Directors and Officers Liability Insurance

Transcription

1 Directors and Officers Liability Insurance Challenges and Coverages Richard S. Pitts, IIAI General Counsel 8900 Keystone Crossing, Suite 800 Indianapolis, Indiana Phone: Fax: Directors and Officers Liability The Agenda: Corporate Law Principles The Reasons for D&O Coverage / The Profile of a D&O Purchaser D&O Coverage Issues Coverages Exclusions Section One: CORPORATE LAW PRINCIPLES Corporate Organization: A Side Note: LLCs Shareholder Shareholder Shareholder Shareholder Shareholder Entity / Role Corp. Limited Liability Co. S Corp. Partnerships Director Director Director Owners Members Shareholders Shareholders Partners President or Chief Executive Officer Overseers Directors Managers Directors General partners Vice-Presidents CIO? Secretary Treasurer or CFO Daily Operators Officers Managers (?) Officers Partners 1

2 A director has a fiduciary relationship to the corporation being served. Fiduciary comes from the Latin fides, meaning faith or confidence. Shareholders (and others) expect supervision and control over corporate policy and practice. Fiduciary standards involve both a duty of care and a duty of loyalty. A director shall, based on facts then known to the director, discharge the duties as a director in good faith with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and in a manner the director reasonably believes to be in the best interests of the corporation A director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: Officers or employees Legal counsel or public accountants A committee of the board A director is not acting in good faith if the director has knowledge concerning the matter in question that makes reliance [on the reports of others] otherwise permitted by [this law] unwarranted. A director may, in considering the best interests of a corporation, consider the effects of any action on: Shareholders Employees Suppliers Customers Communities in which offices or other facilities of the corporation are located, and Any other factors the director considers pertinent A director is not liable for any action taken as a director, or any failure to take any action, unless: the director has breached or failed to perform the duties of the director's office in compliance with this section; and the breach or failure to perform constitutes willful misconduct or recklessness. 2

3 Conflicts of Interest: A conflict of interest transaction is a transaction with the corporation in which a director of the corporation has a direct or indirect interest. A conflict of interest transaction can be VOIDED by the corporation if ALL of the following are FALSE: The material facts and the director s interest were disclosed and the Board still approved. The material facts and the director s interest were disclosed and the shareholders still approved. The transaction was fair to the corporation. Indemnification of Directors: IC : Permissive Indemnification A corporation MAY indemnify an individual made a party to a proceeding because the individual is or was a director against liability incurred in the proceeding if: the individual's conduct was in good faith; and the individual reasonably believed that the conduct was in the best interests of the corporation Indemnification of Directors: IC : Mandatory indemnification Unless limited by its articles of incorporation, a corporation SHALL indemnify a director who was wholly successful, on the merits or otherwise, in the defense of any proceeding to which the director was a party because the director is or was a director of the corporation D&O Claims By Business Source: Ins. Info. Inst. Section Two: REASONS FOR D&O / THE D&O PURCHASER 3

4 Types of Director Claims Types of D&O Claimants Tillinghast Towers Perrin: Towers Watson: Who Buys D&O Insurance? Why Not D&O? 5 0 Need Cost Scope Counsel Uninsur. Towers Watson: Do Directors Inquire About D&O? FC&S: Should They Ask? Because of the threat to directors' and officers' personal assets, and because of the increasing frequency and size of actual awards against directors and officers, D&O has become for many executives a prerequisite to accepting a position as a director or an officer. 4

5 Towers Watson: What Are the Propellers? What Should Influence Buyers? Fortin, 2007 National Directors Institute: Items that buyers ought to consider include: LONG-TERM V. SHORT-TERM Weigh the pros and cons of buying from insurers who try to time the market or behave erratically. What Should Influence Buyers? Fortin: RISK APPETITE If your risk profile changes, is your insurer s risk profile broad enough to accommodate that change? CAPACITY MANAGEMENT What s the limit that the insurer will commit to any one risk, and how much of your risk will the carrier bear itself as opposed to passing it to a reinsurer? What Should Influence Buyers? Fortin: PRIMARY V. EXCESS Does the insurer have the actuarial and claims structure necessary to be a primary insurer (a leader ), or are they a follower? CLAIMS Interview the insurer about its claims process: Is claims administration outsourced? Are claims handled by attorneys? What is the process when there is a dispute about a claim? Gen Re: Current size of D&O market at $8 billion; up from $3 to $4 billion a few years ago. 55 companies write D&O; many others have exited New capacity is flowing to the smaller company sector Gen Re: Citing the Securities Clearinghouse Class Action (Stanford) study for 2002: There were there were 261 class actions with an average $29.4 million loss -- a total $7.6 billion. Premium for 2002 was $8 billion. The frequency of class actions increased nearly 100% over the past seven years, while severity increased 459%. 5

6 But We re Not that Big!?! A private company needs D&O insurance especially if it's involved in raising capital or anticipates merger or acquisition activity. Both of these events can expose a company and its directors and officers to litigation. Get a lower limit and retention. Rains & White of Morrison & Foerster LLP 15 Questions You Should Ask Before Buying D&O Insurance But We re Not that Big!?! According to the National Union Fire Insurance Co. the division of American International Group which writes D&O in 25 recent federal securities class actions, 17 of the companies had revenues of $500 million or less while six had $100 million or less in revenues. And of the 1,850 companies sued in securities class actions, only 100 were Fortune 500 firms, meaning the rest were not. O Reilly, 'Middle Market' Not Immune to Directors & Officers Worries But We re Not That Big!?! Accounting standards have gone up with the advent of Sarbanes-Oxley. Lenders, customers and others are expecting the same treatment. Chubb s survey shows 32% of private CEOs think Sarbanes-Oxley has impacted them. O Reilly, 'Middle Market' Not Immune to Directors & Officers Worries But We re Not That Big!?! Independence is a growing concern for directors, even in the smaller companies For publicly tradeds, independence is required for audit and compensation functions Will the requirement for independence seep down to the private companies, as with other Sarbanes-Oxley requirements? A Touch of History Section Three: D&O COVERAGES AND EXCLUSIONS D&O began in the 1930 s, after the Great Depression started but didn t really take off until the 1960 s And waxed and waned through the 1980 s, 1990 s, and on to today. 6

7 FC&S: The Basic Structure Directors and officers liability insurance actually consists of two distinct coverages; one for the personal liability of the directors and officers themselves, and one for the corporation's obligation, if any, to indemnify its directors and officers against them. ISO: Structure ISO Management Protection Family of Forms: MP Executive Liability Coverage Form (contains both coverages) MP Executive Liability & Entity Securities Liability Coverage Form (contains the third coverage) We still say A and B and C coverages D&O Coverage A : Coverage A Executive Liability We will pay on behalf of the "insured persons" such "loss" which the "insured persons" become legally obligated to pay as a result of a "claim" first made against them during the "policy period" or during the Extended Reporting Period, if applicable, except to the extent that the "company" has indemnified the "insured persons" for such "loss". D&O Coverage B : Coverage B Company Reimbursement We will pay on behalf of the "company" such "loss" for which the "company" has indemnified the "insured persons", as permitted or required by law D&O Coverage C : Coverage C Entity Securities Liability We will pay on behalf of the "company" such "loss" which the "company" becomes legally obligated to pay as a result of a "securities claim" D&O Coverage C: "Securities claim" means any "claim" brought by a securities holder of the "company" against any "insured person", or with respect to Coverage C, against the "company" if such "claim": Alleges violation of any securities laws, any similar state statute or similar common law or Arises from the purchase or sale of, or offer to purchase or sell, any securities issued by the "company" whether such purchase, sale or offer involves a transaction with the "company" or occurs in the open market. 7

8 Who s an Insured Person? "Insured person" means any former, present or future duly elected director or duly elected or appointed officer of the "organization [or equivalent] outside the United States of America An Insured Person Three Things to Check: 1. Past acts and retired officers 2. New positions / Board expansions 3. Subsidiary D&O coverage Scope of Coverage: Coverages A, B and C require a claim Claim is defined broadly and includes civil, criminal and regulatory proceedings Claim also requires that the claim arise from an alleged wrongful act Wrongful Act means [A]ny actual or alleged error, misstatement, neglect or breach of duty by the insured persons in their insured position or capacity for the company [O]r any matter claimed against them solely by reason of their serving in such insured position or capacity. D&O Coverages A B and C All Say: However, this insurance applies only to a "claim" arising out of a "wrongful act" which occurs on or after the Retroactive Date, if any, shown in the Declarations, and before the end of the "policy period". D&O Coverage Conditions: No duty to defend: The "insureds" must defend and contest any "claim" made against them.we do not assume any duty to defend under the terms and conditions of this Policy. Duty to contest: [T]he "insureds" shall not admit or assume any liability, enter into any settlement agreement, stipulate to any judgment, or incur any "claims expenses" without our prior written consent. 8

9 D&O Coverage Conditions: Settlement rights: We may, upon the written consent of the insureds, make any settlement of any claim which we deem reasonable. Settlement Hammer : If any of the insureds withhold consent to such settlement, our liability for all loss resulting from such claim will not exceed the amount for which we could have settled such claim D&O Coverage Conditions: Burning Limits: "Claims expenses" are part of the "loss" and are not payable by us in addition to the Limit of Liability, but are payable within the Limit of Liability shown in the Declarations, thereby reducing the Limit of Liability shown in the Declarations. D&O Exclusions: Prior and Pending Litigation Exclusion What happens when the acts span two policy periods? What happens if one lawsuit is from an investor, and another from a lender over bad financials? According to Vicki E. Fishman and David M. Gische, Directors and Officers Liability Insurance Overview, courts read the exclusion BROADLY, i.e., in favor of the carrier and not the insured. D&O Exclusions: Prior Acts Exclusion Can be manuscripted a major transaction, i.e., merger, etc. Can be standard expiration of prior policy. How important is that application? D&O Exclusions: Professional Liability Exclusion When is a doctor a doctor? When is a doctor an administrator? Do the actions at issue (or services) require special training and expertise? Are you sure you want that attorney or accountant sitting on the board? D&O Exclusions: Dishonesty Exclusion Dishonesty, fraud or will violation of laws or statutes Adjudicated or alleged? Where? The main action? The coverage action? Personal profit exclusion 9

10 D&O Exclusions: Insured versus Insured Exclusion Bars claims by one insured against another Designed to prevent orchestration of a suit for the proceeds But what about a trustee or a receiver? D&O Exclusions: ERISA: FC&S: [S]ome insurers have chosen to eliminate coverage from their D&O liability policies for liability based on ERISA. Instead, the exposure is covered through separate employee benefit liability insurance. Davenport, Nat l Dir. Inst. 2007: Coverage Items to Consider / Negotiate: 1. Severability: [T]he presence or absence of a severability provision will determine whether only those responsible for the nondisclosure lose coverage, or everyone the company, and all officers and directors. Davenport, Nat l Dir. Inst. 2007: Coverage Items to Consider / Negotiate: 2. Non-rescindable A-Side: It is increasingly possible to obtain policy language that makes this coverage non-rescindable. Davenport, Nat l Dir. Inst. 2007: Coverage Items to Consider / Negotiate: 3. Punitive Damage Coverage: Some policies cover punitive damages and some don t. Additionally, some states do not allow this coverage, but there are terms that can be negotiated into a D&O policy to maximize the possibility that punitive damages will be covered. Davenport, Nat l Dir. Inst. 2007: Coverage Items to Consider / Negotiate: 4. Regulatory Investigation Coverage: Many D&O policy forms either don t cover or provide only limited coverage for regulatory investigations, which can be quite expensive. 10

11 Davenport, Nat l Dir. Inst. 2007: Coverage Items to Consider / Negotiate: 5. General Counsel Coverage: Many D&O policies do not provide coverage for inside lawyers when acting as a lawyer. A separate policy may be needed for that. 11