The Typical D&O Policy Contains Two and Sometimes Three Parts:
Part A covers directors and officers, reimbursing them directly for claims of liability that arise from their corporate duties.
Part B covers the corporation, reimbursing it for expenses it pays on behalf of the directors and officers, if state law permits or corporate charter or bylaws require the corporation to indemnify directors and officers.
Part C appears in some policies. Part C, or “entity coverage,” covers the corporation itself when it is named in a lawsuit or claim. Insurers began adding entity coverage to their D&O policies in the 1990s, in response to a spate of securities and employment practices liability lawsuits that named the corporation as a defendant along with the directors and officers.
Entity Coverage or No?
On the plus side, buying entity coverage protects the corporation from potentially expensive claims when it is named as a defendant in a D&O suit. It can also help eliminate disputes about allocation. (See following section.) On the negative side, including entity coverage in your D&O policy means a claim against the corporation could exhaust any limits available to cover directors and officers. And if the company files for bankruptcy as the result of a D&O suit, the existence of entity coverage could jeopardize coverage for directors and officers under the policy. A policy with entity coverage could become a corporate asset and be used to pay creditors, rather than protect directors and officers from the claim.
Claims can get complicated when the corporate entity is named as a defendant along with directors and officers. If the D&O policy does not include entity coverage, the insurer must allocate defense and settlement costs among the (covered) directors and officers and the (uncovered) entity to determine how much of these costs the policy will pay.
Allocation provisions determine how the claims payments will be allocated. Some assign specific percentages — such as 70 percent and 30 percent — which means the insurer would pay 70 percent of costs and the corporation 30 percent. Other allocation provisions leave the allocation up to negotiation between the insurer and corporation.
The person who signs the application for D&O coverage must warrant that the information included is true to the best of his/her knowledge. If the application contains a “material misrepresentation,” traditional insurance law voids coverage. A severability provision provides that material misrepresentation by one person will not void coverage for others. Most policies today only provide partial severability, which generally means that the CEO and CFO, who must sign off on the financial statements many insurers require, would not be covered in the event of a material misrepresentation.
Insured vs. Insured Exclusions
The insured versus insured exclusion prohibits coverage for claims filed by a corporation against its directors and/or officers. Originally intended to eliminate coverage for ordinary business losses due to bad judgment, the traditional insured versus insured exclusion could also eliminate coverage in a bankruptcy situation. You can ask your insurer to modify the exclusion so it does not apply to claims or suits brought by a bankruptcy trustee or similar party.
Insurers want to resolve a claim as quickly and inexpensively as possible. This can sometimes mean settling a claim that could have been won in litigation, to avoid high defense costs and potential costs of a loss in court. Some policies include a provision, nicknamed the “hammer provision,” that encourages insureds to accept “reasonable” pretrial settlement offers by limiting the insurer’s liability for the claim to the amount of the proposed settlement. Policyholders should negotiate to have these provisions removed.
Alternative Dispute Resolution (ADR) Provisions
ADR provisions require the insured to consent to participate in ADR at the insurer’s request. ADR can cut defense and litigation costs, but it can also limit your options in a claim situation. When possible, you should negotiate to remove these provisions. D&O insurance is a complex, nonstandard product, with many possible provisions and exclusions. For more information on structuring D&O coverage for your organization’s specific needs, please call us.