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Marketing
The ABCs of D&O
The recent plethora of insolvencies makes proper D&O coverage critical
By Dennis H. Pillsbury
“The alarming rise in the number and scope of corporate bankruptcy filings, added to a similar spike in seizures of insolvent or financially troubled banks by the FDIC, underscores the critical necessity of directors and officers liability insurance,” according to an ACE Progress Report on the financial crisis.
The paper, “Financial Crisis: Bankruptcy Implications for D&O Insurance,” was prepared by Keith Lavigne, senior vice president, ACE Professional Risk; Scott Meyer, executive vice president, ACE Professional Risk; and Carol Zacharias, senior vice president and deputy general counsel for North America, ACE Group.
Although there are a host of reasons for a D&O claim, the paper points out that “more than any other cause of litigation against corporate officers and directors, bankruptcy poses the greatest threat of personal financial risk and the most complicated coverage issues.”
In 2008 and 2009, more than 150,000 U.S. companies (one out of every 200 businesses) filed for bankruptcy protection, the paper points out, noting that “the rate of bankruptcy filing has more than doubled in the last two-and-a-half years.” And more may follow. Zacharias points out: “Bankruptcies are a lagging economic indicator, tending to follow poor financial news by a period of three quarters and more.”
ABC
D&O insurance has evolved into three basic insuring agreements—Side A, which directly insures directors and officers; Side B, which reimburses the corporation for directors and officers losses that are indemnified by the corporation; and Side C, which protects the corporation for its own liability.
The paper points out that all three coverages “are part of typical D&O insurance policies today, with Sides A, B and C included within one policy. Directors and officers thus share the limits of the policy with the company. If the company’s indemnification obligations or its separate liability deplete the limits of insurance under the Side B and Side C coverages, the limits for individual directors and officers may be eroded, in some cases to nothing.”
For this reason, it might be prudent for agents to offer a separate Side A policy, in which a specific limit of protection is dedicated exclusively to the directors and officers.
The need for separate Side A coverage is especially important when a bankruptcy filing occurs.
Automatic stay
The paper notes that when a company files for bankruptcy protection, “an ‘automatic stay’ activates, relieving the debtor company from the pressure of demands by creditors.” Of concern to directors and officers at this time “is whether the automatic stay will prohibit access to D&O insurance proceeds, especially for upfront and continuing legal defense costs.” This can be of great concern when the policy covers the corporation as well as the directors and, therefore, its proceeds may be subject to the automatic stay.
“The purchase of separate Side A D&O coverage exclusively for the directors and officers mitigates concern over an automatic stay,” the paper points out. Zacharias notes that because the corporation is not covered under Side A policies, “it is less likely that the policy or its proceeds will be considered an asset of the bankruptcy estate and therefore subject to the automatic stay.”
The ACE executives also recommend that a provision be inserted in the D&O policy that states that “the company agrees to waive the automatic stay with regard to the policy and its proceeds in the event of a bankruptcy filing.”
More problems
The ACE executives point to two other areas that could cause problems in the event of bankruptcy—the “Insured vs. Insured” exclusion and regulatory exclusions.
The “Insured vs. Insured” exclusion came about to avoid collusive action between insureds; but in bankruptcy proceedings, “the exclusion may apply if the trustee sues the directors and officers on behalf of the debtor company,” the paper explains. To avoid this problem, newer D&O policies, including those offered by ACE, contain exceptions to the exclusion, addressing claims brought by a bankruptcy trustee, examiner, liquidator or receiver.
The paper also notes that “many D&O policies also attempt to narrow coverage by excluding claims brought by regulators.” In a period when banking regulators are hunting for culprits with deep pockets, this can prove to be an especially bad exclusion for directors and officers who are looking to fight such actions.
Not just for public companies
Although today’s concerns center around public companies that are facing potential shareholder lawsuits, Scott Meyer points out that “no entity is exempt. Increasing numbers of lawsuits have been filed against private companies and charitable organizations as well. Any person who is considering a position as a director or officer of a company or charity needs to be certain that D&O coverage is in place. Otherwise, they could be facing a situation where their personal assets are at stake.”
The ACE executives also point out the warning signs that agents should consider when looking at a D&O risk, especially signs that a bankruptcy may be in the company’s future. “If a company is selling off good assets that it should, in fact, hold onto, this may be an indication of behavior leading up to an eventual bankruptcy,” says Keith Lavigne.
Meyer adds: “Knowing who the creditors are also is very important from an underwriting standpoint, as different creditors have different attitudes and approaches to companies in financial distress. Some want to put the company immediately into bankruptcy to take advantage of asset sales to make a quick recovery.”
Agents also should be aware that the threat of possible bankruptcy or even a filing for bankruptcy does not necessarily preclude placing D&O coverage. Lavigne notes that underwriters will spend time meeting with senior management to discern their strategies and tactics to turn around the company. “If a company is likely to come out of bankruptcy reorganized and renewed, we perceive the risk of a D&O claim as lessened,” he says.
The complicated nature of D&O coverage makes it “imperative that companies seek coverage that is world class from a highly-rated carrier with the reputation, financial strength and underwriting expertise to understand litigation risks and coverage nuances.”
A copy of the complete progress report is available at www.aceusa.com/news |
