Director’s & Officer’s (D&O) insurance policies are contracts potentially worth tens of millions of dollars, but during their annual renewal, their wording frequently is given little or no review. Companies often focus mainly on the economic terms (premium, deductible, and limits), and confirm their high-level understanding of who and what is covered. But unlike most important contracts, businesses frequently accept the terms exactly as offered, and pay little or no attention to the actual wording.
This is a missed opportunity, because D&O policies generally are open to negotiation and can be improved substantially with relatively little investment. The key is knowing which terms to negotiate, because the majority of coverage disputes focus on a small number of terms. If the key terms can be revised with just a few words, and bad terms can be eliminated, the difference is night and day.
A lawyer who routinely handles coverage disputes can identify the key provisions and recommend improvements, usually in just a few hours of work, and in many cases, these terms can be removed or modified. The ideal time to involve a coverage lawyer is sixty days before renewal, but it is possible to do a review and negotiate changes in a much shorter time. A policy review typically identifies a wish list of 10-15 provisions to change or remove, and then a negotiation will achieve as many improvements as possible. In many instances, changes can be made for no additional premium. In others, the insurer may offer an improvement, for example, an enhanced “Claim” definition, in exchange for a higher premium. The policyholder can then consider the types of claim scenarios that might arise and decide if this is a good investment.
A policy review is worthwhile for many lines of insurance, but especially so for D&O policies, due to the high dollars at stake, the wide variation in terms available in the marketplace, and insurers’ greater willingness to modify terms. To in-house attorneys, D&O insurance often commands extra attention because it provides personal protection to the most senior people in the company.
Here are some examples of policy terms that arise frequently in coverage disputes, and generally are negotiable in a renewal, and therefore are worth a close look in a pre-renewal review.
Dispute Resolution Clause. Many D&O policies contain an ADR clause requiring arbitration, mediation, or some combination of the two. The absence of such a provision means that either the policyholder or the insurer is free to file a lawsuit at any time. Insurers usually will agree to include or remove such a provision, depending on the policyholder’s preference. The most favorable provisions afford the policyholder the choice between arbitration or litigation for any given claim. Many corporate legal departments have a strong preference one way or the other about arbitration, so it is important to review the ADR clause and make sure it reflects the company’s desire. And if arbitration is selected, frequently the clause itself needs to be reviewed to ensure that it is not stacked in favor of the insurer. For example, some policies require that the arbitrator(s) have experience working for an insurance company, which makes an unbiased panel unlikely. The dispute resolution clause is probably the most important part of a policy review, because a bad one can make enforcement of the policy difficult, expensive, or impractical.
Right to Choose Defense Counsel. If dispute resolution is the most important provision, choice of defense counsel is a close second. Some policies provide the insurer unchecked discretion to appoint counsel of its choice, but these provisions usually can be negotiated to give the policyholder the right to choose, or at least the right to consent to the insurer’s choice. If a policyholder has a preferred law firm or short list of firms, it is often possible to have those firm(s) pre-approved in an endorsement to the policy.
Definition of Claim. Most D&O policies are structured so that the definition of Claim, along with the definitions of Loss, form the core of the insuring agreement. Claim definitions include at a minimum a lawsuit, an arbitration, and a written demand for damages. A strong definition goes further and includes preliminary scenarios that require outside legal counsel, such as informal interviews and investigations, subpoenas and document requests, and requests for tolling agreements. Sometimes a Claim definition can be broadened upon request, or in other instances an enhanced definition is available for additional premium. A broad definition of Claim is a good feature because it expands coverage, but it also expands the notification duty. This can lead to a late notice trap if a corporate legal department is unaware of what constitutes a Claim, so an organization need to remain abreast of exactly what proceedings are covered under its D&O policy.
Definition of Loss. Standard definitions include costs of defense, compensatory damages, and settlement amounts. Stronger definitions include fines, administrative penalties, and punitive damages. Punitive damages coverage is an important feature, and difficult to negotiate because some states’ laws prohibit coverage. The best definitions of Loss include coverage for punitive damages under the “most favorable law” that could apply.
Intentional Conduct Exclusions. Exclusions for deliberate or intentional wrongdoing are standard, and therefore unavoidable. But it is important that the conduct must be proven “in the underlying action” before the exclusion(s) apply. Without these key words, an insurer is free to bring its own action against the policyholder, in addition to the underlying suit itself, and relitigate whether the policyholder committed deliberate wrongful acts.
Allocation of Defense Costs Between Covered and Uncovered Matters. The majority of states require an insurer to defend an action in its entirety if some claims are covered, and some un-covered. D&O policies, however, frequently contain “allocation” provisions, which permit the insurer to provide only a partial defense in these scenarios, while others require the insurer to provide a complete defense. Policyholders should insist on the latter, especially if they reside in a state whose law would require a complete defense.
Definition of Insured Persons. D&O policies frequently define the individual insured persons beyond formal and narrow definition of “Director” and “Officer,” and will cover employees at various levels in the company. A broad definition of Insured Person is generally considered a favorable feature. However, as with the definition of Claim, the broader definition brings increased notification requirements, and potentially unintended consequences if the definition is used elsewhere in the policy. A policy review should consider each place where the Insured Person definition appears, and the effects that it could have on disclosure and reporting obligations.
Insured vs. Insured Exclusion. D&O policies exclude coverage for lawsuits between insured parties themselves, and that concept itself is not controversial. However, coverage disputes under this exclusion have become increasingly common because often the exclusions are poorly written (or do account for quirks in the definitions of Insured Parties) and insurers assert this exclusion in scenarios where the real party at interest is not connected to any insured party. The Insured vs. Insured exclusion must be reviewed in conjunction with the definition of Insured Parties, and the organizational structure of the policyholder, to make sure that it cannot be stretched to exclude legitimate third-party claims.
Prior Notice Exclusion. The prior notice exclusion bars coverage for any Claim that arises from circumstances that were the subject of an earlier notice under a different policy. This exclusion is consistent with the construct of Claims Made policies, so long as it contains the qualifier that the notice under the prior policy is “accepted.” Many prior notice exclusions fail to contain this qualifier, which creates a gap in coverage if a notice of circumstances is rejected, and then the same circumstances later mature into a Claim.
Issues Affecting Individual Insured Persons. D&O policies frequently contain provisions designed to protect the individual Insured Persons from circumstances or bad actions on the part of other insureds. For example, these provisions govern the extent to which misconduct of one insured will be imputed to another for purposes of exclusions, or the extent to which knowledge of one insured will be imputed to another when determining application disclosure requirements. These provisions vary widely, and usually can be revised or tightened. For this reason, savvy individual Directors often hire their own counsel to review a company’s D&O policy before agreeing to serve on its Board of Directors.
Bankruptcy. D&O policies contain a variety of provisions defining the parties’ rights and duties if the Named Insured files for bankruptcy protection. As one example, some policies contain a provision stating that the automatic stay does not apply to policy proceeds. This provision has potential to benefit creditors, to the detriment of the Insured’s estate, and potentially to the detriment of individual directors and officers. Many provisions that appear innocuous could have significant, and often unintended, consequences in the event of a bankruptcy. So if there is a chance that a company will file bankruptcy in the coming year, it is essential that its D&O policies be revised with that possibility in mind.
