Paul Ferrillo

In the following guest post, Paul Ferrillo,  a partner in the law firm Greenberg Traurig LLP in New York City, takes a look a six recurring problems that directors can have with their D&O insurance and how to avoid them. I would like to thank Paul for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit an article. Here is Paul’s article.


In talking with a friend in the directors and officers (D&O) insurance space for about 25 years, he and I always marvel how “some things change, and some things always remain the same.”  By saying this we mean “remain the same” because it always seems that some things in the D&O area actually remain the same despite the many corporate meltdowns we both have experienced in our careers.  We should learn from this rich history of debacles and the resultant D&O problems they cause.  But it too often seems that we don’t quite get it.

The list of avoidable D&O insurance problems is long and ugly.  And it gets longer and uglier each year.  The top six, in the order of priority:

  1. Are you buying enough insurance? Companies never seem to buy enough D&O coverage to cover the inherent risks of their business;
  2. Carrier quality matters more than wording: Companies always seem to buy coverage from carriers that never saw a Claim they actually wanted to pay.
  3. Getting Side-A Coverage Right: A bit of a repeat of Problems 1 and 2, but with respect to Side-A, non-indemnified loss coverage, but it also includes getting the mechanics/form right.  Side-A is the most important D&O insurance buy providing last-line of defense coverage at reasonable prices;
  4. Offering exposure: IPO-related D&O risk continues to compel a robust D&O program with adequate capacity.  The recent Cyan decision should have us rethinking whether old limits adequacy models have become obsolete and state court cases may cost more, faster.
  5. Be ready for bankruptcy—even if it seems highly unlikely. Stuff happens. Be prepared;
  6. Social accountability and event driven claims (thing #MeToo, emissions disclosures and ESG) are actually not new—but the exposure is only getting worse as the court of public opinion can move much faster and have greater impact today than ever before. It’s not just that people can publish their thoughts more easily, but others are listening and engaged in unprecedented ways.

Given the craziness of today’s economic and political world, directors and officers really should really get answers to the problems we identify below.  So here is some immediately actionable advice:

  1. Did your company buy enough D&O coverage? Before even agreeing to consider a board position, a director really should think about this question because its both a question and a big problem.  The reason it is a problem is because there NEVER seems to be enough D&O coverage.  We believe it’s a function of a lot of things: the failure to appreciate and generally understand the enterprise risk of the business (like, e.g. the company’s economic capital risk of not having the money to do things it needs to do), the failure to understand the basics around revenue recognition, the failure to assess basic business risk (i.e. how is the company doing? What economic cycle are we in right now?  Boom, bust, recession?), and finally (today) the failure to understand and appreciate cybersecurity risk.

Understanding enterprise risk can help, but its hard to make general assumptions about it its components and their ultimate effect upon the business.  We recognize the problem, and therefore look at the “cost of risk” to be not just a function of risk, but also the economic cost of getting the company about of a huge jam.  Yes, we are talking here about market capitalization risk and reputational risk, which go hand in hand.  Meaning, a company “messes up” big time.  It loses 25% of its market capitalization, and loses business as well because customers lose faith in the company based upon its handling of the mess.  The company gets sued, and then must figure out how to settle the cases before the cases jeopardize everything.

Metrics to consider when assessing this sort of risk:

  1. What is the common stock market capitalization of the company? Figure this out for common stock and publicly traded bonds.  Add the two market caps together.
  2. Assume the company has a major problem (e.g. a financial restatement of earnings) and loses 25% of its market capitalization. For starters, here, assume the market capitalization drops by $1 billion.  The market cap loss generates both securities class actions and derivative actions.
  3. Assume the case is bad, and that the range of settlements for a bad case (with SEC involvement) is 5-10 percent of market cap loss.
  4. So the suit might settle in a range of 50-100 million dollars with a mid-point of $75 million
  5. Throw in a few million dollars for investigations, the derivative action and defense costs (here 5 million dollars).
  6. File “peer review” analysis deep in the file cabinet where it belongs. It only perpetuates problems.  Use real-life math examples (above) which made sense.
  7. Don’t forget to factor in heightened cost of defending today’s multi-authority investigations (still at risks of piling on) and defense costs (higher rates multiplied by more work from balkanized enforcement and litigation) into the worst-case analysis. Because if it is bad and for some, it will be, it likely will involve investigations, enforcement, internal investigations securities litigation and the court of public opinion.

Hence, we advise Directors to specifically ask about D&O limits and how was it decided how much to buy? What if in the above case, the Company carried only $40 million in D&O insurance?  Would you serve on the board?  Yes, there is never enough money to buy zillions of dollars of coverage.  But no, companies really do not have much of an excuse why they should not adequately insure their directors and officers.

How do you know how much D&O coverage to buy?  Well, see our back of the envelope formula above to get some sense of how we might view a sufficient purchase of D&O insurance.  We think a limits purchase closer to $80 million is a better number.  But ask your D&O broker what he or she thinks, but test the advice.  While brokers typically offer a range of analytical tools, some are pretty, but not well designed to speak to what your company needs, seem to me like fake news and others truly offer meaningfully  insightful analytics that help assess D&O limit adequacy. Do ask early, and often.  If you are contemplating a transaction or bankruptcy, ask again. It is far better not waiting until the last second to make adjustments.  That said, even last-minute critical improvements are better than none at all—even if they may seem really expensive.  Not having the coverage would be far worse.

  1. Will your carriers pay your claim? While listed as problem 2, this is perhaps the most important question to ask. Without a trustworthy claims paying approach and proven claims handling expertise, What did your really buy from the insurer.  There is no point in buying  D&O insurance if the carriers won’t pay.

Again this is a hugely judgmental question.  So, again, ask around:

  • ask your broker which carriers are the best;
  • ask your fellow directors from their experience on other boards whom they have seen pay claims; and
  • ask your company’s regular securities defense counsel who it has seen pay claims, or otherwise leave directors high and dry at the mediation table.

For us, we generally stick with the proven, name brand carriers that have been around for years and years, and of those, only the carriers that have not failed us.

  1. Does your Company buy excess Side A D&O “DIC” coverage? This is an older question, with a new twist.

Since the financial crisis we have always recommended dedicated Side A D&O limits for the directors and officers only.  Side A is for non-indemnified loss (defense costs, judgments and settlements) that a company cannot or will not advance or indemnify (like e.g. an adjudicated finding of bad faith against a director), or that it is financially unable to indemnify because of insolvency or a bankruptcy.  This generally means Side A usually pays the cost of settling shareholder derivative actions, and/or, in a bankruptcy, it sits excess over the traditional tower of insurance.

How much excess Side A coverage should a Company buy? Rule of thumb is Side-A Excess should be about one-third to one-half again the size of your underlying traditional A-B-C D&O Limits.  More and more we are finding the simple answer is more than you have bought in the past.  Why?  Increasing settlement amounts in many cases are exhausting D&O limits.  Increasing regulatory action defense costs are stressing out existing limits of liability and making settlement costs worse, especially on the shareholder derivative side of the equation.  We have seen a lot of companies underinsured recently when dealing with settlement issues.  Especially on the Side A D&O side.  Don’t let that happen to your company.

  1. Section 11 claims, will cost more to defend and settle: In 2018, the United States decided Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S.Ct. 1061 (2018) which agreed that the state courts retained jurisdiction over Section 11 cases brought under the Securities Act of 1933.  This means; (A) more defense costs since combined Section 11 and Section 10b-5 Claims (under the 1934 Act) will have to be defended in both federal and state court (instead of only in a federal court parallel proceeding); (B) more defense costs since Section 11 claims might be brought in more than one state court (i.e. the place of incorporation and the principal place of business), and (C) potentially higher settlement costs in the state proceedings, since the state courts have, in the past, not regularly seen or litigated Section 11 claims.  A, B and C all now mean more limits of liability will need to be purchased especially for those companies considering a public offering.
  1. Will your policy respond in all bankruptcy settings? It better!  This is another potential “life or death” problem for a director or officer one step removed.  What happens if their company has to file a Chapter 11 bankruptcy proceeding in US bankruptcy court and thereafter litigation against the board and senior management is brought by the company’s creditors?

Given that the company likely has many different groups of creditors (bondholder, note holders, lien holders), each potential group of creditor should be specifically named in the exception to the “Insured versus Insured” (or Entity vs. Insured) exclusion which governs Claims by one insured against another insured. In a bankruptcy setting, one insured “could be” the company, with claims being brought by a creditors committee (or other bankruptcy committee) on its behalf.  In such a case that Claim could be excluded from coverage.  See Indian Harbor Insurance v. Zucker, 860 F.3d 272 (6th Cir. 2017). Carriers have attempted to simplify and remove (or “carveback”) many parts of this exclusion, sometimes no language is perfect.  So, it’s important to ask questions.  Note that sometimes a more forgiving Side A excess policy, with no insured versus insured exclusion also might help alleviate some of the risk that a litigation claim might not be covered in bankruptcy.

Second, create clarity in your policy around payments that get made post-filing for litigation and other Claims.  This clarity comes by making sure (in the policy’s “Priority of Payments” clause) that claim payments on behalf on directors and officers always get paid first, before expenses of the company are even considered.

Third, make sure your policy both covers the entire length of the bankruptcy (called an “extension”), and contains run-off (or “tail”) coverage post expiration.  Why should a policy always exist during the bankruptcy process?  Sometimes people differ in an answer here.  Our answer? Because it makes the directors and officers “feel safer and more secure” so that they stick with the company and successfully reorganize it.

Why do you need run-off coverage?  Because claims sometimes get filed well after the bankruptcy process is concluded because of their complexity (sometimes as late as two or three years after the bankruptcy was filed).  If there is no policy in existence at the time the claim is filed, then coverage may be problematic.  Purchasing tail coverage can help immensely here.  The short answer to all the questions we raise here is that the bankruptcy process can create questions regarding your D&O policy and its application to claims.  The more you deal with the policy issues up front, before the filing and, even better, before a filing becomes a concern,, the easier it can become to resolve those questions.

  1. Are you considering new corporate risks?: Like ones that could lead to “Social Accountability” or “Event Driven” Claims? Like #Metoo, #privacy and corporate #sustainability?   There are always going to be events in your corporate lifecycle that come up unexpectedly — like a leak in your roof or basement — that has the potential to cause a big mess.  You have read about many of the issues in this section in the last two years.  Some have caused executive departures or suit filings.  Some have caused stock drops.  Also, investigations and enforcement . . .  One or two have caused bankruptcies.  These events are hard to accurately predict,  and there is no good answer sometimes on how to avoid them.

Our advice here sound counter-intuitive, but “plan” for a crisis.  Build trust with your stakeholders every day–ahead of time — before there is a crisis. Consider drafting a full blown “crisis communications and response” plan that maps out what the company would do or say (via whom and to whom) if one of these events happened to your company.  Include your lawyers.  Include your PR or Crisis communication firm.  Include Risk Management.  Have a digital crisis communications firm on standby too. Get that firm pre-approved by carriers for any crisis coverage included in your D&O program.  Since the company’s crisis team may not be able to address the needs of a particular director or officer under fire, each director and leading officers may want to have a crisis plan of their own (at least identify and pre-vet legal and crisis professionals).  Sometimes a big crisis can be managed down into a little crisis that goes away in a week.  Sometimes a crisis can be managed in such a way that there is not a huge stock drop.  However, left unchecked or move too slowly, and things can get out of hand.  We have seen crises managed well.  We have seen crises managed poorly.  Plan for the worst.  But hope expert handling of the crisis can help manage this risk to a manageable one.

Here we also have to mention the risk of today, tomorrow and next year too:  #Cybersecurity. You have seen plenty written in blogs over the risk that poor cybersecurity, or poor cybersecurity governance can cause to companies.  We will not repeat this litany of bad news here except to say that these cybersecurity problems are real, nasty and liability provoking—and the risk continues to change daily.

What many directors may not know is that the most recent bad breaches have caused securities litigation and shareholder derivative actions as well because of their severity and market capitalization losses.  This is in addition to privacy class actions and regulatory investigations.  Again, things in the cybersecurity space have gotten far worse over the past two years, and show no sign of improving.  Meanwhile, a wave of data privacy regulation is on this year’s legislative agendas.  Cybersecurity is a risk that actually can be identified beforehand. But it is one that needs to be aggressively managed.

All of these suggestions are easily implemented.  And there are great advisors and brokers out there that can help directors and boards assess both their exposures, their risks and their D&O insurance.  Let’s actually break the cycle and learn from the past.  We will all be better off if the directors and officers faced with the next epic crisis have adequate insurance for the exposures that will likely face.