The right of shareholders to demand inspection of companies’ books and records is of course nothing new. What is new is the increased frequency of books and records demands, often as a result of courts’ requirement for prospective shareholder claimants to investigate alleged misconduct of corporate executives before filing a lawsuit. The scope of the books and records requests is also expanding as well. These developments raise a number of D&O insurance coverage issues, which in turn has led to the rise of a variety of policy wording alternatives, as discussed in a recent paper.
In their July 18, 2017 Law 360 article entitled “Rising Shareholder Demands Drive New Insurance Solutions” (here, subscription required) Sarah Katz Downey of Marsh and Anthony Paccione and Jason Vigna of the Katten Muchin Rosenman law firm note that “the number of books and records request has increased over the past 15 years, and the scope has grown exponentially.” These developments are “largely driven by court decisions encouraging or requiring shareholders to use ‘tools at hand’ to investigate alleged director or officer misconduct before bringing a lawsuit.” These judicial requirements have “helped shape demands into a way to obtain ‘free’ pre-lawsuit discovery.”
As court decisions have trended in favor of shareholders’ requests, “companies must be prepared to provide much more expansive productions of documents.” Responding to these kinds of wide-ranging demands can be a “costly, difficult and time-consuming for any company, best overseen by outside counsel.”
These costs in turn raise questions whether companies’ D&O insurance is available to pay for these expenses. Traditionally, insurers have taken the position that their policies do not cover the costs associated with books and records requests, as discussed further below.
More recently, however, and in response to the increasing frequency and scope of books and records requests, carriers in many instances have been willing to amend their policies to provide some form of coverage for the costs associated with responding to books and records demands.
As the articles authors note, there are two basic ways that carriers are addressing coverage for books and records requests in their policies.
One is to provide sublimited coverage with books and requests included within the definition of derivative investigation costs coverage. The coverage afforded by this approach may be limited as a result of the sublimit and payment of books and records costs could substantially erode the coverage available for a derivative demand. However, the sublimited coverage typically is not subject to a retention.
The second approach is to include the costs associated with responding to books are records requests with the definition of defense expenses. The coverage afforded by this approach is not sublimited but rather includes access to the full policy limits. Obviously the books and records costs, which can be substantially, could significantly erode the policy limits, and are subject to the applicable retention. As the authors also note “other issues must be considered when adding books and records coverage, including notice issues and ‘wrongful act’ language.”
Historically, D&O insurers relied on a variety of different bases for their traditional position that there was no coverage under their policies for books and records demands. Among other things, the carriers typically would contend that there was no wrongful act alleged or that the costs of responding to a books and records request did not fall within the definition of defense expense for which the policy provided coverage. More generally, the carriers would assert that the cost of responding to a books and records request was a corporate operating expense, not a liability cost.
In my experience, policyholders found the coverage denial and the explanations baffling. The policyholders saw the books and records request for what it represented – that is, as the first salvo ahead of an approaching battle. Insureds could not understand why their policies would not respond to the request.
In the current highly competitive marketplace for D&O insurance, carriers have proven willing to adjust their policies to address concerns of policyholders and their advisors about extending coverage to books and records requests. The authors’ article succinctly describes two competing approaches to incorporating coverage for books and records requests. As their descriptions of the alternative approaches show, each approach has its plusses and minuses.
Buyers who have the option to include the costs of responding to books and records requests in their policies definition of defense expenses for which the policy provides coverage, and therefore affording access to the full policy limits (rather than just to the sublimit) will want to carefully consider the implications of this approach for limits selection issues. As the authors detail, in the current environment, books and records requests can be costly, which in turn could mean that these costs could substantially erode the policy’s limit of liability – leaving only diminished amounts available for the lawsuit that is likely to follow. Policyholders selecting this option will want to carefully consider whether to purchase increased limits of liability or additional layers of excess insurance to ensure the sufficiency of the insurance available.
The authors also correctly point out that merely including language extending coverage to the costs of responding to books and records requests may not be sufficient to avoid all problems. As they correctly point out, the definition of wrongful act, for example, needs to be taken into account, to ensure that the absence of any wrongful act allegation in the books and records request does not defeat coverage. The timing and requirements for notice issues should also be addressed.
The considerations involved with choosing among the various options for implementing books and records request coverage and the significance of the associated policy wording issues underscores the importance for policyholders of ensuring that they have enlisted the assistance of a knowledgeable and experienced advisor in their insurance acquisition process.