Pay on Behalf Language

Indemnify Language

The concept of the corporate-reimbursement coverage part is illustrated in the following example.

 

Loss paid to corporation on a reimbursement basis

 

 

 

Entity Coverage

(Not-for-Profit and Association Liability Policies)

Claims made against the organization arising out of wrongful acts of its directors and officers may be covered, either within the policy's insuring agreements or in an attached endorsement. The following wording appears as an optional coverage part in an endorsement to a policy form designed for not-for-profit entities.

 

Chubb, Entity Relative Endorsement

Loss paid on behalf of entity

 

Entity coverage can provide important protection to the organization when the entity is named directly or as a codefendant with the individual insureds.

 

While entity coverage may provide protection not otherwise available to the corporation, there are three potential major drawbacks. First, the additional premium for the extension of coverage can be substantial—sometimes 50 percent or more of the D&O policy premium. Second, the limit of liability available under the corporate-reimbursement and individual-liability sections could be eroded by claims paid under the entity coverage. Lastly, some insurers provide entity coverage only for not-for-profit, association, or public-entity programs or limit the coverage available to for-profit corporations to claims related to alleged violations of securities laws.

 

Entity Coverage (For-profit Corporations)

 

Once exclusively available to not-for-profit organizations, healthcare providers, and associations, entity coverage has become available in recent years for some for-profit corporations. Entity coverage available for corporations is normally written to cover one or more specific well-defined types of claims as opposed to the broad coverage grant usually offered non-profits.

 

For example, National Union was one of the first insurers to develop and introduce a form of entity coverage endorsement covering the corporate entity for open market securities claims alleging wrongful acts made by the corporation in connection with the purchase or sale of securities. Such coverage addresses a potentially catastrophic exposure faced by many insureds, which in large part was previously uninsurable. Open market securities claim means any claim that alleges a wrongful act in connection with the purchase or sale of securities of the company other than a transaction in which the Company or an Affiliate of the Company is the purchaser or seller of the securities, either directly or indirectly. [National Union, Entity Coverage Endorsement 55996 (1/94)]

 

A particularly problematic exposure for publicly held corporations that has developed in recent years is that of being targeted by groups specializing in class action securities litigation. Such groups often involve law firms that contrive and bring class action suits based on a variety of theories regarding fluctuations in the price of the target company's stock. While some claims are brought by legitimately aggrieved shareholders, some plaintiffs make unsubstantiated claims contending that management knew of events likely to affect stock prices and purposely or negligently withheld releasing such information. Because such suits invariably name both the corporation and one or more directors or officers, all sorts of problems can arise. Allocation of loss between the insured directors and officers and the uninsured corporation is particularly problematic. And even where small variations in stock price occur, because of the potentially large size of the plaintiff class, claimed damages are often astronomical. Just mounting a defense to a class-action suit can be quite expensive and creates pressure to settle even when claims are obviously bogus. National Union's Entity Coverage Endorsement was designed to address these problems by adding the following wording to the insuring agreement.

 

National Union, Entity Coverage Endorsement 55996 (1/94)

Such coverage extensions may be expanded to include claims made against the corporation as issuer of securities pursuant to specified registration statements.

 

Entity coverage wording can be lengthy and add or amend many policy terms, definitions, and conditions. While such coverage enhancements can be expensive, have limited availability, and are often subject to a variety of limitations, the nature of entity coverage provides protection not normally available from any other source of insurance.

 

When reviewing D&O insurance policies, it should be noted that some incorporate the term legally obligated to pay within the insuring agreement. The term legally obligated to pay, or similar language, is also sometimes found in the policy definition of loss.

 

Policies that do not use legally-obligated-to-pay language may be preferable to those that do because the language may preclude coverage for equitable relief. However, the court in the Okada v. MGIC Indemnity case concluded that the insurer was responsible to make contemporaneous payment of defense costs partly because the definition of loss included amounts the insured was legally obligated to pay. For more information, see the article Duty to Defend in this section.

 

Employment Practices Liability (EPL) Entity Coverage (For-Profit and Not-for-Profit Corporations)

 

Over the past several years many D&O insurers have offered employment practices liability (EPL) coverage for the business entity either as part of the individual liability and company reimbursement insuring agreements or in a separate insuring agreement. An example of each approach is shown in the following examples:

 

Entity Insuring Agreement)

Separate EPL Insuring Agreement

 

Other insurers may offer entity coverage for EPL claims by adding a special endorsement to the D&O policy. Since the directors and officers are typically insureds under EPL entity coverage clauses, there is usually no need to add separate coverage to the policy for these individuals.

 

EPL entity coverage typically extends coverage under the D&O policy for claims that involve allegations of employment-related discrimination, sexual harassment, wrongful termination, and other employment-related offenses. These coverage extensions are sometimes created by deleting the exclusions for bodily injury, emotional distress, libel, slander, defamation, and other personal injury offenses or by broadening the definition of wrongful act to include these offenses. The definition of insured is also usually broadened to include employees. In addition, the insured-versus-insured exclusion is often modified to make it inapplicable as respects EPL claims.

 

When provided within the scope of a D&O policy, however, EPL coverage may have the following limitations:

 

•Because many D&O policies do not contain a duty to defend, any endorsement to provide EPL coverage under such a policy is likely to also not contain such a duty. In contrast, most stand-alone EPL policies do provide an affirmative duty to defend.

•The entity, corporation, or organization may not be an insured.

•There may be no coverage for persons who are not directors or officers or who are not otherwise individually insured under the policy.

•Where the definition of insured or insured persons has been broadened to include employees, it may be necessary to eliminate or modify the insured-versus-insured exclusion.

•There typically is no third-party liability coverage for discrimination or harassment.

•Claims under an EPL coverage extension may erode the limits of liability of the core D&O policy. Some D&O insurers provide a separate limit of liability for EPL claims, often for additional premium.

•In the absence of a duty to defend, the insurer may require an allocation of defense costs between covered and uncovered persons or allegations.

 

For these reasons, some insureds have in the past elected to obtain coverage for employment practices claims through purchase of a separate EPL policy. However, because the cost of combining D&O and EPL coverage in a single policy in the late 1990s was often less expensive than the cost of purchasing separate policies, insureds found themselves seriously considering combination policies. Today, because of the widespread availability of various combined and individual coverage options, there does not appear to be a clear preference, and broad and cost effective EPL protection can be obtained using either approach.

 

Stand Alone Side-A Coverage

 

(Information on Side A policies was provided by Dan A. Bailey, Esq. Mr. Bailey is a member of the Columbus, Ohio, law firm of Bailey Cavalieri LLP. He specializes in D&O liability insurance, corporate and securities law.)

 

Despite the typically huge difference between the resources and insurance needs of the company versus that of the individual directors and officers, traditional D&O insurance affords essentially the same coverage for D&Os (under Side-A) and for the company (under Side-B). Only the amount of any retention and perhaps the applicability of a couple of exclusions will vary, depending upon whether the loss is indemnifiable by the company. Because loss under the Side-B coverage is far more frequent and generally far more severe, the scope of coverage afforded under a traditional D&O policy is designed to create a reasonable underwriting response to a company's D&O indemnification exposures.

 

Since the vast majority of claims covered under a D&O policy are indemnified by the company, a Side-A only D&O policy allows insurers to afford much broader coverage terms than reasonably possible under a Side-B policy. The following examples are some of the many possible features in a Side-A policy form that can provide broader coverage protection than the typical D&O insurance policy form. Discussion of enhancements to some newer Side-A policy forms is also included.

 

Scope of Coverage

 

•No presumptive indemnification: coverage applies without any deductible if the company rightly or wrongly refuses, or is financially unable, to indemnify the directors and officers. Side-A insurers typically expect the organization to indemnify the insured person(s) if the company is legally and financially able to do so. However, while the refusal requirement makes sense from the insurers' standpoint, it creates a potential gap in protection for the insured persons. If the company simply ignores an indemnification request from an insured person, that insured person will not be indemnified by the company and will not be covered under the traditional Side-A policy since the company has not refused to indemnify the insured person. In order to eliminate that potential gap in protection, many new Side-A policy forms state that coverage exists if the company fails to indemnify the insured person within a defined time period–usually sixty to ninety days) after the insured person requests indemnification, whether the company affirmatively refuses to indemnify.

•Broad definition of claim that includes not only civil or criminal judicial, administrative, regulatory, or arbitration proceedings and investigations, but also oral or written demands and circumstances that may give rise to a claim: while the broad definition may mean the policy covers many types of claims, costs incurred by a director or officer purely in his capacity as a fact witness (as opposed to a defendant or potential defendant) are typically not covered under a D&O policy. Some of the new Side-A policy forms now specifically cover the costs incurred in interviewing or deposing a fact witness.

•Broad “outside position” coverage: the policy provides blanket nonprofit outside position coverage for any person—not just directors and officers—serving in an outside position at the request of the company. There is no exclusion for claims made by an outside entity or that entity's directors and officers. This blanket non-profit outside position coverage is typically triple excess (i.e., the coverage is excess of any indemnification and insurance available from the outside entity, as well as any indemnification from the company).

Some new Side-A policy forms extend this blanket outside position coverage to service as a director or officer of any for-profit outside entity, provided such service is at the request of the company. If not properly managed by the organization, such for-profit outside position coverage could result in an unintended dilution or exhaustion of the Side-A limits of liability. This might occur where an insured person serves at the request of the company as a director or officer of a large publicly-held company which is the target of shareholder class action or other significant litigation. To protect against such unintended dilution of the Side-A limits, this for-profit outside position coverage could be limited only to private for-profit companies (unless the publicly-held for-profit outside entity is specifically scheduled in the Side-A policy) or limited only to directors or senior executive officers of the company serving the outside for-profit entity.

•A few Side-A policy forms purport to provide a coverage enhancement by stating that the policy follows form to most of the provisions in the underlying D&O insurance program. However, such follow-form coverage may actually limit the scope of coverage that can be afforded under an extremely broad Side-A policy. This is because one of the principal benefits of purchasing a Side-A excess DIC policy is to obtain broader coverage than is available in the underlying D&O insurance program.

The broadest Side-A policy forms will contain all of the applicable coverage terms and conditions without reference to the underlying policies. A few self-contained broad Side-A policies, however, do contain an acceptable follow-form provision that applies only to the extent an underlying policy affords broader coverage than the terms and conditions of the Side-A policy.

 

Exclusions

 

•No express exclusions regarding ERISA, Section 16(b) of the Securities Exchange Act of 1934, pollution, prior litigation, or defamation, or other personal injury: while both traditional and Side-A D&O policies exclude coverage for loss incurred by directors and officers in their capacity as ERISA fiduciaries, a few new Side-A policy forms expressly include coverage for such claims. This is not necessarily a favorable feature because ERISA fiduciary liability coverage is available under a fiduciary liability insurance program. Including the coverage within the Side-A policy potentially dilutes the Side-A policy's limit of liability unnecessarily;

•Narrow illegal personal profit and remuneration exclusions that apply only if the wrongdoing has been determined by adjudication or if the illegal remuneration is repaid in settlement; also, a narrow dishonesty exclusion that applies only if adjudication determines active and deliberate dishonesty was committed with actual dishonest purpose and intent. These exclusions do not apply as respects defense costs.

Like all D&O policies, Side-A policies typically exclude coverage for claims arising out of deliberately fraudulent conduct, willful violations of law, or receipt of illegal personal profit or remuneration. Although a few new Side-A policy forms purport to delete the exclusions section of the policy in its entirety, even those newer policies exclude coverage for this type of egregious wrongdoing by adding the conduct exclusions to the policy's definition of loss.

Historically, the main issue for debate under the conduct exclusions has been what events will trigger the exclusions. Insureds frequently seek a provision stating that the exclusions apply only if a final adjudication establishes that the referenced conduct actually was committed by the insured person. However, D&O claims are almost always settled without such a final adjudication, which eliminates the conditional application of the exclusion. To avoid that unfair result, some Side-A policies have in the past stated that the conduct exclusions apply if either a final adjudication or a guilty plea (or perhaps a written admission under oath) by the insured persons establishes that the insured person actually committed the excluded conduct. Some insureds resist that broader trigger language for fear that the exclusion will inadvertently be triggered in instances where coverage in fact was intended and is desired by the insureds.

In order to create a more balanced approach that addresses the legitimate concerns of the Side-A insurers and the insured persons, at least one new Side-A policy now states that the conduct exclusions apply if either of the following occur:

1.A final adjudication in any proceeding, other than a proceeding initiated by the insurer, establishes the respective insured person actually committed the referenced conduct; or

2.The respective insured person admits to committing the referenced conduct in a guilty plea or other written admission under oath, provided that the exclusion does not apply based upon such a guilty plea or written admission if a majority of disinterested directors of the parent company elect to waive the applicability of the exclusion with respect to the insured person.

•A narrow bodily injury/property damage exclusion that is not applicable to derivative or class action claims by securities holders, nor to pollution claims: while some Side-A policies also contain exceptions to the exclusion for claims by securities holders, claims for emotional distress or mental anguish, claims relating to climate change and claims against outside directors, some of the newer Side-A forms delete the bodily injury/property damage exclusion in its entirety. However, deletion of the exclusion arguably is not in the interests of the insured persons since its absence may allow an organization's general liability insurer to shift losses that would otherwise be covered under a general liability policy to the Side-A policy, thereby unnecessarily diluting the Side-A policy's limit of liability;

•A narrow insured vs. insured exclusion that applies only if the claim is by or on behalf of the company, and at least two current senior executive officers approve or assist in prosecuting the claim. This exclusion is not applicable to claims made by persons insured under the policy, to claims outside the U.S. or Canada, or after the parent company has a change of control. Some of the newer Side-A policies do not contain an insured vs. insured exclusion. Although removal of the exclusion can be beneficial to insured persons, the absence of this exclusion in a Side-A policy could invite collusive lawsuits by or on behalf of the company. Since settlements and judgments in lawsuits by or on behalf of the company are typically not indemnifiable, the company does not expose itself to any liability by initiating such claims against its insured persons and could effectively convert its Side-A insurance policy into a liquid asset by prosecuting such a claim against its insured persons. Such behavior by the company would obviously not be in the best interests of either the Side-A insurer or the insured persons. For this reason, absence of the insured vs. insured exclusion arguably may not be a prudent coverage enhancement.

A few of the new Side-A policy forms contain a more balanced approach to insured vs. insured exclusion in which the exclusion applies only to those claims that are most likely to be truly collusive. For example, the narrowest version of this exclusion applies only to claims by or on behalf of the company and only if the claim is brought within the U.S. by or with the active assistance or participation of at least two senior executives of the company, with the following exceptions:

• Claims made after a change in control or bankruptcy of the company

• Claims by or on behalf of a bankruptcy or insolvency of a trustee, examiner, creditors committee, or an assignee thereof

• Claims in which the senior executive's assistance and participation is protected by a whistleblower statute or is pursuant to a subpoena or similar legal process

• Defense costs.

A few of the new Side-A policy forms also include a carve-out stating that the exclusion does not apply if independent legal counsel opines in writing that the failure of the company to bring the claim would likely result in liability to the insured persons for failure to assert the claim. This type of carve-out to the exclusion should allow coverage for meritorious claims by or on behalf of the company but should exclude collusive lawsuits brought by the company for the purpose of collecting money under the Side-A policy and narrow other insurance and prior notice exclusions that apply only to the extent loss is actually paid under other policy.

 

Miscellaneous

 

•There may be no requirement that the insurer consent to defense counsel.

•Provides for mandatory binding arbitration of any coverage dispute.

•Protective policy renewal provisions: for example, as respects three-year policies, the insurer must give nonrenewal notice at least two years in advance. Renewal premiums are determined pursuant to an established rating plan, and renewal policies include all coverage enhancements included in any new standard policy form issued by the insurer. In addition, the policy is noncancelable except for nonpayment of premium.•If the parent company is acquired, a three-year run-off coverage period is provided for no additional premium.

•Notice of claim to the insurer is required only after the in-house general counsel or risk manager of the company first learns of the claim.

•The policy may not be rescinded based upon the restatement of any of the company's financial statements included within the application.

•If the insurer nonrenews, the policy's limit of liability is reinstated for the discovery period.

•Protective bankruptcy provisions are included. The policy is not subject to automatic stay under bankruptcy law, and policy proceeds are to be first applied toward prebankruptcy wrongful acts.

•A Difference-in-Conditions dropdown feature applies if the policy is written as excess. Side-A excess DIC policies traditionally state that the DIC coverage is triggered only if the underlying insurer refuses to pay the covered loss. This refusal requirement creates a potential coverage gap for the insured persons if the underlying insurer fails but does not refuse to pay the covered loss. To eliminate this potential gap in coverage, many of the newer Side-A policy forms now state that the DIC coverage is triggered if the underlying insurer refuses to pay or fails to pay within a defined time period (usually sixty to ninety days) after the insured person requests payment from the underlying insurer.

Because the Side-A policy limits of liability are not depleted or exhausted by payment of claims involving company liability or indemnified loss, the coverage is preserved for when the directors and officers really need it (i.e., when the company cannot or will not indemnify).

 

Financial Inability to Indemnify

 

If the company becomes subject to a bankruptcy proceeding, it may be unable to fund its D&O indemnification obligation. In that circumstance, Side-A coverage will likely be the only financial protection available to the directors and officers.

 

Should Side-A coverage be unavailable, the personal assets of the directors and officers could be at risk. An issue will likely arise in the context of the bankruptcy proceeding as to whether the typical D&O policy is an asset of the bankruptcy estate. If it is an asset, the automatic stay applicable to all assets of the bankruptcy estate will effectively freeze the policy and may preclude the directors and officers from accessing the policy's proceeds.

 

Courts have disagreed as to whether a typical two-part D&O policy constitutes an asset of the bankruptcy estate. Some courts have concluded the policy is such an asset since it affords coverage for the company's D&O indemnification obligation. Although other courts have either ruled that the D&O policy is not an asset of the estate or have ruled that the proceeds of the policy (as distinct from the policy itself) are not assets of the estate, it is unclear what result will occur in any particular bankruptcy proceeding. This uncertainty is exacerbated if the D&O policy also affords securities entity coverage, since insurance policies that afford coverage for claims against the company are typically considered by courts as assets of the bankruptcy estate.

 

In other words, under a typical D&O insurance policy, it is uncertain whether the directors and officers will have access to the policy proceeds in the event of the company's bankruptcy. However, that uncertainty is virtually eliminated under a Side-A only policy since the company is not an insured under that type of policy, either with respect to its D&O indemnification obligation or with respect to securities claims against the company. Therefore, a Side-A only policy can afford more predictable and potentially more protective coverage for directors and officers in the event of the company's bankruptcy.

 

Limit of Liability

 

In today's complex D&O claims environment, it is common for several different types of proceedings to be brought against several different groups of insured persons at the same time, and it is increasingly difficult to resolve all of those multiple claims against multiple insured persons in a single global settlement. As a result, some claims against some insured persons may be settled without resolving other claims against other insured persons. For example, in the Enron D&O litigation, the outside directors' settlement exhausted the remaining D&O insurance proceeds, thereby leaving the officer defendants with no insurance (and no indemnification from the bankrupt company) to fund defense costs and any settlements or judgments incurred by the officers.

 

To provide greater assurance to directors and to officers that their coverage will not be exhausted by claims against other directors and officers, Side-A policies that cover only officers or only outside directors are now available. However, because the decision to purchase those separate policies can create internal political issues within an organization, a few Side-A policies now contain a provision allowing the organization to purchase separate limits for only outside directors and only officers within the context of the standard Side-A policy. These separate limits are in addition to the standard aggregate limit of liability of the Side-A policy applicable to all insured persons combined. Under the broadest version of this feature, the additional limits become effective if and when the Side-A policy's base limit of liability is exhausted by covered losses incurred by any insured person. The additional limits then apply to any covered claim first made at any time during the policy period and therefore afford greater coverage than a traditional limit reinstatement provision.

 

This additional limit of liability provision can also include a priority of payment provision, which maximizes the total amount payable under the Side-A policy in the event a covered loss is subject to both the base limit and the separate additional limit. Absent such a provision, the Side-A insurer could pay a loss to which the separate limit applies out of the base limit, thereby leaving other loss which is covered only by the base limit uninsured. To avoid that result, a few Side-A policies expressly state that if covered loss could be subject to both the base limit and the additional limit, then the loss shall be allocated between the two limits “in whatever portions will maximize the total amount of such Loss paid under the Policy.”

 

A similar need for separate limits of liability arguably exists with respect to retired outside directors. Because D&O insurance is claims-made coverage, an outside director who leaves the board must rely on the company to maintain adequate coverage for that outside director for the next four to six years while the outside director is still susceptible to claims for alleged wrongdoing while serving as an outside director of the company. In order to provide those outside directors comfort that their future exposure will be adequately insured, a long-term runoff Side-A policy insuring only former outside directors is now available from a few insurers. That long-term Side-A coverage typically is afforded through a separate retired director policy, but could be incorporated into the standard Side-A policy, subject to an additional limit of liability as previously described.

 

Derivative Settlements/Judgments

 

Shareholder derivative lawsuits can be filed either in tandem with a shareholder class action lawsuit or as an isolated lawsuit. A typical two-part D&O insurance policy will respond to a settlement or judgment in either type of lawsuit, provided that the class action lawsuit (or any other claim in the same policy period) does not exhaust the available limit of liability before the potentially nonindemnifiable derivative lawsuit settlement is paid. Because tandem class action and derivative lawsuits are frequently settled at the same time, prior exhaustion of the limit of liability is usually not a problem.

 

However, there is today a somewhat greater tendency to settle the larger class action lawsuit quickly, even if the tandem derivative lawsuit cannot be settled at the same time. For example, in one recent case, a company elected to settle a securities class action within a few months after its filing for more than $100 million (thereby exhausting the D&O policy's limit of liability) even though the tandem derivative lawsuit could not then be settled for a reasonable amount. Approximately eighteen months later, the tandem derivative lawsuit was settled for approximately $15 million. Fortunately for the directors and officers, the company maintained an excess Side-A only D&O policy, which was not implicated in the indemnifiable class action settlement and therefore was available to fund the nonindemnifiable derivative settlement.

 

In situations where the company wants to settle a large class action lawsuit but cannot yet settle the tandem derivative lawsuit for a reasonable amount, insureds are faced with a difficult dilemma under a standard two-part D&O insurance program. On the one hand, the insureds can use the proceeds from the D&O policy to fund the class action settlement, thereby benefiting the company by eliminating the risks, distractions, and adverse publicity associated with such a potentially catastrophic claim. However, such a strategy may leave the defendant directors and officers with inadequate insurance protection for a subsequent nonindemnifiable derivative settlement.

 

On the other hand, the insureds can preserve the D&O insurance proceeds for a subsequent derivative settlement. However, such a strategy would deprive the company of a large source of funds to pay the early class action settlement.

 

Priority of Payments Provision

 

Many standard D&O insurance policies with securities entity coverage contain a priority of payment provision mandating that all proceeds under the policy be maintained for the nonindemnifiable derivative settlement, the amount of the class settlement, or the likely amount of the subsequent derivative settlement. Thus, if the insured company desires or is compelled to settle the class action early, it must fund the entire settlement amount out of its own assets and seek reimbursement under the D&O insurance policy for the covered portion of the loss at some later date when the derivative lawsuit is settled. This may require the company to advance tens of millions of dollars, if not hundreds of millions of dollars, to resolve the class action, even though much or all of such a settlement is otherwise covered under the untapped D&O insurance program.

 

From the perspective of the defendant directors and officers, this dilemma is especially frightening. If company management is not sympathetic to the defendant directors and officers, it may choose to use the D&O insurance policy to fund the indemnifiable class action, thereby leaving the defendant directors and officers with little or no insurance to settle the subsequent nonindemnifiable derivative lawsuit. Although the defendant directors and officers would likely object to use of the policy for that purpose, the extent of the directors' and officers' financial protection under the policy will be uncertain.

 

The problems discussed here can be greatly mitigated, if not eliminated, by the purchase of Side-A only coverage that applies excess of the company's standard D&O insurance program. Such excess coverage assures the existence of insurance protection for nonindemnifiable claims against directors and officers even if the rest of the D&O insurance program has been exhausted by indemnifiable or entity losses. As a side benefit, such coverage may allow for deletion of the priority of payment provision in the underlying D&O policies, thereby enabling the company to access the underlying D&O insurance proceeds for an early settlement of the class action even if the tandem derivative lawsuit is not settled at the same time. Obviously, the larger the limits for this Side-A only coverage, the greater the likelihood that this type of insurance program structure will accomplish the goals of both the company and the insured directors and officers.