5 things to know about Side A D&O coverage

If there is a form of professional liability insurance that few,if any, organizations can't afford to do business without,it's Directors & Officers (D&O) liability insurance.

There are a wide variety of D&O insurance products andoptions available, but one of the most valued by individualdirectors and officers is the Side A insurance policy. Side Ainsurance provides direct coverage for individual directors andofficers when the organization is legally unable or unwilling toindemnify its directors and officers. Two of the more commonreasons for this failure to indemnify are the bankruptcy or insolvency of the organization or a legalprohibition against indemnification.

Without the added benefit of Side A coverage, if anunindemnifiable claim situation were to arise, the individualdirectors and officers could be personally exposed to significant legal expenses, judgments andsettlements. Moreover, without the benefit of a Side A policy, anorganization may find it difficult to recruit, attract and retainthe most qualified candidates for its operations and corporategovernance.

There are several points to keep in mind when considering Side AD&O coverage. Organizations should discuss these with theirinsurance broker and insurance partners.

1. Coverage limits

The Side A policy is essentially a form of excess D&Oinsurance that generally sits on top of a traditional D&Oinsurance tower of coverage. A traditional A, B & C D&Opolicy contains three components of coverage, each of which can beindividually or jointly triggered by a particular claim situationor event.

Side A coverage component provides D&Ocoverage to directors and officers for unindemnifiable claimsituations.
Side B coverage section reimbursesorganizations for indemnity payments made by the organization onbehalf of the company's directors and officers.
Side C provides coverage to the corporateentity for particular types of claims (primarily, claims forviolations of the securities laws).

All those components are subject to one limit of liability.Thus, a claim-triggering coverage under a particular section of theD&O policy can and often will erode the available policy limitsthat may be indispensable to cover other types of claims. Therationale and justification for the Side A policy is to ensurethere will be sufficient and accessible coverage solely for theindividual directors and officers.

2. Coveragescope

Over time D&O insurers broadened the coverage availableunder the Side A policy by deleting or limiting some traditionalD&O policy exclusions and adding difference-in-conditionwording (DIC coverage). This allows the Side A policy to operate asan excess insurance policy and “drop down” to provide neededinsurance coverage when the underlying insurer is unable — orunwilling — to pay a covered loss on behalf of the directors andofficers.

As the Side A policy generally sits on top of a traditionalD&O insurance tower, it provides broader insurance coverage andcan potentially fill in some gaps in a variety of claimsituations.

3. Market behavior and claim environment

D&O insurance is a competitive market, with numerous insurersoffering the same or similar coverage. Unfortunately, when it comesto adjusting a claim, not every D&O insurer competes to payclaims properly and promptly. As more claims emerge under Side Acoverage, some Side A D&O insurers may attempt to limit oravoid their responsibilities.

Additionally, in recent years, plaintiffs' counsel representingshareholders appear to view Side A D&O insurance as apotentially lucrative insurance proceeds recovery opportunity inconnection with shareholder-driven derivative lawsuits. Further, asa result of some recent high-profile and sizable derivative suitsettlements involving profitable and successful companies, thereare indications that a new trend may be emerging of larger and morecostly derivative settlements, which theoretically createsadditional challenges for insureds and their D&O insurers.

A shareholder typically files a derivative lawsuit on behalf ofthe company against the company's directors and officers when theplaintiff believes the organization has been materially harmed bythe allegedly improper actions or inactions of the directors andofficers.

Plaintiffs, for example, may make a claim that as a directresult of the directors' and officers' mismanagement the companybecame the subject of government investigations and prosecutionsresulting in the company having to pay substantial fines orpenalties. Even worse, the company may be legally banned orprevented from engaging in future business transactions.

Because the purportedly injured party is the corporation itself,other than the company paying for the directors and officersdefense costs and expenses, generally the corporation is legallyunable to pay judgments and settlements on behalf of the directorsand officers as the company would be paying the judgment orsettlement to itself.

4. Legal settlements

If a D&O insurer in a company's D&O tower objects to asettlement opportunity in connection with a derivative suit onbehalf of the organization's directors and officers, arguing thatthe proposed settlement is unreasonable, or the insurer refuses toparticipate, due to the DIC language in the Side A policy, thecompany could then look to its Side A coverage to step in and pay aportion of the settlement.

In other words, in certain situations the Side A coverage can belooked at as a reliable and useful source of insurance coverage inaddition to those times when the underlying D&O insurancepolicies are exhausted.

In those instances when the underlying D&O insurer takes anadverse position on coverage, the Side A D&O policy may betriggered and after paying loss, the Side A insurer may thendetermine that it's appropriate to exercise its right to pursue theunderlying recalcitrant D&O insurer to recover the monies thatthe underlying D&O insurer should have and was legallyobligated to pay. Although this may be a problematic state ofaffairs for the D&O and Side A insurer, the Side A coverage isnonetheless working to protect the uninsured and personally exposeddirectors and officers.

Because the vast majority of D&O litigation is ultimatelysettled, and to avoid coverage disputes, it's critical for theinsureds and their brokers to know and understand whether aparticular insurer possesses a strong and reliable reputation forsupporting its insureds in difficult and costly claim situations.In addition, the insured should confirm that the proposed insureris recognized for standing by its insureds and following the termsand conditions of its policy.

5. Open communication

Given recent market behavior and the potential for costlysettlements, the importance of a clear, candid, open and robustline of communication between insurers, insureds and the insurancebroker cannot be overstated. An insurer misunderstanding andnot appropriately responding to a claim not only makes the D&Oclaim process more challenging and cumbersome but also can createan unpleasant and potentially expensive experience for the brokerand most importantly the insured.

When it's necessary and appropriate for a Side A D&O carrierto step in, it's not unlike a backup quarterback coming off thesideline to finish the game. As the Philadelphia Eagles learned inDecember 2017, when their starting quarterback sustained aseason-ending injury, it's important to have a talented andexperienced backup who knows the entire playbook. Fortunately forthe Eagles, their backup quarterback, Nick Foles, took the team allthe way through the playoffs and won the Super Bowl.

Strong partnerships, teamwork and regular and candidcommunications are key to overcoming a challenging and difficultclaim situation. In the complex world of D&O insurance,organizations should choose their insurance partners with care.

Steven Gladstone is XL Catlin's Global Practice leader forProfessional Claims. he can be reached at steven.gladstone@xlcatlin.com.

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