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| Best Practices: On the Board |
Bonfire of the Indemnities
Suzanne McGee
06/01/2005
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Within most companies, boardroom discussion about D&O
insurance still often revolves around the amount of coverage available. That is
important, of course, but what should matter more to an individual sitting on a
board is how that policy is structured, who it covers and its wording. In part,
that is because even the largest policy may cover only $500 million in
losses—and for multibillion-dollar companies, the combination of legal costs and
settlements or judgments can dwarf even the biggest policies.
Scrutinizing
D&O policies, however, is far from straightforward. “The policies used to be
seven or eight pages long; now they are an inch thick,” warns William
Passannante, cochairman of the insurance recovery group in the New York law
office of Anderson Kill & Olick.
A policy can include coverage for many
sources of liability. Some companies are discovering that they can save on
insurance costs by bundling D&O coverage with, for example, insurance
against employment claims such as sexual harassment lawsuits against staff
members. Well-informed board members look to this kind of coverage and similar
D&O tactics to protect themselves from a plethora of problems that,
realistically, no director can monitor or guard against.
However, this type
of overarching coverage seems to be more the exception than the rule, often
because of its cost. “There is a fundamental conflict of interest that exists
between the company and its executives, and the outside directors,” Galban says.
This divergence is exacerbated by the fact that directors’ personal assets can
serve as a magnet for attracting lawsuits—even though they may play only a
minimal role in deciding what D&O insurance policy to buy to shield
themselves from these risks.
In the wake of the accounting scandals,
regulatory inquiries and court actions, insurers are trying to find new ways to
circumvent fulfilling D&O policies when trouble strikes. Underwriters have
been altering the language in their policies to give themselves more room to
walk away or to strong-arm a company to settle. “There are all sorts of new
trapdoors to get out of the obligation, where once they would just say they
covered you for liability,” Passannante says. Prior to 2000, for example,
underwriters might have been able to limit coverage or even withdraw or rescind
a policy altogether in the wake of an act by directors or officers “arising out
of, based upon or attributable to the committing in fact of any criminal,
fraudulent or dishonest act, or any willful violation of any statute, rule or
law.” Today the language reads something like this: “ arising out of or
resulting directly or indirectly from any criminal or fraudulent act, error or
omission.”
Even so, knowledgeable board members can lobby for expanded
coverage. “Directors can still push to have the language changed to something
more favorable, if they are aware of the importance of the words,” says Paul A.
Ferrillo, a New York-based attorney in securities and corporate governance at
Weil, Gotshal & Manges.
Addenda Value
One of the features that Downey and other independent
directors seek is a Side A or Clause 1 policy. These addenda to blanket D&O
policies cover directors and officers for any expenses or damages when they
cannot be indemnified by the company and when a blanket policy is not in
force or has been exhausted or rescinded by the carrier. Cash-rich companies
that prefer to self-insure against balance-sheet risks are often buying Side A
or Clause 1 policies instead of blanket policies. Two of the four boards on
which Downey sits—Emulex and First Consulting Group—already have Side A
coverage. “I think by the time we finish renewing our policies this year, we
will have it in all four boards,” he says.
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