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Managing risk
inadequately protects them. Outlined
below are some specific circumstances
where an individual officer or director may
expect such protection.
Derivative suit judgments or settlements:
The ability of the company to indemnify
its officers and directors for judgments or
settlements resulting from a shareholder
derivative action may be significantly
limited or prohibited by statute in a
company’s state of incorporation. For
example, Delaware generally does not
allow indemnification of settlements
or judgments in an action brought by
or on behalf of the company unless
the court permits such action. In such
circumstances, Side A coverage may
apply as long as the conduct of individual
directors and officers also complies with
the limitations and exclusions of the
insurance policy.
Public policy prohibition against
indemnification: Indemnification
for claims related to registration of
securities and antifraud provisions of
the federal securities laws (and other
federal statutes, such as the Racketeer
Influenced and Corrupt Organizations Act
and antitrust laws) may be precluded by
public policy. The SEC’s view is that such
indemnification is against public policy
because it undermines the securities
laws’ deterrent effect. However, the SEC
does not regard the maintenance of D&O
insurance as against public policy, even
where the company pays the premium. As
a result, it may be possible for insurance
to respond to protect individual directors
and officers in such circumstances where
indemnification from the company is
prohibited as a matter of public policy.
Conduct not in “good faith” and
“reasonable belief”: The company may
indemnify a director or officer only if such
person acted in good faith and in a manner
that he or she reasonably believed to be
in, or not opposed to, the best interests of
the company. As a result, acts that do not
satisfy the “good faith” and “reasonable
belief” standard may not be indemnified
by the company. In such circumstances,
claims made against an individual director
or officer may be insurable so long as the
conduct of such individual also complies
with the limitations and exclusions of the
insurance policy.
Refusal by board to indemnify: If the
board or other authorized designee
either declines in writing to indemnify
an individual or fails to make or initiate
a determination to indemnify an
individual, insurance may respond to
protect individual directors and officers,
but it may be subject to a retention or
deductible depending on the structure of
the program.
To avoid a circumstance where an
individual insured might be personally
responsible to pay a retention, many
public companies today purchase a
variation of Side A insurance often
referred to as Side A DIC (the “DIC”
refers to the “difference in conditions”
provisions that are contained in this
type of insurance policy). Side A DIC
insurance provides broader coverage and
is often purchased in addition to and in
excess of the traditional D&O (Sides A,
B and C) insurance described above. In a
circumstance where the board or other
authorized designee declines to indemnify
an individual as described above, Side A
DIC insurance could be called upon to
provide directors and officers coverage
at the primary level of the program (no
retention).
Near insolvency: Should the company
approach insolvency, it will approach
the “zone of insolvency,” where officers
and directors may be deemed to owe
certain fiduciary duties to creditors of the
company. Although not yet insolvent, the
company might choose not to indemnify a
particular director or officer for fear that
such act may be a breach of fiduciary duty
owed to creditors of the company or may
be the subject of an order by a bankruptcy
trustee to return those proceeds. Insurance
may respond if limits of the policy are not
otherwise eroded.
Actual insolvency or bankruptcy: The
company either may be insolvent or, in
the context of U.S. bankruptcy laws, may
be unable or unwilling to indemnify an
officer or director if the bankruptcy trustee
determines that such indemnification is
either unwarranted or improper. Moreover,
assuming that such indemnification of
an officer or director was warranted and
proper, the proceeds of the policy might be
deemed an asset of the “estate” and subject
to an automatic stay. The obligation to
indemnify may be deemed an unsecured
obligation, placing the affected officer’s or
director’s interest behind the interests of
secured creditors and on par with other
unsecured creditors awaiting payment or
settlement.
If there is some risk that the company
may avail itself of the protection of U.S.
bankruptcy laws, it may be useful to
seek an explanation from the company’s
insurance advisor and counsel as to how
the company’s D&O insurance policy may
respond to a number of potential issues.
Key issues to understand would include
identifying any issues related to:
• how limits in the policy are either
allocated or prioritized to coverage
other than coverage of claims made
against a director’s or officer’s personal
assets;
• whether the design of the company’s
D&O insurance program is such that
directors or officers will not be subject
to a retention or deductible if the
company is permitted to but fails to
indemnify such an individual; and
• what—if any—language exists in the
policy to waive an automatic stay as
regards the company’s policy.
Choosing a D&O policy structure, limits,
retention and insurers: The company
should consider several questions before
selecting the limits and structure of its
D&O policy, including the following:
• How susceptible is the company to
a class action lawsuit or government
enforcement action?
• If the company suffers a class action
lawsuit, what might it cost to defend
and settle?
• What limits, structures and retentions
do the company’s peers purchase?
• How can the balance between coverage,
limit, retention and price be optimized?
• What is the overall financial stability of
each insurer on the program?
• How can the program most costeffectively
address exposure for foreign
directors and officers?
92 NYSE IPO Guide