Would Your D&O Liability Insurance Policy Withstand A Bankruptcy Filing?

How can you assure that your directors and officers insurance policy will provide adequate protection in a bankruptcy?

We suggest examining a number of critical elements in the D&O coverage and the overall liability program.

While the traditional sources of protection for corporate officers and directors are indemnification from the corporation, as well as directors and officers liability insurance that, in a sense, serves as a supplement or backstop to corporate indemnification, there is much more to it when bankruptcy is involved.

Directors and officers would ordinarily look to the corporation to advance the defense costs and pay any settlement or judgments in the event of a lawsuit, according to the company's indemnification provisions. But in a bankruptcy, the ailing corporation may not be able to cover those costs, and the indemnification protection may become worthless.

Chances are the directors and officers would have to rely on the D&O insurance coverage next.

THE PIVOTAL PROVISIONS

How a D&O insurance policy will respond in the event of a bankruptcy depends on a number of key provisions that can vary widely from carrier to carrier. To maximize protection for directors and officers, it's critical to examine, and possibly negotiate, the following:

o Change of Control Provision–a provision that is gaining increased relevance in light of recent corporate bankruptcies and bank takeovers.

Know what kind of change-of-control triggers are in your D&O policy and when they go into effect. For example, will your change-of-control provision be triggered in the event of a bankruptcy filing where the corporation obtains debtor-in-possession status?

o Priority-of-payments endorsement–the proceeds of the D&O policy first go to pay for the defense of individual directors and officers; and then, if anything is left, to the defense of the company.

If a company seeks bankruptcy protection, is the D&O policy available to pay defense costs and liability for the individual directors and officers?

Bankruptcy trustees could argue that the D&O policy provides entity coverage and thus is an asset of the estate.

o Waiver of automatic stay provision–waives the stay to the extent it would block individuals from getting the proceeds of the policy.

When a company files for bankruptcy, the assets of the company are "stayed" or held by the bankruptcy court to disperse at a later time. If the D&O policy contains entity coverage, the policy is considered to be an asset of the company and is stayed when the company files for bankruptcy.

The bankruptcy court needs to release the D&O insurance policy from the stay in order for the directors and officers to have access to it. The waiver of the automatic stay provision states that the insureds have agreed to waive and release any automatic stay or injunction, and that they agree not to oppose any relief from such stay or injunction.

o Full severability provision that applies to the application and the exclusions to protect innocent or nonparticipating directors and officers.

Such a provision guards against the possibility that actions of another director will affect the ability of nonparticipating directors to receive payments under the policy.

o Nonrescindable Side A coverage.

Side A coverage is found in the D&O policy and covers directors and officers in the event they do not receive indemnification from their companies. It is possible to obtain language that makes this coverage nonrescindable.

o Separate Side A-only insurance policies that provide protection exclusively to directors and officers to the extent the company can not or is unable to indemnify them.

In the event the company enters bankruptcy and a court freezes the D&O policy as an asset of the bankruptcy estate, this policy will provide protection.

Additionally, if directors and officers find themselves without sufficient protection due to insolvent D&O insurers, lack of indemnification from the corporation, or if the D&O carriers deny or attempt to rescind coverage, this separate policy will offer protection only for the directors and officers.

o Side A excess difference-in-conditions coverage is designed to sit above–or in excess of–a corporation's primary D&O insurance coverage.

As an excess coverage, it would respond if the limits of the primary insurance were ever exhausted by defense costs or a settlement.

As a difference-in-conditions policy, it can also drop down and become primary coverage in certain situations, such as when the underlying policy denies coverage for some reason.

Excess DIC policies solely protect the individual directors and officers. These policies are nonrescindable

o The insured vs. insured exclusion with a carve-out for lawsuits brought by bankruptcy trustees and creditor committees.

In the last few years, bankruptcy trustees have been aggressive about filing lawsuits against former directors and officers. This carve-out could ensure the individuals targeted by such litigation would be entitled to coverage.

o A fraud/crime exclusion appears in every D&O policy, but there are differences in the fine print that determine when the exclusion kicks in and to what type of conduct it applies.

o Extended reporting period coverage, also known as tail coverage, is a feature that allows companies to buy a period of time which attaches at the end of the policy period during which they can report claims.

It is possible to obtain a notice-of-circumstance provision during this discovery period, not just the policy period, and to predetermine the cost of this tail coverage for numerous years.

o Regulatory exclusion that absolves the insurer of paying claims in the event of enforcement actions, investigations (formal or informal) and other fallout as a result of government oversight.

This exclusion was last seen during the savings and loan crisis, but it is making a comeback these days.

o A hammer clause, typically found in D&O policies, states that in the event an insured refuses a settlement recommended by the insurance company, the insurance company's liability is limited to the recommended amount.

Depending upon the ultimate outcome of a suit, this could result in a significant portion of a judgment being paid by an insured.

START EARLY

In these tumultuous times, board members and officers should review their indemnification provisions and scrutinize the D&O policy. Naturally, it is far easier to negotiate D&O policy provisions or even seek other carriers while the company is on sound financial footing.

We suggest starting the re-negotiation or renewal process for D&O policies at least six months before policies expire. This is the best way to create a D&O program that maximizes protection for the board members and officers, especially in the current economic and litigation environments.

Rick Grimes is an executive vice president for Professional Risk Solutions, a wholesale insurance broker and provider of directors and officers, errors and omissions, and cyber security liability coverages headquartered in Somerset, N.J. Mr. Grimes may be reached at rick@prsbrokers.com. Karen Kutger, vice president and branch manager of the Philadelphia branch of Professional Risk Solutions, may be reached at karen@prsbrokers.com.