The September 9, 2015 U.S. Department of Justice (DOJ) memorandum to DOJ’s prosecutors and civil litigators makes it clear that the DOJ will be focusing on potentially culpable individuals, not just their corporate employers, when investigating alleged corporate wrongdoing. Among other things, the memorandum directs that it will not permit the release of “culpable individuals from civil or criminal liability when resolving a matter with a corporation.” The memorandum also says that DOJ will focus “on individuals as well as the company and evaluate whether to bring suit against an individual based on considerations beyond that individual’s ability to pay.” (For more detailed discussions of the memorandum, please click here and here).
Whether DOJ’s announcement will result in more accountability, more prosecutions and more convictions, remains to be seen. But, what should not wait is a review of corporate directors and officers liability insurance policies. D&O liability policies cover directors and officers of the insured company for alleged “wrongful acts,” typically defined to include alleged breaches of duties, negligence, misstatements and misleading statements. Some policies extend coverage to other individuals, including rank and file employees and even temporary workers. Of course, the D&O policy will also often cover the company for its own misconduct, most commonly in connection with certain securities claims. The point is that depending on the breadth of the investigation, there may be many insureds seeking protection under the D&O policy.
There are, of course, limitations on D&O coverage for deliberate misconduct, fraud, ill-gotten gain and criminal actions, among other matters. Typically fines and penalties are not covered and these and other losses also may not be indemnifiable under corporate by-laws or applicable law. But in most instances when an individual is a potential target of a government investigation, the most valuable D&O coverage is the carrier’s obligation to advance costs of the investigation and defense. Without this coverage, most individuals would be unable to mount a competent defense in all but the most straightforward cases.
Defense cost protection is even more important now. If the DOJ adheres to its announcement, more individuals are likely to face longer, and more costly, legal battles. Depending on the nature of the potential charges or the corporation’s solvency, they may not have their corporation backing them up through corporate indemnification or advancement obligations.
Another concerning aspect of the DOJ’s new emphasis on individuals is that more individuals—all seeking coverage under the same D&O policy—will be seeking to have independent counsel represent them rather than trust their fate to the hands of the lawyers representing the corporation. This is because the DOJ’s memorandum makes a conflict between the corporation’s interests and the individual’s more likely. This conflict may either preclude common representation or make joint representation less attractive to the individual. In particular, under the DOJ memorandum, potentially culpable individuals cannot obtain a release as part of the settlement with a corporation, reversing a common practice where the corporation bears the entire burden of an investigation for all intents and purposes.
All of this means, of course, that more lawyers will be employed and getting paid by the D&O insurer, quite possibly for longer periods of time. And that in itself presents issues because defense costs paid by the D&O policy reduce the amount of coverage available. Every dollar spent in defense by any of the insureds—corporate or individual—is one less dollar available to defend the rest of the case or pay a settlement or judgment. As a result, it is not unusual even now for one or more layers of coverage to be exhausted by defense costs. The problem will only get worse if more individuals are hiring separate counsel.
There are several steps that corporations, directors, and officers should take now with respect to their D&O coverage to reduce or avoid problems down the road should they become involved in a government investigation.
- Find out if existing D&O policies have “final adjudication” language in their “conduct” exclusions—exclusions for dishonesty, fraud, improper profit or advantage and the like. Final adjudication clauses prevent the insurer from withholding defense costs from insureds until the very end of the investigation and then only when there has been a final adjudication of culpability within the terms of the exclusion.
- Not all final adjudication language is the same. Be sure the final adjudication language excludes declaratory judgment or other actions brought by the D&O insurer and instead require that any such final adjudication be in the underlying proceeding in which the individual is a party.
- Final adjudication should also mean “final,” that is, not subject to any further review or appeal, not just an agency determination or trial court adjudication.
- Side A coverage, for loss that the corporation does not pay on behalf of the insured, should apply not only when the loss is non-indemnifiable under the by-laws or applicable law (e.g., in derivative actions alleging breach of fiduciary duty) but also when the corporation fails or refuses to indemnify the individual. Individuals should not have to wage a fight against their own corporation to be able to fund their defense.
- Consider adding a Side A/Difference in Conditions (DIC) tower of coverage, i.e., coverage that is available only to individuals, not the corporation. Side A/DIC coverage is particularly important to directors and officers because the corporation’s defense costs alone may completely erode the available limits. Because most D&O liabilities are indemnifiable by the corporation, however, whether to add significant amounts of separate Side A/DIC coverage involves a careful weighing of the cost and potential benefit.
- Determine if investigative costs are covered if a suit is not filed. Under some policies, a “claim” that triggers coverage is limited to the filing of a suit or a demand for monetary or other relief. Some insurers have taken the position that a subpoena or civil investigative demand does not fall within this definition. But as experience has taught, the cost of complying with these pre-suit investigations can result in defense costs on the scale of defense costs in a lawsuit.
- If reasonably available, consider increasing limits of the Side A/DIC tower. Typically excess layers of coverage are available at a lower cost per dollar of coverage. Whether significant limits will still be available at a modest premium compared to primary coverage remains to be seen.
- Consider unbundling the D&O policy so that it only covers typical D&O exposures. In recent years, D&O insurers have offered products that include employment practices liability, fiduciary liability (ERISA), and other types of coverage. As noted above, some D&O policies now cover even rank and file employees. If there is an unfortunate coincidence of claims that fall under more than one coverage type, or a wide variety of claims are made, limits will erode even faster. When it comes to D&O policies, because such policies are eroded as defense costs mount, sometimes less is more for the individual insured officers and directors.
- Determine if there are coverage gaps. Recent experience has exposed that some D&O policies include professional services exclusions, for example, that the insurer interprets broadly to exclude any potential coverage. Attention should also be paid to the exclusions for pollution, bodily injury, and other exposures to be sure there are carve outs for claims that may be made against individual insureds.
- Find out how allocations of coverage are determined if there are both covered and non-covered claims asserted against the insureds. Allocation disputes with the carriers remain one of the most frequent sources of frustration and tension between insurers and insureds. A pre-determined allocation can often reduce these problems without a great deal of stress.
- If a policy requires use of “panel” counsel for defense of claims, make sure that the firms that would be chosen if the company’s or the individual’s future was at stake are included on the panel.
Companies and their directors and officers should not assume that their D&O coverage is standard. In fact, there are substantial and often nuanced differences among the policies offered by the carriers. Carriers also differ in their claims handling practices, their preference for certain defense counsel, and other practices. Policies are frequently customized with pages of endorsements that enhance (or sometimes retract) coverage. Experienced counsel and insurance brokers can counsel on what is available in the market and what the pitfalls are among the options. For companies who do not have D&O policies, it would behoove them to look into adding D&O insurance coverage to their risk management portfolio. Directors and officers should periodically review the coverage the company has in place.