One could hardly ask for a more serendipitously named case if one wanted to write about insurance coverage for a substance emitted into the atmosphere than Sealed Air v. Royal Indemnity Co., but such an appellation was delivered by the New Jersey Appellate Division last Friday.  The case addresses Directors & Officers (D&O) liability coverage for alleged fraudulent statements in SEC disclosures concerning alleged pollution.  Before addressing the case, however, we need to take a short detour into the world of climate change disclosure.

We read today in the chemical industry trade press that the public perception of climate change reached a tipping point in 2006, which was the time when people finally concluded en masse that climate change was here, was important and was going to have significant impacts. The article stated as well that the corporate world is likewise aligned to this perspective.

However, if one pulls up the Fifth Survey of Climate Change. Disclosure in SEC Filings of Automobile, Insurance, Oil & Gas, Petrochemical and Utility Industries (2006) (available at foe.org/camps/intl/SECFinalReportandAppendices.pdf) - - one notes that while some industries have a 100% rate of climate change disclosure, others disclosed at rates of 50% or less. In the industries surveyed, the insurance sector brought up the rear at 19%. Undoubtedly disclosure rates have increased, but nowhere close to 100%. The Carbon Disclosure Project reports that in 2007 there was slightly over 50% response to its climate change questionnaire sent to 2400 companies throughout the world.

Domestically, some corporations make disclosure; others do not. This is to be expected when the Securities & Exchange Commission has no specific requirement for climate change disclosures. Instead, companies and their lawyers must parse through Regulation S-K and determine what in their business triggers reporting obligations as the result of current and anticipated "material effects" of compliance with environmental laws, material litigation relating to discharges into the environment, and "known trends, events, and uncertainties" likely to have an impact on liquid assets as well as earnings. 17 C.F.R. §§ 229.101, .103, .303 (2005). We will not explore here whether climate change disclosures would fall within the strictures of Regulation S-K. It is assumed, however, that some disgruntled investor will make the claim that a company’s disclosures were inadequate. Directors and officers would likely be sued for overseeing the alleged inadequacies. Would there be coverage under a corporation’s directors and officers liability policy in such a case? Happily for policyholders, another court has just added support for coverage. Sealed Air Corporation v. Royal Indemnity Company, Slip Op., Docket No. A-5951-06T3 (N.J. App. Div. August 15, 2008).

One of the key issues in such cases will be whether the nearly ubiquitous pollution exclusion would bar coverage. Carriers are certain to assert that carbon dioxide emissions are pollutants (we contest this view - see the June 27, 2008 blog posting) and, accordingly, allegations that corporations failed to make appropriate disclosures relating to carbon dioxide are not covered.

While no one has yet litigated this issue in the climate change context, even where the nexus between a claim and pollution is as broad as "based upon, arising out of or in any way involving" the pollution, a pollution exclusion does not apply where "the gravamen of the … complaint has its root in securities fraud and misrepresentation, not pollution." Sealed Air at 19.

The underlying lawsuit for which Sealed Air sought coverage was filed against Sealed Air and its directors and officers, alleging a fall in stock value attributed to alleged misrepresentations made by Sealed Air’s directors and officers in connection with a well-publicized corporate transaction. This is precisely the type of claim that should fall squarely within the insurer’s definition of "Wrongful Acts" under a D&O policy, and one which any business would reasonably expect to be covered. Yet, to avoid its coverage obligation, the insurer asserted that coverage disappeared because the pollution exclusion was applicable to acts vastly separated in time and space and actors from Sealed Air’s allegedly misleading statements to the financial markets.

The argument, however, failed. After examining the events giving rise to the claim, and dissecting the policy language, the Appellate Division concluded that "[t]he alleged pollution, in and of itself, did not give rise to the damages alleged …. Without the numerous intervening events and, ultimately the securities fraud litigation, there would be no damages which could be alleged by the securities holders and, thus no claim." Id. at 23-24. Thus, "the alleged pollution at issue was too attenuated from the damages arising from the alleged misrepresentation to trigger the pollution exclusion provision in the … policy." Id. at 2. "[W]e find that the plain and ordinary language of the policy, as well as the reasonable expectations of the insured, prevents [the insurer] from disclaiming coverage based upon the pollution exclusion, …" Id. at 26.

The court’s decision is consistent with the Sixth Circuit Court of Appeals’ holding in Owens Corning v. National Union Fire Insurance Co. No. 97-3367, 1998 WL 774109 (6th Cir. Oct. 13, 1998). Contra National Union Fire Insurance Co. v. U.S. Liquids, Inc., 88 Fed. Appx. 725 (5th Cir. 2004) (per curiam).  See also J. Wylie Donald & Grace Kurdian, Insurance Coverage for Climate Change Disclosures: Are You in Good Hands?, Corporate Governance Advisor (Aspen Pub. Sept./Oct. 2007).

Notwithstanding this helpful result for policyholders, proactive insureds should address the application of pollution exclusions in their D&O policies at renewal rather than rely on a court favorably parsing expansive exclusionary language in favor of the insured.