Last week, the Ninth Circuit affirmed fraud convictions for Theranos’ former CEO, Elizabeth Holmes, and former COO, Ramesh Balwani, upholding an order finding both defendants personally liable for $452 million in restitution to various Theranos investors. While it remains to be seen whether the embattled executives will pursue further appeals to the US Supreme Court, the years of litigation and appeals following Theranos’s untimely demise in 2018 highlight the importance of directors and officers having robust “final adjudication” language in conduct exclusions found in all D&O liability policies.

Modern D&O policies contain exclusions for fraudulent or criminal acts. But those exclusions usually cannot apply until a “final adjudication” establishes that the alleged fraudulent or criminal conduct actually occurred. The result is that individuals defending against alleged fraud get the benefit of a defense funded by the D&O policy unless and until the fraud is finally proven. And even where fraud is finally adjudicated, the onus is placed on the insurer to try to recover those costs from the policyholder, which is easier said than done when an entity is insolvent or a beleaguered individual endured years of litigation and appeals. In both cases, the insured may be unable to repay thousands if not millions of dollars in advanced legal fees and expenses if dragged into a new lawsuit by the D&O insurer.

The importance of securing timely and robust defense coverage cannot be overstated. In the case of Theranos, some investors have alleged that the company maintained at least $30 million in D&O coverage. Yet Elizabeth Holmes’ defense alone reportedly cost in excess of $30 million.

When reviewing your D&O policy with an eye towards maximizing executive protection and defense coverage, consider these key issues:

1. What is a “final adjudication”? Negotiate triggers in conduct exclusions to be as narrow as possible. If the policy requires a final adjudication, how is that defined? Some policies specify complete exhaustion of all appeals, while others may trigger at earlier stages. Does the exclusion contemplate adjudications in the underlying action only or in other actions, like those initiated by the insurer to determine coverage under the policy? Are defense expenses expressly carved out from the exclusion? Slight variations can materially impact whether coverage is preserved.
2. What are the insurer’s advancement obligations? A narrow conduct exclusion is only effective if the policyholder can receive the benefits of full and efficient reimbursement of ongoing defense costs in litigation prior to any final adjudication. At a minimum, the policy should make clear that the insurer has a duty to advance defense costs until it is determined that the previously advanced defense costs are not insured.

But how quickly must those payments be made? And what happens if there is a dispute where the insurer is claiming that uncovered parties, claims, or matters allow for limited defense reimbursement under the policy’s “allocation” provision? Following the flow of money from the insurer to the individual (and perhaps back again in a repayment situation) will ensure there are no reimbursement snafus in the midst of contentious litigation that distracts from the underlying defense.

1. How to ensure protection for “innocent” insureds? If one bad actor commits fraud and loses coverage, it should not impact coverage for other individual defendants. Pay close attention to “severability” provisions. Does the policy provide full or limited severability? When, if at all, can wrongful acts committed by one insured by imputed to other insureds who were not involved in the wrongdoing? How does the policy treat other misrepresentations, like those in applications?
2. How to protect executives when the company cannot? Under most D&O policies, the company has access to the same set of limits that otherwise would be available to protect individual insureds. If the company can indemnify and advance legal fees for its executives, those shared limits are usually not problematic. But when the company is insolvent and in bankruptcy, as was the case with Theranos, the D&O policy is the only source of protection preventing executives from personal exposure.

The solution is purchasing dedicated “Side A” coverage that sets aside separate limits that are available exclusively for the benefit of directors and officers when the company is unable or unwilling to provide indemnification. Some D&O policy forms provide built-in dedicated Side A-only limits, but many times they are purchased through standalone policies. Structuring a D&O program with adequate Side A coverage can ensure executives have an insurance backstop to defend, settle, and pay claims when they need it most.

For corporate executives, these small but important aspects of defense coverage under D&O policies can be the difference between executives being fully protected in protracted litigation and being left uninsured and subject to personal exposure.