Ins And Outs Of D&O Insurance Coverage

Tuesday, March 14, 2006

Mary McCutcheon, http://

Abstracted from: Covering Yourself
Farella Braun & Martel, San Francisco, CA
8-K - Vol. 1, No. 4, Pgs. 24-26

Many sides to protection.
Despite the growing risk of litigation and the threat of exposure to personal liability, many CFOs remain unfamiliar with the protections afforded under the provisions of their D&O liability insurance. Yet, according to insurance coverage attorney Mary McCutcheon, the kind of D&O coverage a company purchases impacts the protections available at both the individual and the corporate level. Years ago, D&O liability insurance was designed to protect the personal assets of directors and officers; the guarantee of corporate indemnification obligations to those individuals was a secondary consideration. Most policies contained two components: Side A covered directors and officers if the company could not indemnify them for legal or financial reasons such as a settlement or judgment; Side B covered the company's obligations to individual officers and directors and was considered corporate insurance. Over the last 15 years, companies have argued that insurers should bear all of the costs when directors and officers are jointly liable. To answer these concerns, insurers developed Side C coverage, which insures for corporate liability.

Drawbacks to split coverage.
While Side C coverage protects at both the individual and the corporate level, it also gives rise to thorny issues, the author points out. For example, a bankrupt company might seek to eliminate or restrict the rights of individuals under the policy, or require them to share policy limits, eroding the expected coverage. Even at solvent companies, liabilities sometimes threaten to chew up the policy proceeds. As a remedy, many companies opt to buy only Side A coverage for individual directors and officers, yet a financially stable company is not well-served by this approach. The premiums might be better spent in improving the balance sheet or for other constructive purposes. Other companies purchase only Sides A and B, then split the defense and indemnity coverage, but this strategy has drawbacks as well. Disputes might arise over which expenses are jointly incurred, and the arrangement could influence strategic decisions such as whether to hire separate attorneys or whether to dismiss insured officers.

Inadvertently taking over the company's risk.
Given the complexity of D&O insurance, many executives who believe they are covered might actually have significant exposure, and they risk incurring steep costs to defend themselves in a lawsuit. Insureds should also read insurance-related documents carefully before signing, For example, signing a reimbursement agreement before the insurer advances defense costs under Side B coverage could subject the insured to inadvertent assumption of the company's risks. Corporate indemnification agreements do not usually limit attorney's fees, but entering into a direct relationship with the insurer might entangle the director or officer in a dispute over defense fees. The author recommends that insured executives and board members retain counsel for independent advice and negotiate modifications where possible.

Abstracted from 8-K, published by Daily Journal Corporation
44 Montgomery Street, Suite 250, San Francisco, CA 94104

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