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 and options available, but one of the most valued by individual directors and officers is the Side A insurance policy. Side A insurance provides direct coverage for individual directors and officers when the organization is legally unable or unwilling to indemnify its directors and officers. Two of the more common reasons for this failure to indemnify are the bankruptcy or insolvency of the organization or a legal prohibition against indemnification.
Without the added benefit of Side A coverage, if an unindemnifiable claim situation were to arise, the individual directors and officers could be personally exposed to significant legal expenses, judgments and settlements. Moreover, without the benefit of a Side A policy, an organization may find it difficult to recruit, attract and retain the most qualified candidates for its operations and corporate governance.
There are several points to keep in mind when considering Side A D&O coverage. Organizations should discuss these with their insurance broker and insurance partners.
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1. Coverage limits
The Side A policy is essentially a form of excess D&O insurance that generally sits on top of a traditional D&O insurance tower of coverage. A traditional A, B & C D&O policy contains three components of coverage, each of which can be individually or jointly triggered by a particular claim situation or event.
- Side A coverage component provides D&O coverage to directors and officers for unindemnifiable claim situations.
- Side B coverage section reimburses organizations for indemnity payments made by the organization on behalf of the company’s directors and officers.
- Side C provides coverage to the corporate entity for particular types of claims (primarily, claims for violations of the securities laws).
All those components are subject to one limit of liability. Thus, a claim-triggering coverage under a particular section of the D&O policy can and often will erode the available policy limits that may be indispensable to cover other types of claims. The rationale and justification for the Side A policy is to ensure there will be sufficient and accessible coverage solely for the individual directors and officers.
2. Coverage scope
Over time D&O insurers broadened the coverage available under the Side A policy by deleting or limiting some traditional D&O policy exclusions and adding difference-in-condition wording (DIC coverage). This allows the Side A policy to operate as an excess insurance policy and “drop down” to provide needed insurance coverage when the underlying insurer is unable — or unwilling — to pay a covered loss on behalf of the directors and officers.
As the Side A policy generally sits on top of a traditional D&O insurance tower, it provides broader insurance coverage and can potentially fill in some gaps in a variety of claim situations.
3. Market behavior and claim environment
D&O insurance is a competitive market, with numerous insurers offering the same or similar coverage. Unfortunately, when it comes to adjusting a claim, not every D&O insurer competes to pay claims properly and promptly. As more claims emerge under Side A coverage, some Side A D&O insurers may attempt to limit or avoid their responsibilities.
Additionally, in recent years, plaintiffs’ counsel representing shareholders appear to view Side A D&O insurance as a potentially lucrative insurance proceeds recovery opportunity in connection with shareholder-driven derivative lawsuits. Further, as a result of some recent high-profile and sizable derivative suit settlements involving profitable and successful companies, there are indications that a new trend may be emerging of larger and more costly derivative settlements, which theoretically creates additional challenges for insureds and their D&O insurers.
A shareholder typically files a derivative lawsuit on behalf of the company against the company’s directors and officers when the plaintiff believes the organization has been materially harmed by the allegedly improper actions or inactions of the directors and officers.
Plaintiffs, for example, may make a claim that as a direct result of the directors’ and officers’ mismanagement the company became the subject of government investigations and prosecutions resulting in the company having to pay substantial fines or penalties. Even worse, the company may be legally banned or prevented from engaging in future business transactions.
Because the purportedly injured party is the corporation itself, other than the company paying for the directors and officers defense costs and expenses, generally the corporation is legally unable to pay judgments and settlements on behalf of the directors and officers as the company would be paying the judgment or settlement to itself.
4. Legal settlements
If a D&O insurer in a company’s D&O tower objects to a settlement opportunity in connection with a derivative suit on behalf of the organization’s directors and officers, arguing that the proposed settlement is unreasonable, or the insurer refuses to participate, due to the DIC language in the Side A policy, the company could then look to its Side A coverage to step in and pay a portion of the settlement.
In other words, in certain situations the Side A coverage can be looked at as a reliable and useful source of insurance coverage in addition to those times when the underlying D&O insurance policies are exhausted.
In those instances when the underlying D&O insurer takes an adverse position on coverage, the Side A D&O policy may be triggered and after paying loss, the Side A insurer may then determine that it’s appropriate to exercise its right to pursue the underlying recalcitrant D&O insurer to recover the monies that the underlying D&O insurer should have and was legally obligated to pay. Although this may be a problematic state of affairs for the D&O and Side A insurer, the Side A coverage is nonetheless working to protect the uninsured and personally exposed directors and officers.
Because the vast majority of D&O litigation is ultimately settled, and to avoid coverage disputes, it’s critical for the insureds and their brokers to know and understand whether a particular insurer possesses a strong and reliable reputation for supporting its insureds in difficult and costly claim situations. In addition, the insured should confirm that the proposed insurer is recognized for standing by its insureds and following the terms and conditions of its policy.
5. Open communication
Given recent market behavior and the potential for costly settlements, the importance of a clear, candid, open and robust line of communication between insurers, insureds and the insurance broker cannot be overstated. An insurer misunderstanding and not appropriately responding to a claim not only makes the D&O claim process more challenging and cumbersome but also can create an unpleasant and potentially expensive experience for the broker and most importantly the insured.
When it’s necessary and appropriate for a Side A D&O carrier to step in, it’s not unlike a backup quarterback coming off the sideline to finish the game. As the Philadelphia Eagles learned in December 2017, when their starting quarterback sustained a season-ending injury, it’s important to have a talented and experienced backup who knows the entire playbook. Fortunately for the Eagles, their backup quarterback, Nick Foles, took the team all the way through the playoffs and won the Super Bowl.
Strong partnerships, teamwork and regular and candid communications are key to overcoming a challenging and difficult claim 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 for Professional Claims. he can be reached at firstname.lastname@example.org.