in Nebraska. Defendant Pacific Insurance Co. provided an excess coverage policy, which applied once Kiewit reached the limits of the primary policy. This secondary policy provided an additional $ 10 million in coverage for any loss that was covered under the primary policy.
In 1988, Kiewit formed a subsidiary, Kiewit Communications Co., which eventually became MFS Communications Corp. (MFSCC), to pursue business opportunities in the telecommunications industry and to provide businesses with an alternative source of local telecommunications services. In June 1989, MFSCC increased to 80% its ownership interest in Metropolitan Fiber Systems, Inc. (MFS Telecom), a company that managed an alternate local communications network in Chicago. James Crowe, CEO of MFSCC; Royce Holland, president and chief operating officer; and Terrence Ferguson, general counsel; were the MFSCC executives primarily involved in these negotiations, with Crowe acting as the lead negotiator. The original owners of the company--Arthur Brantman, Anthony Pompliano, Howard Gimbel and David Husman--retained the remaining 20% of the shares in MFS Telecom. In August 1990, the 20% interest was further divided so that 10 individuals held the shares.
Several of the minority shareholders approached Crowe in late 1991 regarding the sale of their shares to MFSCC. Only Anthony Pompliano completed the deal at this time, selling for $ 85,000 per share in June 1992. In July 1992, negotiations renewed with the remaining minority shareholders, leading to MFSCC's purchase of the remainder of the minority shares for $ 135,000 per share. MFSCC paid Pompliano an additional $ 50,000 per share to equalize his sale price with that of the other minority shareholders.
In May 1993, MFSCC sold 20% of its stock through an initial public offering. As a result, six of the minority shareholders brought an action in March 1994 in the Northern District of Illinois against Crowe, MFSCC and Kiewit. The four-count complaint contained allegations of violations of federal securities laws, fraud, breach of fiduciary duty, and breach of contract and the duty of good faith and fair dealing. MFS was named in all four counts, while Crowe and Kiewit were named in Count I for violation of federal securities laws. Peter Kiewit notified Federal of the lawsuit in June 1994. In August 1994, Pompliano and his wife joined the suit as plaintiffs. Pompliano had served as president and CEO of MFS Telecom from January 1988 until April 1990. He was also a director and vice chairman of Telecom's board from April 1990 until June 1991. Federal learned of Pompliano's joining the lawsuit sometime between August and October 1994.
The complaint alleged that MFS had concealed material information from the plaintiffs prior to the sale of their shares of Telecom stock to MFS in September 1992. More specifically, the plaintiffs alleged that MFS had failed to inform them of its plan to implement an initial public offering of stock (IPO) in Telecom's parent company, MFS, and its retention of Salomon Brothers, an investment banking firm, to implement the sale. In light of the planned IPO, the plaintiffs alleged that stock was much more valuable at the time of sale than the price they received and that they would not have sold their shares had the defendants disclosed the material information. Plaintiffs also alleged that MFS engaged Salomon Brothers for advice concerning how to buy the minority shareholders' MFS Telecom stock prior to, and as part of the plan for, a public offering involving MFS Telecom.
Also allegedly unknown to the minority shareholders was the fact that during the negotiations to acquire their MFS Telecom stock, MFS was also secretly negotiating with British Telecommunications PLC regarding a potential substantial investment by British Telecom in MFS Telecom. The plaintiffs alleged that by failing to disclose this material information, MFS breached the shareholder agreement and the duty of good faith and fair dealing arising thereunder by inducing the minority shareholders to enter into the 1992 stock purchase agreements and thereby sell their MFS Telecom stock at an unfair price.
As to Crowe specifically, the complaint stated that on August 24, 1992, he "submitted to the Minority Shareholders a written offer to purchase their MFS Telecom stock at a price of $ 135,000 per share. Because MFS Telecom was a private company, the minority shareholders were dependent upon defendants to provide them with complete, accurate and current information about the company so that they could evaluate MFS' offer." Count I of the complaint also contained allegations that Crowe was a controlling person of MFS within the meaning of Section 20(a) of the 1934 Securities Act and that he participated in and exercised control over the operations of MFS, including the decision to omit the material information.
Crowe had been CEO of MFSCC since its inception and was the highest ranking employee at the company. He had primary responsibility for establishing the strategic plans and objectives of MFSCC, including all aspects of capital acquisition such as public offerings, stock purchases, and mergers and acquisitions. For initiatives in these areas that required board approval, Crowe was responsible for making recommendations and presenting them to the board for approval.
The insurance policy did not require Federal to assume the defense of the lawsuit, and all three defendants retained the law firm Bartlit, Beck, Herman, Palenchar & Scot. In July 1994, Federal sent Kiewit a five-page letter summarizing its view of the allegations in the complaint and the terms of the policy.
Federal set forth specific policy provisions under which coverage might be denied, including the finding of fraud, intentional misconduct or personal profit, or the award of penalties or punitive damages. Federal concluded the letter with a reservation of rights under the policy to deny coverage or rescind the policy, stating that:
it reserved all rights under the policy and available at law to deny coverage . . . on additional and alternative bases as other terms, conditions, exclusions, endorsements, and provisions of the policy, including representations, statements, declarations and omissions in connection with the application therefor, are found to be applicable.
The letter also stated that Federal's "position as to the coverage for this matter [is] premised upon . . . presently known facts and are by necessity subject to change as additional . . . facts are developed through the course of discovery and further pleadings."
Although not responsible for control of the defense, Federal agreed to pay--after the $ 2.5 million deductible--80% of the defense costs based on a Federal claims adjuster's following assessment:
"given the role of Mr. Crowe in negotiating the deal with the plaintiffs; in that he was the only person to discuss and finalize stock purchase with the plaintiffs, and that he came up with valuation based on his knowledge of the business, his role and defense of his activities is one key to the defense of this action . . . Crowe's role does seem to be central to the defense of this action."