Directors’ and officers’ liability (D&O) insurance protects the personal assets of corporate directors and officers in the event of a lawsuit or other “claim” made against them for, among other things, an alleged breach of their duties in managing the organization. D&O insurance directly covers individual directors and officers for their defense costs, judgments against them, and settlements when they cannot be indemnified by the company, and also covers the company to the extent it pays defense costs, judgments, and settlements as indemnification. It may also cover the legal fees and other costs incurred by the company as a result of a securities claim made against the company as an entity.
The first installment of this blog series on D&O insurance addressed several “nuts and bolts” features of D&O insurance, including the key insuring agreements and definitions. This post discusses key exclusions, as well as common policyholder pitfalls, and new issues that are emerging in 2020.
Key D&O exclusions
All D&O insurance policies contain exclusions. D&O insurance policies are not standardized, however, so the number and wording of the exclusions may vary from policy to policy and insurer to insurer. Most traditional D&O insurance policies can be expected to contain the following exclusions:
- Conduct exclusion precludes coverage for fraudulent or criminal conduct by an insured, and may also preclude coverage for other forms of intentional or willful conduct, such as violations of statutes. Today, most versions of this exclusion require a final adjudication establishing that an insured person committed the excluded conduct, and may further require that the final adjudication occur in the underlying claim itself, before the insurer may apply the exclusion. Typical D&O policies also will provide that the excluded conduct committed by an Insured Person may not be imputed to any other Insured Person, and that only the conduct of select senior officers of the company (usually the CEO and CFO) will be imputed to the company itself.
- Insured v. insured or entity v. insured exclusions preclude coverage for claims asserted by an insured against another insured. The entity v. insured form of the exclusion applies only to a claim made by an insured entity against another insured. Insured v. insured or entity v. insured exclusions should contain a number of exceptions, including, among others, for independent securityholder derivative claims, claims asserted on behalf of an insured company in bankruptcy, and claims asserted by former directors and officers who are no longer employed by or in the service of the company.
- Bodily injury and property damage (BI/PD) exclusions preclude coverage for claims for bodily injury or property damage. The reason for the exclusion is because BI/PD risks are typically covered by commercial general liability insurance. Modern D&O policies should include exceptions to the BI/PD exclusion for securities claims and for claims made against directors and officers where the company is unable to or is legally prohibited from indemnifying them.
- ERISA exclusions preclude coverage for claims arising under the Employee Retirement Income Security Act of 1974 (ERISA), or similar laws, involving employee welfare and benefit plans sponsored by the company.
- Prior notice exclusions may apply if a notice of claim was made under a prior policy. Many modern D&O policies limit this exclusion to claims noticed and accepted for coverage under a prior D&O policy.
- Pending or prior proceedings exclusions may apply if an insured had notice of prior proceedings against an insured before a specified date.
Common policyholder pitfalls
Most commonly, policyholders seeking coverage under D&O insurance may experience challenges related to the following issues:
- Insured capacity of insured persons. D&O policies typically cover insured persons only in their “capacities” as such. Policy language may allow for coverage for “mixed” allegations against directors and officers.
- Related claims. All D&O policies treat related claims as a single claim first made at the time of the earliest such claim. Policy language defining what it means to be “related” can differ widely, however, and it is often difficult to determine whether or not multiple claims are, in fact, “related.” Moreover, in addition to case law of potentially limited guidance, the related-claims analysis is typically heavily fact-driven.
- Timing and adequacy of notice. D&O insurance is “claims-made” coverage, meaning that the policy is triggered by the date when a claim is first made, not when the conduct at issue in the claim allegedly occurs. Thus, notice of a claim is typically required as soon as practicable after the company becomes aware that the claim has been made. Some policies require that notification be made before the expiration of the policy period, but others have more liberal requirements that allow reporting after the policy period, typically not more than 30 or 60 days. Although some jurisdictions apply a “notice prejudice” rule that the insurer may not deny coverage based solely upon late notice unless it can demonstrate that its interests were prejudiced by the late notice, many jurisdictions strictly construe claims-made notification provisions.
Below are some of the most common D&O insurance pitfalls and strategies to avoid them.
- Give timely notice – it is critical to report claims timely.
- Understand what events trigger notice obligations and have a reporting protocol in place.
- Remember that a “claim” may include more than just a lawsuit; it may include written demands for monetary or non-monetary relief, requests to toll a statute of limitations, and notices of formal investigation.
- Provide notice to primary and all excess insurers, and to all potentially implicated insurers.
- Note that the end of the policy period and renewal may raise special notice issues.
- When in doubt, give notice.
- Respect the duty to cooperate with the insurance carrier.
- Communication with the insurer is key.
- Promptly obtain consent to incur defense costs and to settle.
- Respond to reservations of rights and denials of coverage.
- Address reservations of rights and denials of coverage early to help resolve issues before settlement opportunities arise.
- Review all potentially relevant policies.
- A claim may potentially trigger more than one policy, for example, D&O and employment practices liability (EPL) insurance.
- Protect legal privileges when communicating with insurers and brokers.
- Assume anything communicated to an insurer or broker may not be privileged.
What’s new in 2020?
Companies renewing their existing coverage may encounter new questionnaires and supplemental applications requesting information related to the COVID-19 pandemic and their financial health. Some questionnaires ask for detailed information about pandemic preparation and response. In other cases, insurers have added questions aimed at gauging the pandemic’s impact on company operations. In such cases, experienced coverage counsel can help you navigate the renewal process.
In addition to the impact on the economy on the D&O insurance market driven in part by the pandemic and associated economic downturn, many companies renewing coverage or placing new policies are encountering a “hard market” in which insurers are restricting capacity and increasing premiums, notwithstanding that the policyholder may be in good financial health. This hard market has been driven by a number of factors, including several years of historically high securities class action and shareholder derivative settlements. It is important to approach renewals and new placements strategically. Alternatives to a traditional D&O “tower” of primary and excess policies may be available, but should be considered very carefully with the advice of counsel.
For more information on D&O insurance, please review these related resources:
- D&O insurance basics (Part 1 of 2)
- COVID-19/bankruptcy protections: gloves, masks and D&O insurance
- COVID-19 and directors & officers claims: A roadmap for insurance renewal
- COVID-19 and D&O insurance coverage: Have we seen this movie before?