All off-the-shelf Directors & Officers (D&O) insurance policies contain a very large number of coverage shortcomings. Many of these shortcomings individually could result in millions of dollars of lost coverage. Fortunately, D&O policies are negotiable. This industry practice was publicly acknowledged by the former chief underwriting officer of one of the world's largest D&O insurers in a 1998 article when he wrote, "Each D&O policy is more akin to a negotiated commercial contract than an off-the-shelf insurance product." The message was that a policyholder should use the form policy as a jumping-off point to begin negotiations to enhance the policy's coverage. That message is still true today.
While there are a number of ways to improve the shortcomings in a typical D&O policy, we provide three examples here of how changes to a single policy definition - that of a "Claim" - can greatly improve your protection.
Claim is a key definition in a D&O policy. Without a claim, there is no coverage.You might expect that so pivotal a term would be standardized. Unfortunately, that is not the case.
Entity Coverage For SEC Investigations
There are dramatic differences among policies as to whether and when an SEC investigation constitutes a claim. Since companies often spend millions of dollars defending an SEC investigation before the SEC ever files a lawsuit, the definition of claim in your policy is critical to whether your insurer covers defense costs for an SEC investigation.
For example, some policies define claim to include an "administrative or regulatory proceeding" against the insured company. However, other insurers take the position that an administrative proceeding does not include an SEC investigation. This means that an investigation is not a claim and that the related defense costs are not covered.
Other policies provide broader protection by covering an SEC investigation authorized by a formal order of investigation "but only while [the investigation] is also pending against an Insured Person." The advantage of this definition is that coverage can attach much earlier than under a definition limited to an "administrative proceeding." But this definition still falls short. Since the SEC generally does not name individuals in a formal order of investigation, it may be difficult to establish that the SEC investigation is also pending against an insured person. This could leave the company's defense costs uncovered.
A better alternative is to purchase a policy that defines claim to include an SEC investigation commenced by the issuance of a formal investigative order, and does not include a requirement that such investigation also be maintained against an insured person. The XL Management Liability and Company Reimbursement Insurance Coverage Form, DO 71 00 09 99, is an example of a D&O policy that provides such coverage. If your policy does not provide this coverage, it may be possible to negotiate changes.
Criminal defense costs can be sky high. Just ask Richard M. Scrushy, former HealthSouth CEO, who ran up bills of more than $25 million defending against fraud and related charges brought by federal prosecutors, according to media reports. The costs to defend against such proceedings would not be covered by policies that do not include criminal proceedings in the definition of claim. Given the government's increased emphasis on bringing criminal charges against executives, it is now more important than ever to negotiate the definition of claim to cover criminal proceedings.
Some policy forms define claim to include both "written and oral demands for monetary damages." The addition of an oral demand to the definition might seem like a desirable expansion of coverage. However, this addition may create coverage problems for the insureds. For example, an officer who receives an oral demand might not recognize it as a claim (because most policies do not treat an oral demand as a claim) and thus may not report it to the insurer in a timely manner. No timely notice, no coverage. Then there is the problem of proof. Trying to establish what a disgruntled stockholder said to the CEO and then determine if it constituted a reportable demand for monetary damages is a difficult task. To avoid these potential coverage issues, we recommend that you ask the insurer to delete oral demands from the definition of claim. Insurers typically grant this request.
The preceding discussion may contain more information than you ever wanted to have on the definition of a claim. However, if you have gotten this far, we trust that you have gained a greater appreciation of the large number of coverage shortcomings that may exist in a D&O policy and an awareness of the enormous dollar consequences small word changes can have on coverage.
Stephen J. Weiss is a Partner practicing insurance, corporation and securities law in the Washington, DC office of Holland & Knight LLP. He can be reached at (202) 457-5920. Thomas H. Bentz, Jr. is an Associate practicing in the same areas in the firm's Washington office. He can be reached at (202) 828-1879. A similar version of this article appeared in Directors & Boards magazine, Fourth Quarter 2005.