It is important that directors and officers insurance provide the necessary protections. In times of financial turmoil, it is especially advisable for companies to review their D&O insurance coverage to ensure that their directors and officers are adequately protected. Although not exhaustive, set forth below are some of the critical issues to be considered in the context of D&O insurance policies.
The Extent of Coverage
In a D&O policy, the definition of “Claim” can significantly affect the scope of coverage provided under that policy. The breadth of the definition, moreover, can differ significantly from one carrier’s form to another. Forms also vary considerably with respect to the extent to which administrative or regulatory investigations are included within the definition of Claim. Unless specifically negotiated and carefully worded, many D&O policies will not automatically cover investigations, or at best, will provide very limited coverage. The insured needs to make certain that the formal triggers providing for investigative coverage are not unnecessarily restrictive. The definition of Claim must also take into account the types of litigation and investigations that may occur across a wide variety of jurisdictions, in order for coverage to apply.
For companies with U.S. securities exposures, another important issue is whether the D&O policy specifically includes coverage of damages that fall under Section 11 of the Securities Act of 1933 within the definition of “Loss.” Courts in certain jurisdictions have held that in the absence of such express language, Section 11 damages are restitutionary in nature and are therefore not “Losses” as provided for under a D&O policy. In order for coverage to apply, wording should be carefully drafted and negotiated.
Wording should also be carefully reviewed with regard to the advancement of defense expenses to determine whether such advancement is mandatory or discretionary, as written. Where the advancement of defense expenses is permitted but not required by law, D&O policies (and carriers) will presume that the company’s discretion has been exercised, and that the advancement of expenses has been made pursuant to its indemnification obligations (whether it has or not). Therefore, the policy should reflect the advancement of expenses as provided for in the underlying indemnities, and further, should provide for mandatory advancement of expenses under the policy in circumstances where the company is not able to advance expenses due to, for example, legal prohibition or insolvency. If the policy is not properly drafted, a director or officer will be forced to pay his/her own expenses. In addition, the policy should provide that defense expenses will be advanced within a specified time period in order to ensure timely payment.
The Implications of Bankruptcy
Disputes under D&O policies can arise when the insured, whether voluntarily or involuntarily, files for bankruptcy or becomes insolvent. It is important to have bankruptcy provisions that adequately facilitate access to the policy proceeds in the event the scenarios above occur. The company should request specific provisions ensuring that the D&O insurance policy is available for the primary benefit of its directors and officers in the event of a company’s bankruptcy. Specifically, the company should request the inclusion of the following bankruptcy protections in its policy:
Priority of Payments. In bankruptcy, the “automatic stay” prevents claims against the bankruptcy estate, including insurance policies and certain insurance policy proceeds that belong to the estate. However, the automatic stay will not prevent the assertion of claims against directors or officers, so directors and officers may be left without coverage if the proceeds of the D&O policy are deemed to belong to the estate. Proceeds of D&O policies with (i) Side A coverage, provided for directors and officers of the company in the absence of indemnification by the company, which usually does not have a retention (deductible) and (ii) Side B coverage, provided for the company for its obligation to indemnify the directors and officers in the event of claims against them, which usually has a significant retention will not generally be deemed to belong to the bankruptcy estate and, therefore, may be distributed during bankruptcy. For policies that also provide Side C coverage (the majority of policies written since 2000), provided for liabilities of the company, which, like Side B coverage, usually has a significant retention, a properly drafted policy can ensure that certain of the proceeds of the policy are available to the directors and officers. A “priority of payments” provision provides that Side A claims have priority over Sides B and C claims and Side B claims have priority over Side C claims. Bankruptcy courts have concluded that the “priority of payments” provision has the effect of excluding from the bankruptcy estate certain of the proceeds of the policy, thereby conferring directors and officers access to those policy proceeds.
Bankruptcy Clause. Together with the “priority of payments” provision, the “bankruptcy clause” should ensure that the policy proceeds are available to the directors and officers. A properly drafted “bankruptcy clause” evidences, among other things, a clear intention that the company’s policy is intended to protect and benefit the individual directors and officers and that, in the event of bankruptcy of the company, the company will lift the automatic stay to the extent the stay is preventing the directors and officers from accessing the policy. The “bankruptcy clause” should also include an express statement that a bankruptcy filing by the company will not relieve the insurer of any of its obligations under the policy.
Financial Insolvency Clause. A properly drafted “financial insolvency clause” enables directors and officers to access the policy from the first dollar (i.e., eliminating the retainer (deductible)) in the event that the company is unable to pay indemnifiable claims of directors and officers due to its insolvency.
Change of Control. Policies do not usually cover claims made after a “change of control.” The policy must exclude, or not refer to, a bankruptcy as a change of control trigger.
Insured v. Insured Exclusion. In a bankruptcy, an “insured v. insured” exclusion is problematic because if a trustee or other party representing the interest of the company (an insured) brings a claim against the directors and officers (also insureds), the exclusion is triggered. Therefore, it is important that the policy include an exception to the exclusion to allow coverage for claims brought by a bankruptcy trustee, an examiner, a creditors’ committee and their respective assignees and functional (and, where relevant, foreign) equivalents.
In addition to the above issues, it is also important to determine whether the policy contains a “retroactive” or “continuity” date. D&O insurance policies are “claims made” policies. This means that a D&O policy will only cover claims made during the policy’s term, subject to any negotiated extensions. When a company changes carriers, there is a risk that the new carrier may impose a “retroactive” or “continuity” date, for example, reflecting the policy inception date, thereby excluding coverage for any alleged wrongful act committed prior to such date. The result is that directors and officers will be without coverage for claims relating to an alleged wrongful act that took place prior to the retroactive date, even if the claim is made during the current policy’s term.
Further, a small but just as significant issue involves notification provisions. It is impetrative such terms in the policy are clear and unambiguous because if claim notification requirements are not closely complied with, coverage will often be compromised. In certain circumstances, a claim may be deemed void. The notice provisions should afford the directors and officers greater flexibility when reporting a claim.
Lastly, in order to ensure adequate protection for directors and officers, a review of the language in each excess policy is necessary to determine whether coverage is consistent with the underlying policy. A company will often have additional layers of coverage which incorporate the terms and conditions of a number of insurance carriers. Even though excess policies are meant to “follow form,” i.e., have the same exact terms and conditions as the primary policy, subtle wording differences often create significant gaps in coverage. These gaps in coverage tend to go undetected until the directors and officers are faced with a significant claim. It is necessary to carefully review each of these policies to ensure that the definitions conform and that there are no additional exclusions or variations between the different layers. In addition, if the insured contributes its own funds towards a settlement, many excess insurers will not recognize the primary policy limits as being “exhausted.” Therefore, unless the policy wording is changed to recognize an insured’s contribution of its own funds towards settlement, the insured may not be able to access coverage beyond the limits of the primary policy.
Now more than ever it is essential that companies review their D&O policies with a more discerning eye to ensure that their directors and officers are provided with all the necessary protections. The discussion above addresses the key points to look for when doing so, and although not a complete list of potential issues, the major areas of concern have been addressed in the context of D&O insurance policies. Remember: it is better to negotiate these points with carriers during the placement or renewal stage, rather than have to unexpectedly face a denial of coverage later when directors and officers are most vulnerable and exposed to risk.