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SAFEWAY, INC. v. NATIONAL UNION FIRE INS. CO.

October 22, 1992

SAFEWAY, INC., Plaintiff,
v.
NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA, Defendant.



The opinion of the court was delivered by: D. LOWELL JENSEN

 On September 30, 1992, this Court heard defendant's motion for summary judgment on specified issues. John J. Dacey of McKenna & Fitting appeared for plaintiff. David B. Paynter of Lewis, D'Amato, Brisbois & Bisgaard and Jonathan Thier of Cahill, Gordon & Reindel appeared for defendant. Having considered the papers submitted, the arguments of counsel, and the applicable law, the Court GRANTS defendant's motion for summary judgment on the specified issues for the following reasons.

 I. BACKGROUND

 This case involves an insurance perspective on the corporate takeover wars fought in the mid-to-late 1980s. Safeway Stores, Inc. ("Safeway") brings this action for indemnification against its insurer, National Union Fire Insurance Company ("National Union"), who from May 29, 1986 through May 29, 1987, provided Safeway with a directors' and officers' liability insurance policy. The policy included direct coverage for directors and officers as well as a corporate reimbursement clause covering Safeway for expenditures incurred through indemnification by Safeway for the defense and settlement of claims against its officers and directors. Safeway brought the action seeking approximately $ 13 million that Safeway allegedly incurred in settling lawsuits brought against its directors and officers in 1986. These shareholder lawsuits arose in connection with Safeway's acquisition by Kravis, Kohlberg & Roberts ("KKR") in a leveraged buy out.

 A. The Takeover of Safeway and the Shareholder Actions

 In response to a hostile takeover attempt, Safeway invited KKR to become its "white knight." On July 25, 1986, Safeway's directors entered into a merger agreement with KKR. Pursuant to the agreement, KKR would buy 73% of Safeway's public stock, at $ 69.00 a share, before the end of August 1986, with the actual merger to take place in November 1986. The merger agreement authorized Safeway to declare a quarterly dividend of up to $ .425 per share prior to the consummation of the merger. This amount represented Safeway's "regular" *fn1" quarterly dividend payment which was scheduled to be paid on September 30, 1986 to shareholders of record as of September 2, 1986. In addition, Safeway agreed to be liable for a "breakup penalty" of $ 45 million in the event that KKR lost out to another bidder and the KKR/Safeway merger did not take place. KKR created a special affiliate, "SSI," to purchase Safeway shares and facilitate the transaction.

 Shortly after the announcement of the proposed takeover agreement, six class action lawsuits were filed by Safeway shareholders: four in California state court, one in Maryland state court, and one in federal court in this district ("shareholder actions"). Included as defendants in the shareholder actions were Safeway, Safeway's directors, KKR, KKR individual defendants, SSI, and Merrill Lynch, which acted as Safeway's consultant for the merger. The shareholder actions alleged generally that Safeway's officers and directors breached duties to the corporation and its shareholders by approving a tender offer for and acquisition of Safeway by KKR. The actions alleged that Safeway and KKR aided and abetted the breach, in part, through negotiation of the $ 45 million breakup penalty. The gravamen of the shareholder actions was that the shareholders would receive inadequate consideration for their stock. The shareholder actions sought to enjoin the KKR buy out or, in the alternative, to recover damages and attorneys' fees. Safeway notified National Union of these pending lawsuits on August 12, 1986.

 On August 19, 1986, the parties to the shareholder actions entered into a tentative settlement agreement memorialized in a "Memorandum of Understanding." The settlement agreement provided for a modification to the existing merger agreement between Safeway and KKR. Under the original terms of that merger agreement, KKR had agreed to buy 73% of Safeway's public stock at $ 69 per share before the end of August 1986. Safeway was authorized to issue its regular quarterly dividend of $ .425 per share ($ 26.2 million) to be paid on September 30, 1986 to shareholders of record as of September 2, 1986.

 As a result of the settlement agreement, Safeway agreed to advance the record date for a portion of the dividend and to provide for two separate record dates for payment of the Fall 1986 dividend. The August 19, 1986 Memorandum of Understanding provided that the shareholders would receive approximately a $ 11,500,000 dividend payable by Safeway in September 1986.

 Under the terms of the initial merger agreement, KKR, as shareholder of record of 73% of Safeway stock on September 2, 1986, would have received 73% of the entire $ 26.2 million quarterly dividend, amounting to $ 19.1 million. Pursuant to the merger agreement as modified by the settlement agreement, KKR would acquire its 73% of Safeway stock after the first record date for payment of dividends and would therefore receive 73% of only the later $ 10.5 million dividend, amounting to $ 7.6 million. As a result of the settlement agreement, KKR gave up $ 11.5 million of dividends it would have received under the original merger agreement and shareholders of record other than KKR, including shareholder plaintiffs, received the $ 11.5 million in dividends. The bottom line result was to add $ 11.5 million to the takeover price to be paid by KKR to Safeway.

 The events contemplated by the Memorandum took place as planned. The Safeway board of directors authorized issuance of the split dividend on August 19, 1986, KKR acquired its 73% share of stock on August 29, 1986, and the quarterly dividend was paid on September 30, 1986 to shareholders of record on August 28, 1986 and September 2, 1986. Inasmuch as defendant directors were owners of Safeway stock on August 28, 1986 they received a portion of the $ 11.5 million early dividend payment provided for in the settlement agreement. Safeway notified National Union of the settlement agreement, including the split dividend provision, on August 29, 1986.

 The terms of the Memorandum were ultimately memorialized in a formal Stipulation and Agreement of Compromise and Settlement ("Stipulation"), dated May 15, 1987. Pursuant to the Stipulation, the California state court actions were consolidated in a single action. On September 16, 1987, the Alameda County Superior Court entered an order confirming the terms of the settlement for the California state court shareholder actions as "fair, reasonable and adequate." On November 16, 1987 Safeway paid $ 1,784,477.15 to counsel for the shareholder plaintiffs in accordance with the order of the Alameda County Superior Court.

 B. The National Union Policy

 The National Union insurance policy ("Policy") issued to Safeway includes a Corporate Reimbursement Section that provides, in pertinent part, as follows:

 This policy shall . . . pay on behalf of the Company . . . Loss (as herein defined) arising from any claim or claims which are first made during the policy period against . . . a Director or Officer (as herein defined) of the Company, by reason of any Wrongful Act . . . but only when the Directors or Officers . . . shall have been indemnified by the Company for damages, judgments, settlements, costs, charges or expenses incurred in connection with the defense of any action . . . to which the Directors or Officers may be a party . . . pursuant to law, common or statutory, or the Charter or By-Laws of the Company duly effective under such law which determines and defines such rights of indemnity.

 Policy, "Corporation Reimbursement," P 1 (attached as Ex. A to Paynter Declaration, Aug. 27, 1992).

 The policy defines "loss" as:

 any amount the Company shall have paid to a Director or Officer as indemnity for a claim or claims . . . whether actual or asserted and . . . shall include damages, judgments, settlements, costs, charges and expenses incurred in the defense of actions . . . for which payment may be required or permitted according to applicable law, common or statutory, or under provisions of the Company's Charter or By-Laws effective pursuant to such law[.]

 Id., P 2(c).

 On February 1, 1988 Safeway made a claim on the policy for defense costs of $ 342,000 and $ 1.78 million for plaintiffs' attorneys fees in connection with the settlement of the shareholder actions. On May 27, 1988 National Union refused to pay the claim, contending that the settlement payments reflected uncovered disbursements and that Safeway failed to allocate, as required by the insurance contract, between expenses paid on behalf of covered directors and officers, and those paid on behalf of parties not covered by the contract.

 On October 26, 1988 Safeway filed the instant action, stating for the first time a claim for the $ 11.5 million dividend payment made in accordance with the provisions of the settlement agreement. Safeway also sought indemnification for defense costs, amounting to $ 342,000, *fn2" and the $ 1.78 million payment for the shareholders' attorneys' fees. Safeway further claimed that National Union acted in bad faith in denying Safeway's claim.

 C. March 31, 1992 Order

 On March 31, 1992, this Court issued an Order deciding Safeway's motion for summary judgment on various issues arising from this lawsuit and defendant National Union's motion for summary judgment on a single issue: Whether or not Safeway's claim that its $ 11.5 million dividend of August 28, 1986 is a "loss," within the meaning of National Union's insurance policy. *fn3" Safeway, Inc. v. National Union Fire Ins. Co., No. C-88-3440-DLJ (N.D. Cal. Mar. 31, 1992) ("March 31, 1992 Order"). The Court ruled that plaintiff's payment of the $ 11.5 million dividend was not a "loss" under the policy. *fn4" The Court also granted plaintiff's motions for summary judgment on the following issues:

 1. The shareholder actions alleged "wrongful acts" within the meaning of the policy.

 2. Payment of plaintiff's attorneys' fees in the underlying shareholder actions constituted "loss" within ...


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