As the recovery of the worldwide economy grinds on and regulators tighten their grip, directors and officers are looking more closely at the language and enforceability of their directors and officers (“D&O”) policies and questioning whether the historical “one global policy” approach to insuring D&O liabilities really works. Evolving cross-border risks are putting the topic of “international director liability” on the table at board meetings of companies with foreign operations.
This client alert is designed to educate directors and companies on some of the emerging legal issues they should be aware of when it comes to getting covered for claims on a global basis. There is often an imperfect legal fit between a global D&O policy, available indemnification and local law.
Indemnification Is Critical
Coverage under a standard D&O policy is based on the presumed availability of corporate indemnification. In a D&O policy, traditional “Side A” insuring agreements provide coverage for nonindemnifiable loss and “Side B” insuring agreements provide coverage for indemnifiable loss. D&O policies have provisions expressly presuming that the relevant company will indemnify and advance expenses to a director or officer to the maximum extent “permitted by law” (e.g., a presumed Delaware law standard). While bifurcating coverage between Side A and Side B works perfectly well when applying Delaware law, difficulties arise in other jurisdictions where the legality and enforceability of indemnification is not well defined.
When the scope of indemnification becomes unclear, D&O coverage becomes unclear. One argument is that all loss should be covered under Side A because indemnification is uncertain and, therefore, unavailable. Another interpretation is that all loss should be covered under Side B because indemnification is uncertain and, therefore, unlimited. Side A coverage tends to be broader with no retention (deductible) applying. Side B coverage usually has a significant retention often amounting to millions of dollars. Of course, when indemnification becomes unclear, an insured person typically prefers Side A coverage and no retention, rather than funding a multi million dollar retention before being able to access coverage.
Even with indemnification agreements in place, indemnification arrangements often fall short of providing the maximum protection “permitted by law.” For example, in the United States, indemnification agreements and by-laws often do not provide for the mandatory advancement of expenses. In such instances, the D&O policy and the relevant indemnification provisions must be revised to match each other so there is no gap between available indemnification and the D&O policy. Properly dovetailing the relevant provisions among the various documents requires a combination of corporate law expertise and sophisticated knowledge of relevant D&O policy wording issues.
Local Insurance Is Often Necessary
Historically, companies have purchased one global policy hoping to protect all of their directors and officers worldwide. Unfortunately, complications may arise when local directors and officers end up in foreign court and find that their company’s global D&O policy does not protect them because their global policy does not meet the requirements of a “local” or “admitted” (“admitted”) insurance policy in the relevant jurisdiction.
An admitted insurance policy is a policy purchased from an insurance company licensed in the state or country where the policy is purchased. An admitted insurance policy is purchased through a locally licensed agent or broker and the policy form and marketing are regulated by local authorities. Many countries have stringent laws and regulations dictating that any risk in their country must be insured through an admitted insurance policy. In other words, any risk in the country (including a director or officer) must be insured by an insurance company that is locally licensed.
In a growing number of countries, such as Russia and certain countries in Asia, admitted insurance is mandatory. In some countries it is even illegal for a foreign subsidiary’s directors and officers to be covered by the global D&O insurance program of the parent company in another jurisdiction. In some foreign countries, companies may face potential fines, excise taxes, currency issues or other legal impediments to a global policy responding to local D&O claims.
Because the legal requirements and related consequences vary widely from jurisdiction to jurisdiction, directors and companies should ask:
- What are the laws on indemnification? To what extent is indemnification allowed and from what source? Is indemnification provided to the maximum extent permitted by law?
- Does local law require locally admitted insurance?
- Can the global policy respond to a claim in that jurisdiction? What are the potential legal impediments to a global policy responding?
Companies need to answer these questions to understand the potential risk in a particular country. Companies should work with their lawyer, broker and insurer to develop a comprehensive network of protection for their directors, which includes the appropriate indemnification arrangements, a global D&O policy and locally admitted insurance.
Policy Wording Must Be Reviewed
One of the main reasons why many D&O insurance programs are not truly global in nature is that standard D&O policy wording, left unrevised, does not reflect the legal and commercial realities of many jurisdictions. While specific policy terms may be adequate in the parent company’s jurisdiction, those same terms may not be suitable for subsidiaries in other jurisdictions. The same provisions can have different meanings when considering cross-border risks.
For example, certain non-U.S. D&O policy forms have an exclusion that coverage will not be provided for any “willful or reckless” violation of a statute, regulation or other law. This provision is not usually found in a U.S. D&O policy form because an exclusion for reckless conduct could preclude coverage for U.S. securities claims, of which a key element is scienter, i.e., acting either willfully or recklessly. This subtle wording difference could lead to a denial of coverage in a U.S. securities class action suit.
Another example is the “insured versus insured” exclusion. This exclusion prohibits coverage when one insured brings a lawsuit against another insured. This exclusion is generally standard in U.S. policies, but is not appropriate in numerous jurisdictions, such as Germany, where a dual board structure exists. In a dual board structure, the law typically imposes a duty on what is generally known as the supervisory board to bring proceedings against officials if their actions adversely affect the company. A D&O policy containing an insured versus insured exclusion would thus preclude coverage for such claims and would eliminate significant coverage for both the company and its directors.
These are just two examples. There is a long list of issues that typically arise when one policy tries to cover global risks. The point to bear in mind is that there is no “one size fits all” standard D&O policy that adequately meets the risks and exposure faced in all jurisdictions. Policy terms, if not closely reviewed and revised, could lead to significant gaps in global coverage at both the director and company level.
There is no simple or uniform answer when it comes to global protection. Ultimately, in order to ensure sufficient protection, directors and companies should continually monitor emerging risks and regularly assess such risks in relation to the scope of their indemnification arrangements and the overall structure of their D&O insurance program worldwide.