Directors’ & Officers’ Liability Insurance – The Fundamentals

1. Directors’ & Officers’ Liability Insurance – The Fundamentals By: Bryna Rosen Misiura Jeniffer A.P. Carson

2. What is D&O Insurance? • D&O policies provide insurance coverage for claims brought against the directors and officers of a corporation, not against the corporation itself.

3. History • Introduced by Lloyd’s of London in late 1930’s • Introduced before directors and officers faced the liability they face today • Since then, expansion of federal securities laws and other federal statutes • Today, cost of defending and settling these cases is astronomical.

4. Role of Directors and Officers • Shareholders typically elect a board of directors • The board of directors typically appoints officers • Officers run the day-to-day management of the business

5. Role of Directors and Officers • Directors are responsible for: • Adopting a business strategy • Approving all major policies and procedures • Supervising the officers • Insuring compliance with federal and state laws, including issuance of securities

6. Fiduciary Relationship • Directors and Officers have a fiduciary relationship with the corporation • They owe the corporation the duties of: • Care • Loyalty • Obedience

7. Business Judgment Rule • Protects directors and officers from liability for the reasonable business decisions they make • Directors and officers are entitled to rely upon the expertise of others, such as accountants, in making their decisions • However, breaches of the duty of care are frequently added to lawsuits brought on other grounds • Types of potential claims: • Imprudent investment choices • Mismanagement of the corporation • Improper payment of dividends • Other decisions that may cause a diminution in profits/value

8. Lawsuits Based on Breach of the Fiduciary Duty of Loyalty • Derivative actions – filed by shareholders • Types of derivative actions: • Undisclosed conflicts of interest • Insider trading • Appropriation of a corporate opportunity • Authorization of loans of corporate funds on preferential terms

9. D&O Liability Based on Federal Statute • Securities & Exchange Act of 1933/1934 (Securities) • Sarbanes-Oxley Act of 2002 (Securities) • Sherman and Clayton Acts (Antitrust) • Title VII of the 1964 Civil Rights Act • Americans with Disabilities Act of 1990 • Age Discrimination and Employment Act of 1967 • Family and Medical Leave Act • National Labor Relations Act • Employee Retirement Income Security Act (ERISA) • Internal Revenue Code

10. D&O Liability Based on Federal Statute • Racketeer Influenced and Corrupt Organizations Act (RICO) • Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) • Resource Conservation and Recovery Act (RCRA) • Latham Act (Intellectual Property) • Federal Election Campaign Financing Act of 1971

11. D&O Liability Based on Massachusetts Statute • MA Securities Act • Employment discrimination • Tax Law • Antitrust Laws

12. Elements of the D&O Insurance Agreement • Two Insuring Clauses • Side A Coverage – Insures Directors and Officers when the Corporation Refuses to or Cannot Indemnify • Side B Coverage - Reimburses the Corporation for Indemnifying its Directors & Officers

13. Other Common Insuring Clauses • Securities Coverage • Protects the corporation and its officers from securities claims • This coverage is optional and may be added to the policy either as an additional insuring agreement or as an endorsement.

14. Other Common Insuring Clauses • Employment Practices Liability Coverage (EPLI) • Protects against discrimination suits or wrongful termination, or failure to promote • Corporation may choose to purchase this coverage in stand-alone policy format because: • Subject to D&O policy aggregate limit • Cover fewer types of claims than stand-alone policies

15. Common D&O Policy Provisions • Mandatory Arbitration Clause • Assignment • Cancellation • Damages • Mergers and Consolidations • New Subsidiaries • No-Action • Other Insurance • Subrogation

16. Common Exclusions • Bodily Injury, Personal Injury, or Property Damage • Bribes, Payments and Gratuities • Dishonesty • ERISA Claims • Hostile Takeovers • Insured vs. Insured Suits • Personal Profit

17. Common Exclusions • Pollution Claims • Prior and Pending Litigation • Prior Policy Loss • Remuneration Return • Security Holder • Short-Swing Profits • Wrongful Employment Practices

18. Duty to Defend • Average cost to defend D&O case exceeds $500,000 • Defense expenses include any reasonably and necessary legal fees and expenses incurred in the defense of the claim • Most policies do not impose a duty on the insurer to defend • Insured has right to choose counsel • When included in policy’s aggregate limit?

19. Duty to Defend • However, insurer generally has right to consent to choice of counsel, defense strategies, expenditures and settlements • Historically, the insurer was not typically obligated to advance defense expenses • Courts have interpreted this inconsistently, some requiring advancement of costs and others not. • Now, most insurers will write policies with provisions for advancement of defense costs • Will be negotiated into price of policy

20. Definition of Loss • Varies depending on policy • Characterizes the losses that will be covered

21. Definition of Loss Example • Loss means adjudicated damages, settlements and defense expense, however, loss shall not include: • criminal or civil fines or penalties imposed by law, • matters which are uninsurable under the law pursuant to which this policy shall be construed • punitive or exemplary damages or the multiplied portion of any multiplied damage award or • taxes or wages.

22. Definition of Loss • Terms warranting discussion: • Criminal or civil fines and penalties • Uninsurable matters • Punitive, exemplary and multiplied damages • Taxes and wages

23. Definition of Wrongful Act • Governs which acts or omissions trigger coverage • Three examples:

24. Basic Definition of “Wrongful Act” • Wrongful Act is an actual or alleged breach of duty, breach of trust, neglect, error, misstatement, misleading statement, omission, breach of warrant of authority, or other act done or wrongfully effected by an any Insured.

25. Expanded Definition of “Wrongful Act” • The term “Wrongful Act” shall mean any breach of duty, neglect, error, misstatement, misleading statement, omission or other act done or wrongfully attempted by the Assureds or any of the foregoing so alleged by any claimant or any matter claimed against them solely by reason of their being such Directors or Officers of the Company.

26. Restrictive Definition of “Wrongful Act” • “Wrongful Act” shall mean any actual or alleged negligent act, error, omission, misstatement, misleading statement, neglect or breach of duty by the Director or Officers, individually or collectively, in the discharge of their duties solely in their capacity as Directors or Officers of the Company.

27. Expands The term “Wrongful Act” shall mean any breach of duty, neglect, error, misstatement, misleading statement, omission or other act done or wrongfully attempted by the Assureds or any of the foregoing so alleged by any claimant or any matter claimed against them solely by reason of their being such Directors or Officers of the Company. Restricts “Wrongful Act” shall mean any actual or alleged negligent act, error, omission, misstatement, misleading statement, neglect or breach of duty by the Director or Officers, individually or collectively, in the discharge of their duties solely in their capacity as Directors or Officers of the Company. Comparison of Two Similar Definitions

28. Guidelines for Evaluating Definitions of “Wrongful Act” • Scrutinize the proposed language carefully. • Compare the wrongful act definition with any exclusions, limitations or other endorsements. • Avoid definitions that are limited to specified acts and do not extend coverage to other, unspecified acts. • Avoid definitions that restrict coverage to negligent acts. • Avoid definitions that require the wrongful act to be committed solely in the discharge of the directors’ or officers’ duties.

29. What is a “Claim”? • Coverage not invoked unless claim made • Obligation to notify insurer of claim • Varies from to policy • Once insurer notified, insurer must determine whether coverage is triggered

30. “Claim” – Example 1 • “Claim” means any judicial or administrative proceeding, including any appeal therefrom, against a Director or Officer in which such Director or Officer may be subjected to a binding adjudication of liability for damages or other relief.

31. “Claim” – Example 2 • “Claim” means (1) any written notice received by any Insured that any person or entity intends to hold such insured responsible for a wrongful act, or (2) any judicial or administrative proceeding initiated against any insured seeking to hold such insured responsible for a wrongful act, including any appeal therefore.

32. “Claim” – Example 3 • “Claim” means: • any civil proceeding in a court of law or equity, including any appeal from, which is commenced by the filing of a complaint, motion for judgment or similar proceeding; • any criminal proceeding which is commenced by the return of an indictment; • any administrative or regulatory proceeding which is commenced by the filing or issuance of a notice of charges, formal investigative order, subpoena or similar document; and • any written demand or notice to an insured describing circumstances that are likely to give rise to the claim against an insured of any proceeding described in paragraph (a), (b) or (c) above.

33. When is a Claim Timely? • Claims-Made Basis • Both the event giving rise to the claim and the claim itself must occur during the policy period • Exception: Potential Claims • Occurrence-Based Claim • Requires the event giving rise to the claim occur during the policy period. The claim itself need not be made during the policy period.