Directors and Officers Liability: Exposures, Risk Management and Coverage, 2nd Edition

By John H. Mathias, David M. Kroeger, Alexander J. May and 2 more

With liability often looming just over the horizon, corporate directors and officers rely on liability insurance and indemnification for peace of mind. Finally, there is a book that spells out in detail how these protections really work—and how they differ.

Directors and Officers Liability: Prevention, Insurance and Indemnification examines such topics as: the risks officers and directors face; derivative and class actions; when insurance is available; and when a corporation is required—or allowed—to provide indemnification. The authors have included comprehensive coverage of indemnification agreements and liability insurance policies, with point-by-point analysis of provisions, procedures, exceptions and gray areas.

Book #00659; looseleaf, one volume, 678 pages; published in 2000, updated as needed; no additional charge for updates during your subscription. Looseleaf print subscribers receive supplements. The online edition is updated automatically. ISBN: 978-1-58852-095-1.

• Language: English
• Publisher: The National Underwriter Company
• Release date: Jan 8, 2013
• ISBN: 9781938130885

John H. Mathias

John H. Mathias, Jr. is senior partner and head of the Insurance Coverage Litigation Group of the Chicago office of Jenner & Block, a national firm with offices in Chicago, Washington D. C., Los Angeles, New York, and Dallas. He has served as the Co-Chair of the Insurance Coverage Litigation Committee of the American Bar Association's Litigation Section. He is a veteran trial lawyer who has lectured and written frequently on developments in insurance law. In recent years, Mr. Mathias has counseled companies, directors, officers and risk managers on a wide array of complex insurance coverage and procurement issues in the context of securities fraud class actions. He is a graduate of Harvard Law School (1972) and Dartmouth College (1969).

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The National Underwriter Company

Directors and Officers Liability: Exposures, Risk Management and Coverage, 2nd Edition

By Joseph P. Monteleone, Esq.

Directors and Officers Liability: Exposures, Risk Management and Coverage, 2nd Edition, is the single, concise resource that takes you from start to finish through the entire spectrum of issues and considerations connected to the high-profile, high liability area of D&O/Management liability.

Following developments such as the Dodd-Frank Act and the Small Business Jobs and Credit Act, D&O and management exposures are growing—and changing.

There are now also many significant international exposures that affect officers, directors, and management even in companies that would not expect such exposures. In addition, management and directors of private and not-for-profit entities face unique issues that are generally overlooked by D&O risk resources.

Written by Joseph P. Monteleone, Esq., a partner in the law firm of Tressler LLP who has nearly 30 years of experience in both private legal practice and as an insurance company claims executive, this resource covers all of those key areas and more.

This fully revised second edition includes:

•  An entirely new chapter on International D&O and other Emerging Risks

•  Thorough updates that reflect current case law and D&O issues

•  An expanded chapter on Claims Process Issues, such as coverage letters and settlement dynamics

•  Important new information about excess/primary insurance relationships

•  An emerging risks chapter that includes discussions of the Foreign Corrupt Practices Act, the new UK Bribery Act, Chinese Reverse Merger Litigation, and the Morrison decision involving foreign cubed securities litigation

•  Must-have information on coverage disclaimers and reservation of rights

•  And more

And all of this is based on the expertise of a highly respected, hands-on practitioner who has dealt directly and successfully with the widest range of D&O issues, coverage, and litigation.

Only Directors and Officers Liability: Exposures, Risk Management and Coverage, 2nd Edition enables you to manage the full spectrum of D&O risk and insurance issues, all from a single, reliable resource.

To place additional orders for Directors and Officers Liability: Exposures, Risk Management and Coverage, 2nd Edition or any of our products, or for additional information, contact Customer Service at 1-800-543-0874.

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Preface

Originally written in 2008, Director’s and Officer’s (D&O) Liability provided much needed useful and relevant information to everyday practioners. This second edition updates and details various evolutionary changes in the areas of both director and officer (D&O) liability, as well as the attendant coverage issues under the insurance.

There are a few key points to note as we examine the late 2012 landscape.

First, the public company D&O arena continues to be fairly stable. The paradigm exposure for these entities and their management continues to be the securities class action. Frequency ebbs and flows, but always fairly consistently in a range of between 175 and 250 corporate entities sued each year. Severity has incrementally increased, but we have not seen drastic upticks in settlement values during this period.

Second, the private company and not-for-profit arenas continue to be the growth areas. Unlike public company D&O, which has pretty much become a non-discretionary insurance purchase, most experts would agree that only about 25 percent of the private and not-for-profit entities maintain such insurance. As we explore in Chapter Four, the exposures are there for these entities and more and more insurers are offering this coverage in a very competitive environment.

Third, coverage issues unfortunately continue to proliferate. On one hand it is useful to have a body of case law to guide in the resolution of these coverage disputes. It is somewhat disheartening, however, to witness the same disputes recurring time and again. These arguably wasteful exercises are perhaps exacerbated as more disputes are resolved in confidential arbitration and mediation processes that are not memorialized as public records to guide future disputants.

Finally, the emerging risk areas are becoming more international in scope, compared with four years ago with more foreign-based companies becoming the subject of U.S. litigation, as well as emerging claims in foreign jurisdictions themselves. In addition, in late 2008 we were just experiencing a broad-based financial setback and ultimate recession in the U.S., the outcome of which was many statutory and regulatory reforms, including most notably the Dodd-Frank Act in 2010 and the JOBS Act in 2012. Only time will tell the ultimate impact of these reforms.

No book is written in a vacuum, and this one is no exception. I wish to acknowledge the efforts of my former partner and co-author on the first edition of this work, Carrie E. Cope. Much of her excellent work carries forward into this edition and continues to be timely and topical.

Joseph P. Monteleone, Esq.

November, 2012

About the Author

Joseph P. Monteleone, Esq., is a partner in the New York office of Tressler LLP and has more than thirty years of experience in the insurance arena, both in the private practice of law and as an insurance company claims executive. He is a frequent author and speaker on topics within his practice areas both in the United States and internationally. Joe has authored over one hundred papers, books, book chapters and other texts, and has made over two hundred presentations on various insurance coverage topics.

He practices primarily in the areas of directors and officers (D&O), professional liability, errors and omissions (E&O), employment practices liability (EPL), and other claims-made insurance products. Joe provides coverage advice and monitoring of underlying litigation in these areas, as well as policy and endorsement drafting services, expert witness, and arbitration and mediation services.

Joe is a practicing lawyer, admitted to the bars of both New York and New Jersey.

About the Editors

Senior Developmental Editor

Rebecca von Gillern is a senior developmental editor with the Professional Publishing Division of the National Underwriter Company, Summit Business Media. She manages the editorial development of the Advisor’s Guide and the Tools & Techniques series of investment and planning products. She also develops other financial services content for the company. Rebecca has been developing content for the higher education and business-to-business markets for the past sixteen years.

As the owner and principal editor for Bookworm Editorial Services, Rebecca was responsible for ensuring client satisfaction by collaborating with publishing company project teams and authors in the creation of publication strategies. Her work was focused on adding value through enhanced clarity, accuracy, and marketability of print and digital product.

She began her career with Thomson Learning, where she developed and revised federal and state taxation publications. At Thomson she also developed product in the disciplines of accounting, business communication, communication, introduction to business, management, marketing, and the sciences. She is a graduate of the University of Southern Mississippi.   

Editorial Director

Diana B. Reitz, CPCU, AAI, is the editorial director of the Professional Publishing Division of The National Underwriter Company. As such she is responsible for the overall integrity of all division publications. She previously was the Director of the Property & Casualty Publishing Department of the Professional Publishing Division.

Ms. Reitz has been with The National Underwriter Company since 1998, when she was named editor of the Risk Financing and Self-Insurance manuals and associate editor of the FC&S Bulletins®. She also is coauthor of the National Underwriter publication, Workers Compensation Coverage Guide, and has edited and contributed to numerous other books and publications, including The Tools & Techniques of Risk Management and Insurance, Claims magazine, and National Underwriter Property & Casualty newsweekly.

Prior to joining The National Underwriter she was with a regional insurance broker, concentrating on commercial insurance. She is a graduate of the University of Maryland and St. Francis College.

Table of Contents

Preface

Chapter 1: Introduction

The Origins and Evolution of D&O Liabilities and Insurance

Reasons for Buying D&O Insurance

How D&O Insurance Differs from Other Insurance Products

Chapter 2: Claims

Introduction

The Claims Handling Process1

Coverage Letters

Key Policy Provisions Impacting the Claims Handling Process

Allocation

Settlement Dynamics and Claims Resolution

Chapter 3: Indemnification

Introduction

Mandatory and Permissive Indemnification

Legal Restrictions on Indemnification

Advancement of Defense Expenses

Impact of Indemnification on D&O Insurance Issues

Chapter 4: Key Exposures for Public, Private and Not-for-Profit Entities

The Public Corporation

History of the Federal Securities Laws

Legislation Reforming the Federal Securities Laws

The Privately-Held Company

Fiduciary Duties of Directors and Officers

The Not-for-Profit Entity

Chapter 5: The D&O Insurance Procurement Process

Selecting an Insurer

Roles of Agents, Brokers, and Other Producers

State of the D&O Market - 2012

Obtaining Coverage: Ten Practical Tips

The D&O Policy Application

Chapter 6: D&O Insuring Agreements and Coverage Triggers

D&O, Corporate, and Entity Insuring Agreements

Self-insured Retentions

Presumptive Indemnification Provisions

The Claims-Made Aspect of the Policy

Payment of Defense Costs

Advancement of Defense Costs

Limit of Liability for Payment of Defense Costs

Chapter 7: The Key Policy Provisions

Notice of Circumstances

Policy Extensions

Territory

Cancellation

Subrogation

No Action Clauses

Other Insurance

Alternative Dispute Resolution (ADR)

Policy Exclusions

Exclusions Outside the Exclusions Section

Exclusions in the Exclusions Section

Exclusions for Matters That Should Be Covered Under Other Insurance Policies

Other Common Exclusions

Chapter 8: Areas of Frequent Coverage Disputes

Rescission and Known Circumstances Exclusions

Interrelated Wrongful Acts

Contractual Liability Exclusion

Prior Acts Exclusions16

Personal Profit and Dishonesty – The Conduct Exclusions

Reasonableness of Defense Fees

Consent to Settle Provisions

Indemnifiable Loss

Other Insurance Provisions

Excess/Primary Insurance Relationships

Chapter 9: Related Management Liability Insurance Products

Side A Only Difference In Conditions (DIC) Policies

Employment Practices Liability Insurance (EPL)

Fiduciary Liability Insurance

Cyber Liability Insurance

Chapter 10: International D&O Risks and Other Emerging Risks

Exposures for U.S. Companies and Directors and Officers in Foreign Jurisdictions

Exposures for Foreign Companies and Directors and Officers in the U.S.

The FCPA and UK Bribery Act

Emerging U.S. Exposures

Appendix A: Litigation Management Program

Litigation Reporting

Litigation Billing

Appendix B: Hudson Public Company D&O Policy with Declarations

Appendix C: Hudson Not-For-Profit Form, Declarations, General Terms & Conditions, and D&O Policy

Appendix D: Hudson Side A Only DIC D&O Policy with Declarations

Appendix E: Hudson Excess Policy with Declarations

Appendix F: Legal Status of Punitive Damages Insurability

Chart Presents State-by-State Policy With Case Citations

Chapter 1: Introduction

Directors’ and Officers’ (D&O) liability insurance policies have evolved to a great extent today from their origins about eighty years ago. Yet, in many ways the fundamental nature and purpose of the coverage remains the same, i.e. an insurance policy intended primarily for the protection and benefit of the duly elected directors and duly appointed officers of the corporation. Any insurance provided to the corporation itself and nonofficer employees, as is common in many current policy forms, remains secondary to the goal of protecting the officers and directors.

The Origins and Evolution of D&O Liabilities and Insurance

The first D&O liability insurance policy forms were introduced in the London insurance market after the United States Congress enacted the Securities Act of 1933, which was passed following the stock market crash of 1929. The Securities Act was a response to allegations of corporate fraud in the early 1930s. Although the 1933 Act was considered landmark legislation at the time, it was limited in scope and was quickly followed by the Securities Exchange Act of 1934. This Act expanded the federal government’s authority to regulate securities by establishing the Securities Exchange Commission (SEC) and ultimately promulgating Rule 10b-5; a foundation for present day securities fraud litigation. While this legislation continues to apply to the most significant claims faced by public companies in the United States today—securities fraud class actions—the federal securities laws continued to evolve with the passage of the Private Securities Litigation Reform Act in 1995 (PSLRA) and the Securities Litigation Uniform Standards Act in 1998 (SLUSA). More recently, in 2002, Congress passed the Public Company Accounting and Investor Protection Act of 2002 (SOX) and later the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) in an effort to restore consumer confidence in the stock markets following corporate scandals involving high profile companies such as Enron and WorldCom, as well as the credit crisis and ensuing financial collapses in 2008. Dodd-Frank is still undergoing considerable rulemaking activity almost two years after its passage, and much remains to be seen as to its ultimate impact.

The statutory and common law sources of liability, along with D&O insurance, have evolved over the years in both nature and scope as more insurers have entered the marketplace and policies have begun to be tailored for different types of risks. While D&O insurance for public companies continues to receive the most attention in the business and legal media, there are three primary D&O markets, each with its own unique attributes:

•  Public company D&O

•  Privately-held company D&O

•  Not-for-profit organization D&O

Although the lines are not as distinctly drawn in the private and not-for-profit sectors, historically there have been three fundamental coverage grants or insuring agreements in a D&O policy. In the last few years, while some insurers have expanded the number and scope of the coverage grants in their policies to meet the changing needs of their insureds, the basic insuring agreements—and the purpose for them—have remained the same.

D&O policies contain what is commonly called Side A coverage. Many would consider this D&O insurance in its purest form: a product designed solely to cover the nonindemnified exposures of an organization’s directors and officers.

Laws governing indemnification by a public or private corporation, as well as by not-for-profit organizations, vary from state to state. The law of the state where the company or organization is incorporated or organized must be followed. The state where the organization is incorporated or organized may or may not be the same as the state where the company is headquartered or has its principal place of business. For example, many public companies, regardless of where they are headquartered, continue to be incorporated in Delaware because of the favorable business laws in that jurisdiction.

Indemnification laws, particularly over the past few decades, have become so broad in scope that almost all but the most egregious misconduct may be indemnified. The nuances of indemnification law will be discussed in greater detail in Chapter 3, but it is important to note that most wrongful conduct of directors and officers will be indemnifiable, and in fact indemnified, by the corporation. Thus, only a minority of claims will be subject to Side A coverage; usually only a situation where the organization is bankrupt or otherwise financially unable to provide indemnification, or prohibited by laws from providing indemnification. Such is the case in a shareholder derivative suit settlement or judgment where indemnification is prohibited by Delaware and the majority of other states. Unlike insurance, corporate indemnification is generally not subject to any monetary limits of liability unless designated in the corporation’s articles of incorporation, charter bylaws. However, as in the case of an insolvent insurer, a corporation’s obligation to indemnify its directors and officers may be worthless in the event of the corporation’s financial collapse.

Although in the last few years there has been a proliferation of D&O policies that solely provide Side A coverage, most D&O policies contain a Side B coverage generally applicable whenever there is a covered claim for which the corporation or organization lawfully indemnifies, or is required or permitted to indemnify, the director or officer for that claim. Although the corporation is not itself insured under the policy for its own liability (except in Side C situations, described below), payments under Side B are made by the insurer to reimburse the corporation for its indemnification payments to the individual insureds. Someone unfamiliar with D&O insurance should not be confused by the organization’s insured status because the Declarations to the policy may well designate the organization as the named insured or insured organization. The organization, however, is insured only to the extent it indemnifies its directors and officers. The vast majority of claims under a D&O policy are under Side B precisely because of the breadth of indemnification under the law.

Until the mid-1990s, there was no Side C, or entity coverage, provided to the corporation, especially to public companies. The concept emerged because of costly and protracted disputes over allocating coverage between the uncovered corporation, on one hand, and the insured individual defendants, on the other. In many cases, all defendants were represented by the same counsel and settlement agreements and judgments did not provide for any particular allocation of liability. Therefore, the disputes centered on allocating not only those settlement or judgment amounts, but also the defense costs incurred. As those disputes were most highlighted in the securities arena because of the magnitude of the settlements, entity coverage was introduced under D&O policies issued to public companies for securities claims as defined in the policies. Thus, with individuals and the corporation, as well as nonofficer employees—both covered under the policy—allocation disputes arising from the corporation’s status as an insured under the D&O policy came to an end for all practical purposes. Nonetheless, under the majority of D&O policies on the market today, the large public company typically remains uninsured for all other claims outside the realm of securities matters.

Reasons for Buying D&O Insurance

There are two primary purposes for obtaining D&O insurance.

The first is to protect individual directors and officers. Historically, D&O products were referred to as sleep insurance for the directors and officers. In a sense, D&O insurance complements corporate indemnification by providing this protection. In the majority of claim situations, the individuals need not be directly concerned with D&O insurance because their liability exposure and legal expenses will be subject to indemnification. Nevertheless, D&O insurance may become the individual’s primary source of protection in situations where the corporation becomes financially insolvent. Also, as stated above, particularly in Delaware and the many other states that follow Delaware law in this area, corporations cannot indemnify an individual for a settlement or judgment amount when he or she is sued by a shareholder or other party on behalf of the corporation. These are commonly known as derivative actions, and the primary rationale for holding a settlement or judgment amount obtained in one to be nonindemnifiable is that it would, in effect, make for a circular recovery. Specifically, as the purpose is to recover money for the corporation, it would defeat that purpose to require the corporation to reimburse an individual director or officer for whatever he or she may owe. There is, however, no prohibition against an insurer stepping in to pay these amounts on their behalf. Thus, D&O insurance acts as a backstop here where indemnification is prohibited.

One cautionary note, however, is that in the case of an insolvent corporation, the directors and officers are left with only recourse to the D&O insurance, which has a finite limit. Although rare, there are in fact cases where the D&O limits are simply not sufficient enough to protect the individuals and contributions need to be made from their personal assets. Arguably, this took place in the context of the Enron settlement a few years ago.

The second purpose of D&O insurance is quite simply balance sheet protection. The policy is not always readily thought to be such a vehicle but, given the scope of corporate indemnification, more often than not it is the company that is being reimbursed under the policy for its indemnification and defense expense advancement.

How D&O Insurance Differs from Other Insurance Products

Aside from the intrinsic nature of the coverage, D&O insurance coverage differs from other insurance products in significant and, depending upon the nature of the product being compared, various ways. Corporations in the United States, whether for-profit or not-for-profit, almost universally purchase general liability coverage. Such policies commonly cover bodily injury, property damage and personal and advertising injuries. D&O policies typically do not afford coverage for such claims and, in fact, may specifically exclude coverage for bodily injury, property damage, and personal injury. In addition, while general liability insurers typically have the duty to defend their insureds in the event of a claim, the insureds have the duty to defend themselves under D&O policies issued to publicly traded corporations. As a result, D&O policies issued to public companies often have, with certain exceptions, large self-insured retentions that must be satisfied before the insureds can receive payment for defense costs or other loss. In contrast, general liability policies often have measurably smaller deductibles that do not apply to defense costs.

In addition, D&O policies issued to public companies often specifically exclude coverage for employment-related claims, as they are tailored to address the major exposure faced by the organization which