Editor: Why have Director and Officer (D&O) liability policies been in recent headlines?
Cuykendall: High profile scandals recently rocked the corporate world, including the collapse of WorldCom, Enron and others. In their wake, the Sarbanes-Oxley and stock exchange listing requirements have intensified the focus on the responsibilities of various corporate officers and directors. As the nature and the extent of personal accountability are contested, the debate about whether D&O coverage is available to recoup some of the losses is getting headline attention.
Editor: What does a typical D&O policy cover?
Cuykendall: A typical D&O policy uses fairly broad wording. It covers losses incurred by an officer or director in a suit by the corporation, stockholders or third parties. The carrier either pays the directors or officers directly, or it covers the corporation's costs if the officers or directors have already been indemnified and reimbursed by their corporation. D&O insurance has exclusions for acts of deliberate dishonesty.
Editor: What provisions of a D&O policy are vital to understanding its coverage?
Cuykendall: D&O policies have changed over the years and now have three general parts. One part provides for the individual coverage of the director and officer for which there is usually no deductible. The second part covers the corporation, if it has given an indemnity to encourage its directors and officers to serve. This is usually contained in the bylaws or in separate agreements between the officers and directors and the corporation. The third part can cover the corporation's own liability for what the directors and officers have done under the legal doctrine of respondeat superior. That is, under certain circumstances, the corporate entity may be held liable for the bad acts of those acting on its behalf.
Editor: Commentators have voiced uncertainty about coverage in a D&O policy for an in-house lawyer who serves the dual role of an officer and director. What is the dilemma?
Cuykendall: The dilemma arises, in part, from the fact that lawyers have separate professional liability coverage available to them. When lawyers distinguish the legal advice from business advice when they are talking to their clients, the applicability of the professional liability coverage is clear. This distinction is meaningless, however, once a lawyer rises to the level of being a director or officer of the corporation.
The legal principle known as "the business judgment rule" protects directors and officers, regardless of their professional qualifications, from business judgments exercised on behalf of the corporation.
I think that these concepts have gotten a little muddied. It is also possible that the insurance industry is looking to design a new form of coverage.
Editor: Does a D&O policy typically contain an express exclusion of professional services liability?
Cuykendall: The Association of Corporate Counsel recently interviewed eight companies in detail about their indemnification and D&O coverage for in-house lawyers. The sampled companies ranged from large to small and included nonprofits as well as for-profits. None of the companies interviewed said that their current D&O policies had an express exclusion for professional services liability. I think the definition of professional services as an exclusion actually developed from other types of policies. For example, business owner insurance could have a professional services liability exclusion.
When researching the question, Alan Chew and I found a case applying Pennsylvania law, Harad v. Aetna Casualty & Surety Co., 839 F.2d 979 (3rd Cir. 1988), in which the appellate court held that a business owner's policy excluded liability for professional services provided by an attorney. Whether this type of holding could extend to D&O policies has led some commentators to question whether D&O coverage is available to in-house attorneys serving in a dual capacity as officers or directors.
Editor: How does a D&O policy dovetail with other liability insurance policies that cover an in-house lawyer?
Cuykendall: ACC's survey indicates that D&O insurance is often bid with other executive protection policies. These include such policies as employers liability insurance, which protects employers against most types of discrimination claims. That is a new form of insurance that has developed in the last ten to fifteen years.
Sometimes D&O insurance is also bid with fiduciary liability coverage for corporate employees who are serving as fiduciaries for the company's benefits plans. Although it is a separate type of insurance, it falls under the umbrella of executive protection.
Crime insurance may be bid with D&O insurance. The carriers providing D&O coverage also tend to offer employers liability, fiduciary liability and crime coverage.
A very new form of coverage is called employed lawyers insurance, which is malpractice insurance for in-house lawyers, who typically do not carry professional liability insurance because they only have one client and most of their advice ultimately gets blessed at the general counsel level. The general counsel is typically covered by the D&O policy.
Editor: When an in-house counsel receives a court-appointed case or handles another pro bono matter, would coverage be available under a typical D&O policy?
Cuykendall: Coverage for pro bono and other public service is a matter of negotiation with the D&O carrier. I have been talking with our outside counsel about whether professional liability policies have a business judgment exclusion. They have all been saying that it does not, but since I am not an outside lawyer, I do not know. They did say that the pro bono exclusion is part of a typical malpractice policy, but you can negotiate it. Since law firms and corporations often encourage pro bono work, you can get an endorsement that says, "pro bono work done at the request of the company or firm is covered."
Editor: How do the rules of general insurance construction support the argument that D&O coverage should apply to an in-house lawyer serving as an officer or director?
Cuykendall: The first rule of construction is that ambiguities are construed against the insurer. In a very recent decision, the U.S. District Court for the Eastern District of Pennsylvania affirmed this rule in AEGIS v. Rigas, 2004 U.S. Dist. LEXIS 4498 (E.D. Pa., decided 3/17/04). In its lengthy and well reasoned opinion, the court analyzed the D&O policy related to the underlying dispute involving the Adelphia scandal.
Another rule of construction discussed in the AEGIS case is that the burden is on the insurer to exclude coverage. Finding that the clause in the D&O policy at issue has two reasonable interpretations, the court picked the one advocated by the insured because the burden was on the insurer to have stated the clause more clearly.
Finally there is the doctrine of reasonable expectations. If you are a director or officer and you are named in a D&O policy, you expect that you are going to be covered unless there is a clear exclusion. The AEGIS case has a wonderful quote, "it would be possible for carriers issuing D&O policies to explicitly reserve to themselves the unfettered discretion of whether to advance defense costs" and, by corollary, the unfettered discretion to decide whether professional services liability should be included or excluded. The court goes on to say that carriers "might be reluctant to issue a policy with such a draconian power because they would find it difficult to sell."
Editor: In the absence of a specifically negotiated exclusion, what public policy considerations support coverage in a D&O policy for an in-house lawyer serving as an officer or director?
Cuykendall: With the heightened responsibilities under the Sarbanes-Oxley Act, a corporation wants to be able to recruit the most talented people in the positions of officers and directors. One way of recruiting them is to assure them that they have D&O coverage.
One reason a corporation will want lawyers to serve as officers and directors is because their legal training creates sensitivity to ethical issues, specifically how to recognize potentially troublesome conflicts of interest. For good reason, lawyers are often referred to as the "conscience" of their corporations. It is against the public interest to discourage them from service as officers or directors because of unreasonable exposure to personal liability.
Editor: Where can in-house attorneys find resources to help address questions about their companies' D&O policies?
Cuykendall: I would encourage in-house attorneys to join the Association of Corporate Counsel. The resources it makes available to its members online include a Leading Practices Profile, which gives examples of what companies are doing to provide indemnification and insurance coverage for their in-house lawyers.
Another resource available from ACC is an article from the newsletter of ACC's Dallas-Fort Worth Chapter by Charles R. Lotter, Executive Vice President, General Counsel and Secretary of J.C. Penney Corporation, Inc. Entitled "Some Thoughts on D&O Insurance Strategies - Post Enron," the article includes the following practical tips:
Analyze whether the limits and deductibles in your D&O policy are comparable to industry and other peers;
Try to obtain multi-year renewals;
Negotiate extended reporting for up to one year from the expiration of the policy period for an additional premium paid at the end of the policy period;
Broaden the definition of "claim" to include written demands for relief, lawsuits and administrative and regulatory investigations;
Include a broad definition of insured that covers directors and officers of not only the company, but also its subsidiaries and majority-owned entities and joint ventures, as well as retired directors and officers;
Consider a separate policy to cover directors and officers serving on boards of non-profit organizations as well as scheduled outside directorships on for-profit boards;
Make advancement of defense costs mandatory;
Include bankruptcy provisions that (1) provide maximum coverage even if the company goes bankrupt; (2) extend to claims against the officers and directors brought by the bankruptcy trustee; and (3) give priority to the directors and officers over the corporation in the order of payment clause;
Avoid ADR clauses so that any dispute about D&O coverage can be consolidated with the underlying securities or other litigation.
Editor: Thank you for sharing your insights. Where can our readers find more information about ACC?
Cuykendall: They can visit its website at www.acca.com.