Articles / Corporate Governance
War Risk Exclusions Invoked to Thwart Cyber Coverage
With cyber-attacks on the increase, companies and corporate boards are appropriately increasingly focused on the risk and cyber insurance as a means of mitigating the economic cost of an attack. With this background, a new wrinkle in the landscape may be developing which I call to my readers’ attention.
Almost all insurance companies have within their policies (not just cyber policies, but all general casualty policies) what is called a “war-risk exclusion.” While the specific language and terms of the exclusion vary from policy to policy, these clauses generally provide that if a loss occurs as a result of an act of war, the loss is excluded from coverage and claims resulting from the loss will be denied.
As many readers know, I am the chair of an American Bar Association insurance section committee. Our committee has been following this issue carefully for the past year or so. Our concern: if a nation state (Iran, North Korea, China) hacks a company’s system and a loss ensues, is coverage for such loss excluded under applicable war-risk exclusions? Consider, as reported in the New York Times on February 18,
Businesses and government agencies in the United States have been targeted in aggressive attacks by Iranian and Chinese hackers who security experts believe have been energized by President Trump’s withdrawal from the Iran nuclear deal last year and his trade conflicts with China.
Are such attacks an act of war, and is coverage for a resulting loss excluded?
At each insurance conference that I’ve attended recently, I’ve asked underwriters, brokers, and attorneys representing insurers and insureds about this issue. Until now, all have related something to the effect that while a “hard” answer will depend on the specific clause and circumstances of a loss, the speaker is not aware of any claim being reviewed or denied based upon the war-risk exclusion.
This may be changing! In October, 2018 a company filed suit in Chicago, Illinois challenging a denial of a claimed loss based upon the applicable policy’s war-risk exclusion.
In Mondelez International, Inc. v. Zurich American Ins. Co., Mondelez sought $100 million in coverage under its Zurich all-risk property policy for property damage and business interruption losses sustained during a cyberattack it suffered during the summer of 2017. The insurance expressly covered cyber perils, including “physical loss or damage to electronic data, programs, or software, including physical loss or damage caused by the malicious introduction of a machine code or instruction.”
Zurich denied Mondelez’s claim, invoking the war exclusion. Of note: the war exclusion in Mondelez’s policy excluded losses for “hostile or warlike action … by any … government or sovereign power … military, naval or air force,” or an agent or authority of the aforementioned entities.
While the outcome is uncertain, the precedent and trend merit close observation. Ask your risk consultants about this issue and this case!
Joshua Gold, Anderson Kill Policyholder Advisor, “War Risk Exclusions Invoked to Thwart Cyber Coverage: The Shape of Things to Come,” January/February 2019.
SEC Allows Rejection of Mandatory Shareholder Arbitration
In December 2018, Hal Scott, a Harvard professor and shareholder of Johnson & Johnson, submitted a shareholder proposal requesting that the board adopt a mandatory arbitration bylaw applicable to “disputes between a stockholder and the Corporation and/or its directors, officers or controlling persons relating to claims under federal securities laws in connection with the purchase or sale of any securities issued by the Corporation.” Additionally, the proposed bylaw prohibitted class actions and included a five-year sunset provision unless re-approved by the shareholders.
In response, Johnson & Johnson tried to exclude the proposal, arguing that the bylaw would violate federal and state law (Rule 14a-8(i)(2)) by weakening “the ability of investors in Johnson & Johnson’s securities to pursue a private right of action under Exchange Act Section 10(b) and Rule 10b-5.”
Johnson & Johnson, which is based in New Jersey, also argued that the proposal would violate state law and submitted a letter from the New Jersey Attorney General. The letter advised the SEC that adopting the proposal would cause Johnson & Johnson to violate state law because New Jersey law limits the subject matter of corporate bylaws to matters of internal concern to the corporation. Additionally, the Attorney General asserted that under both New Jersey and Delaware law, forum-selection provisions for federal securities laws do not address matters of internal concern, so any related bylaw provisions are void.
On February 11, 2019, the SEC issued a no-action letter to Johnson & Johnson if it relied on Rule 14a-8(i)(2) (violation of law) to exclude the shareholder proposal requesting adoption of mandatory arbitration bylaws. In issueing the no-action letter, the SEC relied on the letter from the New Jersey Attorney General, stating “[w]hen parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials….We view this submission [by the New Jersey Attorney General] as a legally authoritative statement that we are not in a position to question.” The SEC did note, however, that in granting the no-action request, it was “not expressing its own view on the correction interpretation of New Jersey law” or if the proposal would violate federal law.
Prof Scott’s response to the SEC decision: he says that he is weighing his options, including appealing the SEC decision in court.
SEC Chair Jay Clayton issued a statement in support of the staff’s hands-off position, stating that he “agree[d] with the approach taken by the staff to not address the legality of mandatory shareholder arbitration in the context of federal securities laws in this matter,” and pointing to the unsettled and complex nature of the issue. The no-action letter also advised that “[p]arties could seek a more definitive determination from a court of competent jurisdiction.”
Readers may wish to know that rapid action by the SEC seems unlikely as Mr. Clayton has previously stated that mandatory arbitration provisions were “not on [his] list of near-term priorities” and continued debate would “divert a disproportionate share of the commission’s resources” from more pressing issues. Mr. Clayton has also stated that he wants to avoid a brawl over a subject that would pit business groups against investors and may divide the SEC across partisan lines, as Republicans tend to favor mandatory arbitration.
Additionally, in response to questions by Elizabeth Warren in February 2018 regarding mandatory arbitration provisions, Mr. Clayton stated that he was “not anxious to see a change in the area” and that if the issue came up, “it would take a long time for it to be decided, because it would be the subjected of a great deal of debate . . . this is not an area that is on my list of where we could do better.” If, in the future, the SEC does make a policy decision on such proposals, Mr. Clayton notes that the decision “should be made by the commission in a measured and deliberative manner.”
Cydney S. Posner, Lexology, “On shareholder proposal for mandatory arbitration bylaw, Corp Fin passes the hot potato,” Feb. 12, 2019.
Dave Michaels and Gabriel T. Rubin, The Wall Street Journal, “SEC Allows Rejection of Mandatory Shareholder Arbitration,” Feb. 12, 2019.
Letter to SEC and shareholder proposal: Letter from Marc S. Gerber to U.S. Securities and Exchange Commission, Skadden, Arps, Slate, Meagher & Flom on behalf of Johnson & Johnson, “Johnson & Johnson – 2019 Annual Meeting Omission of Shareholder Proposal of The Doris Behr 2012 Irrevocable Trust,” Dec. 11, 2018.
Staff No-Action Letter: Letter from U.S. Securities and Exchange Commission to Johnson & Jonson, “Re: Incoming letter dated December 11, 2018,” Feb. 11, 2019.
Chair of the SEC public statement: Chairman Jay Clayton, U.S. Securities and Exchange Commission, “Statement on Shareholder Proposals Seeking to Require Mandatory Arbitration Bylaw Provisions,” Feb. 11, 2019.
Hostage Negotiation Skills Provide Lessons for the Boardroom:
Negotiating with al-Qaeda kidnappers, briefing the government about emergencies, dealing with domestic robberies – Suzanne Williams, the first female head of the hostage crisis unit at Scotland Yard, has dealt with it all. After her retirement following three decades at Scotland Yard, Williams has now started working as an independent consultant.
Although the stresses of office work may seem trivial in comparison to police work, Williams acknowledges that “any job has its stresses.” Still, she sees the similarities, noting that “[y]ou need to be well-prepared, whether you’re talking to some terrorists in Iraq or going into a big meeting.”
Williams’ top tips include first, identify the people who are the “real decision makers,” then knowing what is negotiable, and preparing a second-best scenario to fall back on. Furthermore, she advises using surprise to your advantage, such as “springing meetings on bosses at a moment when they seem unoccupied.”
Williams also provides advice for specific situations. For example, when preparing for salary negotiations, Williams advises researching statistics, calculating averages, and making sure your pitch is evidence-based rather than impassioned. Williams says “[y]ou need to make clear this is a serious discussion, not a water-cooler conversation.”
When dealing with a manager who relies upon “hostile silence” in response to requests for pay increases, Williams advises not feeling the need to fill every silence, but rather asking direct questions to force a response, such as “what are you thinking about?” or “have I stunned you?”.
Recently, the Brexit negotiations have been an especially common topic. Williams disagrees that a compromise is always the best outcome because this can mean neither party gets what they want. She states she thinks negotiations to leave the EU should have been handled by a cross-party team and criticizes British politicians for being naive about what could happen.
On a personal note, I’ve gotten to know Sue and hold her in the highest regard. She’s a frequent guest lecturer at the Oxford Programme on Negotiation of which I’m privileged to be a part of the faculty, and her talks are always insightful and spot-on. I’m always impressed by the lessons that board directors and corporate executives can take from her experiences – our and her experiences at the negotiating table are not as dissimilar as first appear.
Helen Warrell, Financial Times, “Hostage negotiation skills provide lessons for the boardroom,” Jan. 6, 2019.