D&O Insurance In The Dodd-Frank Era: What You Need To Know To Protect Your Directors And Officers

Saturday, June 23, 2012 - 12:19

It's 5:00 p.m. on a Friday, and one of your company’s directors informs you that he and your company were just sued. What are the obligations of the company and its insurer to the director? What if the defendant is you

The last decade has seen increased liability exposure for directors and officers due, in large part, to financial scandals, accounting restatement cases and the resulting increased regulation imposed by the Sarbanes-Oxley and Dodd-Frank Acts. Directors and officers (“D&Os”), targeted more frequently in the gun sights of zealous shareholder advocacy groups, are more focused on indemnification and advancement rights, both under their company’s bylaws and other corporate documents and also under the company’s D&O insurance policy. According to Brian Walters, general counsel at Matthews International Corporation, “Companies want to recruit and retain experienced, qualified individuals to serve as directors and officers. In what has become a more regulated and litigious environment, comprehensive indemnification agreements and D&O policies that provide broad coverage are considered necessary prerequisites by increasingly discerning director candidates.”

As in-house counsel, you must know and understand how your company and its insurer should respond to the five o’clock bombshell. First, look at the company’s bylaws, indemnification agreements and employment agreements. Do those documents require the company to advance and indemnify its D&Os? If so, under what circumstances?  

Second, assess what kind of coverage your company’s D&O policy provides. D&O policies are indemnity, not liability, policies that provide coverage for claims made against a corporate insured’s past, present and future directors and officers. Typically, D&O policies contain two parts – “Side-A,” which provides coverage for D&Os when the corporation has not indemnified them, either by choice or by operation of law, and “Side-B,” which provides coverage for sums a corporation is required or permitted by law to indemnify D&Os. Some policies also include “Side-C” or “entity coverage” to insure the company itself against securities claims. It is imperative you understand the type of coverage your company purchased.

Third, determine how the coverage applies to covered claims. Some D&O policies provide for the advancement of fees and expenses as they become due. Others reimburse the company only for those sums the company has already indemnified after a full and final decision on the merits. Significantly, these policies are generally wasting policies – the payment of fees erodes available policy limits. Be aware of conflict and representation issues that might arise because of wasting policies and carefully consider these factors if you are permitted to select counsel under your policy.

Fourth, assess any limitations on coverage. D&O policies often contain “conduct” exclusions that operate to exclude coverage where the insured gained any personal profit or advantage or where the insured committed dishonest or fraudulent acts. Look to see whether your policy requires a “final adjudication” adverse to your D&Os before the exclusions are triggered. Many courts have held that “final adjudication” exclusions do not apply to pre-judgment settlements. In response, some insurers have replaced the “final adjudication” language with a requirement that an insured’s conduct “in fact” took place. There is no bright-line test for the “in fact” exclusion. Some courts have held the “in fact” requirement becomes effective with “some pertinent factual finding” that the insured’s behavior fell within the exclusion. Others have required only that the allegations fall within the exclusion.

When negotiating coverage, avoid these limited-language policies. Ensure consistency between the D&O policy and the company’s advancement and indemnification obligations in the company’s corporate documents/indemnification agreements. If the corporate documents require advancement of fees until the wrongdoing is finally adjudicated, the same requirement should be included in the D&O policy. Otherwise, the insurer could withhold the payment of fees while the company is required to make ongoing payments. 

Fifth, most D&O policies also contain an “insured versus insured” exclusion. Intended to prevent collusive suits whose end game is to fund business losses through insurance proceeds, it excludes coverage where one insured sues another insured. In today’s regulatory environment, which encourages and incentivizes corporate whistleblowing, negotiate coverage that limits the application of this exclusion. For example, your company’s D&O policy should include carve backs of coverage under certain circumstances, including for claims asserted with the assistance of corporate whistleblowers. 

Sixth, if your Friday afternoon fire drill is the result of an SEC investigation as opposed to a lawsuit, determine whether your D&O policy excludes responses to regulatory investigations. If your D&O policy has such an exclusion, consider obtaining a stand-alone policy to fill that gap. In addition to the added protection for corporate investigations, monies spent under a stand-alone policy will not erode the limits of the company’s primary D&O policy.   

Finally, if you are the Friday afternoon defendant, determine whether the company’s D&O policy covers in-house counsel. While claims against in-house counsel are certainly not as prevalent as those against D&Os, in the post-Enron, Sarbanes-Oxley/Dodd-Frank era, such exposure may be on the rise. Most D&O policies only afford coverage for elected directors and appointed officers. While some in-house counsel serve as directors or officers, coverage depends on whether in-house counsel is being sued for conduct as a D&O or as in-house counsel. If the D&O policy does provide coverage for in-house counsel, be aware that such coverage will erode the available coverage for the company’s other D&Os raising possible conflict issues. Some companies have separate professional liability policies specifically designed for in-house counsel. Those policies have their own limits of coverage and, therefore, do not erode the limits available to the company’s D&Os.    

Understanding the obligations of the company and its D&O carrier with respect to advancement and indemnification of D&Os is essential. Brian Walters agrees, noting, “The value-added proposition for in-house counsel is not limited to protecting just the interests of shareholders, customers and employees on behalf of the corporation. It necessarily extends to assessing how best to be prepared, in advance, to effectively mitigate and contain potential liability for the company’s directors and officers by developing, implementing and monitoring thorough and thoughtful D&O indemnification and insurance coverage strategies.” If your position may put you in the five o’clock hot seat, then it is critical that you review your company’s D&O policy in advance to assure that adequate protection is in place and to understand what limitations may apply.

Jennifer E. Johnsen has been a member of the Federation of Defense & Corporate Counsel since 2008. She is a Shareholder at Gallivan, White & Boyd in Greenville, South Carolina, where she chairs the firm’s Business & Commercial Litigation Group. Her practice focuses on business and commercial litigation, insurance coverage and life, health and disability benefits litigation. She is a graduate of Suffolk University Law School and obtained her undergraduate degree in Politics from Mount Holyoke College. She has been named in The Best Lawyers in America® in the practice area of Employee Benefits (ERISA) Law and currently serves as Vice Chair of the FDCC Life, Health and Disability Section. She is a member of DRI and the South Carolina Defense Trial Attorneys Association, and she is a past president of the Greenville County Bar Association. 

Please email the author at jjohnsen@gwblawfirm.com with questions about this article. To learn more about the Federation of Defense & Corporate Counsel, visit www.thefederation.org.