If insolvency of your company occurred tomorrow, would you personally be prepared or adequately covered? Oftentimes a directors’ and officers’ (D&O) insurance policy is the only thing that stands between the company’s creditors and a D&O’s personal assets. Ensuring adequate protection is crucial in today’s unstable economy. Thus, it is important that your company’s D&O policy, which is a legal contract subject to negotiation, is reviewed and negotiated by a knowledgeable attorney so that it contains the strongest possible protection.

Not all D&O policies are created equal, and some provide much greater protection than others.  We often work with boards of directors, board committees, general counsel, risk managers and individual directors and officers on all aspects of D&O liability insurance policies, including reviewing, negotiating and purchasing D&O and fiduciary liability insurance; advising on the adequacy of corporate bylaws, charters and indemnification agreements with respect to director and officer liability; assisting boards and board committees in evaluating the quality of the company’s D&O coverage; counseling individual directors and officers on minimizing the risk of personal liability; assisting boards and companies in overseeing the litigation of securities fraud, ERISA and derivative claims; and assisting companies, directors and officers in obtaining D&O insurance recoveries.

Specifically, D&O insurance policies contain a handful of important coverages, often referred to as Side A, Side B and Side C coverage.  Side A coverage provides coverage to directors & officers and sometimes employees when the entity cannot or will not indemnify them, often when the entity is insolvent.  Side A coverage is the last line of defense for a director and officer that protects their personal assets.  Side B and Side C coverage provide balance sheet protection to the entity, with Side B for reimbursement of indemnity obligations to D&Os.  Side C coverage provides coverage for the entity itself in the event that it is sued directly.  

As a director or officer of an insolvent company, you want to make sure you have enough dedicated Side A limits to adequately protect you in the event that the company’s creditors attempt to target you personally once the company is insolvent.  Oftentimes, companies purchase dedicated Side A limits of coverage that sits excess of a regular Side ABC limits primary policy.  Remember that the amount of limits the company has purchased for D&O coverage is inclusive of defense costs.  In other words, paying attorneys’ fees for the defense of a third-party liability claim brought by, for example, the company’s creditors will erode and reduce the limits remaining available to pay for the settlement or judgment of such lawsuit.

As a result of auditing policies, we find that we often are able to assist our clients in negotiating significant, important policy enhancements, often at no additional premium charge. The best time to seek such coverage enhancements is when the company is in a stable and healthy financial outlook.  The worst time is when the company is on the brink of insolvency.  Therefore, it is best to consider auditing your coverage when you do not need to be worried about an impending claim.  

What follows are a few items to cross-check on your policy prior to insolvency occurring to ensure that your policy is adequate and has the best market favorable terms:

Does Your Policy Exclude Claims Brought by Bankruptcy Trustees or Creditors’ Committees?

In the event your policy contains a common exclusion referred to as an insured vs. insured or organization vs. insured exclusion, you should make sure it contains a carveback allowing for coverage when a claim is brought by an insured organization through a bankruptcy trustee, creditors’ committee, litigation trustee, assignee or the like to allow for coverage.  This carveback is readily available in the marketplace at no additional premium cost, but you just need to make sure that you ask that it be included.

Does Your Policy Give Priority of Payment to D&Os’ Side A Claims?

Most good D&O standard, off-the-shelf Side ABC policies already contain an “order of payments” provision that in the event the amount of loss exceeds the remaining limits, payments will first be made under the Side A (non-indemnified) claims, which makes it unlikely that a bankruptcy court will find the D&O policy to be solely an asset to the bankruptcy estate.  You should ensure that your policy contains such a provision.

Does Your Policy Contain a “Creditors Exclusion” or Provision in the Policy Making it Inapplicable when Bankruptcy is Filed?

Read the fine print.  You should make sure that your company’s policy does not contain a creditor’s or bankruptcy exclusion or other provision that would cause the policy to not provide any protection to the trustees, directors and officers in the event of insolvency or a bankruptcy filing.  Oftentimes such provisions would be contained in endorsements to the policy, so be sure to review the entire policy, including all endorsements in looking for any such coverage limiting provisions.

Does your Policy set out Reasonable, Preset Premium Amounts for the Purchase of a Tail Policy at Different Increments of Time – 1, 3, 6 years?

Tail coverage expands the time to provide notice of a new claim that alleges a wrongful act that occurred before the end of the original policy period.  In the event that tail coverage need be purchased at the end of the policy period, which often happens in the event of insolvency, you should make sure your policy contains preset reasonable premium amounts for the purchase of such tail coverage in various increments such as 1, 3 and 6 years.  While insurers are more often willing to sell such coverage once insolvency has occurred, the premium for such coverage is often much higher than it would have been if negotiated in advance while the company was still solvent.

In times of insolvency, we have seen insurance companies attempt to avoid their coverage obligations too many times. Because we regularly represent our clients on the claims side, we are very familiar with the loopholes that insurance companies use, and we are able to put this knowledge to good use in correcting potentially ambiguous policy language during a policy audit. 

Acquiring legal counsel who focuses on these matters with the ability to conduct a D&O insurance program audit offers several benefits. First, and perhaps most importantly, you can have a candid discussion with your counsel about the scope of coverage, risk management concerns, potential claims or broker liability all under the protection of the attorney-client privilege. Communications with insurance brokers are often not privileged. Second, as insurance coverage counsel, we keep abreast of the latest developments in insurance coverage law. We know what type of policy language is likely to cause coverage disputes between carriers and insureds and can suggest favorable policy language to help you avoid such disputes. 

D&O policy language should not be taken lightly. After all, it can be used to successfully resolve insurance litigation, and just a few words can make millions of dollars worth of difference. In the times prior to, during and after insolvency, is your D&O policy up to par and will you be protected?

This article first appeared in the Fall 2013 Renaissance Newsletter from Morris Anderson.