The purchase of standard form insurance policies is a routine part of doing business. Oftentimes, insurance is treated as an unavoidable expense for which placement decisions are driven by the desire to keep premium expenses under control. But insurance is a valuable corporate and personal asset—particularly with respect to directors and officers (D&O), fiduciary liability and other management liability insurance programs. It is not uncommon, however, for even the most sophisticated individuals and businesses to treat insurance policies as boilerplate forms that are "all the same" and need little or no legal scrutiny. While this may be an overstatement, it underscores the common gulf between the scrutiny afforded to insurance coverage terms and the potential significance of those terms for the financial well-being of insured companies and individuals.

Insurance policies are complex contracts that can serve as a safety net for the insured when confronted with significant liabilities. For example, management liability insurance programs may provide coverage to both a company and individual directors, officers or fiduciaries for liabilities incurred as a consequence of claims for actual or alleged "wrongful acts" in connection with the management of the company. These policies are typically called upon to provide protection with respect to stock-price drop, shareholder derivative and other categories of claims aimed at second-guessing corporate decisions. As the backstop for these high-stakes claims, which are costly to defend and may endanger the financial well-being of individual directors and officers, the terms and conditions of management liability insurance policies have significant legal and financial consequences. What’s more, not every insured has the same needs or faces the same risks, and seemingly minor variations in policy terms can significantly alter the outcome of a claim for coverage.

For example, all management liability insurance policies contain some version of a "crime/fraud" exclusion that applies to claims involving fraudulent, dishonest or criminal conduct. The types of claims for which these policies are intended to provide coverage frequently make allegations involving the excluded conduct. There are numerous permutations of this exclusion, each with significant impacts for coverage. Does the exclusion allow the conduct of any one insured person to be imputed to the company and to other insured persons? Does the exclusion apply to allegations that the excluded conduct occurred or must the plaintiffs prove that the conduct occurred before the exclusion will apply? If a mere allegation is insufficient, how must the excluded conduct be established in order to trigger the exclusion? These and numerous other variations—commonly found in insurance forms offered by major management liability insurers—will have different effects on the availability of insurance proceeds to pay for defense and indemnification.

Following are several scenarios that further illustrate how some common variables in management liability insurance policy terms can have dramatic economic and business consequences:

• The SEC launched an investigation of suspected insider trading, titled “In Re Company Securities.” Although the company itself only received an initial general informational subpoena, the SEC served multiple subpoenas on several former directors and requested multiple interviews with them, as well as their associates and family. The company was obligated under its bylaws to advance defense costs on behalf of the former directors. The controlling D&O liability insurance policy provided that the insurer would reimburse the defense costs in the event of a "claim," which was defined in part as an "investigation" of an "insured person." The insurer took the position that the investigation was of the company (not the insured persons) and that there was no "claim" until the SEC filed a civil complaint against one of the former directors. The dispute was resolved only after protracted litigation and significant expense to the company. Unbeknownst to the company, the insurer had an alternative policy form that defined a "claim" to include the service of an investigative subpoena on an "insured person.” Had this language been in place, the company could have saved a great deal of time and money.

• A publicly traded company was in the midst of a change in corporate control. There had been board dissension about the manner in which competing proposals for the takeover had been evaluated. Against this backdrop, there was reason to fear that one or more classes of interested stakeholders would eventually bring litigation concerning the transaction. Of vital importance to the board and the company was preserving the continuity of its D&O and fiduciary liability policies, which typically convert into run-off policies upon a change in corporate control. The run-off endorsement proposed by the company's insurer stated that claims involving any facts, circumstances or events taking place after the transaction would not be covered by the run-off policy. That same insurer offered an endorsement to the post-transaction insurance stating that claims involving any facts, circumstances or events taking place before the transaction would not be covered under the new policy. Although the insurer insisted that it did not intend to create any discontinuity in coverage, it was nearly inconceivable that a claim would be brought that did not involve some combination of facts taking place both before and after the transaction. As such, the company ran the risk of being uninsured unless alternate language could be manuscripted.

• Three executives (including the CEO and CFO) of a company were involved in an accounting fraud that consisted of booking sham sales with cooperating entities and then making corresponding sham purchases from those same entities to create an appearance of growing revenues. Once the fraud was detected, the company restated its financials, cooperated fully with the authorities, terminated the CEO and CFO, and refused to approve any advance of their defense costs without a court order. Nonetheless, the company’s D&O insurers sought to rescind their policies. In the ensuing shareholder lawsuits, the company incurred substantial liabilities. Unfortunately, the policy applications, which were signed by the now-former CEO, contained extremely unfavorable representations and warranties, and rescission and severability provisions. Collectively, they provided that if the person signing the application had reason to be aware of inaccuracies in the application or the materials incorporated into the application (e.g., the financial statements), the policy would be void ab initio as to all insureds, including completely innocent individuals. Unfortunately for the company and its board, litigation with the D&O insurers resulted in summary judgment in favor of the insurers. The company might have avoided this mishap if it had explored alternate forms of the representations and warranties, severability, and rescission terms at the time of placement.

Each of these examples illustrates how treating the insurance policy as a significant commercial contract either identified or would have helped identify potential hazards for coverage. Careful scrutiny of an insurance contract at the outset—with an eye to identifying problematic terms and with an understanding of how these terms are applied by insurers and interpreted by the courts—can provide significant value to policyholders. In some cases, it may be possible to identify and obtain more favorable or more suitable policy terms that ultimately make the difference between being covered and paying for defense and settlement costs out of your own pocket.