My primary objective on this blog is to address important developments
in with world of directors' and officers' liability as they occur. From time to
time, however, readers contact me with more fundamental questions about
executive liability and protection, particularly regarding the basics of
indemnification and D&O insurance. In response to these recurring
questions, I intend to prepare a series of posts, to be published
intermittently in the weeks ahead, discussing these more basic issues.
This post is the first of the series and will address the
basics about indemnification and insurance and how they interact.
It is a basic fact of life in this day and age that
individuals serving as corporate directors and officers face a significant
litigation exposure. Claims are regularly brought against corporate officials
on a wide variety of legal theories, including, for example, allegations of
breach of fiduciary duty or of securities law violations. These lawsuits are
expensive to defend and they also potentially expose the individual to
significant personal liability.
Companies typically protect their executives from these
legal expenses and liability exposures are through indemnification and
Corporate officials' front line of liability protection is
indemnification. This statutorily authorized protection is usually embodied in
corporate documents such as articles of incorporation or by-laws, and generally
encompasses the rights to both advancement of defense expenses and
Corporate indemnification represents important protection
for company officials, even for those at companies that purchase and maintain
significant levels of D&O insurance. D&O insurance is subject limits of
liability, whereas indemnification is theoretically unlimited (although, of
course, practically limited by the indemnifying company's financial resources).
Indemnification is often very broad, often extending "to the maximum
extent permitted by law", whereas D&O insurance polices contain
numerous exclusions and conditions. In addition, D&O insurance must be
renewed each year, with possible changes in terms and conditions.
Indemnification rights are much less likely to be changed, particularly for
corporate officials who negotiate their own indemnification contracts.
The company's indemnification provisions specify the
procedures individuals must follow in order to obtain indemnification. It is
worth considering that indemnification questions often arise when at a time of
corporate turbulence, which may complicate an individual's efforts to obtain
indemnification or advancement. A separate written indemnification provision
can not only provide much greater procedural specificity but it can also
provide certain protections against wrongful withholding of indemnification, by
providing presumptions in favor of indemnification and providing for "fees
on fees" (that is, fees incurred in order to enforce rights to advancement
Although corporate indemnification is broad, it is not
unlimited. There are times when a corporation may not indemnify an individual -
for example, there generally are limitations on a corporation's ability to
indemnify individuals found liable in shareholders' derivative suits. In
addition, insolvency may prevent a company from honoring its indemnification
D&O insurance provides protection for company officials
when corporate indemnification is not available, whether due to insolvency or
legal prohibition. D&O insurance also provides a mechanism for corporations
to be reimbursed when they do indemnify their executives.
The coverage provision in which the D&O policy provides
individuals with insurance protection when indemnification is not available is
commonly referred to as Side A coverage. The D&O insurance policy's provision
for reimbursement of a company's indemnification obligations is referred to as
Side B coverage.
In more recent years, many D&O insurance policies have
also incorporated a Side C coverage as well, which provides insurance
protection for the corporate entity's own liability exposures. In D&O
insurance policies for public companies, this Side C protection is usually
limited just to the company's liabilities under the securities laws.
Coverage B and C essentially operate as balance sheet
protection for the company. Coverage B also provides a way for companies to
contractually transfer their indemnification obligations to the insurer
(subject of course to all of the policy's terms and conditions).
Coverage A is essentially catastrophe protection for the
individual executives. It provides a way to ensure that litigation protection
is still available to them even if the company is financially unable to
indemnify them or legally prohibited from doing so.
D&O insurance policies are generally built to complement
other types of insurance that most companies carry. For example, D&O
policies will typically exclude coverage for loss arising from bodily injury or
property damage, because those exposures are addressed in the company's general
liability and property insurance policies. The D&O policy, by contrast to
these other types of coverage, protects the insured persons from economic loss
arising from claims made against the insured persons for wrongful acts in their
Many companies find that the amount of insurance available
in a single policy of D&O insurance insufficient to provide adequate
protection and so they purchase additional limits of liability through excess
D&O insurance policies as part of a tower of insurance arranged in various
One of the most important functions of D&O insurance is
to protect the individuals when the company has become insolvent and unable to
honor its indemnification obligations. This protection is afforded under Side
A, as discussed above. Because of the critical importance of this insurance
protection, some companies choose to buy additional amounts of insurance
providing additional limits of liability just for this Side A coverage, in the
form of Excess Side A insurance.
In the current marketplace, this Excess Side A insurance
often provides certain additional insurance protection in the form of coverages
whereby the Excess Side A insurance will "drop down" and provide
first dollar protections. These additional coverages are in the form of
"Difference in Condition" (or "DIC") protection, and would
apply, for example, in the event an underlying D&O insurance carrier is
insolvent or if the underlying policy is rescinded.
Many D&O insurance buyers are very sensitive about the
cost of the insurance -- and appropriately, as D&O insurance is often
perceived as expensive (although currently relatively less expensive than it
has been at times in the past). However, the scope of insurance protection afforded
is much more important than the cost. Small incremental cost savings sometimes
available pale by comparison to the potential financial significance of the
scope of coverage afforded.
There is no standard D&O insurance policy. Each D&O
insurance carrier has forms that differ from their competitors' and most
policies are generally the subject of extensive negotiations. In order for
D&O insurance buyers to be assured that they have the broadest available
terms and conditions and the appropriate insurance structure put in place, it
is critically important that they associate a knowledgeable and experience
broker in their acquisition of the insurance. The best brokers also have
skilled and experience claims advocates available to protect their clients'
interests in the event of a claim.
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.