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Managing risk if the company is unable or unwilling to indemnify the individual director or officer directly. • Side B: Corporate reimbursement insurance—Insuring Agreement B, also called “Side B,” protects the company against a loss incurred by the company in indemnifying an officer or director for claims made against them. Side B coverage is commonly referred to as balance sheet protection. A deductible or retention applies for claims made under Side B. • Side C: Corporate coverage against securities claims—Insurance Agreement C, also called “Side C,” protects the company against a loss resulting from securities claims made directly against it. A deductible or retention also applies for claims made under Side C. A D&O insurance program can be customized to meet the particular demands of a public company and its officers and directors. Many companies, however, commonly purchase a D&O insurance policy in which a single limit of liability is shared equally among all three insuring agreements. The effect of this is that a single policy limit protects both the personal assets of directors and officers and certain financial obligations of the company. Companies also frequently purchase additional, dedicated limits of Side A coverage, with broad policy terms and conditions, and a DIC or difference in conditions feature (see discussion in (b) D&O Insurance and indemnification). Companies purchase these additional limits for a number of reasons, including considerations related to premium pricing, philosophical predispositions, balance sheet strength and the broader protection afforded individual officers and directors in such Side A policies. (a) D&O policy provisions Certain provisions in a D&O policy may affect the extent to which the policy responds favorably. Some of the key concepts are discussed below. Rescission: Material misrepresentations or nondisclosure of material information in the course of the application process for a D&O insurance policy may result in What is the structure of the D&O policy post-IPO – typical “ABC” policy example No Side A Insureds Directors and officers Personal assets Corporate assets Corporate assets D&O insurance Insuring agreement A: individual insureds Personal assets protection Covered claim against directors and officers Indemnification Personal assets protection (Individual) the insurer seeking the drastic remedy of policy rescission or avoidance. Through rescission, an insurer voids coverage under the policy for all insureds and returns the premium paid by the company. Rescission of an insurance policy by an insurer may result in severe consequences for the company and its directors and officers. A successful rescission results in all or a portion of the D&O insurance policy being null and void and, ultimately, can result in a loss of coverage for all named insureds on the policy, including innocent directors and officers. Certain D&O policies today can be negotiated to make some or all insuring agreements nonrescindable. Yes Side B Insureds corporate balance sheet D&O insurance Insuring agreement B: corporate reimbursement of individual insureds Corporate risk transfer Both Corporate risk transfer (Company) Covered claim against corporate entity Side C Insured corporate entity as a defendant (for securities claims only) D&O insurance Insuring agreement C: corporate entity coverage (for securities claims only) Corporate risk transfer Severability of the application: Rescission raises the concept of severability. In this context, severability simply relates to the question of whether the knowledge of one or a limited number of covered officers or directors will be imputed to (and potentially result in a loss of coverage for) all the insureds named in a policy (including the company itself). Severability imposes a limit on the extent to which the knowledge of one individual insured is imputed to the company and other insured individuals. As a result, nearly all D&O insurance policies contain provisions which state that no insured person’s knowledge will be imputed to any other insured and which limit the identified 90 NYSE IPO Guide
Managing risk individuals—usually the CEO and CFO—whose knowledge will be imputed to the company (as an insured itself). As another—and perhaps better—alternative, the company may seek a policy that is not rescindable for any reason. Obtaining a fully nonrescindable policy may involve trade-offs in other coverage or additional premium. Frequently, the company’s periodic securities filings and financial statements under the Exchange Act and registration statements under the Securities Act are expressly made part of the application for D&O insurance. Claims of inaccurate or incomplete disclosure in such filings incorporated into the application for insurance may be the basis for claims made by insurers that the application was materially false or misleading. As a result, accounting restatements—depending on their nature, scope and magnitude—may provide insurers with an additional basis to rescind a D&O insurance policy. Conduct exclusion: Almost all D&O policies contain exclusions barring coverage for certain “bad conduct” by directors or officers. Generally, they include: • intentionally dishonest acts or omissions; • fraudulent acts or omissions; • criminal acts; • willful violations of any statute, rule or law; • an insured’s obtaining an illegal profit; and • an insured’s obtaining an illegal remuneration. From an insured’s perspective, each of these exclusions should be limited as much as possible. For example, as noted above, it is important to consider enhancements to a policy so that the conduct of any one insured director or officer will not be imputed to any other insured. This should limit the exclusion of coverage to the individual directors or officers who actually committed the excluded conduct, while maintaining coverage for other insureds. It is also important to clarify the point at which coverage exclusions apply or are triggered. Certain policies state that the exclusions apply if the excluded conduct “in fact” occurred. This can be troublesome because of the ambiguity involved in interpreting what “in fact” actually means. Insureds should consider seeking a more clearly defined parameter for determining when a conduct exclusion may apply. Policies stating that the exclusions apply only if the excluded conduct was established in connection with a “final adjudication” of the underlying claim generally better protect directors and officers. However, although “pure” final adjudication language provides broad protection for individual directors and officers, it could result in the depletion of limits, leaving less in available limits to protect nondefendant directors and officers. Priority of payment provisions: Unlike many other types of commercial insurance, traditional D&O policies protect two distinct sets of beneficiaries: the company’s individual directors and officers and the company. Because there is a limit of liability for D&O insurance programs, situations may arise in which insurance proceeds may have to be prioritized among the insured parties. Typically, a priority of payments provision requires that the claims against the individual directors and officers be satisfied first, before claims against the company are satisfied. However, sometimes this provision may have unintended consequences. For example, a situation may arise in which a number of concurrent claims are made against the company and its individual directors and officers. This could include shareholder derivative suits (settlements of which may not be indemnifiable by the company) and securities class actions (settlements of which are indemnifiable). If the securities class action suits are settled before the settlement of the shareholder derivative actions, insurers may delay payment of any proceeds under the policy for a securities claim until settlement of the shareholder derivative action. A delay in such a settlement payment may adversely affect timing or funding of a proposed settlement of such a claim. “Entity v Insured” exclusion: Many D&O policies contain a so-called entity v insured exclusion, which bars coverage for a claim brought by an insured company against an insured director or officer or another insured corporate entity. This exclusion has historically been broader than it is today, so many of the concerns about the overreaching nature of this exclusion have been eliminated. However, there remain certain exceptions to this exclusion that should be considered, most of which relate to situations in which a company finds itself in insolvency or bankruptcy. (b) D&O insurance and indemnification Directors and officers no doubt find it especially troubling when the company is financially able to indemnify or advance defense costs to them but chooses not to or simply ignores their requests. Many directors and officers assume that in such a circumstance, the company’s D&O insurance policy would respond. But that might not be the case. In a traditional D&O policy, if the company is permitted to indemnify an officer or director but chooses not to, the insurer often will first seek the application of a “self-insured retention” (in other words, a deductible) that under ordinary circumstances would not apply. This is sometimes called a “presumptive indemnification” requirement. Under this circumstance, the self-insured retention would have to be paid by an officer or director prior to accessing any proceeds of a D&O policy. In some cases, the self-insured retention may be substantial. Directors and officers should seek clarification from their insurance brokers and counsel on the extent to which their D&O insurance policies allow directors and officers to access the policy proceeds in the event the company is able but unwilling to indemnify or advance defense costs to them. In fact, most traditional primary D&O policies, similar to Side A D&O policies, are now responding to a loss on behalf of a director or officer within 60 days if the director or officer has not received a response from his or her company regarding whether it will indemnify the director or officer for the matter in question. This has significantly reduced the punitive aspect of presumptive indemnification. A properly constructed D&O policy generally is meant to provide a level of protection for individual directors and officers in the event the company’s indemnification or advancement obligation NYSE IPO Guide 91
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