D&O Liability Insurance in a Time of Financial Uncertainty
As companies scramble to mitigate losses arising from government shelter-in-place directives intended to halt the spread of the COVID-19 virus, the insurance world has focused on business interruption coverage disputes and lawsuits. But if the economic disruptions arising from the pandemic and the efforts to control it continue, we could see more attention focused on directors and officers liability insurance – not only with claims that trigger D&O policies, but also increasing challenges in the placement and renewal of D&O insurance programs.
As of the date of this article, only two securities class actions relating to COVID-19 events have been filed: one against a cruise line company that allegedly misrepresented the expected impact of the virus on its business, and the other against a pharma company that allegedly falsely claimed that it had developed a COVID-19 vaccine.
Pundits disagree as to what extent further litigation will ensue: If all financial markets have suffered serious losses in response to the global pandemic, how can investors of any one company prove that their losses were the result of specific misrepresentations or other wrongdoing on the part of that company? However, the plaintiffs’ bar has been innovative and relentless in pursuing “event-driven” litigation against companies (and their directors and officers) in past circumstances (e.g., security breaches, #MeToo claims, opioid distribution and illegal banking practices).
In view of the current global crisis, plaintiffs could pursue claims arising out of supply-chain mismanagement, failure to anticipate or respond to the pandemic in a timely manner, insider trading, failing to properly manage an insolvent company and the like. If a company does not survive the crisis, creditors may pursue such claims in bankruptcy court, with the directors and officers of the insolvent company as their main targets.
The purpose of this article is not to comment on the wisdom or merits of such litigation, but to address the steps that public and private companies (and their directors and officers) should consider taking to maintain and even strengthen their D&O liability insurance program.
Insurance Placement and Renewal
To state the obvious, the D&O market was brutal even before the financial markets took a tumble this year. Premiums and retentions were up — sometimes by multiples — and companies in some sectors had difficulty purchasing adequate coverage at any price. Concerns about volatility in the financial markets and companies’ abilities to adapt to a “shelter-in-place” economy may drive costs even higher, and insurers may impose stricter underwriting standards as they attempt to ascertain risk in a time of uncertainty. They may scrutinize insureds’ current and projected financials in all sectors of the economy and ask more detailed questions about finances and operations. This scrutiny may apply to renewals (which typically are placed with minimal underwriting) as well as new placements or purchases of higher limits. And on the other hand, independent directors may demand greater D&O protection as a condition of service on the board of a company, particularly one whose operations potentially are impacted by the pandemic.
Although the following are among the “best practices” for the purchase of insurance at any time, they are particularly critical now:
This is No Time to Skimp
Everyone is cutting costs, but saving money by cutting D&O coverage may be penny-wise and pound-foolish. The coverage provides balance-sheet protection for the company in the event of litigation, which could consume enormous resources in defense and settlement costs even if meritless. It also provides a backstop to a company’s indemnification obligations to its directors and officers.
Take Care with Warranties
Companies should take care to provide accurate responses to questions posed or information requested by insurers in the placement process. Otherwise, they might be vulnerable to a rescission defense if the information is later determined to be materially false. Any warranties should be as specific as possible and limited to those individuals with actual knowledge of the warranted matters.
Pay Attention to Non-Indemnifiable Risks
Companies should review their program structure to ensure that officers and directors are protected in the event of a loss that cannot be indemnified by the company. Such losses include insolvency events and derivative actions, both of which (as noted above) may become more frequent in the coming months. Public companies may want to consider purchasing additional coverage for independent directors (but not if a claim is anticipated – warranties could render the new coverage void).
Take a Look at Exclusions
Insurers may seek to add exclusions limiting their exposure to COVID-19-related risks, particularly in vulnerable sectors. Such exclusions could include broader bodily injury or pollution exclusions or even exclusions for any losses arising from the financial impact of a pandemic. This is also the time to make sure that all exclusions, and particularly bodily injury, pollution and fraud exclusions, are as broad as those typically available in the current market.
Is a notice of circumstance prudent?
If a company faces challenges renewing its current program on the same terms and conditions as the expiring program and is concerned about a potential claim that has not yet matured into a reportable event, it should consider whether to provide a notice of circumstance under the expiring policy. This can be a complex decision with both pros and cons, so it should not be undertaken without the advice of the company’s broker and, possibly, coverage counsel.
At present, it appears that securities and derivative actions arising from the financial disruptions caused by the COVID-19 pandemic are unlikely to present unique coverage issues. However, insurers who have suffered portfolio losses in recent years may aggressively raise coverage defenses to ward off further losses. A few things to consider:
Give Prompt Notice
Do not hesitate to provide notice of any type of demand that may qualify as a “claim” under the policy in the hopes that it might not be a “big deal.” If it later becomes one, the insurer may be able to deny coverage for all or part of the loss.
Don’t Accept a Denial Without Further Review
Insurers may be tempted to raise a “bodily injury” or “pollution” exclusion as a defense to COVID-19-related claims. However, such exclusions (at least in public company policies) typically include exceptions for securities claims arising out of these risks and for claims against officers and directors for non-indemnifiable loss. These exclusions are intended, and should be worded, to apply only to direct claims for such injuries (which are covered under general liability or pollution legal liability policies). Even if the policy includes a broader exclusion, coverage counsel may be able to develop arguments to eliminate or limit the impact of that exclusion.
Keep the Insurer Informed of Developments in the Litigation
This point could just as easily be labeled “be realistic!” While a company’s initial response may be to vociferously assert that the litigation is meritless and vigorously defend against what it perceives to be a specious claim, as the case progresses, new information may come to light which changes this view. Also, if a case cannot be resolved at the dismissal phase, the costs of defending against the litigation may drain the policy limits so that little is left to fund a settlement prior to summary judgment or trial, much less a significant judgment if the initial assessment is wrong. Once having heard a rosy prediction about the likelihood of success, insurers may be reluctant to grant adequate settlement authority as the case nears trial, even if the company and its defense counsel determine that a significant settlement is now appropriate.
People and businesses face many uncertainties in the coming months. D&O insurance exists to mitigate and protect against the risks and uncertainties of unforeseen events, whatever the source. Companies and their directors and officers should expect no less of their D&O insurance if the impact of the COVID-19 pandemic creates unprecedented and serious exposures to their corporate (and personal) financial well-being.