D&O Insurance - Side A Only DIC Policies - Why Should There Not Be An "Entity vs. Insured Person" Exclusion?

Posted by Joe Monteleone on March 10, 2011

Side A Only DIC policies contain very few exclusions and, for the most part, that is the way these policies should be written. One exclusion, however, that has gone by the wayside with perhaps unintended consequences is the insured vs. insured exclusion.

While I do not advocate restoration of the classically broad insured vs. insured exclusion even with numerous “carvebacks”, one needs to consider the ramifications of not having at least the modern entity vs. insured person version of such an exclusion, i.e. an exclusion that will remove from coverage suits brought by the company against its own (typically former) officers and directors.

We recently concluded a contentious arbitration and mediation that illustrates the pitfalls, at least to the insurer and the purchasing entity, of not having this exclusion. The pertinent facts are as follows.

Shortly before it was acquired by K Company, W Company bought a Side A Only DIC policy from which an original insured vs. insured exclusion had been deleted without replacement. After the policy incepted, both W and K were sued by W’s former general counsel for refusing to pay her $180,000 in severance benefits pursuant to agreements in place before the acquisition. W and K (as its successor in interest) counterclaimed for breaches of fiduciary duty. While these claims arguably sought affirmative relief, it was abundantly clear that the counterclaims were asserted primarily as a defense to the claim for severance benefits. The former GC tendered the counterclaim to the Side A insurer, which began paying defense expenses. The claim was also tendered to the underlying A-B-C D&O insurers, but they successfully and correctly disclaimed coverage based upon their insured vs. insured exclusions.

The insurer and insured former officer had lengthy battles over allocation between the covered defense of the counterclaim and her uncovered claim for severance benefits. Ultimately, the dispute went to mediation before more extensive discovery and an arbitration hearing was to take place.

The insurer correctly took the position that all of the former officer’s legal expenses had to be indemnified as a matter of applicable California and Delaware corporate law, as well as the California labor code and the by-laws of W Company. Although the officer also took that position, she simply asserted in mediation that she did not care who paid her legal expenses, i.e. any combination of the insurer and the corporations would do! Essentially, the corporations effectively dropped their counterclaims shortly after the mediation commenced and offered to pay the $180K in severance benefits. The battle then devolved into one over which party would bear the officer’s legal expenses, which were approaching $500K and of which the insurer had already advanced about $150K.

The mediator was very able and despite his urging of compromise by all parties, only the corporations and the officer’s insurer made reasonable concessions. The officer refused to even drop her claim for statutory interest on the severance amounts and her counsel refused to make any meaningful concessions off their fees.

While there was no patent evidence of collusion, the officer was content to simply let the battle be one between her insurers and the corporations. At one point, the general counsel to K Company asked me how the officer got this insurance. I answered immediately and honestly that K, as successor to W Company, bought it for her! When I asked her privately how did she know to give notice to the broker and her Side A insurer when she was no longer with the company, she smugly replied that she was there when the insurance was purchased for the benefit of her and all W officers and directors.

An entity vs. insured person exclusion would have removed this dispute from coverage. Although the absence of the exclusion proved immensely helpful to the officer, there was no legitimate reason not to have it on the policy. The arbitration was at its very core a claim for severance benefits brought by the insured herself and should not have been covered for that reason. The counterclaim proved to be serendipitous for her as it opened a door to coverage, much to the regret of both insurer and her former employer.

While I appreciate the view that the policy responded just as it should, and the corporation’s desire for balance sheet protection is not part of the equation in Side A Only DIC coverage, I share this as a cautionary tale as these coverages continue to evolve and become more commonplace. In my view, an entity vs. insured exclusion would have leveled the playing field.

I would love to hear your thoughts.

Dedicated Limits: What Is The Primary Purpose Of The D&O Insurance Policy?

Posted by Joe Monteleone on August 18, 2010

businessmanhand.jpgAlthough the earliest D&O forms from the London market in the 1930s through the mid-1990s were written solely to protect individual directors and officers, this original intent of the covers has become compromised with the advent of entity coverage for securities fraud claims.  Putting aside this Side C or entity coverage, since the corporate governance reforms undertaken in the late 1980s, the overwhelming majority of claims presented under these policies have been subject to Side B coverage, which typically applies only to claims where the company has in fact indemnified its directors and officers.  The major exceptions occur where there is an inability to indemnify due to corporate insolvency or impermissible indemnification in a derivative suit for a settlement or judgment amount under the law of many jurisdictions.  These exceptions move the losses over to the so-called Side A of the policy, which covers unindemnified exposures.

Within the past ten years there has emerged a proliferation of “Side A only” forms that sit excess over a traditional program of D&O insurance have exploded as a purchasing option over the past five years.  There are a wide variety of forms on the marketplace today extending coverage to directors, officers and, in some cases, employees of the corporate entity, but not the entity itself.  While these forms are not compromised with any entity coverage, they do not offer the even more undiluted protection of “dedicated limits” policies, including the following that cover:

  • Independent directors only
  • Executive officers only
  • Audit Committee members only
  • Retired directors only

The last category is perhaps the newest and most intriguing.  It is essentially a policy that is purchased on behalf of an individual director upon his or her resigning or retiring from board service.  The typical policy term is six years, sufficient to extend protection beyond the expiration of most statutes of limitation applicable to alleged wrongdoing while the individual served on the board.  The policies typically insure only the retired director and are purchased on his or her behalf by the corporation – just another perquisite that I understand is priced similarly to the proverbial gold watch!

These policies are worded so that they will apply excess over other available insurance, including traditional D&O programs and other “Side A Only” programs that the corporation may maintain.  However, this dedicated limits policy offers unique protection to the retiree, the most important of which is a dedicated limit that cannot be eroded by other insureds.

Coverage dedicated specifically to one or more classes of independent directors is especially valuable when you recount any given number of recent D&O claims where the so-called “black hat” CEO and CFO incurred millions of dollars in covered defense expenses, settlement and judgment amounts.  Several well–publicized settlements in the past few years, such as in the Enron, Worldcom and Just for Feet litigation, required uninsured individual director contributions because the limits simply ran out.

One note of caution, however, that must be borne in mind even with the best of these dedicated limits forms.  No policy can provide protection where a zealous prosecutor or governmental regulators makes a condition of settlement that the individual or entity will not seek recourse to indemnification or insurance.  We have seen that phenomenon in recent litigation brought by the SEC and others involving mutual fund late trading and other wrongful practices.  Nonetheless, it is rare in private litigation that a plaintiff’s counsel and client will forego exhausting available insurance and instead seek to financially punish a defendant with out-of-pocket loss.

Remarkably, these dedicated policy forms are being strongly advocated by insurance coverage counsel, whether they be policyholder advisors or, like this blogger, typically practicing on the insurance company side.  It is not often that we find common ground, and perhaps this is the best endorsement for these new coverages.