Does Your Directors' & Officers' Policy Protect You? 

publication 

Winter 2005 - (Lang Michener InBrief )

Lang Michener InBrief
Litigation involving directors and officers is no longer something that happens only south of the border. Should the unthinkable occur, are you adequately protected? Or will you find yourself fighting on two fronts – with those claiming against you and also with your insurer? It is best to review coverage now, or when negotiating a policy, and not when the claim arrives. 

This paper outlines some of the reasons why it is important to have your policy or proposed policy reviewed by legal counsel as well as your insurance broker. 

The Application

This is the first linchpin of coverage. If there is a material misrepresentation, the whole coverage may be at risk, as some of the directors/officers of Nortel are finding out. If there hasn't been a claim, it may be possible to remedy it. Does a misrepresentation void coverage for everyone or just for the person who made the misrepresentation? What can you do to minimize the risk in this area? 

The Coverage 

As one might expect, Directors' and Officers' ("D&O") policies started out protecting the directors and officers directly (Side "A" coverage). Then, coverage for the company (Side "B") was added to reimburse it for payments that it makes to or on behalf of directors/officers arising from the company having indemnified them. Then, "outside directorships" coverage was introduced, usually for non-profit positions or offices held by directors/officers/employees. Then, various forms of "entity" coverages evolved, which protected the company – securities claims, employment practices, crises, pollution defence. In one case with which I was involved, a patent infringement endorsement protecting the company was added. However, a claim in any one of these areas can and will erode the policy limits that would otherwise be available for the directors/officers. Equally importantly, when the company is insolvent, the receiver or trustee can and does look at D&O policies with entity coverage as a corporate asset to be used for the benefit of creditors, again at the expense of the directors/officers. 

The Insureds 

If you have a structure that deviates from a simple corporation with perhaps some subsidiaries, your policy may have glaring structural gaps. Recent D&O policies that I reviewed for income trusts involving a structure of two trusts above a limited partnership with a corporate general partner had problems in the definitions of who was and who was not covered. At best, it was unclear. At worst, there was a gap. To reiterate, the time to sort this out in not when a claim arrives at your doorstep! 

Exclusions

Some exclusions are inevitable. One standard one, for example, excludes claims arising from pension matters. If your company is the sponsor of the pension plan, the directors are ultimately liable for managing the plan. If you have any concerns in this area, you should consider getting separate fiduciary coverage or negotiate away the exclusion. Even defined, contribution plans may entail exposure. However, some exclusions go beyond what is acceptable. One recent one excluded any claims alleging inadequate insurance coverage. Do you have a major shareholder that has representation on the board? There are exclusions that may apply if that shareholder makes or becomes involved in a claim.

Defence Costs 

A good defence may be your best way of avoiding getting tagged with a claim. But defending a claim is expensive. Therefore, this portion of the D&O policy is very important. Who chooses the defence counsel? Are defence costs advanced as incurred? What happens if the claim alleges some matters that are not within the D&O coverage? Are investigative costs covered? These questions raise important issues about this area of protection. 

Miscellaneous Matters

D&O policies are invariably "claims made" forms of contracts. That is, the claim must be made within the policy term. Some policies try to further curtail this coverage by cutting off claims arising from matters that occurred prior to a certain date. Having a discoverability period after the policy terminates may be important in insolvency situations because getting renewed coverage under those circumstances will not likely be possible. 

And, of course, there is the issue of whether your D&O policy allows the insurer to terminate it at will.

D&O policies usually contain endorsements, sometimes many endorsements, intended to tailor the standard terms to your coverage and your company. Sometimes the endorsements are in conflict. Sometimes they take away substantial areas of coverage. 

Review When? 

When should you consider a review of your D&O policy? Certainly at the time of first getting a policy, at the time of renewal or when you are changing insurers. These reviews are general in nature because they are not tied to a particular fact situation. However, the board and the officers need to know the scope of their coverage, and the strengths and weaknesses of their D&O policy. 

Another time that a policy review may be important is when the company or the board is embarking on a specific project, be it an acquisition, a divestiture or when a special committee of the board is looking at a particular transaction. 

Companies pay a lot of money for their D&O policies. A thorough review of your D&O policy may be your best insurance!