Bump-up exclusion

The bump-up exclusion is an exclusion in American D&O (directors and officers) policies that takes out of covered loss the extra price an acquirer pays to settle a suit by the target's shareholders. In 2001, the federal Court of Appeals for the Seventh Circuit (272 F.3d 908), in an opinion by Judge Richard Posner, refused to treat as covered loss a sum paid by Level 3 Communications. The company had used it to settle a suit by former shareholders of a company it had taken over. They said it had bought their shares too cheaply using misleading information. The reasoning fits in one sentence: giving back what was wrongly obtained is restitution, and restitution is not insurable. The bump-up exclusion writes that idea into the definition of loss in American D&O policies. When a claim alleges that the insured paid inadequate consideration to acquire an entity or its assets, the part of a judgment or settlement that amounts to increasing that price is not loss. Defense costs stay covered, almost always through an express carve-back. The typical case is the merger objection suit in Delaware, where the target's shareholders argue the board sold too cheaply. An acquirer that settles for a few extra dollars per share, paid to the former shareholders, does not claim that top-up as a loss. The difficulty comes with suits based on misleading disclosure in the merger documents, under Section 14(a) of the Exchange Act or Section 11 of the Securities Act. The insured argues that it is compensating a disclosure injury rather than a price gap. American courts have split depending on the wording, especially on the words “effectively increased”. The exclusion also appears in the policies of French groups that buy in the United States.