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Insurance Roundtable of Baltimore

Annual Fall Seminar

Private Company Directors’ & Officers’ Insurance

Hunt Valley, MarylandOctober 12, 2012

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Presentation Outline

• Private Company D&O– The Basics– Terms & Conditions– Limits and Structure

• Emerging Issues– M&A Litigation– JOBS Act– Social Media– Excess Coverage Triggers

• Recurring Issues– Warranties– Antitrust Exclusion – Contract Exclusion – Disconnect: Clients’ Expectations vs. Marketplace Reality– Client Assuming Not Covered, Therefore Notice Not Given

Claims against Private Companies

Source: Towers Perrin Directors and Officers Liability Survey

Percentage of D&O Claims by Claimant Private Companies

Other Third Parties 11%

Customers & Clients 3%

Competitors11%

Shareholders 32%

Employees43%

Why Private Companies Buy D&O Insurance

• Unanticipated claimants, unanticipated claims• The high costs of defense• Unanticipated inability to indemnify• Relatively modest incremental cost on top of EPL• Private company D&O insurance = broad coverage

D&O Insurance-- The Basics• Professional Liability Insurance for Directors and Officers• Private Company form includes broad entity coverage• Provides Coverage for

1. Loss 2. Arising from Claims Made During the Policy Period3. Against Insured Persons4. For Wrongful Acts5. In an Insured Capacity

Policy MechanicsY

TRIGGERActions of D&Os that aren’t indemnifiable

PAYSOn behalf of D&Os

RETENTIONNone

TRIGGERActions of D&Os that are indemnifiable

PAYSOn behalf of entity tofund indemnification

RETENTIONApplies

TRIGGERActions of entity

PAYSOn behalf of entity

RETENTIONApplies

CA B

Y

TRIGGERActions of D&Os that aren’t indemnifiable

PAYSOn behalf of D&Os

RETENTIONNone

TRIGGERActions of D&Os that are indemnifiable

PAYSOn behalf of entity tofund indemnification

RETENTIONApplies

TRIGGERActions of entity

PAYSOn behalf of entity

RETENTIONApplies

CA B

D&O Insurance: Exclusions• D&O Insurance is Not “All Risks” Insurance• Conduct Exclusions• Exclusions to Fit D&O Insurance with other coverages• Prior Notice / Other Insurance / Prior Claims• Environmental / Nuclear Exclusions• Uncommon Exclusions:– Commissions Exclusion– Failure to Maintain Insurance Exclusion– Antitrust Exclusion

Key Coverage Considerations• Separate or Combined limits• Duty to Defend or reimbursement• Full prior acts coverage• Broad definition of Claim• Broad definition of Employment Practices Wrongful Act• Full coverage for private securityholder exposures• Coverage for punitive damages• Wage and Hour law claim defense costs coverage

Key Coverage Considerations• Third Party discrimination and sexual harassment coverage• “Final adjudication” language on misconduct exclusions• Fully severable exclusions• Fully severable application• No major shareholder or family exclusions• No anti-trust or unfair trade practices exclusions• No bankruptcy / insolvency exclusion

Limit Distribution

Total AssetsParticipants Reporting

First Quartile

($ millions)

Median ($

millions)

Third Quartile

($ millions)

Average ($

millions)

$0 to $6 million 669 1 2 3 2.51

$6 to $10 million 306 1 2 3 2.78

$10 to $50 million 406 2 3 5 4.55

$50 to $100 million 72 2.25 5 10 5.72

$100 to $400 million 72 3 5 10 8.58

What D&O limit? How Much Should I buy?

Special Considerations Involving Outside Directors

• Individuals’ Separate Interests Have Policy Structure Implications:– Interests of Insider Officers and Outside Directors Not Always Aligned

Outside Directors? Divergent Interests• Problem of Single Policy, Shared Limits– Limits Exhaustion (Collins & Aikman)– Insolvency (Just for Feet)– Individual targets / plaintiff “bounties” – Derivative Suits (Options Backdating)

• Advantage of Dedicated Insurance• Program Structure Solutions– Dedicated Side A/DIC Policy– Individual Director Liability Insurance (IDL)

Excess Side A/DIC Protection• Side A: When the company is unable to indemnify (insolvency or legal prohibition)• Difference in Condition:– Carrier Insolvency– Traditional carrier denies coverage (fewer exclusions)– Company refuses to indemnify– Traditional Carrier Rescinds Coverage

Alternative Policy Structures

Insurance Structures for Individual Protection

What to Talk About When Talking D&O

• Personal liability exposure• Indemnification – and its limits• Individual liability protection (possible need for

Excess Side A only coverage?)• Limits Adequacy • Program Structure• What Underwriters Look For• Risk Management• “Never Had a Claim/Don’t Need the Insurance”

Emerging Issues: Merger Objection Litigation

Year Deals Litigation % With Litigation

2005 181 70 38.7%

2006 230 97 42.2%

2007 249 97 39.0%

2008 104 50 48.1%

2009 71 60 84.5%

2012 124 105 84.7%

2011 103 97 94.2%

Total 1,062 576 54.2%

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U.S. publicly traded targets, Transaction > $100 Million (Source: M. Cain, S. Davidoff, Takeover Litigation in 2011)

Merger Objection Litigation

• Shifting Mix of Litigation• Not Only Frequency, But Severity• Data Reports Concern Large Public Companies,

But Small Deals Involved, Too• Affecting Primary D&O Pricing • Separate M&A Retentions (More Common for

Public D&O But Also for Private Company D&O)

Emerging Issues: The JOBS Act

• Jumpstart Our Business Startups (JOBS) Act • Signed Into Law April 2012• Intended to Facilitate Capital Formation and

Boost Employment• Potential Effects Much Greater for Private

Companies

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The JOBS Act: Key Features• Eased Restrictions for Private Offerings– Advertising, Solicitation Allowed– Reporting Exemptions Expanded (e.g., up to 2,000

shareholders now allowed)• IPO “On Ramp” Procedures– Confidential Filing– “Testing the Waters” Allowed

• Emerging Growth Companies– Reduced Reporting Requirements– Relief from Dodd-Frank, Sarbanes Oxley Requirements

• Crowdfunding on Internet Portals Allowed

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Crowdfunding

• Subject to SEC Rules (Due January 2013)• Limited to $1 Million Per Year• Must Register with SEC– Over $500 Million: Audited Financial Required

• Potential Securities Act Liability for Misrepresentations

• Concern: Blurs the Line Between Private and Public Companies?

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Private Placements

• JOBS Act provisions allow much larger private offerings

• Allowance of Solicitation and Advertising: Potential for Mischief

• Private Companies with as many as 2,000 Shareholders

• Again, Blurs the Line Between Private and Public Companies

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JOBS Act: D&O Insurance Implications• Private Company D&O Insurers Concerned• Most Concerned About Reduced Private Financing

Restrictions• Crowdfunding– Revised Securities Offering Exclusions– Crowdfunding Exclusion Endorsements

• Special Considerations for Pre-IPO Companies• Stay Tuned– Most Insurers Still Determining Response– Crowdfunding Rules Not in Place Until January 2013

– JOBS Act is THE Hot Button private company D&O topic for 2013

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Emerging Issues: Employer Social Media Policies

• Costco Wholesale Corp., National Labor Relations Board, September 7, 2012

– Company Policy: statements “posted electronically (such as [to] online message boards or discussion groups) that damage the Company, defame any individual or damage any person’s reputation, or violate the policies outlined in the Costco Employee Agreement may be subject to discipline, up to and including termination of employment.”

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Employer Social Media Policies: The NLRB’s Decision in Costco

• The NLRB Found that Costco’s Rule “clearly encompasses concerted communications protesting [Costco’s] treatment of its employees.” Costco’s maintenance of the rule therefore “has a reasonable tendency to inhibit employees’ protected activity” and as such “violates” the National Labor Relations Act.”

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EPL Insurance Implications of the Costco Decision

• Social Media Policies May Inhibit “Concerted” Communications, Violate NLRA.

• Problem: Typical EPL Policy Contains NLRA Exclusion• Possible Option?: NLRA Exclusion Carve-Back to

preserve coverage for Retaliation Claims – preserving coverage for claims based on retaliation for

exercising rights protected by the NLRA

• Limitation: Carve-back rarely extends to class or mass actions.

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Excess Insurance Trigger

• Circumstance: Underlying Insurer Pays Less Than Full Policy Limits, Policyholder “Funds the Gap”

• Excess Insurer Contends: Payment Duty Not Triggered Because Underlying Insurance Not Exhausted by Payment of Loss

• Historically: Zeig v. Massachusetts Bonding: Exhaustion Requirement Ambiguous, Excess Insurer Payment Obligation Enforced

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Excess Insurance Trigger

• Exhaustion Requirement: Comerica case (E.D. Mich. 2007) found exhaustion trigger requirement unambiguous

• Long Line of cases now holding that excess insurer’s payment obligation not triggered where underlying insurance not exhausted by insurer’s payment of loss.

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Excess Insurance Trigger

• Solution: Excess Policy Payment Trigger Expressly Contemplates Payment of Underlying Amounts by Insurer or Insured

• Practice Pointer: Amended Trigger Coverage Must be Incorporated All the Way Up the Tower.

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Recurring Issues: Antitrust Exclusion

• Insurer Shall Not be Liable for Loss:

– Based upon, arising from, or in any way related to any actual or alleged violation of any law, rule or regulation relating to anti-trust, restraint of trade, unfair business practices or interference with another’s business, contractual or economic relationships or interests

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Antitrust Exclusion (Cont’d)

• Referred to as “Antitrust” exclusion but sweeps much more broadly

• Many (but not all) insurers have some form of the exclusion in their base policies

• Most (but not all) insurers will remove the exclusion on request

• Even if they won’t remove, will at least provide sub-limited coverage, coverage with coinsurance or defense cost only coverage

• Not a problem with carriers asking for it, problem is allowing it

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Recurring Issues: Contract Exclusion

• The Insurer Shall Not Be Liable for Loss

– Based Upon, arising from, related to or in any way involving, directly or indirectly, any actual or alleged obligation of the Company under any express contract or agreement

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Contract Exclusion

• Basic fairness of exclusion: insured should not be able to voluntarily undertake contractual obligation, fail to perform, and they pass the obligation along to the insurer

• Problem: Exclusion Often Framed and Enforced Overly Broadly

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Contract Exclusion (Cont’d)

• Should Be Limited to Entity Coverage Only• Should provide that it does not apply to the

extent that liability would otherwise attach in the absence of contract

• Arguably Should Use “for” working rather than “based upon, etc.”

• Arguably Should Not refer to “directly or indirectly”

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Recurring Issues: Warranties

• Application for New Coverage: Is the Insured Aware of Circumstances That Could Give Rise to a Claim? (or some variation)

• Perfectly legitimate question for new coverage or increased limits

• Not legitimate question for renewal coverage• Not a legitimate question even if on renewal coverage is

moving to a new carrier

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Recurring Issues: Warranties

• Carrier can rely on warranties to seek rescission or to bootstrap a coverage defense

• All too often, policyholders are sent the wrong application

• All too often, policyholders fill out main form application when moving carriers on renewal

• Knowledge Issue, Process Issue, Training Issue

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Recurring Issue: Notice

• Recurring Notice Problems:– “Didn’t Think it Would Be Covered”– “Didn’t Think it Would Exceed Retention”– Worried About Effect on Renewal Premium– EEOC Claims

• First Principle of D&O Insurance:– Presumption Should Be: Give Notice– Corollary: Submit Matter as Notice of Claim or in the

Alternative Circumstances that Could Give Rise to a Claim

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Recurring Issues: Expectations Gap• Often Disconnect Between Insured’s Expectations and

Marketplace Reality– Current Marketplace: More Important Than Ever to Set

Expectations– Problems Arise When Insured Not Prepared for What is

Coming • Particularly Important in Claims Context– Explain to Insured at the Outset What to Expect from

Claims– Prepare the Insured for Likely Difficult Issues (e.g.,

Allocation)– Critical Importance of Keeping Carriers(s) in the Loop)

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Expectations Gap (Cont’d)

• Address Choice of Counsel Issue at the Front End– Insured May Discover at the Time of Claim that it

really does want its own counsel – Carrier May Agree in Advance to Insured’s

Preferred Counsel – Hourly Rates May be More Susceptible to

Negotiation in Advance– Always Easier to Negotiate Outside of the Claims

Context

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The D&O Diarywww.dandodiary.com

Contact

Kevin M. LaCroix, Esq.RT Pro Exec2000 Auburn Drive, Suite 200Beachwood, Ohio 44122(216) 378-7817kevin.lacroix@oakbridgeins.com

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