Director and officer liability insurance has never been more important to those in the financial services sector.
Bankruptcy filings significantly increase both the likelihood and complexity of litigation against a bankrupt organization's executives. Regulators, shareholders, bankruptcy trustees, bankruptcy receivers and others may seek to find blame for the organization's financial failure and may try to recoup losses.
In today's economic climate, these risks are of particular concern to financial services organizations, especially banks, because they are going bankrupt at record rates.
Directors and officers usually receive indemnification from the organization in the event of litigation, so long as the individuals acted in good faith and in the best interests of the company. However, a bankrupt institution may lack the funds, or may not be permitted to provide indemnification.
Hence, D&O insurance becomes critically important in the bankruptcy context, to protect executives from compounding defense costs and indemnity sums needed to resolve the disputes.
D&O insurance protects directors and officers from liability arising from many breaches of fiduciary duties and violations of various laws. It also protects the entity from various forms of securities litigation. Three insurance agreements provide coverage:
• Side A coverage directly insures directors and officers for covered defense costs, settlements and judgments which are not indemnified by the company. Given today's economic realities and the rising number of bankruptcies, Side A coverage provides critical protection for directors and officers.
• Side B coverage reimburses the company if it indemnifies the directors or officers for covered costs, settlements and judgments.
• Side C coverage insures the company itself for covered liabilities arising from securities claims.
Typically all three coverages are included in a single policy, and all three coverages share a single limit of liability. The policies are usually "defense within the limits" policies, with some exceptions. This means that defense costs reduce the limit of liability.
D&O policies are historically "claims made and reported" insurance policies. This means that the claims first must be made and reported during the policy period, or reported during any post-policy reporting window. Adherence to reporting requirements is critical to securing coverage, even during the upheaval of events in bankruptcies.
Certain steps can maximize access to coverage if the organization becomes bankrupt. Most are taken at the time coverage is first purchased. Make sure that:
• The definition of entity includes the entity as a debtor in possession, so that the entity is still an insured even though its status has changed.
• Any "insured versus insured" exclusion in the policy form does not apply to suits by the bankruptcy trustee or receiver, who may sue directors and officers.
• There is no regulatory exclusion, as financial institutions may be subject to significant regulatory scrutiny upon bankruptcy and regulatory takeover.
• There is no bankruptcy exclusion, as the exclusion may eliminate coverage when executives most need protection.
• Activities that may happen in bankruptcy, such as changes in a majority of board positions or a significant sale of assets, will not trigger the change-in-control section of the policy and suddenly terminate coverage. When an entity goes into bankruptcy, its assets may be automatically frozen under bankruptcy law. Courts are split on whether to freeze applies to the D&O policy and its limits. Some courts have found that the D&O policy and its proceeds are assets of the bankrupt estate and so are subject to the automatic stay. Other courts have found that, while the policy was bought by the entity so it is frozen, the proceeds were intended for the nonbankrupt directors and officers and so the proceeds are not frozen. To maximize the arguments against freezing the policy proceeds, several steps can be taken.
• The policy has a "priority of payments clause," which provides that the policy proceeds will be paid first for the directors and officers and only thereafter for the entity. This supports the position that the policy proceeds should not be frozen as part of the entity's bankrupt estate, because the proceeds are first and primarily for directors and officers, who are not bankrupt.
• There is a policy clause in which the entity agrees to waive the automatic stay.
• There is no entity coverage. Insuring only directors and officers demonstrates that the policy proceeds were never intended for the bankrupt organization and as such should not be subject to the automatic stay.
Bankruptcy poses one of the greatest threats of personal financial risk to directors and officers, and forces upon the insurer and insured a host of complex insurance issues. Critical steps can be taken when coverage is placed that will maximize executive protections. Directors and officers are well served by taking those steps. It is also important that the primary insurer has both a proven commitment to insuring financial institution risks and experience in handling complex litigation so that the only surprises in the context of a claim will be those of the plaintiff's making.
