Chapter 15b Directors' and Officers' Liability

• Library: The Handbook on Additional Insureds (ABA) (2018 Ed.)

CHAPTER 15B Directors' and Officers' Liability

Carl E. Metzger and Brian H. Mukherjee^*

I. Introduction

This chapter provides an overview of common issues associated with the presence of insured persons beyond the insured directors and officers in a directors' and officers' liability insurance (D&O) policy. Where relevant, specific language from publicly available D&O policy specimens currently on the market is highlighted to illustrate the specific policy terms being discussed. As with any analysis of insurance coverage issues, the express terms of the policy and the law of the applicable jurisdiction will determine the extent to which coverage is available.

Unlike in commercial general liability policies, additional insureds in a D&O policy typically are not third-party entities and are not added pursuant to some commercial contract obligation owed by the insured entity.¹ Rather, in many cases, additional insureds are existing employees of the insured entity.² Indeed, the term "additional insured" may be somewhat of a misnomer, because, with certain exceptions discussed herein, additional insureds share the same rights under a D&O policy as other insured persons (i.e., the directors and officers). In other words, all insured persons, whether included in the policy's definition of insured person or added by policy endorsement, are treated equally for coverage purposes. This is markedly different than additional insureds under commercial general liability policies, who typically enjoy more limited coverage than the policy's named insured. Because all insured persons typically are treated equally under a D&O policy, there is much less dispute concerning the rights of additional insureds versus other insured persons.

The D&O insurance marketplace has been "soft" for some time now, meaning that insureds have been able to secure increased coverage grants and more favorable policy terms and conditions, while annual insurance premiums have in many cases stayed flat or even decreased. Accordingly, insureds have been well-positioned to request that D&O insurers cover an increasing number of insured persons under their policies. Although there are a number of benefits to expressly adding additional insureds to a D&O policy and thereby expanding the universe of insureds, the presence of those additional insureds ultimately may have unintended and deleterious effects on the insurance coverage available. Those consequences can potentially impact insurance coverage available for other insured persons, or for the company itself.

In particular, and as its name suggests, a D&O policy is first and foremost intended to provide coverage for the benefit of an entity's directors and officers, thereby providing personal asset protection to them in the event they are sued as a result of actions taken in their corporate capacity. As will be discussed, however, many D&O policies now provide coverage to the entity, as well as coverage to the entity's employees. Today's D&O policies may also include as insureds advisory board members or so-called shadow directors, internal compliance positions such as risk managers, and human resources and investor relations supervisors. The presence of insured persons other than directors and officers raises the following key issues: (a) the specific capacity in which the additional insured is purportedly receiving coverage, (b) the potential dilution of policy limits by the additional insured, (c) the effect of the additional insured on the "priority of payments" provision in the policy, and (d) the application of the so-called insured v. insured policy exclusion.³ Each of these issues will be addressed in turn.

II. Typical Insureds under a D&O Policy

There generally are three categories of insureds under a typical D&O policy: (a) the named insured entity, (b) subsidiaries of the named insured entity, and (c) insured persons, who are the officers, directors, or employees of the named insured or its subsidiaries. Until the 1990s, a typical D&O policy afforded coverage only to directors and officers. Entity coverage (i.e., coverage afforded to the named insured and its subsidiaries), however, gradually became available in response to a number of court decisions concerning the extent to which insurers were permitted to allocate loss under D&O policies to corporate entities (which were not covered) as opposed to insured persons, in proceedings where both the corporation and insured persons were named as defendants.

A. Named Insured

The named insured is generally the corporate entity identified in the declarations page of the policy. Practically speaking, the named insured is often the parent company or other entity sitting atop a corporate organizational chart. The named insured will generally be responsible for paying the premium for the D&O policy, giving notice of claims, and other ministerial matters relating to the administration of the policy.⁴ Notably, a change of control with respect to the named insured (e.g., a sale of a controlling interest of the named insured, or all or substantially all its assets) may also have the effect of terminating the ongoing coverage for all categories of insureds.⁵

There are key differences with respect to the breadth of D&O insurance coverage provided to private company entities or nonprofit entities compared to public company entities. Coverage for the private entity or nonprofit entities tends to be very broad, and with some exceptions, is equal to coverage afforded to insured persons. D&O insurance coverage for public company entities, however, is primarily limited to federal securities law-related claims.⁶

B. Subsidiaries

The next category of insured entities is typically identified by reference to their relationship to the named insured. For instance, a policy may define an "Organization" as inter alia, the named insured and each "Subsidiary."⁷ The definition of Subsidiary will generally be defined to mean an entity in which the named insured owns or controls more than 50 percent of the entity's securities or the right to elect or appoint more than 50 percent of the entity's directors.⁸

C. Insured Persons

The third category of insureds encompasses individuals affiliated with a named entity or subsidiary, often defined as "insured persons," or some similar designation. These individuals typically serve as directors or officers of an insured entity,⁹ and insurance coverage will be available to them only with respect to claims that arise within the scope of their corporate duties to the entity. These individuals typically receive indemnification from the entity to protect them from such claims. Indemnification is typically provided by statute and agreement and can be either mandatory or permissive.¹⁰

III. Adding Additional Insureds to the D&O Policy

As discussed previously, by virtue of a D&O policy's definitions and related terms, categories of entities and individuals are intended to be automatically covered by the policy. The parent company (the named insured) is identified on the face of the policy, and the policy then supplies appropriate definitions to bring under the coverage umbrella the parent company's subsidiaries, and collectively, the directors and officers of those entities. The next section will discuss the addition of other individuals as insureds to the policy.¹¹ Generally speaking, insurers are willing to add additional individuals to the policy where the company has agreed to indemnify those individuals in the event of a claim against them in their corporate capacity.¹² Absent some requirement that the company provide indemnification to a particular individual, however, it is unlikely that he or she will be added to the policy.

Broadly speaking, insured persons can be either non-employees or employees. Non-employees may include "shadow directors" under foreign law, or members of a company's advisory board. Insured employees fall into two general categories: (a) employees who may receive coverage because they are co-defendants with either directors or officers, or are the subject of securities claims, and (b) other specifically enumerated positions, such as employed lawyers, risk managers, and human resources and investor relations supervisors.

Generally speaking, "shadow directors" or advisory board members can be added by policy endorsement. Insurers will add employees directly into the policy definition of insured person, and increasingly the position of general counsel and risk manager is also being expressly reflected in the policy form itself. Coverage for in-house counsel other than general counsel, and other enumerated employee positions, is typically added only by...