Directors and officers insurance is a business essential, without which few people would take on the risk of serving on a corporate board. But D&O coverage can have some glaring gaps, and entrepreneurial plaintiff lawyers are always coming up with new threats.
They’re increasingly pairing securities class actions with derivative suits, for example, in which shareholders sue officers and directors in the name of the corporation itself. A Delaware court this year allowed a derivative suit to proceed against a former McDonald’s executive over claims that he should have ferreted out sexual misconduct by ousted CEO Stephen Easterbrook. The decision was a warning shot that the oversight duties extend beyond mission critical risks like illegal activity into harder-to-manage personnel issues.
Most corporations indemnify their directors against personal loss from such claims. But do they have enough D&O insurance to cover the costs of defending their directors while also settling the accompanying shareholder suit?
“You need to provision for when everything has gone wrong and there’s nothing left for the directors,” says Kara Altenbaumer-Price, a lawyer and broker with McGriff Insurance Services in Dallas.
There are some things D&O insurance won’t cover at all. Shortly after Komatsu announced it was buying mining-equipment manufacturer Joy Global for $3.7 billion in 2016, shareholders accused Joy’s directors of hiding internal growth projections that could have driven the purchase premium above the 48 percent Komatsu paid.
Komatsu agreed to settle the case for $21 million. But when it submitted the bill to Columbia Casualty under its D&O policy, the insurer refused to pay, citing an exclusion for “any judgment or settlement of any Inadequate Consideration Claim other than Defense Costs.” Seventh Circuit Court of Appeals Judge Frank Easterbrook upheld the exclusion, explaining that insurance shouldn’t be a backdoor way for shareholders to get a premium company directors failed to obtain at the negotiating table.
Komatsu’s lawyers argued that a Delaware judge had ruled the opposite way in a similar situation, but Judge Easterbrook wasn’t impressed. “Komatsu Mining wants us to proceed as if all D&O policies contain the same language, but they don’t, so we shouldn’t,” he wrote.
Insurance policies are notorious for containing tricky clauses, and D&O policies are particularly treacherous for the unwary. They tend to be individually negotiated—“manuscripted” in insurance-speak—and can contain overbroad or outdated clauses that exclude coverage for costs directors might otherwise expect to be insured.
Fines and penalties may be covered, for example, “but not if you haven’t taken the effort to manuscript it,” says Altenbaumer-Price. “That means taking the standard contract filed with state insurance regulators and renegotiating it.”
A California court recently ruled in favor of Berkshire Hathaway after it refused to pay a commercial travel agency over a scam by a contractor who exploited the Sabre reservations system to book flights on United Airlines, scoop up hundreds of thousands of dollars in commissions and then cancel the reservations. The D&Opolicy excluded “dishonest, fraudulent, malicious or criminal acts.”
Some policies, especially older ones, have “insured versus insured” exclusions. What are they? If two of your directors get crosswise with each other—not uncommon, especially in closely held businesses—insurance won’t cover the legal bills. The solution is an “organization versus insured” clause, Altenbaumer-Price says, covering fights between directors but not when the company sues a director.
Altenbaumer-Price’s advice for directors: “Ask questions. Get engaged with the insurance broker. Don’t let it just be a situation where the CFO comes to the board meeting with a D&O policy and says ‘here it is.’”