Tag: D&O insurance


D&O Liability: A Downside of Being a Corporate Director

Alex R. Lajoux is chief knowledge officer at the National Association of Corporate Directors (NACD). This post is based on a NACD publication authored by Ms. Lajoux. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

One of the few downsides to board service is the exposure to liability that directors of all corporations potentially face, day in and day out, as they perform their fiduciary duties. The chance of being sued for a major merger decision is now 90 percent; but that well known statistic is just the tip of an even larger iceberg. The Court of Chancery for the state of Delaware, where some one million corporations are incorporated (among them most major public companies), hears more than 200 cases per year, most of them involving director and officer liability. And given the high esteem in which Delaware courts are held, these influential D&O liability decisions impact the entire nation.

This ongoing story, covered in the May-June issue of NACD Directorship magazine, recently prompted the National Association of Corporate Directors (NACD) to take action. Represented by the law firm Gibson Dunn & Crutcher LLP, NACD filed an amicus curiae (“friend-of-the-court”) brief in the matter of In re Rural/Metro, a complex case likely to continue throughout the summer. Essentially, the Court of Chancery ruled against directors and their advisors, questioning their conduct in the sale of Rural/Metro to a private equity firm.

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What’s New in 2015: Cybersecurity, Financial Reporting and Disclosure Challenges

The following publication comes to us from Weil, Gotshal & Manges LLP and is based on a Weil alert; the complete publication, including footnotes, is available here.

As calendar-year reporting companies close the books on fiscal 2014, begin to tackle their annual reports on Form 10-K and think ahead to reporting for the first quarter of 2015, a number of issues warrant particularly close board and management attention. In highlighting these key issues, we include guidance gleaned from the late Fall 2014 programs during which members of the staff of the Securities and Exchange Commission (SEC) and other regulators delivered important messages for companies and their outside auditors to consider. Throughout this post, we offer practical suggestions on “what to do now.”

While there are no major changes in the financial reporting and disclosure rules and standards applicable to the 2014 Form 10-K, companies can expect heightened scrutiny from regulators, and heightened professional skepticism from outside auditors, regarding compliance with existing rules and standards. Companies can also expect shareholders to have heightened expectations of transparency fostered by notable 2014 events such as major corporate cyber-attacks. Looking forward into 2015, companies will need to prepare for a number of significant changes, including a new auditing standard for related party transactions, a new revenue recognition standard and, for the many companies that have deferred its adoption, a new framework for evaluating internal control over financial reporting (ICFR). The role of the audit committee in helping the company meet these challenges is undiminished—and perhaps, in regulators’ eyes, more important than ever.

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Update on Directors’ and Officers’ Insurance in Bankruptcy

The following post comes to us from Douglas K. Mayer, Of Counsel in the Restructuring and Finance Department at Wachtell, Lipton, Rosen & Katz, and is based on a Wachtell Lipton memorandum by Mr. Mayer, Martin J.E. Arms, and Emil A. Kleinhaus.

Directors’ and officers’ (“D&O”) insurance coverage continues to represent a key element of corporate risk management. See memo of July 28 2009. A decision in the bankruptcy of commodities brokerage MF Global, In re MF Global Holdings Ltd., No. 11-15059 (S.D.N.Y. Sept. 4, 2014), provides a recent illustration of how D&O insurance may be treated upon the bankruptcy of the insured company, depending on the specific structure and terms of the insurance at issue.

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How Much Protection Do Indemnification and D&O Insurance Provide?

The following post comes to us from Jon N. Eisenberg, partner in the Government Enforcement practice at K&L Gates LLP, and is based on a K&L Gates publication by Mr. Eisenberg; the complete publication, including footnotes, is available here. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

We consider below how advancement of legal fees, indemnification, and insurance operate when officers and directors become involved in regulatory investigations and proceedings. Part I addresses the enhanced risk officers and directors face today in an Age of Accountability. Part II addresses advancement of legal fees, which may be discretionary or mandatory depending on a company’s by-laws. Part III covers indemnification, which generally requires at least a conclusion that the officers and directors acted in good faith and reasonably believed that their conduct was in, or at least not contrary to, the best interests of the corporation. Part IV examines insurance coverage, which varies from carrier to carrier and may or may not provide meaningful protection. Finally, Part V summarizes the principal lessons from the analysis. Although there is significant overlap with similar principles that apply to private litigation, we limit our discussion here to advancement, indemnification, and insurance for regulatory investigations and proceedings.

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Considerations for Directors in the 2014 Proxy Season and Beyond

Amy Goodman is a partner and co-chair of the Securities Regulation and Corporate Governance practice group at Gibson, Dunn & Crutcher LLP and John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. The following post is based on a Gibson Dunn alert by Ms. Goodman, Mr. Olson, Gillian McPhee, and Michael J. Scanlon.

As we begin 2014, calendar-year companies are immersed in preparing for what promises to be another busy proxy season. We continue to see shareholder proposals on many of the same subjects addressed during last proxy season, as discussed in our post recapping shareholder proposal developments in 2013. To help public companies and their boards of directors prepare for the coming year’s annual meeting and plan ahead for other corporate governance developments in 2014, we discuss below several key topics to consider.

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FDIC Cautions Financial Institutions Regarding Increase in D&O Insurance Exclusions

The following post comes to us from John Dugan, partner and chair of the Financial Institutions Group at Covington & Burling LLP, and is based on a Covington & Burling E-Alert.

The FDIC last week issued a Financial Institution Letter advising financial institutions and their directors and officers of the increased use of exclusionary terms or provisions in D&O policies, and the resulting increased risk of uninsured personal civil liability for directors and officers. (FIL-47-2013, October 10, 2013).

The FDIC Letter urges the directors of financial institutions to make well-informed choices about D&O coverage, including consideration of costs and benefits, exclusions and other restrictive terms in proposed policies, and the implications for personal financial liability for directors and officers.

D&O insurance is a critical asset for financial institutions and their directors and officers, and the FDIC Letter expressly affirms that the purchase of D&O insurance serves a valid business purpose. The FDIC’s Letter is also a timely reminder that the D&O insurance market is in constant flux and that—in addition to seeking advice from insurance brokers—directors should consider seeking advice from experienced coverage counsel to gain a better understanding of the potential impact of restrictive provisions in proposed policies.

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Accounting and Litigation Risk

The following post comes to us from Zhiyan Cao, Assistant Professor of Accountancy at the University of Washington Tacoma, and Ganapathi S. Narayanamoorthy, Assistant Professor of Accountancy at the University of Illinois at Urbana-Champaign.

In our paper, Accounting and Litigation Risk: Evidence from Directors’ & Officers’ Insurance Pricing, forthcoming in the Review of Accounting Studies, we study whether and how financial reporting concerns and traditional measures of corporate governance are priced by insurers that sell Directors’ and Officers’ (D&O) insurance to public firms. As D&O insurers typically assume the liabilities arising from shareholder litigation, the insurance premiums they charge for D&O coverage reflect their assessment of a company’s litigation risk.

Estimation of ex-ante litigation risk has always been a challenge for empirical research. Past studies employ ex-post lawsuits to derive an ex-ante measure of litigation risk. In such studies, a litigation risk prediction model is first estimated with the dependent variable being whether the firm got sued ex-post. The predicted values of the probability of getting sued are then used as ex-ante measures of litigation risk in an empirical model. Such measures ignore lawsuits filed in other jurisdictions and also cannot distinguish between frivolous and serious lawsuits. We employ a market-based measure of ex-ante litigation risk; that is, the D&O liability insurance premium, which incorporates the ex-ante expectation of both the likelihood of lawsuits and the magnitude of damages. In the U.S., public firms routinely purchase D&O insurance coverage for their directors and officers for reimbursement of defense costs and settlements arising from shareholder litigation. Most shareholder litigation is settled within policy limits, with the D&O insurers primarily footing the bill. Therefore, we expect the D&O insurers to price financial reporting risk and corporate governance risk efficiently in order to compensate for their expected payout obligations in the case of lawsuits.

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Protecting Directors When Firms Fail Post-Merger

Scott Davis is the head of the US Mergers and Acquisitions group at Mayer Brown LLP. This post is based on an article by Mr. Davis and William R. Kucera that first appeared in Insights: The Corporate & Securities Law Advisor.

The aftermath of the recent acquisition of Lyondell by Basell provides a striking example of the risk that directors face if they approve a cash merger financed in substantial part through borrowing and the target then fails. The deal was characterized as an “absolute home run” by Lyondell’s financial advisor. [1] But less than thirteen months after the closing of the merger in December 2007, Lyondell filed for bankruptcy. A litigation trust established by the bankruptcy court to marshal the debtor’s assets has sued Lyondell’s former directors, seeking damages on the theory that the merger, while beneficial to Lyondell’s shareholders, unlawfully mistreated Lyondell’s creditors by causing the company to become insolvent. [2] The case is pending. To add to the directors’ problems, the excess directors’ and officers’ insurance carrier has declined coverage on several grounds, among them that, because the litigation trust stands in Lyondell’s shoes, this is an “insured v. insured” matter not covered by the D&O policy. [3]

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Court Rejects Insurers’ Attempt to Avoid D&O Coverage

Marc Wolinsky is a member of the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Wolinsky, Martin J.E. Arms and Olivia A. Maginley. The post relates to the opinion in the case of Pendergest-Holt v. Lloyd’s of London, et al., which is available here.

In a recent opinion, the Fifth Circuit upheld a decision that prohibited D&O insurers from refusing to pay for the defense of a number of executives charged with civil and criminal wrongdoing by the SEC and the Department of Justice. Pendergest-Holt v. Lloyd’s of London, et al., No. 10-20069, 2010 WL 909090 (5th Cir. Mar. 15, 2010). The ruling has implications for insurers and insureds alike, as it will affect the ability of insurers to stop advancement of defense costs and may result in insurers changing the language of their policies.

The case arises out of the widely-reported charges that have been leveled against several executives of Stanford Financial Group. In order to fund their defense, the executives sought coverage for defense costs under two D&O policies. Both policies had an exclusion where the claims arose “in connection with any act or acts (or alleged act or acts) of Money Laundering.” The policies provided, however, that the insurers would only pay defense costs “until such time that it [was] determined that the alleged act or alleged acts did in fact occur.”

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Directors’ and Officers’ Insurance

This post is by Igor Kirman of Wachtell, Lipton, Rosen & Katz. This post was written together with his colleagues Warren R. Stern and Martin J.E. Arms.

At a time of historically significant dislocation in the corporate world, directors and officers now more than ever need to focus their attention on directors’ and officers’ (“D&O”) insurance, as part of their overall strategy involving effective corporate governance and risk management. Although the best protection should continue to come from conscientious attention to directorial and management responsibilities, an effective D&O insurance program, in combination with well-drafted indemnification and exculpation provisions in corporate charters and by-laws, is a critical component of protection for directors and officers at a time of increased scrutiny by shareholders, courts and regulators. Recent judicial developments further highlight the need for careful attention to policy terms, which can be outcome-determinative in significant litigation. Below are some thoughts on D&O insurance in these troubled times.

1. Side A excess coverage:

The main types of coverage provided by many D&O insurance policies are known as A, B and C coverage. The “A” coverage directly indemnifies a director or officer with respect to claims for which the company is not able to indemnify that director or officer, either by reason of law or financial insolvency. (Some companies purchase only A coverage.) The “B” coverage reimburses the company for amounts that it pays to a director or officer through indemnification. The “C” coverage is for claims directly against the company, but, for public companies, that coverage is almost always limited to securities claims. These types of coverage work together to provide broad protection for individuals and the company. But be wary: coverage can be exhausted by claims made on the B and C coverage, i.e., coverage that, in the end, insures the company and not the directors and officers themselves. This may leave directors and officers exposed when they need coverage most — when there is a claim for which the company cannot indemnify them. To avoid this problem, to the extent they do not do so already, companies that purchase A, B, C coverage should consider purchasing additional A-only coverage in excess of the A, B, C coverage. This A-only excess coverage will protect directors and officers if nonindemnifiable claims or obligations arise after the underlying A, B, C coverage has been exhausted. There is also a more comprehensive (and thus more expensive) version of A-only excess coverage known as A-only Difference-in-Conditions (“DIC”) excess coverage. Under DIC coverage, the excess policy will “drop down” to provide coverage when another insurer fails to pay a claim (including as a result of insurer insolvency) or when a company fails to indemnify. DIC policies generally provide broader coverage terms than traditional A-only excess coverage. A DIC policy should also provide coverage if a bankrupt estate successfully argues that the underlying A, B, C policy is the property of the estate. In order to provide the greatest protection against insurer insolvency, companies that purchase DIC excess coverage should consider purchasing it from an insurer that is not on the underlying A, B, C insurance program.

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