Defining a Robust Directors and Officers Insurance Policy

Posted in: Commercial Insurance

Last September’s “Yates Memo,” issued by the Department of Justice – spurred in part by the financial sector’s culpability for the Recession – intended to send a message of watchfulness to our country’s collective C-suite: you are not immune from criminal prosecution and civil sanctions.

The memo has elicited new and renewed concern among executives about the nature of their Directors and Officers (or D&O) insurance coverage, including whether it reflects mandatory indemnification and advancement rights.

In the complicated world of corporate versus individual liability coverage, what exactly should D&O insurance cover, and what sorts of legal complaints does it protect against? Here, a basic introduction

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Who Is Covered

D&O insurance policies cover, not surprisingly, directors and officers — the fiduciaries entrusted with the management of corporations and their assets. As such, directors and officers must exercise due care and diligence in managing corporate affairs. Directors and officers have three commonly recognized duties to the entities they serve: care, loyalty, and obedience. Should the negligence of an officer or director result in losses to the corporation or its shareholders, these fiduciaries can be held personally liable.

If an officer or director is sued for bodily injury, property damage, libel, slander, or false arrest, the corporation’s general liability policy will protect them. It does not, however, protect them from legal action against other kinds of wrongful acts — nor does their personal liability policy, as it likely excludes the individual’s business pursuits.

What Is Covered

While there is no “standard” D&O liability policy, virtually all common forms cover:

  • The corporation’s loss from indemnified directors and officers
  • Personal liability of directors and officers who are not indemnified by the corporation

The definition of “loss” usually includes the cost of defense, which is included within the limit of liability. Most policies specifically exclude fines and penalties.

What Isn’t Covered: Common Exclusions

  • Claims otherwise insured
  • Incidents reported in prior policy periods
  • Bodily injury or property damage claims
  • Liability in connection with pension and welfare plans under the 1974 Employee Retirement Income Security Act
  • Pollution
  • Libel and slander
  • Personal profit: This exclusion eliminates coverage for unlawful use of inside information or manipulation for personal benefit.
  • Return of illegal remuneration not approved by stockholders
  • Dishonest acts, though defense is provided for alleged dishonest acts
  • Failure to maintain proper insurance: This exclusion can and should be removed so as to provide coverage in the event of unintentional errors.
  • Suits brought by one director or officer against another

Possible Allegations

In today’s litigious society, there are many bases for lawsuits against directors and officers.

  • Allegations of Wrongful Acts
    • Conflict of interests
    • Fraudulent conduct, reports, financial statements or certificates
    • Breach of contract
    • Torts
    • Violation of statute
    • Violation of provisions of articles or by-laws
    • Improper self-dealing
    • Acquiescence in conduct of fellow directors engaged in improper self-dealing
    • Transactions with companies in which officers or directors are personally interested

     

  • Allegations of Financial Mismanagement
    • Inefficient administration resulting in losses
    • Sale of assets for unreasonably low prices
    • Wasting of assets
    • Extension of credit where not warranted
    • Failure to ascertain whether extension of credit is warranted

     

  • Allegations of Mistakes or Errors in Judgment
    • Disclosure of material facts
    • False or misleading reports
    • Dissemination of false or misleading information
    • Permitting organization to make improper guarantees

     

  • Allegations of Negligence
    • Continual absence from meetings
    • Failure to examine reports and documents before signing
    • Failure to detect and stop embezzlement of organization funds
    • Failure to file annual report
    • Failure or require withholding tax
    • Failure to inspect organization books and records to keep abreast of its activities
    • Failure to supervise the activities of others in a proper manner
    • Failure to verify facts in official documents before signing them and filing them
    • Shirking responsibility

Types of Suits

  • Derivative action suits
  • Brought by shareholders
  • Brought on behalf of the corporation
  • Representative action suits
  • Brought by shareholders against the corporation
  • Brought on shareholders’ own behalf, rather than the corporation
  • Third party actions
  • Brought by individuals outside the corporation, such as clients, competitors, creditors, government officials, or previous owners
  • Brought on individuals’ own behalf, rather than the corporation

The critical takeaway about the importance of D&O policies is that, in the absence of coverage, individuals can be held personally liable for any of the allegations outlined above. The express purpose of a D&O policy is to protect the entity and the assets of the individuals on the board. Because of heightened awareness surrounding the importance of D&O coverage, having a robust D&O policy is critical to attracting top executive talent.

There are key differences in what constitutes an adequate D&O policy for non-profit organizations and private corporations, and the above is meant to serve only as a preliminary guide. For help understanding the nuances of these policies and how to ensure the most effective protection, contact Jeff Wallop at JeffW@PSAFinancial.com.