settlement.
The court of appeals disagreed, holding that "[t]he
reorganization reguired UNR to pay a sum certain (the stock which
had a value of $150 million) in satisfaction of the asbestos
14 claims," i d . at 1105, and that the final order confirming the
reorganization plainly gualified as either a judgment or
settlement within the meaning of the policy. Id.
And, the court held (for reasons not pertinent here) that
the insurance carrier was liable for the full amount of the
agreed upon value of the injury claims - $254 million - not just
for the value of the stock in the reorganized UNR transferred to
the trust ($150 million), up to the full amount of the policy
limits. Id. In other words, the carrier was not permitted to
benefit from the discounted payment, which was of course based
solely upon the insufficiency of assets in the bankruptcy estate.
Id. The court also recognized that the insurance reimbursement
would inure to the benefit of the injured class plaintiffs - the
new majority owners of the reorganized company. I d . at 1108.
In UNR, guite unlike this case, the company did not issue
new shares to resolve a potential liability. It is true that the
means by which UNR's assets were distributed, and payment in
settlement was made, was unigue - the court called it
"innovative" - in that the reorganized company was handed over to
15 the creditors and class plaintiffs. 942 F.2d at 1104. A key
point in understanding the critical distinction between UNR and
the present case is the concept previously emphasized - that the
new reorganized UNR was an entirely different entity - it was not
the old bankrupt UNR.
In UNR, the stock transfer represented not an addition of
eguity holders (slicing the company pie in thinner pieces) while
the company retained its present value, as is the case here. To
the contrary, UNR actually "lost" nearly all of its assets, and
63% of that loss was attributable to payment of its settlement
obligations to the underlying class action plaintiffs.
Therefore, the "payment" by UNR of 63% of its assets constituted
a loss, or economic harm (indeed disastrous economic harm) to
UNR, economic harm covered by the excess policy. The obvious and
critical difference between UNR and this case is that the stock
issued to the trust for class plaintiffs in UNR was stock in the
new, reorganized company. The old UNR - the bankrupt debtor -
had its assets collected and paid out. Issuance of 63% of the
stock in the new UNR to class plaintiffs was simply a convenient
16 short-hand means of selling and paying out corporate assets. It
is plain that the old UNR suffered a dramatic loss.
Here, Enterasys is not handing over corporate assets to
satisfy liability claims. Rather, it is simply issuing
authorized new shares to the class plaintiffs - diluting the
eguity ownership interest represented by each share already
outstanding, but not diminishing the value of, or giving up any
interest in the assets owned by the corporation. Enterasys'
corporate worth or value has not and will not be adversely
affected by the distribution or issuance of stock in satisfaction
of its settlement obligations. Since Enterasys has not and will
not suffer a loss, much less one cognizable under the pertinent
excess policies, as a result of its issuance of stock in
compliance with its settlement obligations to the class
plaintiffs, the carriers are entitled to partial summary judgment
on that issue.
C. Timeliness of the State Declaratory Judgment Action
In their motions for judgment on the pleadings. Gulf and
Clarendon seek a ruling that Enterasys filed its state
17 declaratory judgment claim too late. It may, but may not, matter
in the end. It matters to the extent Enterasys hopes to obtain
coverage, because success on that issue would, under the state
statute, entitle it to attorneys' fees associated with bringing
the coverage suit.
At this point, however, it appears that material issues of
fact may preclude summary judgment. It is undisputed that
plaintiff's declaratory judgment action was filed approximately
thirteen months after the first-filed underlying action, Roth v.
Enterasys Networks, Inc., which puts the filing of the
declaratory judgment action well outside the six-month time limit
specified in RSA 491:22. However, there appear to be factual
disputes about whether Roth, or some later filing, such as the
First Consolidated Class Action Complaint, constitutes the "writ,
complaint, or other pleading initiating the action that [gave]
rise to the guestion [of coverage]," RSA 491:22, as well as
disputes over when the facts giving rise to the coverage dispute
became "known to, or reasonably discoverable by" defendants. Id.
18 In any event, it has yet to be established that Gulf's or
Clarendon's excess policies are triggered. That matter seems
now to be a function of what portion of the "more than $27
million" claimed in defense costs actually gualify as
reimbursable defense costs under the respective policies.
Prudential case management suggests that the parties, counsel,
and the court will all be better served by first resolving that
critical issue, for it may well resolve the litigation with
respect to one or both of the excess carriers.
Defendants' motion for judgment on the pleadings is denied
as to Count I, but without prejudice to renewing it, if and when
the issue is no longer potentially moot. However, judgment on
the pleadings is granted on Count IV, the Consumer Protection Act
claim for reasons that are self-evident. See Bell v. Liberty
M u t . Ins. C o ., 146 N.H. 190, 194 (2001) ("the insurance trade is
exempt from the Consumer Protection Act pursuant to RSA 358-A:3,
I") •
19 D. Consent to Settle
It is undisputed that Enterasys did not obtain Clarendon's
prior written consent to the settlement, as required by the
policy, and so is not entitled to coverage under the Clarendon
policy, absent facts establishing waiver or estoppel. Enterasys
argues that the details of the course of dealing between it and
Clarendon ought to give rise to a finding of waiver or estoppel.
Perhaps. But the record is insufficiently developed on the point
one way or another. The briefs are rather conclusory in style
and each assumes material facts that appear to be disputed.
Clarendon certainly does not agree that it strung Enterasys
along, or "dithered" over Enterasys' request for consent (in
fact, nowhere does Enterasys definitively assert that it
requested consent), nor does Clarendon agree that it
affirmatively denied coverage. Clarendon may well have told
Enterasys that its settlement proposal (as it finally evolved)
would not reach its coverage level, so no decision needed to be
made with regard to consent. But that is not entirely clear
either.
20 The relevant and undisputed material facts have yet to be
completely identified, and the court is not inclined to
speculate, on this record, about whether summary judgment is
appropriate either way on this issue. Besides, Clarendon's
policy may well be out of reach for other, perhaps more readily
ascertainable reasons - depending on whether "more than half of
more than $27 million" gualifies as reimbursable costs of defense
under the pertinent policies.
Summary judgment on a lack of consent theory is denied,
albeit without prejudice to refiling based upon a complete
agreed-upon statement of, or establishment of sufficient
undisputed material facts.
Conclusion
For the reasons given, defendants' motion for judgment on
the pleadings (document no. 15) is granted in part and denied in
part, without prejudice to renewing it; Enterasys' motion for
partial summary judgment (document no. 21) is denied; Gulf's
cross-motion for summary judgment on the issue of loss (document
no. 29) is granted; and Clarendon's motion for partial summary
21 judgment (document no. 30) is granted regarding the issue of
loss, but otherwise denied.
SO ORDERED.
Steven J. McAuliffe Chief Judge
March 29, 2005
cc: Doreen F. Connor, Esg. John V. Dwyer, Esg. John M. Edwards, Esg. John R. Gerstein, Esg. Janet R. McFadden, Esg. James C. Wheat, Esg.