In the following guest post, Paul Ferrillo, a partner in the McDermott, Will & Emery law firm, takes a look at Excess Side A insurance and discusses its importance as part of a well-structured D&O insurance program. I would like to thank Paul for his willingness to allow 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 a guest post. Here is Paul’s article.
When I and several of my colleagues now go to Directors and Officers (D&O) Liability insurance events, we often remark that “boy, we are getting old.” Indeed many of us remember when Side A excess D&O insurance (Side A) was just the jelly on a peanut butter and jelly sandwich. Nice to have, it added some sweetness to the sandwich, but it was pretty much an afterthought for most companies.
Times changed, the form of Side A changed (and gotten better) and then suddenly large shareholder derivative settlements started to happen in M&A or “deal” related cases post the financial crisis. Side A became important because, under Delaware law, a corporation could not indemnify its directors or officers for the settlement of a shareholders derivative action (the same problem exists for a Chapter 11 bankruptcy, where both defense costs and settlement amounts likely won’t be indemnifiable).
Today, Side A insurance is not just a “must have”, it’s a vital thing for corporations to carry, and for directors to insist upon when they join a board of directors. The numbers of shareholder derivative settlements have increased, and so have settlement amounts, as many companies not only have just securities cases, but significant regulatory investigations where fines and penalties and defense costs have dramatically escalated the cost of doing business. Many of these regulatory settlements have reached $100 million alone. And several shareholder derivative action settlements have approached $200 million or more. We explain below that amount goes right to the damages line in the shareholder derivative action.
It’s not just amounts of Side A coverage that matter, but the type of Side A insurance, as well as the carrier chosen for the Side A tower of insurance. Some of these questions are harder to answer than most, but we do our best below to analyze how litigation and regulatory trends have made Side A a vital part of the D&O insurance equation.
How Much Side A coverage should you carry? Probably A lot.
There are lots of judgement calls here, so we won’t be presumptuous. No right answers here as it depends upon the financial status and business prospects of the company. A good D&O broker can help give good perspective. But so can we.
Let’s assume you are a $10 billion dollar market cap, publicly traded financial institution. You are regulated by a lot of different regulators (both federal and state). In terms of sizing your Side A tower of insurance, let’s assume hypothetically you announce a super big regulatory problem, and your stock drops 15% (big problems can cause that type of drop). Let’s assume the challenged conduct by the regulator is truly “not good” and that the board “should have” theoretically “known” about it (making the class action fact pattern not so great). The result of the announcement — a securities class action, a formal, regulatory proceeding and the inevitable Side A shareholder derivative action. What sort of D&O insurance should you carry (again, our view)?
The securities class action math is a little simpler. Under conventional wisdom and settlement viewpoints (that have been around for years), the securities case should settle for, plus or minus, about $125 million or so, plus defense costs and expert fees.
It’s the derivative action that now needs to be settled. Let’s make up a fine of $75 million coming down from the XYZ agency (that amount would not be unheard of for a bad case today). So your Side A D&O tower should be near or exceed that amount.
So for the heavily regulated public company at issue here, a traditional D&O tower with entity coverage might be $150-175 million. The Side A tower — probably $100 million would be a good measure. Too high you say? Just view previous articles from the D&O Diary on the growth of Side A derivative action settlements (especially event-driven D&O settlements). See Largest Derivate Lawsuit Settlements here (Kevin keeps a pretty up to date list on these settlements). Too high you say? Directors and officers can read the newspapers and the blogs too. They see the writing on the walls too. Too high you say? Well a board needs good board members with both financial and (today) cyber experience. They will be unlikely to serve if their own personal financial interests are not protected through sufficient D&O insurance. Enough said. Again here a good broker can confirm or deny the math, but I bet we are not far off the mark. Better to buy a lot — then too little. Especially if economic times change, or if the fortunes of the company are changing for the worse.
Type of Side A Excess
There are many types of Side A excess D&O insurance – traditional Side A excess follow form, Side A excess difference in conditions coverage and other variants that either drop down, or have terms that require certain of their terms to drop down.
We don’t pretend to know every form of Side A coverage. But we prefer “Side A excess difference in conditions (DIC) coverage” or Side A DIC coverage, which not only serves as excess Side A coverage, but it will drop down when underlying insurance refuses to pay. Certain Side A DIC coverage is broader than others, so again check with us or your broker for exact terms and conditions.
Will your Side A carrier pay your claim?
You have seen this issue come up a lot in the professional literature around D&O coverage. Why? Because with the plethora of carriers getting into the Side A mix, there are a plethora of attitudes around claims paying and claims-handling. There are some name-brand carriers that truly get the term “partnership” with their insured, and there are some, well….no comment. This is spoken from the perspective of 25 years of experience at the mediation table where some Side A carriers have been great, and some have been very ineffective on the settlement of the “bad” case.
Though there is no math here, some correlate that the new carriers in the market have charged the least amount of money to “get in” on the D&O game. Unfortunately, we have been primed that cheap D&O coverage means “good value.” See “Does a Low Price Mean Good Value or Bad Quality?” (discussing consumer research of the “value” of a cheaply priced product). In D&O land, cheap unfortunately most of the times doesn’t mean good. It means cheap. It means potentially that the insurer will give the insured a hard time about coverage. Or giving the insured a hard time about paying its limits when the insureds really need to settle the bad case. Side A coverage is sometimes coverage of last resort. The last thing a director needs is his D&O Carrier to take an aberrant position to avoid paying the claim.
Our advice truly is caveat emptor, or buyer beware. Ask lots of questions if you are a director. Of your risk manager, your broker, your defense counsel, and even friends who sit as directors on other public company boards. Side A coverage is no place to count your dollars. It’s a special coverage that directors need in today’s litigious and regulatory perilous environment. Make sure you can depend upon it when you really need it.
About the author
Paul Ferrillo is a partner with McDermott, Will & Emery. He focuses his practice on corporate governance issues, complex securities class action, major data breaches and other cybersecurity matters, and corporate investigations. He can be reached at firstname.lastname@example.org.