D&o power point presentationrims 2010.10.21

D&O Coverage:
Tailoring Coverage for the Risks that Matter to You
Risk & Insurance Management Society - Chesapeake Chapter
October 21, 2010

Introduction

I. D&O Coverage: Overview

II. Current Issues & Negotiable Terms

I. D&O Coverage: Overview
 Directors and Officers Face Significant Litigation
Exposure
– Where Does D&O Coverage Fit-In?:

D&O Coverage: Overview (cont.)

 Protection For Corporate Officers and Directors is
Found in Four Main Areas:
– The Business Judgment Rule
– Exculpation Provisions
– Indemnification
– D&O Insurance


 The Business Judgment Rule
– The legal presumption that officers and directors have
fulfilled their fiduciary duties in the absence of a showing
of self-dealing or bad faith.


 Exculpation Provisions
– Many states allow corporations to include in their
incorporation documents a provision stating that officers
and/or directors cannot be held personally liable for their
actions in the absence of a showing of self-dealing or bad
faith.


 In Addition to The Legal Protection Afforded by the
Law and Corporate Documents, Companies also
Typically Protect Executives from Legal Expenses
and Liability Exposure Through:
– Indemnification
– Insurance


 When Structuring Indemnification and Insurance
Programs, it is Helpful To Keep in Mind the Types
of Cases that Pose the Greatest Threat to Officers
and Directors:
– Securities Fraud Class Actions
– Derivative Actions
– SEC, DOJ, and Other Regulatory Investigations


 Securities Fraud Class Actions
– Generally brought by a sophisticated Plaintiffs’ bar.
– A common example is where a company learns of a
mistake or misrepresentation in its financial disclosure to
investors, and indicates to those investors that it intends
to restate those financial statements – resulting in a
significant drop in the company’s stock price.


 Derivative Actions
– Those actions brought by shareholders on behalf of the
corporation against the officers and directors for alleged
breaches of fiduciary duty to the corporation.


 SEC, DOJ, and Other Regulatory Investigations
– The SEC has broad power to investigate potential
securities law violations both formally and informally.
• The SEC can also seek civil penalties against officers
and directors.
– The DOJ has the power to bring criminal charges.
– Other regulatory bodies have broad investigatory powers
(e.g. Food and Drug Administration)


 Indemnification is the First Line of Defense for
Corporate Officials:
– Statutorily Authorized
– Embodied In Corporate Documents
– Generally Very Broad
– Theoretically Unlimited Protection


 Indemnification has its Limitations:
– There are Times When a Corporation May Not
Indemnify an Individual (e.g., barred by law)
– Company Insolvency


 Indemnification Under Maryland Law
– A corporation may indemnify any director . . .
• unless the act or omission of the director was material to the
matter giving rise to the proceeding and:
– was committed in bad faith, or
– was the result of active and deliberate dishonesty;
• or the director actually received an improper personal benefit in
money, property, or services;
• or in the case of a criminal proceeding, the director had
reasonable cause to believe that the act or omission was
unlawful.
See Md. Code Ann., Corps. & Ass’ns §2-418(b)(1).


 Indemnification Under Maryland Law (cont.)
– Indemnification may be against judgments, penalties, fines,
settlements, and reasonable expenses actually incurred by the
director in connection with the proceeding.
• However, if the proceeding was one by or in the right of the
corporation, indemnification may not be made in respect of any
proceeding in which the director shall have been adjudged to be
liable to the corporation.



– The termination of any proceeding by judgment, order, or
settlement does not create a presumption that the director did not
meet the requisite standard of conduct set forth in this subsection.
– The termination of any proceeding by conviction, or a plea of nolo
contendere or its equivalent, or an entry of an order of probation
prior to judgment, creates a rebuttable presumption that the
director did not meet the standard of conduct.



– A director may not be indemnified under subsection (b)
of this section in respect of any proceeding charging
improper personal benefit to the director, whether or not
involving action in the director’s official capacity, in
which the director was adjudged to be liable on the basis
that the personal benefit was improperly received.

See Md. Code Ann., Corps. & Ass’ns §2-418(c).


 D&O Coverage Provides Protection for Corporate Officials
When Corporate Indemnification is Not Available
– Legal prohibition
– Company insolvency
– Where the company chooses not to indemnify

 D&O Coverage Also Provides a Mechanism by Which a
Corporation can be Reimbursed When it Does Provide
Indemnification


 D&O Policies Typically Provide Defense and
Indemnification for:
– Securities Class Actions

– Shareholder Derivative Suits

– Miscellaneous proceedings not covered by other
traditional insurance policies (e.g., employment practices
claims, regulatory investigations).


 The Typical Insuring Clauses:

1. Side A

2. Side B

3. Side C


 Side A Coverage: “Personal” Coverage
– Reimburses individual directors and officers for losses
that are not indemnified by the company (typically no
retention or deductible).


 Side A Coverage: “Personal” Coverage (cont.)
– Generally, insurance company agrees to indemnify or
pay on behalf of, the director or officer, all “Loss” that
the individual becomes legally obligated to pay for a
“Wrongful Act” committed in their capacity as an officer
or director.


– Loss:
• Defined in the policies, and generally includes amounts paid in
judgment or settlement, as well as the costs of defense.
– Generally, “Reasonable Defense Costs” includes attorneys’
fees, court costs, filing fees, expert or specialist fees –
consented to in advance.
• Generally excludes fines, penalties, treble/multiple damages,
and matters uninsurable as a matter of law.


– Wrongful Act:
• Generally defined to include any negligent act, error
or omission, or breach of duty committed by the
officer or director in the discharge of their duties in the
capacity as director or officer.
– Duty of Care
– Duty of Loyalty
– Duty to Disclose


 D&O Dedicated Limit Policies
– Generally a separate policy providing Side A type coverage
– Provide additional/excess coverage limits
– Fill potential gaps in coverage
• Dedicated to officers and directors – Coverage for company’s
liability will not deplete coverage.
• Where the underlying D&O policy is held to be a bankruptcy
asset.
• Where the underlying D&O insurer becomes insolvent.
• Where the underlying D&O insurer attempts to rescind
coverage.


 D&O Dedicated Limit Policies (cont.)
– Side A Excess Policies
• Can be structured as simply excess coverage to the
Side A coverage of the underlying D&O policy.


– Side A Difference-In-Conditions Policies
• Can serve as an excess policy or drop down to the
primary position if the underlying traditional D&O
policy cannot, or fails to respond.
– Provides broader coverage terms.


– Independent Directors Liability Policies
• Only provides coverage to independent or outside
directors.


 Side B Coverage: “Corporate Reimbursement”
Coverage”
– Reimburses the company for its indemnification of losses
incurred by directors and officers (typically large
retention or deductible).
– Does not provide coverage to the company for its own
liability.


 Side C Coverage: “Entity” Coverage
– Covers loss incurred by the company for claims against
the company (retention).
• For public companies, generally only responds to SEC related
claims against the company.
• Coverage for claims against the entity can erode coverage for
individuals.


 Employment Practices Liability Add-On
– Sometimes added to D&O Policy by Endorsement
• Generally covers officers, directors, employees and/or the
company against employment-related claims brought by
employees (coverage for claims by third-parties can be added).
– Wrongful discharge
– Failure to promote
– Sexual harassment
– Violations of state and federal employment and
discrimination law


 Typical Policy Features of D&O Coverage

– Claims-Made Coverage
• Only covers claims that are first made during the
policy period (i.e. date of wrongdoing is irrelevant).

– Claims-Made and Reported Coverage
• Some policies also require that the claim be reported
to the carrier during the same policy period.


 Typical Policy Features (cont.)
– Generally no “duty to defend”
• However, they do provide coverage for defense costs and give
insurer the right to associate with the defense and approve
defense strategies, expenditures and settlements.
• Although they do not control the defense, the insurer generally
only required to reimburse “reasonable defense costs.”


– “Pay-on-Behalf of” Coverage
• Insurer is obligated to pay all covered loss “on behalf
of the insured” (i.e. the insured does not have to pay
the loss and then seek reimbursement from the
insurer—this is broader than simple indemnification).


– Outside Position Coverage
• Coverage often provided for claims arising from
directors’ and officers’ roles as directors and officers
of outside entities, if service is at request of or with
consent of the insured company (e.g. non-profit
organizations).


 The D&O Policy Market

– No standard form means that policies vary greatly from
insurer to insurer.

– Important terms are usually negotiable.

II. Current Issues & Negotiable Terms
1. Definition of “Claim”

2. Conduct Exclusions

3. Presumptive Indemnification

4. Policy Rescission and Severability Clauses

5. Definition of “Insured Person”

6. Insured v. Insured Exclusion

Current Issues and Negotiable Terms (cont.)

1. Definition of “Claim”
– Civil proceedings
– Written demands?
– Criminal proceedings?
– Administrative proceedings?
– Administrative investigations?


2. Conduct Exclusions
– Coverage typically excluded for certain self-serving, egregious acts
• Personal profit and advantage
• Fraud
• Willful violation of the law
– How must such conduct be proven in order to preclude coverage
• “In fact” determination
• Adjudication – in underlying proceeding or in coverage action
– Standard of proof will affect ability to settle claims


3. Presumptive Indemnification
– Policy requires Company to indemnify to fullest extent
permitted by law. Failure or refusal to do so could result
in large deductible being applied to personal coverage.


4. Policy Rescission and Severability Clauses
– With relatively recent wave of large-scale corporate
scandals, D&O insurers have attempted to rescind
policies based on misrepresentations in the policy
application.
• Issue: If misrepresentations are made in the
application, whose coverage may be rescinded?


Policy Rescission and Severability Clauses (cont.)
– Severability clauses govern whether the knowledge of
one insured person may be imputed to another insured
person
• e.g. can the knowledge of senior executives be
imputed to innocent directors and officers so as to
rescind their individual coverage?


Policy Rescission and Severability Clauses (cont.)
– Policyholders should seek full severability provisions
that disallow the imputation of any one insured person’s
knowledge to another insured person.


5. Definition of “Insured Person”
– Does the insured want coverage for more than just D’s
and O’s?
• Management positions (e.g. general counsel)
• All employees?


6. Insured v. Insured Exclusion
– Policyholders must look for and attempt to
eliminate provisions that exclude coverage for
claims brought by shareholders with the
assistance of a whistleblower who is an “Insured
Person.”

D&o power point presentationrims 2010.10.21

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