Fed. Sec. L. Rep. P 99,306 Louis F. Allen Carl K. Baker Joyce P. Baker Peter D. Berrington Oliver Birckhead Florence Blaustein, Mary L. Bray T.K. Brooker Donald J. Brooks Joseph Callaghan James Cassel Terry G. Chapman J.A. Clawson John K. Colvin Fred B. Cox John Rawlyn Charles Crabtree Christopher P. Clup Gordon C. Davidson Rutherford Day Donald D. Doty M.D.A. Emblin Audrey Fisher Donald B. Gimbel Kenneth J. Gimbel Katherine Gooch B.G. Harrison Yumiko Honda Herbert W. Hoover, III Margaret W. Jones Donald K. Kent E.R. Kinnebrew, III Walter J. Levy Roland Ley Suzanne Rhulen Loughlin George C. Lyman, Jr. Charles P. Lyon Michael L. McDermott Robert T. McInerny Arthur G. Michels Walter P. Muskat Walter W. Muskat A.D. Pistilli Robert A. Posner Judson P. Reis Harry W. Rhulen Walter A. Rhulen J.O. Ricke E. Joy Rose Mark S. Rose A.F. Smith Own B. Tabor Allen M. Taylor Trude C. Taylor Karl Aronson Joan R. Farrow and Jonathan M. Farrow for the Estate of Jesse M. Farrow Jack Fleck Marilyn Franckx Isabel L. Gallagher Jenn
Docket: 96-2158
Court: Court of Appeals for the Fourth Circuit; September 3, 1996; Federal Appellate Court
The case involves multiple plaintiffs, including Louis F. Allen and others, against Lloyd's of London and associated entities, with appeals heard in the United States Court of Appeals for the Fourth Circuit. The plaintiffs, represented by various legal counsel, seek redress from the defendants, which include Lloyd's and its affiliated groups, with additional parties appearing as amici curiae, such as the Government of the United Kingdom and the National Association of Insurance Brokers. The case was argued on August 27, 1996, and decided on September 3, 1996. The court, led by Judge Niemeyer with Judge Michael and Judge Motz concurring, reversed and remanded the previous decision in a published opinion.
In 1995, Lloyd's of London proposed a $22 billion "Plan for Reconstruction and Renewal" aimed at restructuring its reinsurance requirements and revitalizing the market. As part of this plan, Lloyd's managers offered a $4.8 billion settlement to resolve intra-market disputes, including lawsuits from "Names," the market's members who underwrite insurance. Ninety-three American Names filed a lawsuit in the Eastern District of Virginia, invoking U.S. securities laws to compel Lloyd's to disclose additional financial information regarding the plan. They also sought a preliminary injunction to prevent Lloyd's from requiring American Names to make a binding investment decision by the August 28, 1996 deadline.
On August 23, 1996, the district court granted the injunction, directing Lloyd's to comply with the disclosure obligations under Section 14(a) of the Securities Exchange Act of 1934 and prohibiting any collection from American Names until the disclosure process was completed. A trial was set for November 4, 1996. Lloyd's appealed the injunction, requesting expedited review due to the impending deadline for Names to accept the settlement. Following oral arguments on August 27, 1996, the appellate court granted Lloyd's motion to stay the district court's injunction, ultimately reversing and remanding the case with instructions to dismiss, based on the enforcement of the parties' contractual provisions regarding the governing law and forum in the UK.
The Lloyd's market has a history of over 300 years, originally established for insuring shipping risks. It consists of complex syndicates where Names contribute underwriting capital and are liable for excess losses from their personal assets. The market's integrity is supported by a Central Fund, and the governance is established through acts of Parliament, which require Names to adhere to the rules and bylaws of Lloyd's as part of their membership.
Over 34,000 participants from 80 countries are involved in the Lloyd's market, with 3,000 being Americans. Prospective participants, known as "Names," must travel to London for a personal interview to understand their financial commitments, which include unlimited personal liability for underwriting risks. They cannot resign from the market until all obligations are fulfilled, and any disputes must be resolved in British courts under British law. The Lloyd's market functions on a three-year accounting cycle, with profits and losses assessed at the end of each cycle. If potential liabilities cannot be estimated, Names remain liable.
During the late 1980s and early 1990s, unexpected losses from asbestosis, pollution claims, and catastrophic events led to excess losses estimated at $22 billion before 1993. This situation caused disputes within the market, with Names alleging mismanagement and fraud by managing agents. Many Names struggled to meet obligations, incurring debts to the Central Fund, further complicating collection efforts and threatening the market's integrity.
To address these issues, Lloyd's initiated a comprehensive restructuring plan after three years and over $100 million spent. This plan includes settling intra-market litigation, where Names release claims against Lloyd's for $4.8 billion in credits, and reinsurance of pre-1993 obligations through a new company, Equitas Reinsurance Ltd. Equitas will be funded by loans, a cash call on Names, and the settlement credits. Names were offered the opportunity to settle for a share of the funds, with a provision that those who do not agree may still be required to contribute capital to Equitas. Any remaining capital after settling obligations will be returned to the Names. Lloyd's set an August 28, 1996, deadline for responses, citing the jeopardy to its market's solvency and the impending reinsurance underwriting season.
Ninety-three American Names filed a lawsuit in Virginia, asserting that Lloyd's was violating their disclosure rights under U.S. securities laws. Lloyd's sought to dismiss the case, citing an agreement that disputes be resolved under British law. The Virginia district court denied this motion, ruling that Lloyd's could not demand settlements without complying with U.S. disclosure requirements and ordered them to provide the necessary disclosures within 30 days.
On appeal, the court reversed the district decision, affirming the enforceability of the contractual provisions specifying British jurisdiction and law. The court referenced the Supreme Court's precedent supporting the validity of choice of forum and law provisions unless proven unreasonable. Factors that could render such provisions unreasonable include fraud, significant inconvenience, fundamental unfairness, or contravention of strong public policy.
The district court found no evidence of fraud and deemed litigation in England not gravely inconvenient. However, it ruled against enforcement of the choice of forum and law provisions, citing that they undermined the strong public policy of U.S. securities laws, which mandate investor protections through disclosure requirements.
The district court's conclusion that the public policy underlying U.S. securities laws justifies denying enforcement of the choice of forum and law clauses is contested. While U.S. securities laws emphasize full disclosure to uphold honest capital markets and prohibit waiving disclosure requirements, enforcing the agreed-upon clauses in this case does not undermine these policies. British law similarly prohibits fraud and misrepresentation, offering adequate remedies for parties involved. The Names can pursue claims under British law for deceit, breach of contract, negligence, and breach of fiduciary duty, with access to various forms of relief. The argument that unfavorable foreign laws should prevent enforcement is rejected, as is the notion that U.S. disclosure requirements should apply globally merely because U.S. entities are solicited. The historical context of Lloyd's, where an insurance market operates under British law with specific membership protocols for foreigners, supports the view that U.S. judicial resources should not be expended on predominantly foreign transactions.
Relieving Names of their agreements is not warranted solely due to membership solicitation occurring in the U.S., as the primary activities, including the formation of underwriting syndicates and risk management, transpire in London. Membership solicitation merely facilitates syndicate formation; specifics regarding syndicates and underwriting risks emerge later. The U.S. involvement is incidental, and while American courts occasionally apply U.S. anti-fraud provisions to foreign transactions, such provisions have a broader extraterritorial application than filing requirements. The interest in preventing fraud outweighs routine administrative concerns. Allowing the Names to evade their agreements during financial losses would breach principles of international comity, as U.S. jurisdiction should not extend disproportionately to foreign markets, conflicting with British regulations governing the Lloyd's market.
Imposing U.S. securities laws on this foreign market risks significant repercussions, jeopardizing billions in insurance coverage for U.S. citizens, as American Names could seek rescission based on non-compliance with U.S. disclosure laws. Insurance regulators have warned of the potential chaos this could create in the domestic market. Ultimately, enforcing the Names' agreements to litigate under British law does not undermine U.S. securities policy. The Names present two arguments for U.S. securities laws applicability to the Lloyd's Reconstruction and Renewal Plan: first, they claim that interests in Equitas constitute "investment contracts" under the 1933 and 1934 Acts; second, they argue their investments under the General Undertaking qualify as equity securities, making the Plan a solicitation for consent subject to the requirements of the 1934 Act.
To determine if Lloyd's Plan is an "investment contract" under securities laws, the test from SEC v. W.J. Howey Co. is applied. The Howey test defines an investment contract as a scheme where an individual invests money in a common enterprise, anticipating profits solely from the efforts of others. The focus should be on the economic realities of the transaction, not merely the terminology used.
Lloyd's Plan includes two elements: a settlement offer and reinsurance through Equitas. The settlement offer does not meet any Howey factors, thus cannot be classified as a security. Regarding the Equitas component, it fails the third Howey factor, as participants (Names) cannot expect profits from their involvement; Equitas is designed to reinsure and fulfill existing obligations rather than generate new profits. Any potential rebates for Names from Equitas' capitalization are considered a return of capital, not profits. Additionally, Equitas is prohibited by its Articles of Association from paying dividends, and Lloyd's would donate any operational profits to charity.
Consequently, Lloyd's does not promote Equitas by highlighting potential profits, leading to the conclusion that the Plan does not qualify as a security under securities laws. The argument that the initial investment in Lloyd's is a security, making the Plan a solicitation related to a security, is also unpersuasive. Despite disputes over whether the initial investment qualifies as an "equity security," resolution of that issue is unnecessary because the Plan does not solicit proxy or consent related to any registered security.
Section 14(a) establishes a broad disclosure policy aimed at protecting corporate suffrage rights, as supported by case law, including J.I. Case Co. v. Borak and Mills v. Electric Auto-Lite Co. While fair corporate suffrage is essential for equity security holders, not every management communication qualifies as solicitation under 14(a). Solicitation is defined as management seeking shareholder consent for actions requiring approval, ensuring informed decision-making. The court highlighted that the burden is on the complainant to demonstrate harm from corporate suffrage rights violations.
In this case, neither British law nor the General Undertaking grants Names a role in the formation of Equitas, and the authorization for reinsurance through Equitas stems from a Lloyd's bylaw, not shareholder consent. Consequently, the Plan does not constitute solicitation under 14(a), nor does Lloyd's settlement offer, which allows Names to decide whether to waive claims against Lloyd's in exchange for partial premium funding. There is no authority indicating that such settlement offers are subject to 14(a) disclosure.
Ultimately, the court concluded that the United States securities laws do not supersede the chosen forum and law for dispute resolution, ruling that the Lloyd's Plan for Reconstruction and Renewal is neither a security nor related to one. The district court's order from August 23, 1996, was vacated, and the case was remanded with instructions to dismiss the action.
