Shareholder securities claims are on the rise in the U.S. and in Canada. Bankruptcies are also on the rise. What these two phenomena have in common is that directors’ and officers’ personal liability is at greater risk.
It is common for plaintiffs’ attorneys in securities class actions to target not only the corporation but a number of key directors and officers as co-defendants. A well structured directors’ and officers’ insurance policy (D&O policy) can respond to such claims.
The personal liability that directors can incur in the context of a bankruptcy is different in nature. Various statutes provide specifically for the liability of directors for such things as wages owed to employees, unremitted deductions at source and unremitted GST and QST/PST. A “due diligence” defence may or may not be available. Again, D&O insurance can respond to such claims.
The purpose of this bulletin is not to provide an exhaustive review of the structure and content of a standard D&O policy. This bulletin is instead addressed to directors, officers and their advisers, who already have some familiarity with this insurance product which has always been important but which should be receiving particular attention in these uncertain times. For them, we wish to highlight issues that should receive particular consideration, it being understood that D&O wording varies from one insurer to another and is amended regularly.
APPLICATION FOR INSURANCE
Before addressing specific D&O wording, it is worth noting that completing an application form for D&O insurance is a very important exercise as, in law, the application forms part of the insurance contract along with the policy wording. Particular care must therefore be given to the information provided to the insurer. It is important to note as well that exclusion clauses forming part of the insurance contract are sometimes found in application forms.
All those who are intended to benefit from the D&O policy to be issued have an interest in reviewing the completed form before it is submitted to the insurer.
ENTITY COVERAGE, YES OR NO?
“Entity coverage”, namely insurance coverage for the corporation itself for securities claims, was introduced in the market some years ago. Most corporations welcomed this added benefit to the D&O policy. In recent years, however, very significant U.S. claims have led policyholders and their advisers to take a second look at this particular feature and opinions now differ as to whether such coverage is a good idea. The concern is that all insureds (directors, officers and now the corporation itself) typically share the same policy limits. As such, the liability that may attach to the corporation erodes the coverage for the directors and officers for whom the policy was purchased in the first place. Others express the view that, notwithstanding these concerns, the nature of D&O coverage has evolved and it now makes sense that the corporation itself benefit from such coverage.
Concerns about policy limits being shared by too many parties can be alleviated to some extent by adjustments such as the addition of a Side A Only excess policy (for the sole benefit of the individuals), the introduction of a “priority of payment clause” in favour of the individuals, the purchase of higher limits through new layers of excess coverage, or a combination of all of these elements.
SEVERABILITY (AND NON-RESCINDABILITY)
A D&O policy should contain “severability” provisions with regard to exclusions relating to conduct and also with regard to representations made in the application form.
From an insured’s point of view, the dishonest conduct of a co-insured should have no impact on the first insured’s rights to insurance coverage. A well drafted “severability” clause relating to exclusions for conduct will provide for this.
Material misrepresentations in an application for insurance can lead an insurer to ask that the policy be declared null and void on that basis. As the policy under that scenario is deemed in law to have never existed, all insureds become deprived of insurance, including the “innocent” insureds, unless a well drafted “severability” clause shields them. A provision stating, at least with regard to Side A Only coverage (coverage provided directly to the directors and officers), that such coverage is “non-rescindable” is also advisable.
All D&O policies contain dishonesty exclusions. Their wording, however, does vary. Two general types of clauses are found in the market, namely an “until adjudicated upon” form and an “in fact” form. The “until adjudicated upon” form forces the insurer to defend its insured even where dishonest conduct by the insured has been alleged by the third party, such obligation to defend continuing up to the time these allegations are “adjudicated upon”. As defence costs can be expensive in D&O litigation, this clause is more advantageous for policyholders than the “in fact” version, which allows the insurer, by bringing evidence of the insured’s dishonesty, to take an “off coverage” position and thus seek to have its obligations terminate before judgment is rendered on the third party’s allegations.
Tail coverage, or “extended reporting period coverage” or “discovery coverage” as it is also known, is a feature that in essence allows insureds to buy a period of time which attaches at the end of the policy period, often 12 months, during which they can report claims. It is key to consider the advisability of purchasing this particular coverage when the corporation’s financial difficulties are such that it is unable to renew its D&O coverage. This extension of coverage is, however, limited in scope. It covers claims that manifest themselves during this extended reporting period, but only in relation to “wrongful acts” which took place prior to the extended reporting period.
“FOLLOW FORM” EXCESS POLICIES
Excess policies are often referred to as “follow form” policies in that they are meant to adopt the same insurance wording of the primary policy (follow the form of …). For this reason, the wording of excess policies has historically not received much attention in the context of a D&O insurance review.
A careful reading of most D&O excess policies reveals that, in fact, they are often not true “follow form” policies and that important differences may exist between the excess wording and the primary wording on a number of key issues, such as:
- The trigger of the insured’s duty to give notice to the insurer (must the insured report only “claims” or must “circumstances which may give rise to a claim” also be reported?);
- What substantive law applies to the policy;
- The availability of tail coverage;
- The presence or absence of an arbitration clause.
The lack of uniformity between the excess policies and the primary policies can be a source of serious difficulties.
Excess policies must also be reviewed to determine exactly when the excess insurer’s obligations are triggered. The wording is sometimes to the effect that the excess insurer has an obligation to pay only once the underlying limits have been fully paid by the underlying insurer. What then happens if there is a coverage dispute at the primary level which leads the policyholder to accept less than the full amount of the primary policy limits (a scenario referred to in the insurance industry as “shaving of limits”)? Can the insured in this situation still access the excess layers if the settlement with the third party or the adverse judgement exceeds the limits under the primary policy? The excess policy wording should provide an answer to this question to avoid any debate.
INSURABILITY IN CERTAIN JURISDICTIONS
Corporations doing business abroad face a particular problem. Most often, all directors and officers of the parent company and of all of its subsidiaries throughout the world are covered under the same D&O policy. A problem which has come to light in recent years is that some countries require that a risk insured in their country be insured by a locally admitted insurer. Other countries require in addition that the insurance wording meet certain standards.
Companies with operations outside Canada should consult with their advisers to make sure that their D&O insurance program in place is not in conflict with foreign legislation.
A well structured D&O insurance program is one part of the overall protection that directors and officers should have. A well drafted indemnity agreement with the corporation and/or parent company is also advisable. Such indemnity agreement can fill some of the gaps which, unfortunately, may exist in even the best D&O policy. It is also important to remember that D&O policies are issued on a “claims made” basis, which means that the policy that will apply to a claim is the policy in force at the time the claim is made. Once a director or officer has left the corporation, he or she has very little say with regard to the terms and conditions of the D&O policy issued at renewal time, which may be the policy that will apply in the event of a future claim against the director or officer for events dating back to when he or she was working for or sitting on the board of the corporation. In contrast, an indemnity agreement is a binding contract which crystallizes the parties’ respective obligations for the future. In turn, a well drafted indemnity agreement may provide for the corporation’s obligation to maintain adequate insurance coverage for future claims.
These are just some of the important issues to keep in mind. D&O insurance policies are highly complex insurance products. It is our suggestion that policyholders consult their in-house risk manager or, in the absence of a risk manager, their insurance brokers to determine if their D&O insurance coverage fully meets their needs. We would be pleased to assist in this regard.