Many wineries operate as closely held companies, meaning they’re owned by an individual or small group of shareholders, who are often members of the same family. Disputes regarding ownership interests can arise, particularly when directors, officers or majority shareholders sell or acquire ownership interests in the company. These individuals owe fiduciary duties to act in the best interest of the winery. But, minority shareholders may be surprised to learn, both Delaware and California law treat the purchase and sale of interests in the enterprise as arms-length negotiations (that is, transactions in which two or more unrelated and unaffiliated parties agree to do business, acting independently and in their own self-interests), which do not give rise to any fiduciary obligation on the part of those directors, officers or majority shareholders.

Even in the absence of liability, however, such disputes can be time-consuming and expensive. If the corporation carries directors and officers liability insurance, the attorney’s fees and costs might be covered under the policy. It is important for directors, officers or majority shareholders to be aware of their rights and obligations under such policies in order to protect their claim to coverage. This article will address one of the most common coverage issues that arise in disputes like this, which, if not avoided, can negatively impact available insurance.

Examples from CA and DE

The no-fiduciary-duty rule has shielded such transactions in California in surprising circumstances. For example, a selling shareholder proved that the buying shareholder fraudulently concealed the existence of a new and lucrative product in the works at the time of the sale, resulting in a depressed purchase price of the seller’s shares.  Notwithstanding the proven misrepresentations, the conduct did not constitute a breach of fiduciary duty in a transaction where the shareholders owned equal shares of the company and were represented by counsel and accountants.

But the rule applies even when the parties are not on such equal footing. In another instance in Delaware, no fiduciary duty existed in an arms-length negotiation between controlling stockholders and the directors of a corporation, on the one hand, and a minority shareholder, on the other hand, over the terms of a share repurchase. The seller’s interest in obtaining a higher redemption price was in opposition to the interests of the company and its shareholders generally, and that circumstance did not give rise to a fiduciary relationship; the buyers had no obligation to repurchase the shares at a reasonable price.

Broad coverage for reported claims

Notwithstanding the absence of liability, disputes over ownership interests can be financially burdensome. However, private companies, including wineries, may carry directors and officers or management liability (D&O) insurance or employment practices liability (EPL) insurance that can provide broad coverage. (For instance, where the aggrieved shareholder is also an employee, disputes often include employment-based claims that can be covered under EPL policies.) Those policies, however, often contain requirements that, if not followed, can forfeit coverage altogether (an extremely costly result for the insureds).

One of the most important prerequisites is that the insurer receives timely notice of a “claim,” a word that is usually defined in the policy. D&O and EPL insurance is written on a “claims-made-and-reported” basis. This means that to trigger coverage, the “claim” must firstbe made during the policy period. In addition, it must alsobe reported to the insurer either during that same policy period or during an extended reporting period, usually between 30 to 90 days following the end of the policy period. Both conditions must be satisfied to obtain coverage under these types of policies.

Although it sounds simple, insureds often neglect to provide timely notice of a “claim.” Sometimes, insureds do not realize how broadly “claim” is defined in the policy or that the notice requirement has been triggered. That’s because the meaning of “claim” is generally not limited to legal proceedings but also includes a “written demand for monetary or non-monetary relief.” A “written demand” could be, for example, a letter, email or even a text from the minority shareholder, something insureds might not immediately recognize as a “claim” that should be reported to the D&O insurer.

Timing is everything

There is one more wrinkle: Where such a demand was sent in 2020 and followed two years later by a lawsuit, the later policy treats the lawsuit as the same “claim” as the earlier demand letter — and deems it to have been made during the earlier policy period. If the demand letter was not timely reported during that earlier policy period, the insured is likely out of luck.

Recognizing a “claim” is important in disputes within closely held corporations, which typically do not begin with a lawsuit but are instead preceded by written demands from the disgruntled shareholder. Even if made informally, they might constitute a “claim” that must be reported during the current policy’s reporting period, particularly to preserve coverage for any subsequent legal action.

Thus, if a dispute is about to be uncorked, consult with the company’s insurance broker or legal counsel to ensure that a “claim,” if made, is recognized as such and timely action is taken to report it to the carrier. That way, even if there is no merit to the claims asserted, the insured director, officer or majority shareholder preserves the right to coverage for attorney’s fees and costs.

This article is for general informational purposes only. It is not intended to be, nor should it be interpreted as, legal advice or opinion.