Eight Tips to Evaluate the Quality of Your D&O Insurance
by William Baldiga, Brown Rudnick
September 24, 2012
Too often, the only question asked of a company about its D&O insurance before joining a board or accepting an officer position is, “How much is the coverage?” Whether the policy is $5 million or $25 million is in many ways less important than the exact scope of actual coverage provided. Not all policies of insurance against director and officer negligence are of high quality, and tight corporate budgets are leading too many managers to shop for coverage of any type purely on price and regardless of quality of protection. That may leave you exposed to undue risk. Summarized below are a few practical tips to ensure that a D&O policy provides true protection against fiduciary liability.
Misrepresentations and careless mistakes in the application for coverage can negate coverage altogether. Without reading the application, you will not know whether all representations were entirely accurate. If the application cannot be found, have someone get the application from the broker.
Obviously, all coverage is limited, and any pending or threatened claims reduce the effective coverage available for your protection. You should ask the company to see copies of all notices of pending or threatened claims for coverage.
Solid D&O insurance policies contain “Side A” coverage. Essentially, Side A coverage provides for a special sub-amount of coverage that is available only to individual insureds, so that company reimbursement claims cannot eat up all of the coverage that would otherwise be available to the individuals. Further, even if the company were to go into bankruptcy, most bankruptcy judges will permit continuing and immediate access to the Side A separate basket for the defense costs or liabilities incurred directly by your or other individual insureds even if the primary policy were to be considered “property of the bankruptcy estate.”
Another important concept in D&O policies is “severability” as to the representations made by the company in applying for coverage. All policies exclude coverage for events that were not properly disclosed if known at the time of the policy application. Better policies provide that any misrepresentation will disqualify from coverage only the person making the misrepresentation.
Companies that you serve may have recently undergone, or may be considering, a recapitalization or other material event. Even high-quality D&O insurance policies often provide that coverage will not extend to events that occur after a “change in control,” often with that term very broadly defined. Policies sometimes provide that the mere issuance of warrants that, if exercised in the future, constitute a present change of control, and cause coverage to terminate immediately on the date of issuance. This may require the company to obtain a rider ensuring that pending capital events do not prematurely terminate critical coverage.
Also, most good policies provide “priority in coverage” for individual insureds, so that if there is insufficient coverage to cover all claims, the claims of individual insureds would be given priority over claims of the company itself for reimbursement.
Directors often serve as designees of significant investors. Even good D&O policies sometimes exclude coverage for the acts of “affiliates” of significant owners. Almost always, the insurer is willing to extend coverage to such affiliates if the affiliation is specifically disclosed. Getting a rider in place is critical to provide explicit coverage under those circumstances.
Finally, all D&O policies exclude coverage for claims of one insured versus another, such as lawsuits between officers. The better policies contain an exception to this exclusion to make clear that lawsuits by a company’s creditor representative do not fall within that exclusion.
D&O policies can be dense, especially if you do not review them on a regular basis. You should be able to have this review done for you by the company’s General Counsel office.
William Baldiga is the Managing Director of Brown Rudnick’s Litigation & Restructuring Department, which includes its worldwide bankruptcy practice. He often represents middle market public and private companies in chapter 11 proceedings, official and ad hoc equity and creditor committees and strategic investors in complex reorganization proceedings. Mr. Baldiga can be reached at 617.856.8586 or WBaldiga@brownrudnick.com.