10 Crucial Updates on Your D&O Coverage
from
November/December 2007
by Randy Myers
Like fashion and pop music, directors’ and officers’ insurance is a fast-moving field. “There are always new issues bubbling up, and the coverage is always changing,” says attorney Peter Gillon, co-chair of the national insurance recovery and advisory practice at Greenberg Traurig LLP in Washington, D.C. Typically, the purchase of D&O coverage is handled by corporate insiders—the risk manager, along with the CFO or the treasurer. To be sure your rights as a director are adequately protected, the board should have a proposed policy reviewed by a consultant or attorney who is a D&O specialist. As an additional aid to help you decide whether to send management back to the bargaining table, here are the top things you need to know about D&O insurance today.
1. You probably need more of it.
There’s no simple rule for how much D&O coverage a company should carry. But Michael Turk of the Stamford, Connecticut, consulting firm Towers Perrin suggests that many outfits are underinsured. According to a recent Towers Perrin survey, companies with a market capitalization of between $1 billion and $2 billion are carrying about $40 million in coverage on average, while $10 billion-plus companies are carrying about $195 million. “The maximum limit available in the market is in excess of $1 billion,” Turk says.
“But even this would not be enough for the next Enron or WorldCom.” Attorney Steven Scholes, chairman of the SEC defense group at Chicago’s McDermott Will & Emery LLP, suggests that you ask your company how it decided what limits to purchase, and what the typical settlement values are for comparable-size companies in the same industry.
2. Though it’s called D&O insurance, you should focus on the “D.”
A traditional D&O policy has three components: Side A, which protects officers and directors when the company does not indemnify them; Side B, which reimburses the company when it does indemnify officers and directors; and Side C, which covers claims against the company itself. But a director’s interests don’t always dovetail with those of the company or corporate insiders. Payouts for officers and the company could exhaust the policy’s limits and leave you unprotected. That’s exactly what put five former directors of defunct shoe retailer Just for Feet in the position of having to pay $41.5 million of their own money earlier this year to settle a lawsuit stemming from the company’s bankruptcy. To avoid that possibility, says Turk, outside directors can demand a “Side A” policy of their own. Also known as an independent director liability or IDL policy, it can’t be exhausted by claims against the company or the officers.
3. Your policy may not cover you outside the U.S.
A D&O policy might promise international coverage, but the fine print may reveal that it does so only “to the extent possible.” One reason for the vague wording is that some countries, including Brazil, China, India, and Russia, require that companies maintain local D&O policies. It can be important, therefore, to purchase additional D&O coverage outside the States. Turk says he knows of one company that carries more than 100 policies to protect its officers and directors around the world.
4. Bundling your D&O policy with other coverage could leave you unprotected.
To get as much coverage as they can on the cheap, some companies fold other types of insurance, such as employment-practices liability, into their D&O policies. While that can save money, Turk warns, it also allows policy limits to be eaten up by cases that have nothing to do with protecting you from traditional D&O claims. Don’t accept a bundled policy.
5. Your carrier might deny coverage for reasons unrelated to the claims against you.
Insurers can rescind a D&O policy—return the premium and act as if it had never been issued—if they conclude at a later time that the application contained false information. Fair enough, except that many insurers now require companies to attach their current financial statements to the application. That is bad news if, for instance, you later learn that your CFO cooked the books, an act that could nullify your policy. One remedy, says Mark E. Miller, co-chair of the national insurance recovery and advisory practice at Greenberg Traurig, is to make sure your policy includes so-called severability language that prevents the insurance company from using the deeds of one bad actor to disqualify other officers and directors from coverage. But severability language isn’t infallible, he warns. An even better move is to find an insurer willing to write a nonrescindable, noncancelable policy.
6. In a securities-fraud case, your insurer may balk at covering you.
A common reason to buy D&O insurance is for protection against claims of securities-law violations. Policies spell out coverage for these claims, but they also typically exclude claims related to fraud. Miller says you should insist that your policy have a clause specifying that the fraud exclusion doesn’t kick in until there has been “final adjudication” by a court of law confirming that the fraud occurred. At the least, this ensures coverage if you settle out of court.
7. Taking your company private could put your policy in peril.
Approve a deal to go private and you might forfeit some or all of your D&O coverage for future claims. Most policies have a change-in-control clause stipulating that once a new owner takes control you’re covered only for wrongful acts that occurred before the sale closed. “Although new policies are typically purchased after the company goes private,” says Miller, “it is not uncommon for those new policies to have securities-related exclusions. The problem is, if directors get sued when such new policies are in place—because, say, shareholders decide they should have gotten a better price—you won’t be covered.” The solution, he says, is to buy a so-called “tail” policy that explicitly continues to cover you after a deal, typically for two to six years.
8. Negotiate hard.
Directors can press corporate insiders to negotiate the coverage terms. “There’s competition,” Miller says. “Underwriters don’t want to lose the deal; they want to get the product sold. They are willing to make changes.”
9. If your company can’t afford adequate D&O coverage, find out why.
What directors may not realize or be warned about, says attorney Steven Scholes, is that “there are companies out there that are woefully underinsured, many times because of pricing.” The reason, he says, is that the insurance carrier’s assessment of risk indicates there are problems within the company. A director who finds himself in such a situation should consider resigning from the board—or not joining it if this danger becomes apparent during the recruitment process.
10. No matter how much D&O coverage you buy, you could still be forced to spend your own money.
Sometimes all the D&O coverage in the world won’t keep fingers out of your wallet. When shareholders settled lawsuits against directors of Enron and WorldCom, their attorneys tried to make an example of the board members by stipulating that a portion of each settlement had to come out of personal money—$13 million total for Enron’s directors, $24.8 million for WorldCom’s. “The way you protect yourself from that isn’t by buying an insurance policy,” says Turk, “but by being a good board member.”
