For both public and private companies and their boards, directors and officers (D&O) insurance continues to be a critical component for mitigating potentially significant financial exposure from litigation. In the following guest post, Edgar A. Neely IV and Scott N. Sherman discuss key D&O policy terms and concepts for directors to know for that selection process. Edgar and Scott are both partners at the Nelson Mullins law firm. We would like to thank Edgar and Scott for allowing us to publish their article on this site. Here is the authors’ article.
Quick Primer on D&O Policy “Sides”
Before turning to particulars, a quick primer on D&O policies. At a high level, coverage is typically broken into three sides:
- “Side A” covers individual directors and officers for non-indemnifiable personal loss,
- “Side B” covers reimbursement to the company after it indemnifies individual directors and officers, and
- “Side C” covers the company for covered claims against it (typically securities claims for public companies).
Most D&O policies contain each of these separate coverage components. Understanding these components and ensuring that all three are encompassed by the policy should be the first step for the selection process.
For the coverage terms themselves, below are 10 key terms and provisions boards should consider for selecting an appropriate policy.
- Policy Limits and Order of Payments
In addition to selecting the right overall policy limit, it’s also important to understand how that limit works. A $15 million policy does not necessarily provide $15 million of protection to directors personally. Multiple claims or claims against the company itself may erode the available limit.
Directors should understand how the Side A, B, and C coverages interact and whether the limits available under one coverage section can be eroded by claims under another. Strong Side A protection can also be particularly important when indemnification is unavailable because of insolvency, legal restrictions, or other circumstances. For example, policies can prioritize individual Side A protection first if policy limits begin to erode rapidly due to heavy defense costs or corporate entity-level (Side C) claims.
- Prompt Advancement of Defense Costs
Defense costs can become substantial long before a case reaches settlement or judgment, and directors should avoid having to fund years of defense expenses personally while waiting for the ultimate resolution of a suit or coverage dispute. Some policies may not provide for prompt advancement or include terms that may hold up the process, such as requiring allocation disputes to be resolved or other conditions. Boards should therefore review for advancement terms that provide prompt, mandatory advancement of legal fees and defense expenses before the final disposition of a claim or suit.
- Severability
A strong severability provision generally prevents one insured person’s knowledge, conduct, or misrepresentation from automatically being attributed to another insured. Boards should assess the policy for severability terms, including related application representations, knowledge of circumstances, and policy exclusions. Directors should not necessarily lose coverage because another insured director or officer allegedly made a misrepresentation or engaged in misconduct. Boards can avoid issue that by ensuring one insured’s misconduct cannot be imputed to or used to deny coverage to any other “innocent” director or officer.
- Side A “Difference in Conditions” Coverage
In some circumstances, a company may be unable or unwilling to indemnify an individual insured, including when standard coverage limits are exhausted. Many companies address that risk by purchasing specialized Side A “difference in conditions” (DIC) coverage in addition to their primary D&O policy to provide standalone protection to the individual insured. Directors should consider whether to obtain that specialized coverage.
- Favorable Exceptions to “Insured v. Insured” Exclusion
D&O policies often contain an “insured versus insured” exclusion restricting coverage for claims brought by one insured against another. This exclusion can apply to a variety of corporate disputes involving claims between directors, officers, the company, and shareholders. Broadly worded exclusions can create unexpected coverage gaps for those situations, but ensuring certain exceptions can minimize those gaps. Boards should review the exceptions carefully to determine whether the policy still responds to derivative actions brought by shareholders, employment-related claims, or bankruptcy or insolvency proceedings.
- Regulatory and Government Investigations Coverage
Any company could become subject to regulatory and government investigations or inquiries, whether by the SEC, FTC, or other agencies. These matters can lead to substantial legal expenses even if no lawsuit or enforcement action ultimately follows. Boards should determine whether the policy covers investigations involving directors and officers and, importantly, whether coverage applies to formal investigations, informal investigations, interviews, subpoenas, and requests for information.
- Prior Acts, Continuity, and Retroactive Dates
Directors should also consider whether the policy covers acts occurring before the current policy period. For example, changing insurers can unintentionally create gaps if the new policy does not adequately address prior acts. Boards can avoid such gaps or prior act limitations by maintaining full retroactive coverage dating back to the inception of the company or earliest board service.
D&O policies often treat multiple claims arising from related facts as a single claim. Directors should clarify how multiple claims arising out of the same or continuous wrongful acts are grouped, ensuring they tie back to the most favorable single policy year limit or retention. This includes assessing when claims are deemed related, which policy period applies, and which policy limit is available.
- Non-Rescission Clause
Insurers may attempt to cancel the policy after it is issued, creating a looming concern that coverage could effectively cease to exist when it’s most needed. Boards should therefore look to ensure the policy’s Side A coverage is fully non-rescindable by the insurer once issued, protecting coverage integrity against insurer attempts to invalidate the contract.
- Jurisdiction and Choice of Law
Coverage disputes can also be drawn out by arguments over what law applies and where the litigation must occur—both of which are issues that can meaningfully impact the ultimate result. It’s therefore important to secure favorable “choice of law” and forum selection clauses to avoid protracted litigation with insurers over where coverage disputes must be litigated and the applicable law.
Wrap-Up
It’s important for directors to understand each of these concepts and protections on the front end when engaging in the D&O policy selection process. Then, should litigation arise, they should consult with counsel to review and secure the available rights and protections from personal exposure.
These materials have been prepared for informational purposes only and are not legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Internet subscribers and online readers should not act upon this information without seeking professional counsel.
Scott N. Sherman is a partner at Nelson Mullins Riley & Scarborough LLP, where he practices in complex business litigation and securities litigation and serves as co-chair of the firm’s Securities and Corporate Governance Litigation Group. He represents public companies, directors, and officers in securities class actions and derivative lawsuits and represents special litigation committees as well as companies and individuals involved in SEC and FINA enforcement proceedings. He may be reached at scott.sherman@nelsonmullins.com.
Edgar A. Neely IV is a partner at Nelson Mullins Riley & Scarborough LLP, where focuses his practice on securities litigation and complex business disputes. He may be reached at edgar.neely@nelsonmullins.com.