A bank director’s responsibilities are similar to directors of other types of corporations, including the duties of loyalty and care. Federal banking regulators have strong enforcement powers to address violations of law, breaches of fiduciary duty, or unsafe and unsound practices. When an FDIC-insured bank goes into receivership, the FDIC undertakes an investigation to determine the reason for the failure and whether to pursue claims against directors, officer or their parties for corporate waste, breaches of fiduciary duty or negligence.
Shareholders and customers can also bring claims alleging breaches of those duties.
Directors and officers (“D&O”) insurance is designed to protect the individual directors and officers as well as the corporation against such claims. As with other types of insurance, the coverage provided by a corporation’s D&O policy should be routinely reviewed to make certain that they will meet the needs of the company, its officers and directors by providing both a defense and indemnity for such claims.
D&O Coverage Basics
D&O coverage protects directors and executives from claims arising out of the performance of their corporate duties. A typical policy provides coverage for “any actual or alleged act or omission, error, misstatement, misleading statement, neglect, or breach of duty” of a director or officer in the discharge of his or her duties. There are typically two parts of the insurance, commonly referred to as Side A and Side B. Most bank bylaws include an indemnification agreement that requires the bank to indemnify directors and officers for claims that arise out of their activities on behalf of the bank. Side A Coverage provides insurance to pay liabilities for which the bank either cannot or will not provide indemnification. Side B Coverage reimburses the bank for the amount of money it paid to indemnify the individual directors and officers.
Some policies also provide for Side C or entity coverage, which reimburses the corporation for liability arising out of a defined group of claims, such as securities claims, filed directly against the bank. Absent Side C coverage, the insurer’s defense and indemnity obligations pertain solely to the directors and officers, and the bank will have to pay for its own defense and indemnity.
Not surprisingly, D&O policies typically exclude coverage for claims arising out of fraudulent acts. However, officers and directors accused of negligence in preventing or detecting the fraud may be covered. Most policies require a final adjudication of fraud in order for the exclusion to apply. Many policies will provide a defense to directors and officers accused of fraud unless and until there is a final adjudication of the fraud claim.
Most policies also have an “insured versus insured” exclusion. This exclusion is intended to exclude coverage for collusive or friendly suits in which a company may seek to recover ordinary business losses by making claims against the director and officer insureds who were involved in the transaction that gave rise to the losses. Understanding both the structure and limitations of your D&O policies is important to figuring out whether you are fully protected.
How Much Is Enough?
Perhaps the most important consideration in evaluating D&O policies is to understand the policy’s “eroding” limits. Unlike most general liability policies which limit only amount of indemnification (through settlement or judgment) and have no limit on defense expenses, D&O policies provide a single limit of coverage for both defense expenses and indemnification. The more officers and directors named in a single case, each of whom are entitled to separate counsel can quickly eat away at D&O limits, leaving little to cover a settlement or judgment in the case. Setting appropriate policy limits ensures that an individual’s personal assets are not placed at risk.
Another important consideration in evaluating D&O policies is that they are claims-made policies. Claims-made policies typical require insurers to cover claims that are made against the bank during the policy period. They also generally require the bank to report the claim to the insurer during the policy period, often leaving the bank little time to notify their carriers. Although extended reporting periods can be negotiated, the courts strictly enforce notice requirements.
It is important to assess individual needs and undertake a comprehensive review of existing coverage to ensure that the appropriate coverage is in place for your bank. The marketplace for D&O insurance is competitive and coverage varies among insurers. Thus there is flexibility as to limits, extended periods of reporting, and other aspects of D&O insurance. You should speak to your broker about your options.