DIRECTORS AND OFFICERS LIABILITY INSURANCE COVERAGE FORM ANALYSIS

(March 2020)

INTRODUCTION

This coverage protects insured directors or officers against claims involving allegations of wrongful acts occurring while performing their duties as such. The insurance is divided into two separate coverages. Side A coverage reimburses the individual directors and officers for payments made for loss each has incurred because of wrongful acts. Side B coverage reimburses the corporation for the payments it has made on behalf of the directors or officers themselves. A number of domestic insurers and Lloyd's of London offer this form. It is available to large and medium size business corporations, financial institutions and non-profit or charitable corporations and associations.

COVERAGE ANALYSIS

Claims Made

D&O policies are written as "claims made" policies. This means that the policy that responds to a claim is the one in effect on the date on which the claim is initially made regardless of when the activity resulting in the claim took place. All claims that are related to the initial claim are assigned to the same date as that initial claim and subject to the same each claim limit of insurance. Most claims made policies contain a retroactive date that limits when an activity can take place in order to be covered under the current policy. When a retroactive date is entered on the declarations, the policy will respond to only claims made during the policy period that are for activities that took place after that retroactive date.

Example: Genesis Corporation policy period is 2/1/20-2/1/21. Its retroactive date is 2/1/16.

Scenario 1: Claim made on 4/1/20 for activity on or about 4/20/2015. No coverage because the activity was prior to 2/1/16.

Scenario 2: Claim made on 3/1/22 for activity on or about 3/5/2018. No coverage because the claim was made after the policy had expired.

Scenario 3: Claim made on 5/1/2020 for activity on or about 5/1/2019. This policy may respond because the activity was after the retroactive date and during the current policy year

An extended reporting period may be automatic or available to be purchased which permit claims to made after the policy has expired.

Example: Genesis does not renew its coverage on 2/1/20 because it is ceasing operations. It purchases a three-year extended reporting period to protect its directors and officers.

Scenario 2 above may be covered because the claim was made during the extended reporting period.

Side A and Side B

Most Directors and Officers Liability policies issued are written under a single policy cover, but with two separate coverages although a growing number of businesses are purchasing stand-alone Side A Coverage supplemented by excess Side A/DIC protection.

Directors and Officers Liability (Side A Coverage) - pays on behalf of any directors or officers for their liability arising out of wrongful acts.

Company Reimbursement or Company Indemnification (Side B Coverage) - reimburses the insured company for payment made to its directors and officers. The payments must involve the director or officer's expenses incurred by reason of claims made against them for wrongful acts, and to which they are entitled by the company's by-laws.

The arguments for combining Side A and Side B under one policy may vary by state based on the corporation law of each state and by covered entities based on its depending on the by-laws. A company would be well-served to obtain the advice of corporate attorneys before deciding which form to use.

The available contracts contain different wording, so any contract must be carefully studied. This analysis emphasizes typical provisions.

Note: There is also Side C Coverage. It is Directors and Officers protection for companies when they are named in litigation along with their directors or officers.

There are two methods of describing the covered directors and officers under the Directors and Officers Liability policy. Some underwriters prefer to have the insured company list the titles or positions of directors and officers covered in the applicable declarations page. This permits the underwriters to review the positions insured. Several underwriters have revised their contracts to add an item on the declarations page which reads: "The policy does not provide coverage for the following positions." When such a provision is used, all directors and officers are covered except for any that are specifically excluded by the insured corporation.

The policy also covers loss arising from any claims made against the estates, heirs, legal representatives or assigns of deceased insureds who were directors or officers of the company at the time the acts upon which such claims were based were committed. Coverage also applies to the legal representatives or assigns of directors or officers in the event of their legal incompetency, insolvency or bankruptcy.

Insuring Agreements

Side A - Directors and Officers Liability coverage

This coverage pays on behalf of insureds. It responds to loss arising from any claim or claims which may be made against the insureds, jointly or severally, during the policy period. The loss must be related to a wrongful act performed as a director or officer of the named insured corporation. The coverage is a reimbursement of sums for which the bylaws of the corporation does not permit the director or officer to be indemnified.

Directors and officers belonging to any subsidiary acquired or created after the inception of the policy may be covered, subject to written notice being given to the insurer as soon as practicable, and payment of additional premium required.

Note: Increasingly Excess Side A policies are being purchased by companies to act as an excess layer and/or on a Difference in Condition basis. This protects directors and officers in instances when primary coverage is exhausted or on a drop-down basis when a jurisdiction does not permit indemnification (such as shareholder derivative lawsuits).

Side B - Company Reimbursement or Corporate Indemnification coverage

This coverage pays on behalf of the named insured corporation and responds to eligible claims that may be made during the policy period. The claim may be filed against any director or officer of the corporation. The loss must be related to a wrongful act performed as a director or officer of the named insured corporation. However, the coverage only responds when the directors or officers are entitled, based on state law or bylaws, to indemnification by the named insured. The claims must be for damages, judgments, costs, charges or expenses incurred in connection with the defense of any action, suit or proceeding or any appeal to which the directors or officers may be a party. They may be also for instances whereby the directors or officers are threatened with a suit, action or proceeding based on law or corporation by-laws that define such rights of indemnity. Company Reimbursement coverage also covers any subsidiary company (often subsidiary is a defined term) acquired or created after the inception of the policy.

Note: The insured entity must notify the insurer about any added subsidiary exposure in writing. That notice must be given as soon as practicable and pay any additional premium.

This coverage is particularly important because, in most states, corporations are permitted to make director and officer indemnity provisions in their by-laws or articles of incorporation. This action sets up the power of the corporation to reimburse the director or officer for expenses incurred in defending suits against them for wrongful acts while acting in their capacities as directors or officers. Documents that govern corporate indemnification are:

· The corporate charter

· Code of regulations

· Actions of shareholders

· By-laws and articles of corporation.

Public policy is an important limitation to indemnification. In other words, regardless what is stated in a given document, items that are against public policy do not qualify for protection.

Defense Obligation

The Directors and Officers Liability policy does not contain an express duty to defend the insureds. There is no obligation by the insurer to pay costs of defense on an ongoing basis. The insureds must pay defense costs until the ultimate resolution of the claim to determine whether coverage exists and the insurer is obligated to pay. In practice, insurers typically cover ongoing defense costs, because some insureds could jeopardize the quality of defense if they couldn't afford adequate defense on their own.

Note: The State of New York issued an opinion in 2008 that duty to defend is mandatory on Directors and Offices policy based on their state insurance regulations. Other states may have similar regulations.

Exclusions

Exclusions exist as part of a directors and officers liability policy or are added by endorsement. Because policies are not standardized their exclusions are an important basis for comparison. Often a given insurer's exclusions may be deleted or modified by the insured. Quite often the marketplace itself, or the frequency of certain types of losses, dictates whether the policy is flexible or inflexible about waiving or modifying certain exclusions.

Side A - Directors and Officers Liability Coverage

In policies that have two separate insuring clauses, the following exclusions apply to the Directors and Officers Liability coverage. Typically, there is no coverage for claims involving:

· Libel or slander

· The gain of any personal profit or advantage to which the insureds were not legally entitled

· The return of remuneration paid to the insureds without the previous approval of the stockholders of the named insured when a court has held such unapproved payments to be illegal

· Any accounting of profits that are the result of a purchase or sale by the insureds of company securities within the meaning of Section 16(b) of the Securities Exchange Act (including its amendments) or similar provisions of any applicable law

· Dishonesty of the part of insureds

Note: The policy will defend against loss involving allegations of dishonesty, but the obligation ends upon proof of deliberate dishonesty.

· Any failure or omission on the part of the insureds to effect and maintain insurance.

Note: This exclusion may be deleted if the insured provides the company with full details of their insurance program and if the company would find the applicable insurance program adequate.

· A loss that is insured by any other existing valid policy or policies (including under a previous occurrence-based form)

· Any loss or expense that is reimbursed by the company, when that reimbursement is a lawful obligation.

Note: This loss is covered under Side B

· Bodily injury, sickness, disease or death of any person, or damage to or destruction of any tangible property including loss of use thereof

· Pollutant caused or related personal injury, bodily injury, and property damage.

Note: Some insurers make a limited amount of pollution liability coverage available for an extra premium.

· Payments or favors to any government –foreign or domestic.

· Payments or favors to officers, directors, agents, owners, partners, representatives, or employees of any customers of the named insured

· Any claim brought by any other insureds against one or more directors or officers

Related Court Cases:

D & O "Insured V. Insured" Exclusion Did Not Bar Suit By Receiver

Directors and Officers Liability Policy "Insured V. Insured" Exclusion Is Examined

Note: This exclusion is meant to avoid internal company disputes between the company and its directors for claims due to in-fighting between officers and directors.

· Any claim for wrongful termination of employment

Note: The exclusion precludes suits of employees or officers who allege wrongful termination. Most insurers are very reluctant to provide coverage for wrongful termination in D&O policies, although without a specific exclusion the insurer often has to pay the claim. Some underwriters will add the coverage for payment of additional premium.

· Any offer to purchase, or purchase of securities of the named insured at a premium over its current market value, made by the named insured or its directors and officers

Note: This bars coverage for "greenmail" actions that companies take to avoid a hostile takeover. The greenmail exclusion precludes claims from other stockholders when a company sells shares at higher premium only to certain individuals or organizations to resist a suspected takeover to the exclusion of the claimant stockholders who were not offered the same premium. Such an exclusion might be modified to exempt situations where payment of the above-market price was approved by a majority of the insured's stockholders.

· Any actual or alleged violation of the Racketeer Influenced and Corrupt Organizations (RICO) Act (including any amendments)

Note: This exclusion is used when policies are written on distressed businesses. Since such types of claims are rising in the past few years, attempts should be made to modify the exclusion, so that coverage for defense of alleged RICO claims can be arranged.

· Violation of any responsibilities, obligations or duties imposed by the Employee Retirement Income Security Act (ERISA)

Side B - Company Reimbursement Coverage

Under the Company Reimbursement coverage there is no protection for any loss in connection with any claim made against the directors or officers:

Which is insured by any other existing valid policy or policies under which payment of the loss is actually made, except in respect to any excess beyond the amount of payments under such other policy or policies
When the directors or officers are entitled to indemnity under any policy or policies previously in force.

Other "non-standard" exclusions that could be added by endorsement or in certain situations include claims involving discrimination, anti-trust violations or regulatory agencies.

E.R.I.S.A. (Pension Reform Act) Liability

The Employee Retirement Income Security Act (E.R.I.S.A.) creates a set of exposures that must be dealt with when arranging D&O coverage. The options for handling the potential liability of corporate directors or officers related to violations of E.R.I.S.A. (or other employee benefit program laws), typically involve one of the following:

· A specific exclusion in the D&O policy relating to liability of directors or officers acting as such or as trustees or fiduciaries under the pension law

· Purchase of a separate insurance policy covering the officer or director in the capacity of a benefit plan fiduciary or trustee

· Purchase of a D&O policy covering pension law liabilities as a director or officer by means of a rider to the policy or specific endorsement for an additional premium

D&O policies were not originally designed to deal with pension law exposures and, still today, they are not handled in a standard manner. Insurance professionals dealing with a client's overall risk assessment must be aware that officers or directors may have liability as an officer or director apart from being a fiduciary or trustee of an employee benefit or pension plan. The liability may be created by either their involvement in decisions of the board of directors or in implementing directives of the board that are related to employee benefits.

It is clear that coverage is not standard with respect to pension act liability. It is important that the corporate buyer or agent check with the present D&O carrier whether that carrier provides such coverage. If not, the insured should be provided with a statement of intent that the exposure is or is not covered. If the exposure exists for directors and officers, they should be individually covered as trustees under a separate policy, or the D&O policy should be endorsed, or both actions should be taken.

Definitions

Claims First Made

The earliest point in which any insured receives a valid notification that damages are being requested from a third party. The notice must be shared with the insurer within the applicable policy term.

Defense Costs

The reasonable, necessary expenses and fees that are specific to the defense of qualifying claim or allegation.

Director or Officer

Any duly elected director of the corporation, including officer positions held by such directors, as described in the policy declarations. Coverage applies to past, present and future directors and officers. Covering former directors and officers is important because claims may involve incidents when such persons were actively associated with the covered business.

In covering future directors, the policy makes it clear that protection also applies to claims arising later, after new officers and directors may have come on board.

Insured Persons

The D&O Liability policy covers wrongful acts of elected directors and officers. Many corporations now ask for insurance protection for certain key non-officer positions, such as division or plant managers, personnel managers, etc. Most D&O insurers will extend coverage to specific positions of this nature. Hospitals, mining companies, petroleum companies, construction and real estate, transportation and manufacturing companies are typical types of organizations seeking extensions of insured status to additional personnel.

Loss

Any amount that the insureds are legally obligated to pay for a claim or claims made against them for wrongful acts. It includes damages, judgments, settlements, costs, charges and expenses (excluding salaries of officers or employees of the insurance company) incurred in the defense of actions, suits or proceedings and related appeals. However, it does not include fines or penalties imposed by law or other matters that may be deemed uninsurable under applicable law.

Policy Year

The period of one year following the effective date and hour of the policy or any anniversary thereof, or if the time between the effective date or anniversary and the termination of the policy is less than one year, then such lesser period.

Related Wrongful Acts

Any acts or incidents which are, logically or causally, related to each other to the degree that they are, for all intents, a single, insurable act.

Subsidiary Company

Any company that is wholly owned by the named insured or any company of which the insured company owns more than 50% of its voting stock.

Wrongful Act

Any breach of duty, neglect, error, misstatement, misleading statement, omission or other act committed or wrongfully attempted by the insureds or that are alleged to have been committed solely by reason of their being directors or officers of the company.

Retention

The insurer is liable to pay a percentage of the loss in excess of the amount retained by the insured stated in the declarations up to the limit of liability shown in the declarations. The percentage is based on the participation percentage on the declarations. The participation percentage will vary by company and by insured and could be 0%. Typically, any deductible/retention only applies to corporate reimbursement section of the policy. However, some insurers may waive any deductible for a portion of a loss that exceeds a pre-determined amount (such as $1 million).

The insurer is obligated to pay the excess over the insured's retention in respect to each and every loss, including costs, charges and expenses. The retention must be borne by the insureds and is not eligible for reimbursement. Losses arising out of the same or related acts of one or more of the insureds are considered a single loss and only a single retention is deducted from each loss.

Limit

The provisions of the Directors and Officers Liability portion and the Company Reimbursement portion apply as though they constitute a single policy and the insurer's maximum liability under both coverage parts shall not exceed the limit of liability and the retention shown in the declarations of the policy.

No costs, charges and expenses shall be incurred without the insurer's consent. When an insured grants permission (an insurer must have a reasonable basis for denying consent), the insurer will pay its percentage of all such costs, charges and expenses, subject to the following conditions:

If a claim is paid/settled for less than the limit of liability, related costs, charges and expenses are payable within the applicable limit
If a claim is successfully defended by the insureds, related costs, charges and expenses are payable up to but not exceeding the applicable limit of liability
If a claim payment/settlement exceeds the limit of liability, the insurer's obligation to pay related costs, charges and expenses is limited to the limit of insurance.

Example: Quagmire Corp. is insured by a D&O policy from Exasperated Fire and Casualty. The Exasperated policy provides a $1 million limit. Quagmire's Board is sued and the judgment is for $1,320,000. Quagmire zealously fought the claim and paid $146,000 in related costs. Exasperated pays out its $1,000,000 for the judgment. No limit is available to pay for the related cost so Quagmire must pay $320,000 + $146,000 = $466,000.

The insureds shall not be required to contest any legal proceedings unless counsel (to be mutually agreed upon by the insureds and the insurer) advises that it should be contested by the insureds and the insurers also give their consent.

In the event of the insureds being so required to contest legal proceedings, the insurer, subject to the provisions regarding retention and payment of costs, charges and expenses previously explained, will pay its percentage of all costs, charges and expenses related to the defense of legal proceedings. This payment will be in addition to the applicable limit of liability. Costs, charges and expenses, as defined in the policy, include the cost of any appeal, attachment or similar bond.

Conditions

In Event of Loss

The company named in the declarations or the insured is required to give to the insurer notice in writing as soon as practicable of any claim made, and to give the insurer such information and cooperation as it may reasonably require and as is in the insured's power. If, during the policy period or during the extended discovery period, the company or the insureds receive written or oral notice from any third party that it intends to file a claim or suit for a wrongful act, or the company or the insureds become aware of any occurrence which may create a claim, and the company or insureds notify the insurer (in writing) about the loss (or possible loss) during the policy period or extended discovery period, then any claim which may subsequently be made against the insureds for such wrongful acts is treated as a claim made during the policy period.

Extended Reporting Period

The Extended Discovery Clause provides that if the insurer cancels or refuses to renew the policy, the insureds have the right to an extension of the time permitted to report a claim. The extension, depending upon the amount of additional premium, may last from 30 days to one year following the date of such cancellation or non-renewal, but only with respect to any wrongful act committed before the date of cancellation or non-renewal.

Cancellation

The Cancellation Clause provides that the policy may be cancelled by the company named in the declarations or the insureds at any time by written notice or by surrender of the policy. The insurer may cancel the policy by delivering to the company named in the declarations or by mailing to the company, by registered, certified or other first-class mail, at the company's mailing address, a written 30-day notice of cancellation.

Subrogation

In the event of any payment under the policy, the insurer is subrogated to the extent of such payment to all the insured's rights of recovery. The insured is obligated to cooperate with the insurer to facilitate its ability to assert the subrogated rights against (sue) any responsible party.