If you’re on the board of a private company, you could be personally liable for defense and settlement costs as a result of lawsuits for claims made against you. That is, unless you have the proper coverage in place through your insurance risk management program. All too often, however, the only thing standing between directors and officers and a massive personal financial hit is a D&O insurance policy.
Getting the right D&O insurance, unfortunately, can be challenging. D&O insurance policies are highly negotiated instruments. There isn’t a one-size-fits all form, and it takes expertise to negotiate these highly specialized policies.
What’s more, many private companies are surprised to find out that D&O insurance policies are increasingly difficult to place as more claims cause insurance carriers to be less willing to offer expansive terms and conditions.
In my last post on private company D&O insurance, I talked about key considerations when looking for protection for directors and officers. In this post, we’ll talk about some of the general terms and conditions to be aware of, starting with the structure of a D&O policy.
A typical D&O insurance policy is divided into three insuring agreements—: Side A, Side B and Side C— all of which share the same single policy limit:
Side A is the part of a D&O policy that responds when a company is unable to indemnify its directors and officers; this is referred to as the “personal protection” part of a D&O insurance contract. A common example of when this insuring agreement would respond is when a company goes bankrupt. This part of the insurance policy should pay on a first-dollar basis, that is, there should be no self-insured retention or deductible.
Side B is the part of the D&O policy that reimburses a company for its indemnification obligation to its directors and officers. This part of the insurance policy is generally subject to a self-insured retention or deductible. Side B responds most commonly in the majority of claims brought against directors and officers.
Side C of the D&O policy, also known as “entity coverage,” ensures there is corporate coverage whenever the corporation is sued along with the Ds and Os. Private companies enjoy much broader entity coverage under Side C of their D&O insurance programs compared to public companies (public companies are only covered for securities claims).
Like Side B, Side C is typically subject to a self-insured retention or deductible. Side B and Side C coverage together are often referred to as “balance sheet protection” for a company.
Stand-Alone Side A
Stand-alone Side A is the type of D&O policy that only provides Side A coverage. When well brokered, it provides broader coverage than the Side A typically found in a combination ABC policy (fewer exclusions). For this reason, this type of Side A policy is also referred to as a “Difference-in-Condition” (DIC) policy. Many companies will structure their insurance program to include a combination of regular ABC insurance policies and Side A-only policies.
Why have both? The traditional reason concerns bankruptcy. The concern is that directors and officers with only an ABC policy may find themselves without insurance coverage if their company ends up in bankruptcy.
If a company goes bankrupt with a D&O policy that includes Side C coverage (and perhaps Side B), a bankruptcy trustee might attempt to seize the insurance policy proceeds for the bankruptcy estate, leaving the Ds and Os without coverage. The argument for seizure by a trustee of a stand-alone Side A Policy is much weaker since this policy provides no corporate balance sheet protection.
When companies are doing well, bankruptcy feels like a remote concern; however, an increasing number of well-capitalized companies are purchasing at least a small amount of stand-alone Side A coverage in addition to regular ABC D&O policies because:
- They regard it as a risk management best practice.
- They value the broader coverage that stand-alone Side A polices can offer compared to the Side A portion of a regular D&O policy.
- The stand-alone Side A policy can respond with first dollar coverage in some cases, including if a company refuses to indemnify a director or officer. Without stand=alone Side A protection, if a company were to refuse to indemnify a D or O for an indemnifiable claim, the individual would have to pay the Side B self-insured retention before the insurance policy would respond. This is potentially a big exposure; the retention could be hundreds of thousands or even millions of dollars.
Key D&O Insurance Exclusions
A policy exclusion removes the claim from the scope of the policy’s coverage. Many of these exclusions are negotiable. Here are a few key exclusions to consider in private company D&O insurance:
- Intentional fraud:While insurance carriers cannot insure for these types of claims, the negotiable aspect is the point at which such conduct becomes excluded. If the conduct can only be excluded after a final adjudication of fraudulent conduct, then an insurance carrier will advance all defense costs until the final settlement is made. This is clearly better for an insured D or O than if the exclusion could be triggered earlier in time.
- Insured versus Insured: If the biggest threat of litigation for your private company is that of directors and officers bringing claims against one another, take note that a private company D&O insurance policy is probably not going to respond. This is due to the “insured vs. insured” exclusion. However, you can negotiate the exceptions, i.e. the “carve backs” to the exclusions. An important carve-back to here is the number of years a D or O is separated from the company before the exclusion no longer applies (for example, after 3 years, if the D or O in question sues other Ds and Os, the exclusion is not triggered).
Other Negotiable D&O Coverage Points
When negotiating your D&O insurance policy, there are additional considerations. Keep in mind:
- D&O coverage comes in the form of a claims-made policy.That means, the policy that responds to a claim is the policy in place at the time the claim is made. This is important to note in the event that a company is acquired. In this case, purchasing a tail policy is key. In addition, some D&O insurance policies have a “past acts date” that states the policy will not respond to a claim made during the policy period if that claim relates to a wrongful act that took place before the past acts date. It’s critical that this past acts date be completely eliminated or negotiated as far back in the past as possible. Carriers, in rare cases, may attempt to rescind the policy. In especially bad-fact cases, a carrier may attempt to take the position that the insured misled the insurance carrier at the time the contract was formed. One way of handling this is to negotiate a non-rescindable policy, at least for the Side A part of the policy (and/or the stand-alone Side A part of the insurance program). It’s also important to negotiate the “severability” wording in the policy. For example, where possible, you want to make sure that the knowledge or acts of one insured will not be imputed to another for the purposes of determining coverage.
Lastly, D&O insurance for a private company is just one of a number of insurance policies that corporations should consider as part of their insurance risk management program.
Other policies may be just as important, for example, cyber liability coverage, business interruption coverage and so on. Part of creating an overall insurance risk management program for a company is balancing where you will spend your insurance dollars. One of the important trade-offs may be protecting Ds and Os versus using insurance dollars to protect the company through other types of insurance policies.
The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: email@example.com.