Recently, a guest author for the D&O Notebook wrote about what you should ask before joining a board, a topic I’ve also addressed in past posts. Today, I’m going to explore the opposite end of the spectrum: What steps should you take when leaving a board to ensure that you remain protected.
I get this question a lot, and it makes sense: most directors work very hard to do right by their shareholders while they are on a board, and most directors are the type of people who generally see themselves as having a lot of control and influence over situations—but all of this changes when a director walks away from the board.
This can make a former director feel vulnerable. What happens if a shareholder decides to sue or a regulator decides to ask questions after the board member is no longer on the board?
The good news is that in most cases, there’s a straightforward answer. I’ll go over those answers next.
The easy case is when you have a robust personal indemnification agreement in place. Well-drafted indemnification agreements are designed to protect you for a period of time after you leave the board.
A good indemnification agreement promises to advance legal fees and pay losses on behalf of directors or officers if they are named in a lawsuit for acts and activities relating to their service at the company. Most are drafted so that they will continue to respond even if the lawsuit arises after a director (or officer) has left the company.
There are two caveats.
One is that if the company is acquired, you want the acquiring company to assume the obligations of your indemnification agreement. Again, if your agreement was well drafted, this should happen automatically.
The other situation that requires a little more care if the company goes into bankruptcy. When bankruptcy happens there’s no longer a balance sheet to support the indemnification agreement—which means the indemnification agreement is now useless. (In bankruptcy, indemnification agreements may be regarded as executory contracts, in which case they can be rejected in bankruptcy.)
If bankruptcy is imminent, you probably won’t get any protection from resigning, either. As you would expect, the more time there is between when you left the board and when the company files for bankruptcy, the lesser the chance that you’re ever going to be named in some sort of predator suit for a bankruptcy, or an action by a bankruptcy company.
D&O insurance is designed to cover past, present and future directors and officers. What that means is that, in the normal case, so long as the company continues to purchase D&O insurance, you will continue to be covered by the D&O insurance policy for future lawsuits that relate to your board service.
One caveat, again, is when there’s an acquisition. Your company will stop paying for D&O insurance after the sale. So, before a company is acquired (before the sale is even a discussion), talk to the company about purchasing a D&O insurance tail policy.
A tail policy covers the gap in coverage that can exist after the sale of a company. Remember, the acquirer’s D&O insurance policy typically won’t respond on behalf of the selling company’s directors and officers for claims that are filed post-closing but are related to pre-closing activities.
You’ll pay an additional premium for a tail policy in order to hold the policy open for an added number of years. Six years is a standard term. Shorter terms are available, but not recommended. The idea here is that you want the tail to exceed any relevant statutes of limitations.
In the case of a bankruptcy, we’d look to the Side A portion of a D&O insurance policy. Side A is the part that responds when a company is unable to indemnify its directors and officers. As long as the premium for the insurance was paid in a timely way, the policy should respond even though the company is bankrupt. There shouldn’t be any self-insured retention or deductible before the policy starts to respond.
In the end, while indemnification agreements and D&O insurance together typically provide the protection you need for litigation as a former director or officer under normal circumstances, it’s important to also explore worst-case scenarios (like bankruptcy), and ensure you’re covered for those, too.
You also have one more option: a wealth security policy. These policies are an inexpensive way to get just a little bit more sleep insurance for those who feel they need it.
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.