Protecting against cancellation.

• Author: Weiss, Stephen J.
• Position: D&O Insurance Update - Directors & officers' liability insurance - Column

Here is a policy provision that can pull the insurance rug out from under your feet when you need it the most.

Most prospective outside directors refuse to join a board unless they will be covered by D&O insurance. This is a wise decision. Obtaining just any policy is not enough. Yet, very few directors take the extra step of determining whether the D&O insurance they are offered will adequately protect them against large judgments, settlements, and defense costs arising from future litigation that names them as defendants.

When I have asked outside directors why they fail to take that next step, they give several reasons. Some assume that all D&O policies are alike. Others assume that the CEO, who is covered by the same D&O policy, will make certain that the policy provides first-class protection.

Unfortunately, neither assumption passes scrutiny. First, all policies are not alike. There are about 80 forms in the marketplace and, since there is no standard form, they vary greatly from one company to the next.

Second, CEOs rarely get involved in evaluating the quality of their D&O policies. The task of evaluating a policy, a complex legal document, typically falls either upon a non-legal employee or upon corporate counsel who negotiates one D&O policy a year. (The mismatch in experience between an individual who negotiates one D&O policy a year and an insurance underwriter who does this every day can produce very harsh results for insureds.) In other cases, perhaps because purchasers are intimidated by the "tyranny of the printed form," policy negotiations focus principally on premium levels, not on the breadth of coverage.

Perhaps the ultimate pitfall that directors fail to address is a provision that permits an insurance company to cancel a policy based on misstatements in or omissions from an insurance application. This failure recently had dire consequences for the directors and officers of one large publicly traded company. After the company and its directors and officers had been sued in a securities class action and the company's general counsel properly notified the D&O insurance company, he received a heart-stopping letter from the insurance company. It informed him that an investigation showed that the information submitted in the application was materially inaccurate and that, as a result, the insurance company had voided the policy as to all insureds.

You may face the same risk. Insurance companies, seeking to preserve their...