Directors and officers (D&O) liability insurance policies offer unique insurance coverage options and present a variety of atypical and sometimes unanticipated issues. Since a company purchases the D&O insurance, many directors do not realize what gaps may exist in the protections they expect to receive. This article explores many of the issues a potential director should consider with regard to a company’s D&O insurance policy before joining its board of directors.
First, some basics. The primary concern of a potential director is whether the company’s D&O insurance will cover not only his or her liability, if any, but also the legal defense costs if a claim is made against him or her. This is "Side A" coverage. "Side B" coverage refers to amounts the insurance carrier (hereinafter, "carrier") would pay to the company as reimbursement for indemnification paid by the company to its directors and officers. Lastly, "Side C" coverage protects the company for liability the company itself may have in the event of a claim.
A significant difference between D&O insurance and most other insurance policies is that defense fees and other costs covered by the D&O policy are charged against the policy limits. Legal expenses can, and often do, exceed policy limits, leaving the insureds to fund their additional defense fees and costs themselves, including any settlement costs.
Following are select questions a prospective director should consider asking before becoming a board member:
- The first question to ask is whether the company has D&O liability insurance. If not, you should reconsider taking the board position.
- If there is D&O liability insurance with Side A coverage, does the company have coverage for both reimbursement to the directors’ and the company’s own liability, i.e., Sides B and C coverages? This will help define if they are properly protected.
- Since defense costs can be substantial, even if there is no liability or significant risk of liability, how does the carrier pay defense costs? Unlike most liability insurance policies, a D&O policy does not require the carrier to provide a defense, even for covered claims; the carrier pays the cost of defense. Does the carrier advance the defense costs and expenses or only reimburse them? Similarly, if the corporate bylaws provide for indemnification, do they require the corporation to advance defense fees and costs to the director? Or do the bylaws only provide for reimbursement?
- Who selects the defense counsel? May the insureds choose counsel without the carrier’s consent? Or will the insureds be required to use whomever the carrier chooses?
- What is the amount of coverage? What is the single limit for each claim and all claims in the aggregate? Are there separate sub-limits for some coverages? How likely is it that potential liability and defense costs will exceed the coverage amount in the event of a claim?
- D&O policies typically provide that the carrier will pay all loss for which the insureds become legally obligated to pay on account of a claim for a wrongful act. Are criminal, administrative and regulatory proceedings covered?
- The self-insured retention in a D&O liability policy is often a significant sum, for example, $50,000 or $100,000. Ask how much it is, and, if a claim is made, will the corporation pay that retention before the D&O coverage kicks in?
- A D&O policy generally covers only claims made during the policy period unless expressly agreed otherwise. Have there been other claims that may use up part of the coverage? If so, will there be enough coverage left once those claims are resolved? How did the carrier handle the claim and the defense? Were they cooperative and helpful?
- Are you covered for claims made after the policy expires, and if so, for how long? Is there additional cost? Is it paid for in advance by the company? What about coverage after you leave the board?
- How are defense costs allocated among various insureds and/or sets of insureds? If there is Side C coverage and the company itself is insured for direct liability to a third party, is there any methodology specified for allocation of defense costs between the company and individual insureds?
- With regard to potential settlements, will all funds remaining in the policy, up to the unused limits, be utilized to settle a claim against one insured or one set of insureds to the exclusion of the others? This would leave some insureds uninsured.
- These policies generally provide that the carrier must consent to a settlement. Does the policy also require all insureds to consent to a settlement? Can consent by the carrier or the other insureds be withheld under any circumstances? Or is it limited to situations where consent cannot be unreasonably withheld?
- Is the carrier financially strong and highly rated by an agency such as A.M. Best? If there is an excess carrier and the primary carrier becomes insolvent, will the excess carrier pick up coverage?
- How are the indemnification provisions tied in with applicable law and the corporation’s bylaws? What does the applicable state law provide for indemnification, and, if the bylaws are different, do they provide for maximum indemnification? If so, is it mandatory or discretionary?
- If there are misrepresentations in the policy application, does the carrier have the right to rescind the policy against all insureds, or only against the person who made the misrepresentations and/or the company itself? Similarly, if financial statements were in error and need to be restated, can coverage for all insureds be denied? Further, if there is a misrepresentation in the application and other insureds had knowledge that the representation was false, is there coverage for those insureds who did not have knowledge of the misrepresentation?
- These are just a few of the key, important questions you should ask prior to joining a board to ensure proper coverage. There are also questions regarding, for example, "Insured v. Insured" exclusions and other aspects to examine. Our lawyers have extensive experience in guiding and advising individuals on these complex issues to consider prior to joining a company’s board of directors.
A prospective independent director should have a thorough understanding of the company’s D&O insurance coverage before agreeing to serve. The time to look at these issues and ask questions is before joining a board of directors. Once a claim is made, the policy controls and directors may not be protected as they imagined or desired.