In an environment where public company directors and officers face increasing scrutiny and expanding liability exposures, the indemnification and insurance protections available to them are increasingly important. A July 15, 2013 memorandum from the Gibson Dunn law firm entitled “Director and Officer Indemnification and Insurance – Issues for Public Companies to Consider” (here) takes a look at these complementary and critical liability protections for corporate officials. The memo provides a useful overview of the issues that companies and their boards should consider in connection with corporate indemnification and D&O insurance.
The memo explains that most companies rely on some combination of three liability protections for their corporate directors and officers. The first of these are so-called “exculpatory” charter provisions, which are permitted under Delaware General Corporation Law and equivalent statutes in other states. These provisions generally insulate directors from liability for monetary damages for breaches of the duty of care, but not breach of the duty of loyalty or actions found to be in bad faith.
The “first line of defense” when corporate officials do face liability is indemnification. Indemnification is “broader than insurance in some respects, so it can provide protection in situations where insurance coverage may be more limited” – for example, in the early stages of an investigation, when the costs typically would not be insured because no claim has yet been made.
Delaware’s courts and the courts of most other states generally enforce indemnification provisions as written in corporate bylaws. Nevertheless, corporate officials interested in securing their indemnification rights will want to consider entering a written indemnification agreement. The advantage of an agreement is that it enables companies and their officials to address the rights in more detail. For example, agreements often provide definition of key terms and outline procedures and time frames for obtaining payment and specifying who will authorize indemnification payments. The agreements can include presumptions in favor of indemnification and provide for “fees on fees” (that is, indemnification of fees incurred to enforce indemnification rights). An indemnification agreement can also provide an added layer of protection against unilateral amendment or rescission of indemnification rights.
In the end, however, the company’s indemnification commitment is only as reliable as the company’s balance sheet. A key purpose of D&O insurance is to “fill gaps” when indemnification is unavailable – for example, when the corporation is insolvent or unable to indemnify due to legal prohibition. Examples where the company cannot indemnify include derivative suit settlements (which may not be indemnifiable under some state’s laws) or where the individual has not met the standard of conduct for indemnification. In these situations or when the company is insolvent, the D&O insurance can provide the “last line of defense.”
As the memo notes, D&O insurance is not an “off the shelf” product. The policy terms and conditions are the subject of extensive negotiation. Minor wording changes “can mean the difference between having and not having coverage, or having significantly more limited coverage.”
In addition to the terms and conditions, D&O Insurance program structure also matters as well. A company’s D&O insurance will often involve multiple layers of insurance, usually composed of a layer of primary insurance and one or more layers of excess insurance above the primary layer. Though the excess insurance usually is intended to be “follow form” insurance – that is, providing the same coverage as the primary layer -- there can be important wording considerations pertaining to the excess insurance as well. Among these considerations is the question of the “trigger of coverage.”
Many older excess D&O insurance policies specified that they would only apply if the underlying insurance was exhausted by payment of loss. These provisions could cause problems when for one reason or another there was a payment “gap” in the underling insurance (about which, refer here). More modern policies specify that the excess insurance will apply regardless of whether the underlying amount is paid by the underlying insurer, the policyholder or a third party. (For a more detailed discuss of the problems associated with D&O insurance layering, refer here.)
Another increasingly common feature of many D&O insurance programs is Excess Side A insurance, which provide an added layer of protection when the company is unable to indemnify whether due to insolvency or legal prohibition, Many of these Excess Side A policies include so-called “Difference in Condition” (DIC) protection as well, by which the policy will be triggered – and will fill the gap – for example if an underlying insurer is insolvent or wrongfully refuses to pay.
The memo cites the recent Second Circuit opinion in the Commodore International case (about which refer here), in which the several layers of the bankrupt company’s D&O insurance program had been written by carriers that were insolvent when the time to make insurance payments arrived. As the memo note, “the Commodore case provides a compelling illustration of why Side A DIC coverage is so important.”
The memo also includes a brief discussion of the increasing importance of cyber liability issues. The emergency of these issues has important implications for board oversight issues. The issues also raise important D&O liability insurance issues, and also present the need for policies “that are specifically designed to address cyber liability issues.” The memo notes that there are now policies available in the marketplace that typically provide “for losses that the company incurs in responding to a cyber incident, such as the cost of notifying customers of a data breach, and claims brought by third parties, such as customers alleging unauthorized disclosure of their data.” (My recent discussion of the critical importance for boards to consider and address the question of insurance for cyber issues can be found here.)
According to the memo, given all of these important considerations, “D&O insurance should be reviewed annually,” because “changes in the external environment and the D&O insurance market may warrant changes in coverage.” The memo notes that “for the first time in several years, companies reviewing their D&O insurance can expect higher premiums and the possibility of restrictions of coverage.”
The memo closes with a very important message for every D&O insurance policyholder: “Due to the complexity of policy language and the issues involved, expert advice from qualified professionals is important in obtaining a through understanding of the coverage available under a company’s D&O insurance program.” The professionals should include both legal counsel and skilled insurance professionals. The memo notes that “many boards of directors seek comprehensive analyses of their companies’ D&O insurance programs, undertaken with the assistance of experts, at the time of the initial purchase or renewal of D&O insurance coverage.”
My recent discussion of advancement and indemnification issues can be found here. In a prior post (here), I examined the limits of indemnification. My own overview of indemnification and insurance can be found here. Finally, in my series entitled “The Nuts and Bolts of D&O Insurance” (here), a provide an basic overview of D&O insurance.
Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
For more information about LexisNexis products and solutions connect with us through our corporate site.