New D&O Policy Wordings - Little Changes, Big Surprises

August 26, 2005

Northern California ABTL REPORT, Summer 2005

Like tabloid articles about celebrity trials, news about Eliot Spitzer's insurance industry investigation is diverting, but generally irrelevant to most litigators’ practices.  Other less sensational industry developments, particularly in the area of Directors & Officers liability insurance, will have a more a more direct impact on the defense and settlement of insurance claims.

The Rise of Side “A” Coverage
Traditional D&O insurance consists of three types of coverages: "Side A," which provides coverage for the individual directors and officers when the company is unable to indemnify them, "Side B," which insures the company’s obligations to the directors and officers, and "Side C," which insures the company’s own direct liability (usually limited to securities or employment liabilities).  In response to board member’s concerns about individual exposure, more companies are purchasing additional Side A coverage in excess of their traditional A-B-C program.  Moreover, some companies are eliminating Side C coverage, and buying policies which pay a fixed percentage, typically 70% or 80%, of defense and indemnity costs “jointly incurred on behalf of” the company and the insured individuals in the defense of securities claim. 

If a company has limited or no entity coverage, it may face disputes with its insurers about which costs are “jointly incurred.”  The desire to utilize insurance proceeds can affect strategy decisions such as whether to employ separate counsel for individual insureds, whether to settle out individual insureds, or whether to file dispositive motions which result in a dismissal of the individual insureds only, leaving the company to face defense and indemnity expenses which are not “jointly incurred.”

On the other hand, if there is concern that the policy proceeds will not be sufficient to protect the individuals in the underlying securities litigation, and the company’s ultimate ability to indemnify the individuals is also in question, counsel for individual insureds may resist any strategic efforts which benefit the company at the expense of preserving limits for the individual insureds. 

New Insurers/New Relationships
Despite rumblings of hard times ahead in the D&O market, a number of insurers in fact are entering the market, including new players at the primary level, the first layer of insurance which generally controls the terms of all policies on the program.  This means that securities defense counsel accustomed to working with the "usual suspects" face new challenges:  negotiating billing and reporting guidelines, gaining the trust of unfamiliar claims representatives, and understanding the litigation and settlement philosophies of the new organization.  These challenges are complicated by the fact that many companies are insured by as many as six or seven insurers – each with a different perspective on liability and damages in the underlying action, and each with a view as to why their policy should not provide coverage for the claim.

New Insurers/New Forms
Insurers entering the D&O primary market are issuing new policy forms with subtle but critical wording changes.  Not only do these provisions create greater tensions between individual insureds and the company, they also pose difficult questions regarding joint defense efforts and litigation strategy.

For example, many insurers have modified their “fraud” and “personal profit” exclusions.  Originally, those exclusions only applied if the insured “in fact” committed fraud or gained an improper personal advantage in connection with the underlying claim.  The exclusions eventually were modified to provide coverage until there was a “final adjudication” of improper conduct, a rare event.  Now many insurers are reverting to the “in fact” language, or revising the exclusions to apply when the improper conduct is established by “written evidence.”  Nobody ever really knew what “in fact” meant, and it certainly isn’t clear what “written evidence” means: An ambiguous memo by the alleged wrongdoer?  A declaration by a fellow insured with his or her own agenda? 

The broadening of these exclusions can in fact benefit innocent insureds, as they can demand that insurers stop funding the defense of complicit insureds, preserving limits for the liability of those who were unaware of the wrongdoing but nevertheless may have to pay for it.  On the other hand, if the individual’s wrongful conduct is imputed to the company, the insurer may cut off defense payments at a crucial point in the litigation.

Insurer Requests for Information
As the SEC becomes more aggressive in its investigation of alleged securities fraud, tensions between insurers and insureds increase.  Insurers, under the guise of "seeking cooperation" and "the need to evaluate liability and damages," are demanding that policy holders turn over information relating to SEC investigations.  While an insured must cooperate with its insurer, it is not required to provide the insurer with a roadmap for denying coverage.  Further, insurers are often seeking privileged information, the disclosure of which could harm not only the defense of the underlying securities case, but the SEC investigation as well.  The law regarding privilege and work product in the insurance context, particularly with respect to D&O policies, does not guarantee that information provided to the insurers will be protected from disclosure to third parties.  Defense counsel must walk a fine line between providing information legitimately needed for the insurer to participate in settlement, and waiving privileges to the detriment coverage or defense positions.

These developments may not be as exciting as the insurance scandals in the news.  But they are likely to complicate defense and settlement strategies in the years to come.