Most officers and directors of companies will face litigation at least once during their careers, and 95 percent of Fortune 500 companies maintain directors and officers liability insurance to protect themselves from numerous forms of lawsuits. You need to be prepared for this possible litigation, and understand what type of D&O insurance your company has.
“You don’t want to be caught off guard,” says Scott Sherman, of counsel with Baker, Donelson, Bearman, Caldwell & Berkowitz, PC. “Generally, you cannot prevent lawsuits from occurring. For example, when the stock of a public company drops a significant degree after information is disclosed by a company, you will typically see class action and derivative lawsuits to follow. What you can and should do is at least understand what situations may arise and what insurance covers you so that you understand what insurance protection you have.”
Smart Business spoke with Scott Sherman about how the economy has affected D&O liability litigation, recent D&O cases, new products or tools that will help with litigation, and the different situations where D&O insurance covers a director or officer.
How has the economy affected D&O liability litigation? Are there certain sectors in which litigation has become more prevalent in recent years?
The current state of the economy has impacted the state of D&O insurance and continues to make it a prevalent part of securities cases across industries. In the securities arena, these types of cases include securities class actions and derivative litigation. Notably, in the last year, securities cases have once again been on the rise.
Have there been any recent major cases involving D&O liability litigation?
There have been some recent cases in Delaware that show that directors have to be careful in what they do, but that, overall, legal defenses such as the business judgment rule are still potent defenses to claims by shareholders in derivative actions or otherwise that directors have breached their fiduciary duties to a company.
A Delaware court recently ruled in a derivative litigation brought by Citigroup shareholders that directors will not be held accountable for taking business risks in the normal course of the company’s business. Risk is part of a director’s job, as is making business judgments, and the business judgment rule is designed to protect the directors from having to look over their shoulder every time they make a business decision on behalf of the company.
Have any new products or tools emerged to meet the needs of certain markets related to D&O liability?
There’s been a re-focus by the insurance industry and companies about the different types of coverage available and the right type of coverage for the company’s directors and officers. Although insurance companies use different terms, many insurance companies’ traditional coverage has Side A, B and C, with Side A coverage for directors and officers, Side B for reimbursing the company to the extent it indemnifies the directors and officers, and Side C for the company’s coverage. Some insurance companies include Side C coverage as part of Side B coverage.
There has been a lot written recently about stand alone Side A coverage, which is additional coverage for directors and officers if the company’s coverage caps out because there is, for example, not an order of payments provision that states directors and officers are covered first under the policy before the company. So sometimes without an order of payments provision, you could end up with no coverage left for the directors and officers, even though Side A coverage exists. Stand alone Side A coverage would be useful in that case to provide additional assurances that the officers and directors have insurance in case of a lawsuit.
There is also individual director liability insurance available for independent directors, which is similar to stand alone Side A coverage. A lot of outside directors look at this for additional coverage.
When does D&O insurance cover a director or officer?
In the securities arena, the most typical kind of cases it will cover in my practice are shareholder securities class actions and derivative lawsuits. Traditional insurance policies will cover defense costs, i.e., attorney fees, up to policy limits. The insurance will also cover settlement payments or dollar judgments rendered against the insureds up to limits set in the policy. The deductible can be negotiated into the policy so that the company, rather than the directors or officers, pay that amount.
It is, however, important to understand when the insurance may be excluded. For example, typical insurance policies have fraud and intentional misrepresentation exclusions. If, for example, the directors are involved in the submission of financial statements to the public that a court finds contained materially misstated information and finds that the directors and officers knew about it, that is where insurance companies may argue that these exclusions apply and the directors and officers will not have insurance for the claims.
Other exclusions that may apply include coverage for derivative litigation, regulatory investigations and internal investigations. You must understand what kinds of situations are excluded from your policy, because the last thing you want is to be in a situation where an investigation or litigation arises and you find out after the fact that an exclusion in the policy prevents the directors and officers from using any insurance money to defend themselves. Make sure to ask questions before taking a position as a director or officer, just so you are not caught off guard when or if litigation arises. In short, you want to make sure you understand the insurance will be there to protect you and your personal assets.
Scott Sherman is of counsel with Baker, Donelson, Bearman, Caldwell & Berkowitz, PC. Reach him at (404) 443-6706 or email@example.com.