Q2 2024 FINPRO Management Liability: Need to Know

Every quarter, our management liability team shares noteworthy trends and emerging issues to help US-based companies make decisions to manage their risks. We will cover topics related to directors and officers (D&O) liability, employment practices/wage & hour liability, and fiduciary liability risks and share insights on building an effective, customized insurance program that is fit for an evolving risk landscape.

Our Q2 2024 issue focuses on:

• Recent decisions by the Delaware Chancery Court that have raised concerns that Delaware could lose its status as the preferred corporate home, which has some companies considering moving their charter to Nevada.
• The Supreme Court's ruling in a Title VII case that could make it easier for employees to pursue claims of discriminatory forced transfers without needing to demonstrate significant harm.
• The FTC's recent rule that essentially bans non-compete agreements, with some exceptions.
• The Illinois legislature’s bill that aims to amend the interpretation of the Illinois Biometric Privacy Act.
• Plan sponsors’ efforts to reduce pension-related liabilities by transferring them to insurance companies through annuity contracts.
• Lawsuits regarding mortality tables used for pension benefit calculations and the differing court opinions on actuarial assumptions.
• Litigation experienced by employee stock ownership plans, particularly concerning the handling of sale proceeds and loans.

D&O Liability

Going all in: Nevada’s play to topple Delaware’s corporate dominance

Over the past several months, a handful of court decisions have some suggesting that Delaware — home to 68% of Fortune 500 companies and 79% of all US-based IPOs — risks losing its status as the preferred corporate home.

The cases in question, in which the Delaware Chancery Court undid board decisions, involved issues such as executive compensation and preferential treatment granted to large shareholders. Some companies have moved or threatened to move their charter to another state, with Nevada being the alternative referenced most frequently due to its level of protection for directors.

But changing domicile is not always a straightforward process. In at least one instance, the company’s decision to redomicile resulted in shareholder litigation challenging the transaction, which the Delaware court reviewed under the exacting “entire fairness” standard.

But why do some view Nevada as a better option? After all, for more than 100 years, Delaware has been the go-to for corporations, boasting a highly specialized court system with cases decided by knowledgeable judges generally at a faster pace compared to other jurisdictions.

The answer is simple. Nevada made a concerted decision to provide expansive protections and deference to boards to lure corporate charters away from Delaware.

Examples of Nevada’s benefits over Delaware include:

To further cement itself as the Delaware alternative, Nevada passed a law prohibiting its courts from looking to other jurisdictions to interpret the plain meaning of Nevada statutes.

Considering these differences, it becomes easier to understand why some companies are considering heading to Nevada or another state where they believe they can exercise influence over future legislation. In an environment where derivative litigation continues to represent real and substantial risks, the ability to potentially limit management’s personal liability is tempting.

While it is unlikely that Delaware will lose its status as the corporate law hub, this trend emphasizes the need to consider corporate citizenship when assessing directors’ and officers’ insurance needs.

Since directors and officers of companies domiciled in Nevada enjoy broader protections, there may be lower risk of shareholder litigation. However, companies considering relocating, especially from Delaware, should consider the risk of shareholder claims challenging the decision.

Also note that while Delaware courts have not prevented companies from moving, they have allowed claims challenging the decision to move to continue. One way to reduce the risk of claims is to fully inform shareholders of the pros and cons related to reincorporating elsewhere prior to a shareholder vote.

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Employment Practices/Wage & Hour Liability

Supreme Court lowers the bar on Title VII claims challenging work transfers

On April 17, 2024, in Muldrow v City of St. Louis, a unanimous US Supreme Court ruled that plaintiffs in Title VII cases challenging involuntary job transfers do not need to demonstrate "significant" harm to establish that the transfer is an "adverse employment action."

The Civil Rights Act of 1964 (Title VII) prohibits discrimination in the “terms, conditions, or privileges of employment” because of an individual’s race, religion, sex, or national origin. The Muldrow case revolved around a female police sergeant who was transferred from the Intelligence Division to another unit within the St. Louis Police Department. The sergeant claimed that the transfer resulted in changes to her job responsibilities, schedule, and privileges, such as losing her take-home car, although her pay and title remained the same. She alleged that the transfer was discriminatory based on her sex, as no male sergeants were transferred out of the Intelligence Division, adding that she had been replaced by a male sergeant.

The district court and the Eighth Circuit had previously ruled that the transfer was not an adverse employment action because it did not cause a “materially significant disadvantage” to Muldrow. The Supreme Court held that lower courts' interpretations of the phrase “adverse employment action” deviated from the plain text of Title VII. The Supreme Court established a new, lower standard stating that an adverse employment action is one that causes “some harm” to the employee regarding an identifiable term or condition of employment.

The Supreme Court’s decision represents a significant change in the evaluation of employment discrimination cases by potentially broadening the interpretation of Title VII, specifically regarding job transfers that do not involve a demotion or reduction in pay.  This decision would appear to reduce the burden on employees, making it easier for them to bring employment related claims. As a result, employers should review their policies and practices to ensure compliance with the new standard.

The FTC issues final rule effectively banning workplace non-compete agreements, causing immediate challenges

The Federal Trade Commission (FTC) and the Department of Justice have expanded the use of antitrust law to protect stakeholders other than consumers, including employees. In the most recent development, the FTC in April approved a final rule essentially banning all non-compete agreements for all workers, except for existing agreements with senior executives. The ban, however, would apply to all non-compete agreements with workers, including senior executives, once it is effective in September. The rule, which supersedes state laws, requires employers to inform employees that existing agreements are no longer valid.

Two federal actions were filed in Texas challenging the ban, one by a tax preparation service and the other by the Chamber of Commerce and related business associations. The lawsuits argue that the FTC lacks authority to issue such regulations and challenge the rule's retroactive reach. The Texas federal court in the tax preparation service case has indicated it will issue a decision in early July. In addition to the federal actions in Texas, a small tree trimming business in Pennsylvania has also challenged the FTC's non-compete ban. The federal court in Pennsylvania has announced that it will issue a ruling on the matter by July 23, 2024.

Due to ongoing litigation, it is uncertain whether the FTC's final rule on non-competes will take effect this year or at all. However, if the rule is not barred by a court, employers must comply by September 4, 2024. Regardless, even if the federal ban does not come into effect, it aligns with a nationwide movement to restrict or ban the use of non-competes and other restrictive covenants.

Employers should closely monitor the status of the rule and its compliance deadline. In the interim, it is prudent to understand which agreements would fall within the non-compete rule and be prepared to send notices if the rule becomes effective by compiling a list of employees that may be impacted. Companies should consult with their broker or insurance advisor to assess what, if any, impact this might have under the directors and officers liability and employment practices liability coverages. 

Illinois legislature passes bill clarifying per-scan damages for BIPA violations

On May 16, 2024, the Illinois House of Representatives passed Senate Bill 2979, which aims to amend the interpretation of the Illinois Biometric Privacy Act (BIPA) and limit recovery under the act. It clarifies that multiple scans or transmissions of biometric information by a private entity constitutes a single violation, and limits individuals to one recovery in statutory damages, rather than a recovery for each instance their biometric information is collected or otherwise disseminated. The Bill also recognizes electronic signatures as valid for written consents, thus creating greater flexibility for companies.

This legislative move is a response to the Illinois Supreme Court's 2023 decision in Cothron v. White Castle, which ruled that a claim accrues each time biometric information is captured or collected. The Bill is now awaiting the governor’s signature.

The impact of the Bill on the BIPA litigation landscape is still uncertain. While the amendment significantly reduces liability exposure for private entities subject to BIPA, it will not apply to pending cases. It therefore remains imperative for businesses to continue assessing their liability and compliance with BIPA.

In general, insurance markets have either specifically excluded this exposure or offered a minimal sublimit. Companies should consult with their broker or insurance advisor to determine what, if any, coverage may be available under their employment practices liability or cyber policy.

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Fiduciary Liability

Defined benefit plans not immune to litigation

Amid higher interest rates, premiums, and pension plan management costs, many plan sponsors are keen to reduce their pension-related liabilities by transferring them to an insurer through annuity contracts.

But some pension plans’ derisking attempts have encountered challenges, with a number of participants filing lawsuits in the first half of 2024 against large employers, questioning how some of these transfers were evaluated. The lawsuits allege that the plan sponsors did not carry out sufficient diligence in evaluating the credit worthiness of the insurer to whom they transferred their pension-related liabilities, potentially jeopardizing the benefits in case of default by the insurer. The plaintiffs are asking for the sponsor organization to provide security for the assets and return any profits.

It’s worth noting that the Department of Labor’s Bulletin 95-1 outlines the responsibilities of fiduciaries when engaging in a pension risk transfer, with the guidance advising to select “the safest annuity available,” among other criteria. Many have said this guidance, issued in 1995, needs a refresh.

Since none of the cases allege denial of benefits, there are questions as to whether these suits will hold up in court, even though at least two of them are represented by a prominent Employee Retirement Income Security Act (ERISA) law firm.

In the last few years, insurance underwriters have focused their questions on defined contribution plans since those were the most likely to have claims. As defined benefit plans see an uptick in litigation, we expect underwriters to also start to evaluate the potential of pension transfer liabilities.

Legal challenges and uncertainties surrounding mortality tables in pension benefit calculations persist

Dozens of lawsuits surrounding the mortality tables used to calculate pension benefits have been filed over the past several years. These suits, often referred to as actuarial equivalent lawsuits, are based on the ERISA requirement that unless it is a single life annuity, a benefit is calculated using an actuarial equivalent. Plaintiffs have alleged that the mortality tables being used in these calculations are outdated and shortchange the life expectancy, thereby reducing the payout amounts. 

Courts have issued varying opinions in the past years. Some have said that ERISA does not explicitly state that the actuarial assumption should be “reasonable” or “current,” while there have also been several multimillion-dollar settlements. At least half a dozen suits filed recently have argued that ERISA does have a reasonableness requirement. The companies involved in these recent suits were all using mortality tables from 1963 to 1984; plaintiffs argued that ERISA requires actuarial assumptions to be “current.”

In another development, the IRS published new mortality tables, which went into effect this year, related to terminated plans and missing participant calculations. Note that plan sponsors are not explicitly required to use the new mortality tables for conversion calculations. Again, courts seem to be split. In April, a judge dismissed one of these cases saying that ERISA does not explicitly require a time period and noting that, technically, the sponsor company could use tables from the 16th century. But in May a different judge denied a motion for summary judgment in a similar case and the certified class action is scheduled for trial.

Insurance underwriters continue to ask questions about how calculations are derived and if outside consultants and counsel are engaged. If using outdated mortality tables in calculations, insureds should be ready to explain their reasons for doing so.

ESOPs on the rise, and so is litigation

Employee stock ownership plans (ESOPs) provide employees with an opportunity to own part of the company they work for. There are around 6,500 plans in the US, and in the last year there has been renewed interest in forming them.

ESOPs are used for a number of reasons. Private equity firms, for example, may use some form of ESOP to exit an investment. In other cases, company owners are using these as an alternative to a third-party sale, allowing them to exit their investment by selling it to employees.

These plans also are used to attract and retain talent, a strategy often employed by professional services firms. These transactions, however, tend to be complex and involve complicated valuation considerations. 

In April 2024, a case alleging that the value of the sale proceeds was diverted to executives and shell companies to the detriment of ESOP shares settled for $19 million. Another case alleging an improper loan from the company to the ESOP for cash out of stock settled for $6 million.

The Department of Labor (DOL) can also investigate and bring suits. For a decade, it has been pursuing these lawsuits and had not lost an ESOP case until July 2023. Many thought this loss might slow down the DOL’s investigations of ESOPs; however, in August 2023, it brought a new suit and recovered $22 million from the trustee for plans alleged to have caused the ESOP to overpay for company stock.

There has been significant debate over the DOL’s lack of guidance on the correct valuation procedures, with defense firms and the ESOP Association accusing the department of “regulation by litigation.” In early 2023, the DOL announced plans to publish new guidelines on adequate consideration to provide additional clarity; the guidelines are yet to be released, although they were expected in the first quarter of 2024. 

Fiduciary insurers have long been wary of ESOPs, with many unwilling to write these on a primary basis. Uncertainty in the guidelines for consideration make underwriters even more reluctant to write new ESOPs, citing potential defense costs in untested regulations. It’s important to note that most policies do not automatically cover midterm formation or the acquisition of an ESOP.

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