Our last two Blogs emphasized the importance of indemnification.* However, as my partner Scott DeVries reminds me, a company's indemnification commitment is only as reliable as the company's balance sheet. The other critical piece to the protection puzzle for directors and officers is Directors' and Officers' Liability Insurance that is carefully reviewed and specifically tailored to meet their needs. A key purpose of D&O insurance is to "fill gaps" when indemnification is unavailable – for example, when the corporation is insolvent or unable to indemnify due to legal prohibition. Examples where the company cannot indemnify include derivative suit settlements (which may not be indemnifiable under some state's laws) or where the individual has not met the standard of conduct for indemnification. In these situations or situation where the company is insolvent, the D&O insurance can provide the "last line of defense."
All D&O policies are not the same. Companies, officers, and directors must not regard D&O insurance as an "off the shelf" product. D&O insurance should be reviewed annually by both experienced legal counsel and a skilled insurance professional, because changes in the external environment and the D&O insurance market may warrant changes in coverage.
There are a number of issues that the Board should consider as to its D&O coverage. Some of the most common are the following:
- How much coverage is the company purchasing? Many brokers are well positioned to benchmark the relevant industry and provide an informed sense of what is routinely being purchased.
- Is the policy limited to directors and officers or does it also cover employees? To the extent it covers the latter as well, the increased number of potential claimants may warrant reconsideration of the amount of coverage being secured.
- While it is commonplace for D&O coverage to cover the company as well, is the company purchasing any coverage specifically for the protection of the Ds and Os? This coverage, called Side A DIC coverage, is available on the marketplace and ensures that its limits are available specifically for the intended beneficiaries - the Ds and Os.
- Is the policy definition of "wrongful acts" aligned with the type of acts that may give rise to loss? If not, it may be possible to adapt this by endorsement. Avoiding gaps in coverage requires that all involved in the procurement of insurance understand the potential risks that may be encountered.
- What does the policy provide with respect to the requirement of "final adjudications" and the possibility of severability? Typically, the policies will exclude coverage for fraudulent or other specified acts but only in the event of a final adjudication. Policies also will typically contain a severability provision that limits the scope of the exclusion to the individual who undertook the acts in question.
- What is the operative date for former board members for preserving coverage notwithstanding the "Insured v. Insured" exclusion? D&O policies will typically contain this exclusion, which limits the insurer's liability for claims brought by present or former directors. However, the exclusion typically contains a carve-out for individuals who left the Board before the operative date. This operative date may be subject to negotiation.
- Does the existing coverage continue to apply in a merger or acquisition? Often, the policies will contain a "change in control" provision that terminates coverage effective with the change of control. Frequently, companies will request the insurer to waive this provision or they will purchase a tail so that protection continues to be provided for later filed claims.
Many other questions frequently arise and open lines of communication among Board representatives, risk management personnel and brokers, and outside counsel is critical to ensure that the Board gets the insurance it needs. There is a wide array of coverage available for the asking in the marketplace with insurers frequently willing to modify coverage as requested for the right price.
* FYI, this series on protecting officers and directors was triggered by a couple news items on August 12, which reminded us that now would be a good time for every company to review (and, if necessary, update) the protection it provides to its officers and directors through indemnification and D&O insurance, (i) the Delaware Chancery Court decision against two directors seeking indemnification for their legal expenses (Huff v. Longview Energy Company), and (ii) a New York Times article, "Wall St. Debates Who Should Pay Legal Bills."