In tough economic times, organizations need the expertise of their directors and officers to help weather the storm. In fact, a corporation cannot hope to attract competent directors and officers without comprehensive Directors and Officers (D&O) coverage. It provides both protection for directors and officers against liability claims and covers the expenses associated with defending directors and officers in any litigation filed. Without D&O protection, directors’ personal assets can be at risk. After the increased exposure on directors Policyresulting from Enron and WorldCom and an increase in the number of commentators pointing the finger of blame at directors for the economic crisis, whether warranted or not, good directors are less likely to take the risk of serving on the board of profit or not–for-profit organizations, especially if they may face reaching into their own pocketbooks to pay for a claim and risk personal loss.
It is important that organizations have D&O insurance policies in place to provide the coverage and assurances to key members of the organization so they know they will be protected. As such, your D&O policy may be your company’s most valuable insurance asset during this economic downturn.
Because of the importance of the policy, it is critical that all organizations review policies during tough economic times in order to fully comprehend the policy and understand how it works.
D&O Policy 101
It is essential to understand how the typical D&O policy is structured before engaging in any review of your organization’s policy. Most D&O policies contain three separate coverage agreements. In short, these are:
- “Side A” Coverage— Covers defense expenses and payments of settlements/judgments that arise from claims brought against directors and officers when those costs cannot be indemnified by the company. Usually, no deductible applies to Side A coverage. Therefore, it protects individual directors and officers from having to personally pay the costs of any claims for which they are not indemnified by the company. Essentially, Side A coverage provides the final layer of protection before an individual director’s or officer’s personal assets are subject to a claim.
- “Side B” Coverage — Commonly known as the “company reimbursement” coverage. Side B coverage will reimburse the company for costs of claims when the company is permitted, or required, to indemnify individual directors and officers. This is the primary coverage under which payments are typically made under a D&O policy.
- “Side C”/Entity Coverage — This provides coverage for claims when the company itself is a defendant in the claim. Side C coverage will come into play for any defense costs and/or judgments or settlements that are attributable to the company’s separate alleged liability. On the other hand, if a D&O policy does not include Side C coverage, any amounts allocated to the company’s defense or ultimate liability in that claim would not be covered by the D&O policy.
Five important policy terms and provisions to review
Given the economic times, there are certain key provisions in the D&O policy that should be reviewed by the organization and directors.
- Order/Priority of Payments Provisions
Order of payments provisions are intended to govern payments when amounts are potentially due under Side A, B, and/or C of the D&O policy. These provisions typically provide that payments will be made under the Side A coverage (to the individual directors and officers) first, and before any payments are made under Sides B and/or C of the D&O policy (in which payments would be made to the company). The primary purpose of the order of payments provision is to protect individual directors and officers from an attempt by a bankruptcy trustee or other successor to deny payments to the individual directors and officers under the rationale that the D&O policy and its proceeds are an “asset of the bankruptcy estate.” This provision also may protect the directors and officers where the aggregate limit of liability under the D&O policy is insufficient to discharge the covered liability of both the directors and officers of the company and the company itself.
To avoid any dispute in the language of the policy, organizations desiring to have payments be made to directors and officers first should draft language that specifically includes the terms “first” and “automatic” in all claims situations.
- Definition of “Loss”
The definition of “loss” typically includes the total amount an insured becomes legally obligated to pay as a result of a claim. Most D&O policies specifically except civil or criminal fines or penalties from the definition of loss so if your organization is at risk of regulatory action that may result in the imposition of civil or criminal fines or penalties, this could result in uninsured losses for the company or the individuals. It is important to understand the definition of loss in your organization’s policy and how it relates to the potential claims that directors may seek coverage based on your organization’s business.
- Continuity Date Provisions
Another factor to consider in connection with the availability of D&O coverage is the Continuity Date provisions of the policy. A D&O policy may include a Continuity Date, which will bar coverage for liability arising out of an incident that the insured had notice of prior to the Continuity Date. In these circumstances, coverage would be precluded even if the claim was filed within the applicable policy period.
- Severability Endorsements
D&O policies often contain severability provisions that insulate one insured from losing coverage because of facts known by or committed by another insured under the same policy. Therefore, while certain insureds may not be covered, coverage for other insureds would typically be preserved. This is important because liability arising out of a board committee decision may involve only a few directors with knowledge of the specifics of the company’s action while others may be protected under state corporation law’s right of reliance.
There is a possibility that a D&O policy could be rescinded for any misrepresentation that was relied upon by the carrier in issuing the policy. Thus, it is extremely important to consider and review any disclosures made to your carrier when the application or any renewal was filed to provide better protection against rescission.
Special Consideration of Standalone Side-A policy
Finally, special consideration must be given in tough economic times to additional insurance products to attract or retain good directors. One such product is a stand-alone Side-A policy. Directors should be cautious that the Side-C coverage may exhaust the policy limit, which would leave minimal coverage for their Side-A coverage.
A standalone Side-A policy, which will indemnify directors and officers in situations where a company would not or cannot indemnify them, may solve this problem. But it is important to ensure that the Side-A policy is complementary to the underlying D&O policy.