Do you really know your D&O coverage?

Whether your organization is a publicly held company, private company or nonprofit it is vitally important to have a thorough understanding of the corporate charter and its indemnification of corporate officers and directors and how the directors and officers’ (D&O) insurance policy protect their interests and that of the entity.

Not all policies are the same nor are their meanings. D&O policies differ from carrier to carrier in many respects – while the primary coverage issue is to indemnify corporate directors and officers for defense expenses as well as settlements and judgments made against them – how each carrier does that is the real issue. There are very subtle differences. Let’s take a look at a couple of examples.

What are the coverage concerns?

D&O policies typically contain three coverage parts:

1. Side A: protects officers and directors when the company does not indemnify them
2. Side B: reimburses the company when it does indemnify the officers and directors
3. Side C: covers claims against the company itself

Pay attention to the coverage because company or corporate insiders’ interests don’t always coincide with directors and officers’ interests. That is what happened to five former directors of a defunct company where they were put in the position of having to pay $41.5 million of their own money to settle a lawsuit stemming from a company’s bankruptcy. To avoid this possibility, directors should demand a “Side A” policy of their own. This option has been very popular for several years now. These types of policies are also referred to as independent director liability or IDL policy; it can’t be exhausted by claims against the company or the officers.

Claims denial – one aspect. The insurance carrier may deny coverage for reasons unrelated to the claim against you. Insurers can rescind a D&O policy – return the premium and pretend as though there had never been coverage – if they conclude at a later time that the application contained false or misleading information. Seems reasonable. Insurers today require that financial statements be attached to the application. The problem here is that if your CFO cooked the books unbeknownst to you, this could nullify the policy. To avoid this scenario affecting other board members that have clean hands, it is important to pay attention to the severability clauses contained in the policy. This prevents the insurer from using the acts of one bad actor to disqualify other officers and directors from coverage. However, an even better scenario is to find an insurer to write a policy that is non-rescindable and non-cancelable.

Outside the U.S., directorship may not be covered. D&O policies may provide international coverage but the fine print reveals that it is only “to the extent possible.” This is very vague. Some countries including India, China, Russia and Brazil require that companies maintain local D&O policies. It is therefore important to purchase additional D&O coverage outside the U.S.

Bottom Line: It all begins with the corporate charter and indemnification provision contained therein. Before considering D&O coverage you must have an understanding of how the corporate charter works and who and what should be protected. Then when dealing with D&O policies and coverage make sure that you have a full understanding of the terms and conditions that are incorporated into that particular policy – you may be surprised by who and what is actually covered (or not) and how the policy will respond in the event of a claim (when the rubber meets the road).

Are you OK with being surprised?