SEC Trends & Developments - Summer 2012 - From the Bar… Demystifying D&O Coverage

Directors and Officers (“D&O”) insurance is designed to provide liability coverage – for both defense costs and indemnity (i.e., settlements/judgments) – to a corporation’s directors and officers.  In many instances, a corporation will also purchase “entity” or “Side-C” coverage, which provides liability coverage to the entity itself for claims that typically arise out of the sale of its securities.
D&O policies are “claims-made” policies, meaning that the “Claim” against the corporate entity and/or its directors and officers must be first made during the “Policy Period.”  (In contrast, most general liability policies are “occurrence” based, meaning that the policy covers the policyholder so long as the alleged damage occurred within the Policy Period, even if the Claim is not actually made until after the Policy Period has expired.)

Coverage provided by D&O policies often extends to defense costs associated with criminal and regulatory investigations.  For example, D&O policies will usually cover inquiries made by the SEC or the FBI into allegations of insider trading; this is true even where the insureds are facing simultaneous, related civil lawsuits.
Modern D&O policies generally have three insuring agreements providing so-called Side-A, Side-B, and Side-C coverage.  These insuring agreements are broadly designed to provide coverage to individual insureds and the entity itself for “Loss” resulting from “Claims” made against them during the “Policy Period” for their “Wrongful Acts.”

  • The Side-A insuring agreement covers the individual directors and officers in situations where they are not being indemnified by the company – e.g., where state law prohibits indemnification, or where the company is financially incapable of providing indemnification.  More recently, Side-A insuring agreements have been worded to provide coverage where the directors and officers of a corporation are not being indemnified for whatever reason.  Typically, coverage for non-indemnified loss under Side A is not rescindable and the coverage is fully severable.1 
  • The Side-B insuring agreement covers the individual directors and officers in situations where they are being indemnified by the company.  The easiest way to think about Side-B coverage is that it reimburses the corporation for covered Loss it pays on behalf of its directors and officers.  Coverage for the individual directors and officers will fall under either the Side-A insuring agreement or the Side-B insuring agreement, but not both.  
  • The Side-C insuring agreement covers the corporate entity itself.  For large, publicly traded companies, Side-C insuring agreements typically only cover “Securities Claims,” which concern a corporation’s alleged violations of federal and/or state securities laws.  For smaller, private companies, the Side-C insuring agreement will usually provide coverage for a broader class of claims brought against the entity.

Some D&O policies also contain a “Side-D” insuring agreement that provides sub-limits of coverage for the investigative costs incurred by the corporation in connection with shareholder derivative demands.  For example, a corporation may have a $10 million limit of liability for securities claims – which will include actual shareholder derivative lawsuits – but a smaller (e.g., $250,000) sublimit of liability for corporate investigations undertaken pursuant to a demand from a disgruntled shareholder.
Most companies purchase Side-A and Side-B coverage.  Some companies self-insure the entity itself; that is, they forego purchasing Side-C coverage.  In such situations, serious allocation issues (as to both defense costs and settlements/judgments) can arise when both the insured directors and officers and the uninsured entity are named as co-defendants in the same lawsuit.  For that reason, when a company declines Side-C coverage, the D&O policy may contain an allocation clause or endorsement that specifies an allocation mechanism between covered and non-covered loss.  Usually such clauses/endorsements contain “feel good” language requiring the parties to use their “best efforts” to reach a reasonable agreement as to allocation before resorting to formal dispute resolution processes.

Where warranted and recommended by its broker, a company may also purchase “excess coverage” that (with the exception of policy-specific items, such as the limit of liability and attachment point) is typically written on the same terms as the “primary policy.”  The excess coverage is referred to as “follow form” coverage, meaning that in most material respects, it follows the insuring agreement, exclusions, and terms and conditions of the primary policy; insureds must, however, understand that there is a well-established body of case law that unequivocally holds that excess policies stand on their own.  Thus, to the extent that an excess policy’s insuring agreement, exclusions, and terms and conditions differ from that of the primary policy, the excess policy’s insuring agreement, exclusions, and terms and conditions govern questions of coverage analysis and claims handling.

Finally, in addition to these typical coverages, companies may choose to purchase a Side-A DIC (“Difference in Conditions”) policy.  Side-A DIC policies provide excess Side-A coverage to the individual directors and officers and operate to fill any gaps in coverage under the insuring agreements described above.  The Side-A DIC policy should serve to cover the individual directors and officers in almost any situation where, for almost whatever reason, an underlying carrier is not paying a claim.  Side-A DIC policies have the most restrictive language on rescindability and full severability, both of which inure to the benefit of the individual directors and officers.

Side-A DIC policies also offer the most protection for directors and officers in the case of a corporate bankruptcy.  If a corporate entity goes bankrupt, bankruptcy courts may consider the blended (Side-A, B, and C) D&O policy to be an asset of the bankruptcy estate.  This means that the individual directors and officers may not be able to access the proceeds of the D&O policy to pay their defense costs in related litigation.  Because the Side-A DIC policy is conventionally believed to be solely for the benefit of the company’s officers and directors – and confers no direct benefit on the entity itself – it is treated as separate from the bankruptcy estate.


Limits of Liability and SIRs 

The first, and most obvious, consideration for purchasers of D&O policies is to consider and determine the appropriate Limit of Liability.2 Of similar importance is the self-insured retention (“SIR”), which is the amount that the insured must first pay out-of-pocket before the coverage provided by the policy kicks in.3 Keep in mind that some policies will have different limits of liability applicable to each insuring agreement.  The same may also be true for deductibles and SIRs (e.g., there is usually no SIR for loss under the Side-A or investigative costs insuring agreements; thus, insurers pay defense costs immediately on non-indemnified or claims or on claims subject to sub-limits of liability).

Definition of Claim 

Given the “soft” (insured-friendly) marketplace for D&O insurance that has persisted for several years, the definition of “Claim” has slowly expanded. 

“Claim” now typically includes variations of all of the following: 

  1. Written demands for monetary, non-monetary, or injunctive relief.  This can be a monetary demand in a letter, or a request for arbitration, mediation, or some other ADR proceeding. 
  2. Civil, criminal, regulatory, administrative or proceedings, commenced by service of a civil complaint or a criminal indictment (or similar documents).
  3. An investigation by a governmental body (formal orders, subpoenas, and Wells Notices typically satisfy this portion of the definition of claim).  See, e.g., MBIA v. Federal Ins. Co. (2d. Cir. 2011). 
  4. A shareholder derivative demand.

“Claim” is also usually defined to mean a securities claim.  Often, the entity itself will have coverage for an administrative or regulatory proceedings against it (e.g., a SEC investigation of the entity), but only so long as the proceeding is also brought and continuously maintained against an insured individual.  That is, an individual insured must typically be part of and named in whatever investigation is occurring in order for the entity to also have coverage for a regulatory investigation.

With increasing frequency, the definition of claim includes written requests to the insureds to toll the statute of limitations period.  This means that the D&O policy will treat the definition of claim as satisfied once such a written request is received, even though no actual proceeding has commenced. 

Definition of Loss
The “Loss” covered by D&O policies is judgments, damages, awards, settlements, and defense costs.  Loss does not normally include civil/criminal fines and “matters deemed uninsurable under the law” (e.g., intentional acts, like fraud).  Some D&O policies also provide coverage for punitive and exemplary damages, to the extent permitted by the law of the subject jurisdiction.
Policies may also contain policy-specific carvebacks to the definition of loss.  Some policies do not provide coverage for certain types of securities claims and/or claims involving violations of the Foreign Corrupt Practices Act. 
Policies may also expand the definition of loss.  Examples include costs associated with (i) protecting the assets and/or reputations of directors and officers, or (ii) compliance with certain securities laws (e.g., Section 304 of the Sarbanes Oxley Act, which requires forfeiture of certain bonuses and profits where reporting requirements are offended).
Order of Payments/Allocation of Loss
D&O Policies may contain clauses governing the priority with which policy proceeds are paid out.  Usually, the insurer will first pay Side-A (non-indemnifiable) Loss, followed by Side-B (indemnifiable) Loss, followed by Side-C Loss suffered by the entity.  In this way, the policy will cover the individual insureds before the corporate entity.

Some D&O policies vest the CEO or other executives with the power to withhold policy payments under the Side-B and Side-C insuring agreements.  This is an issue to be aware of when purchasing the policy and, for example, could be amended by endorsement such that discretion to make or withhold payments rests with the entire board of directors rather than just the CEO.  It is possible that a Side-A DIC policy would drop in and provide coverage to individual insureds if the CEO/Board elected to withhold payments under the regular D&O policy.
Where a policy does not contain entity coverage, it is a good idea to include an “allocation” provision.  As noted above, issues of allocation arise where there is no entity coverage, as well as where: (i) there is covered loss and uncovered loss alleged in a claim; or (ii) there are covered insureds and uncovered insureds named as defendants in a claim (e.g., where both individual insureds and the entity are named as a defendants in a litigation, but the entity is not covered because the claim is not a securities claim).  In such situations, policies ask the insureds and the insurer to use their “best efforts” to reach agreement on how to fairly allocate Loss, often based on the “relative legal exposure” of the covered and uncovered parties.  Frequently, the policy will provide that where no agreement on allocation can be reached, the insurer has the discretion to advance whatever amount it deems fair pending agreement – by judicial proceeding or otherwise – on the allocation question.

Defense and Settlement 

Most D&O policies – with the possible exception of those issued to non-profits – are not “duty to defend” policies.  Under a “duty to defend” policy, the insurer has both the right and the obligation to control the defense of the insureds.  This includes the right appoint counsel of the insurer’s own choosing to defend the insureds.
Corporate insureds generally prefer to have the freedom to select their own counsel, sometimes from a pre-screened panel of law firms that have negotiated rates with the insurer.  In many instances, the carrier will negotiate a rate with counsel selected by the insured, because the policy only requires the carrier to pay “reasonable” and necessary costs of defense.  In addition, a carrier will almost always provide defense counsel with billing guidelines and very often conduct a review of the bills to ensure compliance with those guidelines.
Just because a D&O carrier does not have a “duty to defend” does not mean that the insurer is not involved in the claim.  Indeed, the D&O policy’s requirement for cooperation of the insured means that it must keep the carrier apprised of all material developments in the case, and many carriers have specific and detailed reporting guidelines.  D&O policies also prohibit an insured from admitting liability or settling a claim absent the consent of the insurer, with the caveat being that the insurer cannot unreasonably withhold its consent. 
“Conduct” Exclusions 

Every D&O policy excludes coverage for an insured’s bad conduct, such as fraud, dishonesty, or unlawful personal profit.  In this market for D&O insurance, almost all policies require that there must be an actual “finding in fact” or “final adjudication” of such bad conduct for these exclusions to apply.   Some D&O policies even go so far as to require a “final, non-appealable” adjudication before a carrier can deny coverage based on a “conduct” exclusion.  This means that the insurer must provide coverage to an insured until all avenues of appeal have been exhausted; it is only then that the insurer, armed with the judicial finding that the insured acted badly, can seek to recoup the defense costs/judgments it has paid on the insured’s behalf. 

There is a split in authority as to whether an insured can recoup defense costs paid on a claim later found not to be covered.  Some courts have held that unless that right is specifically guaranteed in the policy or agreed to in writing by the insured on whose behalf the defense costs were paid, a carrier cannot recoup defense costs on a claim later found not to be covered.  For this reason, some D&O policies purport to require insureds to execute so-called interim funding agreements or other memoranda by which the insureds agree to repay the insurer for defense costs for claims later deemed to be uncovered.
Severability of the Exclusions and the Application 

The conduct exclusions in many D&O policies are “severable.”  This means that the acts of one insured person will not be imputed to any other insured for the purpose of determining the applicability of the exclusions.  In other words, if it can be shown that one insured person engaged in a criminal or fraudulent act, then coverage would be excluded for that insured only.  (For coverage under the Side-C insuring agreement, many policies will impute the Wrongful Acts of the CEO or CFO to the entity itself).

A similar feature is a provision that severs the statements made in the application for the policy.  When such a provision is present, the knowledge of the entity or of any one individual insured will not be imputed to another individual insured (e.g., if one insured person lied on the application, that lie will not operate to void the policy for another insured person).  This means that the policy would not be rescindable as to the entity and all individual insured persons – just as to those that had made the misrepresentations in the application.

Pending & Prior Litigation (“PPL”) and Prior Notice Exclusions 

Absent a specific endorsement to the contrary, a D&O policy will not cover litigation or regulatory investigations that are pending at the time the policy is issued. (Such proceedings should be covered by the insured’s prior year D&O policy).  Similarly, an insurer will not cover claims that arise out of acts that the insured knew or should have known would ripen into a claim during the policy period; it is expected that these potential claims will be timely noticed to the existing insurer, who will then provide coverage if and when an actual claim is made.

Professional Services (E&O) Exclusion 

Most D&O policies, by exclusion or endorsement, disclaim coverage for professional services.  Such coverage is generally provided under an entity’s errors and omissions insurance policy. Some D&O policies contain a carve-back in the E&O exclusion for failure to supervise or breach of fiduciary duty.

Disputes between Insurer and Insureds 

D&O policies will often contain provisions governing disputes between the insurer and the insureds.  These provisions may require, for example, that all coverage disputes be submitted to binding arbitration, or to non-binding mediation.  It is not uncommon to see either substantive or procedural choice-of-law clauses in these provisions.  In the absence of a specific choice-of-law clause, arbitrators are not bound by the law of a particular jurisdiction, but instead are permitted to interpret the insurance contract without regard to substantive law. (With respect to procedural law, it is commonplace for D&O policies to refer to AAA procedural rules, which similarly do not require the application of traditional choice-of-law rules.)  The lack of a choice-of-law provision is not necessarily a bad thing given that arbitrators will be free to reach the result that is most fair or equitable in their view, but choice-of-law rules can be outcome determinative. Therefore, if the insured considers certain jurisdictions to be more favorable to its interests, it may want to consider asking that a specific choice-of-law clause be added.   

From the Bar… is designed to present our readers with the views of counsel from outside EisnerAmper LLP.

Please visit for more information on Edwards Wildman. You can reach Les Levinson at, Mary-Pat Cormier at, or Greg Pendleton at 


1 This means that the acts of one insured person will not be imputed to any other insured for the purpose of determining the applicability of the exclusions.  See discussion, below. 

2 Consideration should also be given to purchasing excess policies that “follow-form” to the primary D&O policy, providing essentially identical coverage once the primary policy is exhausted. 

3 SIRs should be distinguished from “deductibles.”  Policies with deductibles provide “first dollar” coverage, meaning that the insurer responds to the loss immediately, with the deductible representing that portion of the loss for which the insured must reimburse the insurer.  In contrast, the SIR is the portion of the risk that the insured retains for itself, and unless and until the insured pays that SIR, the insurer will not respond to the loss.  SIRs are generally used by insureds that have frequent, relatively small losses that they are willing to fund themselves in order to avoid an increase in insurance premiums. 


SEC Trends & Developments - Summer 2012 Issue  

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