A number of factors have increased the potential exposure of individuals serving as directors and officers of public companies to claims by plaintiffs' lawyers. In particular, the notoriety of numerous large and well publicized financial frauds has created a strong anti-corporate bias in prospective jurors and the judiciary. Couple this bias with the increased obligations on public companies and their directors and officers by the Sarbanes-Oxley Act including increased civil and criminal penalties for violations of law and increased spending on enforcement by the Securities and Exchange Commission along with state governmental agencies such as the New York Attorney General, Elliott Spitzer, in New York and you have an environment which is stacked against corporate directors and officers.
Traditionally, when directors and officers have been sued in their capacity as such, except for circumstances of fraudulent conduct by the individuals themselves, the corporation for which they serve indemnifies the directors and officers against such losses including, the cost of defense of these actions whether they are private security class actions or investigations conducted by the SEC or other governmental authority. Additionally, the majority of public companies purchase directors and officers liability insurance, which serves to either reimburse the company for its funds spent on behalf of the directors and officers or protects the directors and officers in the event that the company is unable, under various circumstances, to provide such indemnification.
A number of factors recently have created an environment in which the D&O insurance has not been available to the directors and officers in a number of situations, including those situations in which the insurance was needed most - namely when the company was not in a position to indemnify the directors and officers.
These situations have arisen in instances where D&O carriers have gone bankrupt, such as Reliance. In other instances, D&O carriers have rescinded the policies by stating that there were false statements made in the procurement of the D&O insurance which voided the insurance. In virtually all of these instances, the false statements were the same false statements that were alleged in securities litigation by plaintiffs against the
company and its directors and officers. Another example in which D&O insurance was not available to protect the directors and officers was in situations where the issuer has sought bankruptcy protection and the trustee for the corporate bankrupt estate has claimed the insurance policy as an asset of the estate rather than for the benefit of the directors and officers. This situation resulted in two types of circumstances where D&O policies were unavailable to the directors and officers. The first, is in the circumstance where there was D&O coverage, which included entity coverage for securities claims, and the bankruptcy trustee has taken the position that since the entity is one of the insureds it is entitled to all of the policy. The other circumstance is when the D&O carrier has contested the insurance itself, usually through a claim of fraud in the application and the carrier attempts to rescind the policy. In some of these situations, the trustee on behalf of the bankrupt company, has negotiated with the carrier to let the carrier rescind the policy and return the premium as an asset of the bankrupt estate.
The above situations should be troubling to directors and officers expecting to have coverage from their D&O policies, especially at a time when the company for which they serve (or have served) is not in a position to be able to indemnify directors and officers.
Fortunately, there are solutions to some of these problems.
Some of the leading D&O insurance carriers have created products to address the problems of some of the policies issued recently which resulted in a lack of protection for directors and officers.
First, many of the policies written today are excluding entity coverage. This returns D&O coverage to where it was in large part prior to 1995, when many companies started adding entity coverage for securities claims. While a lack of entity coverage will require companies to pay a portion of losses due to securities claims that their carriers have been paying under the entity coverage policies, it will make more of the policy available to the directors and officers and it should avoid the problem of a trustee and bankruptcy for the corporate entity attempting to divert the policy to itself. Additionally, many of the D&O policies that do not include entity coverage contain preset allocation provisions to prevent disputes between the insureds and their company against the carrier over how much each party should be responsible for defense costs and settlement when covered and non-covered parties are jointly represented.
Second, some policies are including language for conduct exclusions which exclude from coverage individuals who have admitted that they committed wrongful conduct. By excluding from coverage such individuals, the innocent officers and directors, who deserve the protection of the policy, will have more insurance available to cover their needs and not have the insurance drained by the individuals who committed fraudulent or criminal conduct.
Third, some D&O carriers are writing either endorsements to their D&O policies or separate D&O insurance that is only applicable to non-employee directors and cannot be rescinded under any circumstances. These policies are generally structured as an "A-side" excess policy that will cover non-employee directors in the event that the traditional D&O insurance has been exhausted or is unavailable, including when the underlying D&O insurance has been rescinded or the D&O insurance is not available because it has been deemed a part of a bankrupt corporation's estate.
Fourth, some carriers will write an excess policy for all directors and officers, including inside directors and officers similar to the access "A-side" policy described above. Again, such policies are nonrescindable and available in the event that the underlying policy is not available.
Fifth, another product that is becoming available for directors and officers is one that is a non-rescindable excess coverage which is triggered in all nonindemnifiable situations in which an insurance carrier for the underlying D&O insurance has allegedly wrongfully denied a claim.
Sixth, it is more important than ever to research the financial strength of the company underwriting the D&O insurance.
Seventh, recognize that the solutions are going to be costly, but will allow directors and officers (and risk managers) to sleep at night knowing that there will be coverage if disaster strikes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.