Directors and officers insurance coverage, which protects the insured from legal liability stemming from wrongful acts, is often treated as an “out of sight, out of mind” matter. But the existence of good D&O coverage can have direct financial implications for the leaders at businesses of all sizes. John Garver III, who has practiced law at Robinson Bradshaw in Charlotte for almost 30 years, explains five unique aspects of the coverage that should be “front of mind.”
- Get full coverage for prior acts as far back as you can, and avoid gaps in coverage.
D&O coverage generally is provided on a “claims made” basis. The coverage is for claims made and reported to your carrier during the term of the policy, usually one year. However, if a company has secured a policy with a new carrier or is getting coverage for the first time, it must ensure there is no exclusion of coverage for alleged wrongful acts occurring prior to the inception of coverage. For example, when fund organizers interact with investors to solicit investments before formally establishing the fund and getting insurance, they will want to ensure coverage at least for any prior periods during which their actions could bring future claims. Similarly, when changing insurers, gaps can occur for various reasons, including a “prior acts exclusion” by the new carrier or a requirement warrant to a lack of knowledge of facts that might give rise to a claim. Even annual renewals can lead to gaps if the company and its broker fail to confirm that continuity of coverage will exist.
- Make certain your final adjudication language is the strongest possible.
All insurance policies contain exclusions. With D&O insurance, many exclusions (such as bad conduct exclusions) do not operate based on allegations, but only kick in upon a “final adjudication” of the facts that would support the exclusion. Companies should pay particular attention to the “final adjudication” language. First, they should ensure that a final adjudication is required, not merely an “admission” by the insured or an allegation by the insurer that the exclusion has “in fact” occurred, which lead to uncertainty and risk for the insured. Second, the final adjudication should be non-appealable, and should be in the “underlying action or judicial proceeding” — that is, the “bad acts” supporting the exclusion should be established by the court handling the actual claim — and not in a separate coverage action by the insurer to establish the applicability of the exclusion.
- Secure broader coverage for governmental investigations.
D&O policies provide coverage in varying degrees for the payment of the costs of investigating and defending a claim. But, when has a “claim” been “made” for such purposes? This quickly becomes a matter of great interest once expenses begin to be incurred. Because the potential expense involved in responding to securities or other regulators’ preliminary inquiries can be very high, companies at risk for such claims should pay particular attention to this portion of their D&O policies. Ensure that the definition of “claim” in the policy includes “informal investigations.” If coverage for costs of investigations is only triggered, for example, after a formal subpoena is issued, material expenses in responding to the government may not be covered. It is best to consider what regulatory tools or approaches your company is most likely to encounter, and to try to negotiate coverage to match.
- Protect the individual insureds and consider stand-alone Side A-only coverage.
The individual insureds at a company, that is, its directors and officers, should insist that the D&O coverage include insurance provided specifically for their benefit. This is typically referred to as “Side A” coverage. “Side B” generally covers the company for its indemnification of directors and officers, and “Side C” covers the company, its officers and directors for certain claims (usually securities claims). Because payments under Sides B and C will erode the limits (reduce the funds) remaining to pay other claims or costs of defense or investigations, individuals should worry that their presumed coverage does not get depleted somewhere else. Individual directors and officers can realize even more protection if a “Side A-only” policy is purchased. Such a policy, usually issued by the same insurer, is a separate policy with its own limits and, typically, less onerous exclusions and conditions of coverage. Side A coverage offers special features, such as priority in the scheme of payments, direct payments to individuals and protection if the company is unable or unwilling to provide indemnification due to bankruptcy, a change of management control and so on.
- Ensure the bankruptcy protection is solid. Do not allow the bankruptcy trustee to claim the proceeds.
Your policy must ensure that the onset of bankruptcy will not change the rights of directors to receive the benefits of a policy originally purchased with their protection in mind. If a trustee is suing the directors in a derivative action, the trustee and the directors both seek to be paid from the same pot of money. Often, D&O policies are “wasting policies,” that is each dollar of defense costs paid reduces the amount available under the policy to pay damages. Therefore, trustees frequently, to safeguard their source of recovery from depletion to pay attorneys engaged to defend against the trustee’s lawsuit, assert that insurance proceeds are part of the estate. Your policy should contain director-favorable language such as: “The bankruptcy or insolvency of any Organization or any Insured Person shall not relieve the Insurer of any of its obligations, including its obligation to prioritize payments….” There also should be a clear outline of the chain of priority for payments (with the directors first). The bankruptcy area is a prime example of where a Side A-only policy mentioned above can provide real benefits.
Garver is a graduate of the U.S. Military Academy and Duke University School of Law.