Directors and officers increasingly face personal exposure from litigation risk, regulatory investigations, and shareholder activism, but the right program of directors and officers (D&O) liability insurance can reduce such exposure. Every director should periodically review his or her company’s D&O insurance program to confirm that it provides the broadest scope of coverage available in the always-evolving D&O insurance market.

Standard D&O policies provide a single policy limit that is shared among three types of coverage:

Side A, for the directors and officers when they are not indemnified by the company or not otherwise insured;
Side B, for reimbursement of the company when it indemnifies directors and officers; and
Side C, for certain claims against the company itself. In the public company context, “Side C” coverage for the company is usually limited to “Securities Claims,” while private company D&O insurance covers companies for a broader variety of claims.

D&O insurance should be considered together with the company’s indemnification obligations. Most companies provide indemnification for their directors and officers that is broader than coverage available under D&O insurance, and a company’s indemnification obligation is uncapped. D&O insurance, on the other hand, is subject to exclusions and a policy limit. That said, D&O insurance protects the company’s balance sheet by covering most of the company’s indemnification obligations (under Side B), and D&O insurance is available to protect directors and officers in certain cases when the company is unable to indemnify them.

The D&O insurance market continues to evolve rapidly. The following are some of the latest trends in the industry.

Offsetting costs from shareholder activism. Shareholder activists continue to be active in the market and aggressive in pursuing directors and officers for perceived mismanagement, entrenchment, and/or alleged breaches of fiduciary duties. In the course of an activist campaign or proxy fight, activists frequently make demands of the directors or the company that trigger coverage under D&O insurance. Depending on the nature of the communications with the activist, the entire policy limit may be implicated; in other cases, D&O insurance sublimits are available to defray a portion of the defense costs. Shareholder activism defense counsel can assist directors and companies in considering whether a company’s D&O insurance is available to offset some of the costs of defense, whether during an activist campaign or as part of an activism preparedness exercise.

Expanding coverage for government investigations. Coverage under D&O insurance for government investigations continues to evolve rapidly. Most D&O policies cover directors when they are the targets of such investigations, but policy language should be carefully reviewed each year to ensure the broadest possible coverage for directors. Many D&O policies also provide limited coverage for a “pre-claim inquiry,” when a regulatory body requests an interview of a director in the course of an investigation of the company. It is also increasingly common for D&O policies to provide some amount of investigations coverage for the company itself. This coverage can include, for example, recognition of retroactive erosion of the retention in the event of a later-filed securities lawsuit involving the same matter and/or coverage for the company when directors are simultaneously targeted in an investigation.

Optimizing D&O insurance coverage for bankruptcy risk. Normally, directors and officers have two sources of funds available for the defense of claims against them: (1) indemnification from the company and (2) D&O insurance. If the company is insolvent or bankrupt, however, indemnification from the company has little to no value. Ideally, D&O insurance protects directors and officers and their personal assets from claims brought by company shareholders or creditors. Directors and officers planning for bankruptcy contingency may consider Side A difference-in-conditions (DIC) coverage because it cannot be rescinded, it offers more flexibility than traditional Side A coverage, and it provides excess and broader protections for company directors.

Negotiating sublimits. Sublimits are policy enhancements that provide retention-free (i.e., first-dollar) coverage for specified events, up to a small percentage of the overall policy limit—usually between $50,000 and $250,000. Policyholder advocates sometimes view sublimits as a way for insurers to carve out items from the coverage provided by the larger policy limit. While this may be true, these sublimits can also provide significant value for companies. For example, we have seen the following sublimits triggered frequently:
- Derivative Demand Investigation Costs. Upon receiving a derivative demand or suit, the board may commence investigation by a special litigation committee. D&O insurance policies frequently provide sublimits for the costs of these investigations. Recently, excess D&O insurers have agreed to add sublimits to their own policies for these costs, meaning that a second, smaller “tower” of D&O insurance may be available to offset these costs.
- Books and Records. Historically, D&O insurers of public companies have refused to cover the costs of defending a books and records inspection demand because the demand is not a “Securities Claim.” Recently, D&O insurers have been adding coverage for these costs to their policies. The most common approach is to add the defense costs associated with a books and records demand to the derivative demand investigation costs sublimit described above. When combined with sublimits from excess insurers, these sublimits can be very useful, especially because books and records demands are being litigated more frequently. Other D&O insurers will add coverage for books and records demand defense costs into the larger policy limit if there is a concurrent “Securities Claim” against the company.
- Crisis coverage. Crisis event sublimits facilitate company responsiveness to high-pressure events. For example, a company’s negative earnings announcement, the loss of a key executive, or the threat of a regulatory investigation are typical triggers of the crisis coverage sublimit.

Understanding your company’s D&O insurance program is critical to managing your own risk profile as well as your company’s risk profile. Every director should periodically review his or her company’s D&O insurance program, ideally with the assistance of an experienced broker and outside counsel.

Sarah Mitchell is counsel and Mustafa Abdul-Jabbar is an associate at Vinson & Elkins LLP. All thoughts expressed here are their own.

Sarah Mitchell and Mustafa Abdul-Jabbar

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