Genzyme Corp.. v. Fed. Ins. Co.

622 F.3d 62

GENZYME CORPORATION, Plaintiff-Appellant,

v.FEDERAL INSURANCE COMPANY, Defendant-Appellee.

No. 09-2485.

United States Court of Appeals,First Circuit.

Heard July 29, 2010.

Decided Oct. 13, 2010.

Robert G. Jones and John D. Donovan, Jr., with whom Peter L. Welsh, Katherine A.K. Mumma, Elizabeth E. Feeherry, and Ropes & Gray LLP were on brief for appellant.

Daniel J. Standish, with whom Marc E. Rinder, Howard Anglin, and Wiley Rein LLP were on brief for appellee.

Before BOUDIN, DYK, ^* and THOMPSON, Circuit Judges.

DYK, Circuit Judge.

Genzyme Corporation (“Genzyme”) appeals from a district court order dismissing Genzyme's complaint against Federal Insurance Company (“Federal”) for failure to state a claim. Genzyme sought to recover its costs in settling a shareholder class action under a corporate and director and officer liability insurance policy (“the policy”) issued to Genzyme by Federal. Federal denied coverage and Genzyme sued, seeking damages of $10 million plus other relief. The district court held that Genzyme's loss was not insurable as a matter of Massachusetts public policy. We disagree with this conclusion. In the alternative, the district court held that Genzyme was precluded from recovering under the terms of the policy's so-called “Bump-Up” clause for any amount paid to settle claims. We agree with the district court that the policy does not cover the amount paid to settle claims against the corporation. However, we hold that the policy does cover any settlement amounts paid pursuant to an indemnification obligation with respect to the directors and officers. Because a portion of the settlement amount may have been paid to settle claims against the directors and officers, we remand to the district court to consider the question of allocation.

I.

A.

Genzyme is a biotechnology corporation organized under the laws of the Commonwealth of Massachusetts. From 1994 to 2003, Genzyme's capital structure included “tracking stock” designed to track the performance of particular business divisions rather than the company as a whole. From December 2000 through June 2003, three series of Genzyme tracking stock were outstanding, one each for the General Division (which traded under the ticker symbol GENZ), the Biosurgery Division (which traded as GZBX), and the Molecular Oncology Division (which traded as GZMO). Each of these tracking stocks was a series of Genzyme's common stock. Genzyme allocated the performance of programs, assets, and liabilities to each division. However Genzyme owned the divisional assets and was responsible for all liabilities. Therefore, though the tracking stocks reflected the financial performance of the separate divisions, the divisions themselves were not separate entities. Each division was owned directly by Genzyme and holders of the tracking stock were holders of a single class of Genzyme's stock and possessed voting rights in Genzyme as a whole. Each of these tracking stocks was registered under the Securities Exchange Act of 1934 and traded under its own symbol on the NASDAQ Exchange.

Genzyme's Articles of Organization (“Articles”) contained an optional share exchange provision which permitted Genzyme to eliminate its tracking stock structure by requiring Biosurgery Division and Molecular Oncology Division shareholders to exchange their shares either for General Division shares or for cash. ¹ The Articles specified that each division shareholder would receive shares of General Division stock equal to 130% of the “fair market value” of the tracking stock in any share exchange. The Articles defined “fair market value” as the average closing price of GZBX or GZMO stock during a twenty-day period commencing thirty days prior to the announcement of a share exchange.

On May 8, 2003, Genzyme announced that it had decided to invoke the exchange provisions in the Articles and thereby eliminate the tracking stocks. We refer to this as the “share exchange.” In particular, Genzyme announced that it would exchange each Biosurgery Division and Molecular Oncology Division share for a certain number of General Division shares, leaving the General Division shares as the only outstanding common stock of the corporation. The share exchange was carried out on June 30, 2003. Each Biosurgery Division shareholder received 0.04914 shares of GENZ stock per share of GZBX stock. Genzyme itself received nothing in the exchange, other than cancellation of the tracking stock.

The share exchange was unpopular with many Biosurgery Division Shareholders and soon after it was announced, a number of shareholder lawsuits were filed against Genzyme, its board of directors, and its officers. One of these cases was filed in the United States District Court for the Southern District of New York against Genzyme, its directors, and two of its officers. That court certified a class consisting of those persons who held shares of GZBX stock when, after the market closed on May 8, 2003, Genzyme announced the share exchange. On August 6, 2007, Genzyme agreed to settle all of the class members' claims against the company and against its directors and officers by making a one-time payment of $64 million. The entirety of the settlement payment was paid by Genzyme. Genzyme now seeks to recover from Federal for the settlement payment in the amount of $10 million, the maximum recovery allowed under the policy. Although at least some of Genzyme's theories might also allow it to recover litigation costs in the shareholder suit, Genzyme does not seek to recover those costs, presumably because the settlement costs ($64 million) exceed the $10 million policy cap.

B.

An understanding of the claims made by the plaintiffs in the class action is integral to an understanding of the dispute between Genzyme and Federal. The operative complaint at the time of settlement, the Fourth Amended Class Action Complaint, alleged that the creation of Genzyme's Biosurgery Division tracking stock was a product of its merger with Biomatrix, Inc. (“Biomatrix”), an independent biomaterials company. This merger combined the assets of Biomatrix with those of Genzyme's Surgical Product Division and Tissue Repair Division to create the Biosurgery Division.

The class action plaintiffs alleged that Genzyme promised at the time of the merger that it would operate Biosurgery as an independent business reflected by tracking stock, but failed to do so. In addition, the class action plaintiffs alleged that Genzyme's directors and officers managed the Biosurgery Division's corporate earnings and withheld positive information about the Biosurgery Division in an effort to artificially depress the market value of the GZBX stock so that Genzyme could fold the Biosurgery Division into the General Division at an exchange rate that would be favorable to General Division shareholders. Since the Articles provided a fixed ratio of exchange which depended on the market value of the Biosurgery Division shares, Genzyme could execute the share exchange with fewer General Division Shares by artificially depressing the market value of the Biosurgery Division shares. General Division shareholders would benefit from an exchange executed by issuing the minimum number of new General Division shares possible.

The class action plaintiffs alleged that Genzyme and its officers and directors violated the securities laws by causing Genzyme to engage in insider trading and by failing to disclose material information to the public. They also alleged that the directors and officers breached their fiduciary duties of loyalty, candor, good faith, and due care to Genzyme shareholders, including the Biosurgery Division shareholders. The class action plaintiffs further alleged that Genzyme breached the implied covenant of good faith with respect to the Articles of Organization and that Genzyme breached the merger agreement it had executed with Biomatrix. Finally, the class action plaintiffs alleged that Genzyme engaged in unfair and deceptive trade practices under state law. The class action plaintiffs alleged that the directors and officers would be motivated to carry out such a scheme by virtue of the fact that they themselves owned large numbers of General Division shares.

The class action in the underlying litigation involved two sub-classes. The members of one sub-class sold their shares in the open market after the share exchange was announced but before June 30, 2003, when the share exchange occurred, and thus did not participate directly in the share exchange. The members of the other sub-class transferred their shares pursuant to the share exchange.

C.

On September 22, 2002, Federal issued the director and officer and corporate liability insurance policy at issue to Genzyme. The policy covers claims made during the period of September 22, 2002, to September 22, 2003, the period during which the class action plaintiffs' complaints were filed. It limits Federal's liability to $10 million and is subject to a $15 million deductible under Insuring Clause 2. Insuring Clause 2 covers losses for which Genzyme grants indemnification to its directors and officers. Insuring Clause 3 covers losses suffered by Genzyme on account of securities claims. Insuring Clause 2 provides:

[Federal] shall pay on behalf of [Genzyme] all Loss for which [Genzyme] grants Indemnification to each Insured Person [i.e., Genzyme's officers and directors], as permitted or required by law, which the Insured Person has become legally obligated to pay on account of any Claim first made against him, individually or otherwise, during the Policy Period ... for a Wrongful Act committed, attempted, or allegedly committed or attempted by such Insured Person before or during the Policy Period.

J.A. 179. Insuring Clause 3 provides:

[Federal] shall pay on behalf of [Genzyme] all Loss for which it becomes legally obligated to pay on account of any Securities Claim first made against it during the...