Your worst nightmare.

• Author: WEISS, STEPHEN J.
• Position: Protecting directors' and officers' liability insurance coverage - Brief Article

How you can protect yourself against abrupt rescission of your D&O policy.

WHEN YOU FIRST agreed to join the board of directors, you were confident that your company had in place the very best D&O liability insurance policy to protect your personal assets. After all, you knew your company had engaged a respected brokerage firm to secure a top insurance package which promised the "broadest management liability protection available anywhere."

And yet, your confidence starts to wane after your company issues restated financials showing lower profits for last year -- and securities fraud lawsuits rain down from the heavens. Although your company gives timely notice of these suits to its insurers, your primary insurer informs the company that it is unilaterally voiding its policy.

The insurer asserts that it has the right to rescind the policy because the company made material misrepresentations and omissions in its application. (When a policy is rescinded, it is void from inception, the insurer returns the premium and it is as if no policy had ever been issued.) And when it rains it pours: The excess insurers in the company's $100 million insurance program rescind their policies as well. Your company has no choice but to sue its insurers for a judgment declaring that they are not entitled to rescind their D&O policies.

All in all, it's a catastrophe only a litigator could love. And right now, litigators are finding a lot to love as more companies restate their results.

How can you protect yourself against this kind of insurance meltdown? What Went Wrong? To purchase (or renew) a D&O insurance policy, a company must complete an application. The typical application requests answers to numerous questions and requires the applicant to attach its latest SEC 10-K Report, all registration statements and proxy statements filed with the SEC within the last 12 months, and the latest interim financial statements. These voluminous attachments are incorporated into the application by the terms of the policy and thus are covered by the company's mandatory representation that the statements in the application are true and complete. A breach of this representation has profound implications for insureds whose policy employs the following wording:

"This policy shall be void if the application and/or any other materials submitted with it contain misrepresentations which materially affect either the acceptance of the risk or the hazard assumed by the insurer.

It...