In 2021 more than 200 new securities class action lawsuits were filed in federal courts. With approximately 500 such suits currently pending, and a slew of other actions being actively pursued against company directors and officers, it is more important than ever that public companies deploy risk transfer strategies to protect management and help shield their balance sheets from litigation costs and potential losses.
One of the most widely used risk transfer devices available to public companies is the directors’ and officers’ (“D&O”) liability insurance policy. As its name suggests, the D&O policy was originally designed to protect the personal assets of directors and officers from liability for actions taken in their official corporate capacities. Over time, D&O policies evolved to cover company losses for its indemnification obligations to directors and officers, as well as the organization’s conduct.
Public Company D&O Policies
Most public company D&O policies are divided into three coverage parts, which are commonly known as Side-A (personal asset protection), Side-B (corporate reimbursement) and Side-C (entity coverage). Today, many public company D&O policies also include so-called “Side-D” coverage (derivative investigation coverage). Some policies also provide coverage for expenses incurred by the company to respond to respond to a shareholder’s request to inspect the company’s books and records; however, the coverage limit for Side-D is usually much lower than that which is available for A, B, and C claims.
Side-A Coverage
Subject to the policy’s exclusions, Side-A coverage broadly protects individual directors and officers from losses caused by their own acts in their capacity as a director or officer for which there is no indemnification available from the company, either because the indemnification is not legally available (e.g., bankruptcy), or the company has refused to indemnify the director or officer. A major benefit of Side-A coverage is that it usually does not have a self-insured retention amount – the amount the policyholder must pay before the insurer picks up the coverage. This means that if indemnification is not available to the officer, the insurer pays the very first dollar of loss up to the policy limit. As long as the director’s or officer’s losses are not otherwise excluded by the policy, the director or officer should not incur out-of-pocket loss unless the coverage limits are exhausted.
Companies may also elect to purchase additional Side-A coverage known as a “difference-in-conditions” or “DIC” policy. DIC is a form of excess coverage that provides additional Side-A coverage to the directors and officers if the traditional ABC policy limits are exhausted or if the company or the traditional D&O insurer cannot or will not advance costs to the director or officer. In such situations, the DIC coverage should drop down to provide a defense and indemnity to the officers and directors.
Side-B Coverage
Side-B coverage reimburses the organization for losses advanced by the company because of its obligation to indemnify the officers and directors for actions taken in their official capacities. Like Side-A, Side-B typically provides coverage for the acts of the directors and officers. However, unlike Side-A, the company must typically pay a stated self-insured retention amount before the insurer’s obligation to pay is triggered.
Side-C Coverage
For public companies, Side-C coverage is usually only limited to securities claims. This coverage protects the company itself from claims alleging the company violated securities laws or regulations, or that arises out of the company’s sale or purchase of securities. These claims often arise following a drop in stock price that coincides with a major event or announcement (such as the filing of amended financial statements or an amended disclosure). Like Side-B, Side-C coverage usually requires that the company satisfy a retention before the insurer’s payment obligation is triggered.
Regardless of whether Side A, Side B, or Side C is implicated, under most policies, the insurer reimburses the insured for the expenses incurred by the insured in defending the claim (e.g., attorneys’ fees, court costs), as well as any damages that may be awarded or included in a settlement.
Side-D Coverage
Last but not least, many modern public company D&O policies offer so-called “Side-D” coverage. Side-D coverage is designed to offset the costs of a shareholder’s demand that the company investigate director and officer wrongdoing. The demand is a prerequisite in some jurisdictions to the filing of a shareholder derivative lawsuit against directors and officers alleged to have harmed the company. Side-D coverage is almost always limited to the costs of investigating the claims or seeking the dismissal of a derivative suit.
Claims and Losses with Examples
With any of the coverages, it is important to keep in mind that certain types of claims and losses are excluded from coverage. For example, most policies exclude coverage for claims made by an officer against the company or her fellow officers and the individual directors. Likewise, conduct that is ultimately determined by a court to be fraudulent or criminal will not be afforded coverage. In addition, many policies do not provide reimbursement for fines and penalties, taxes, multiplied damages and, in certain circumstance, punitive or exemplary damages.
Although the four general coverage types described in this article are found in nearly all modern D&O policies, the precise coverage available to any individual insured will depend on the precise language of the company’s policy and its insuring clauses, definitions, and exclusions. As this language can often appear confusing, it is recommended that directors and officers review their company’s policy with a qualified insurance broker or insurance coverage attorney to understand the scope and limitations of the coverage available to them and the organization.
This article was authored and contributed by Mike Rice, Ben Hale, and Paul Lynch of the Lockton Companies. If you are interested in speaking with Lockton about your company’s D&O insurance program, please contact Mike Rice at 801-520-7660 or mike.rice@lockton.com.