D & O insurance lessons from 'just for Feet'; A classic disaster situation: not enough insurance, bankruptcy, and inability to indemnify the directors.

• Author: Miner, Susan

A RECENT $41.5 MILLION SETTLEMENT by five former outside directors of Just for Feet Inc. brings independent director liability back into the spotlight. Somewhat surprisingly, the size of the personal contributions in this case were significantly greater than the notorious outside director settlements involving WorldCom ($24.8 million) and Enron ($13 million).

The settlement ends litigation stemming from Just for Feet's collapse in 1999 relating to accounting fraud. After the company filed for bankruptcy in November 1999, a bankruptcy trustee was appointed to recover money for the company's creditors. The trustee filed suit in Alabama state court in 2001 against former directors and officers as well as former accountants Deloitte & Touche. The allegations included bad faith, breach of fiduciary duties in delaying filing for bankruptcy despite the advice of experts, misrepresentations, and conflicts of interest.

Where was the D & O insurance?

Quite simply, it was exhausted by shareholder class action litigation filed two years before the bankruptcy trustee's lawsuit was even commenced. Court filings show only $100,000 of D & O insurance was left for the outside directors after the preceding shareholders' securities lawsuit was settled for $24.5M in 2002. Also, three former executives pleaded guilty to criminal charges and their defense costs likely further depleted the D & O limits.

Outside directors rarely contribute personally to settlements. A 2006 Stanford Law School study found only 13 instances in the past 25 years in which outside directors paid settlements out-of-pocket. After the Enron and WorldCom settlements in 2005, there was speculation that personal payments would become the norm. So far at least, that has not been the case.

In the Enron and WorldCom cases, plaintiffs aggressively sought personal contributions following the spectacular and highly publicized collapse of each company. Although court documents suggest their D & O programs had coverage flaws that weakened directors' arguments for coverage, it may be that no amount of insurance would have prevented those payments. (Indeed, at least in the WorldCom case the insurance limits were not exhausted.)

The Just for Feet facts are much more relevant to the average company. It appears the company simply did not have enough insurance, and it was bankrupt and unable to indemnify the directors. This is a classic scenario that a well-structured D & O program could protect against.

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