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Directors and Officers Insurance for Group Captives

12.30.2012

Directors and officers liability (“D&O”) insurance is an important component of any group captive program.  However, captive boards and officers often pay scant attention to the specifics of their D&O coverage except in the unfortunate event a claim or potential claim arises.  Given the importance of such coverage, a D&O insurance policy should be given a close look before it is bound to ensure it provides adequate protection under all circumstances.

D&O policies typically contain three coverage parts—Sides A, B and C.  Side A covers the personal liability of directors and officers for claims relating to decisions made in the course of fulfilling their managerial duties.  Side B reimburses the company when it indemnifies directors and officers for such claims.  Side C covers the company for claims brought directly against it.1  Policies also either provide a defense or cover costs incurred defending a covered claim.
Major provisions of D&O coverage that deserve close scrutiny include the following:

Exclusions

Careful attention should be paid to the wording of the exclusions found in the policy.  D&O policies exclude coverage for deliberately wrongful, fraudulent or criminal conduct.  They also exclude claims arising from circumstances where managers obtained illegal remuneration or acted for personal profit.

Some policies state the insurer cannot deny coverage unless there is a finding “in fact” that the excluded conduct occurred.  Directors and officers should look instead for a policy with language stating that coverage may be denied only if there is a “final adjudication” of intentional wrongdoing.  Policies with the “in fact” language could leave insureds without a defense or advancement of defense costs based on unproven allegations of intentional misconduct.

D&O policies typically include what is referred to as the “insured vs. insured” exclusion.  This provision was originally designed to prevent collusive suits in which a company seeks to recover ordinary business losses by bringing a claim against its directors and officers for the decision that lead to the losses.  Notwithstanding the original purpose of the insured vs. insured exclusion, it can become a problem if a captive becomes insolvent and the receiver brings a claim against the directors and officers.  Although judicial precedent on this issue is split, at least two courts have held that the insured vs. insured exclusion precludes coverage for a claim brought by an insurer’s receiver because the receiver “steps into the shoes” of the insolvent company and therefore is an insured under the policy.2

The problem with the insured vs. insured exclusion can be fixed with a savings clause stating the exclusion does not apply to claims brought in connection with insolvency proceedings.  To avoid any doubt, the savings clause should specifically refer to the types of insolvency proceedings that apply to insurers.  A one-size-fits-all D&O policy might not use language specific to insurance entities.      

Directors and officers also should be certain that the D&O policy contains no exclusion for claims arising out of insolvency proceedings generally.  Any such exclusion obviously is a severe limitation and should be avoided.  Ideally, the policy should contain a provision stating explicitly that the insurer’s obligations are unaffected by the insolvency of the insured company.

Whose Policy Proceeds?

Insolvency can lead to other issues with D&O coverage.  A D&O policy generally has a single limit for defense costs and other losses.  If the captive is insolvent, coverage for individual directors and officers may conflict with coverage for the entity, as directors and officers will want to draw on the policy to pay their attorneys’ fees while the receiver will want to preserve the policy limits to pay damages.

Adding a priority of payment provision stating that the insurer must pay individual directors and officers before it pays the company may lead a court overseeing an insolvency to allow the policy proceeds to be paid first for the directors’ and officers’ defense costs and liabilities.

Another, but more expensive, way to address this issue is to purchase separate D&O coverage for independent directors that does not include Side B or C coverage for the captive.  A court is unlikely to conclude that the proceeds of such a policy, under which the captive is not an insured, belong to the captive’s estate.

Severability and Non-Imputation

The D&O policy should include language ensuring that exclusions for intentional wrongful conduct or illegal personal profit are severable as to each insured.  In other words, the policy should state that a finding or adjudication that one insured has engaged in such conduct will not result in a loss of coverage for other, innocent insureds.  Without such language, a court could find that misconduct by one director or officer will allow the insurer to deny coverage for all.3

In group captive programs, the fine details of D&O coverage understandably tend to get glossed over as the board and officers attend to more immediate concerns about the operation of the captive.  Directors and officers would be well served, however, to review their coverage closely to be certain it will respond appropriately if and when the need arises.

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1 For publicly traded companies, Side C covers only claims relating to securities actions.

2 Serio v. Nat’l Union Fire Ins. Co., 2004 N.Y. Misc. Lexis 3195 (S. Ct. 2004), aff’d 795 N.Y.S.2d 529 (N.Y. App. Div. 1st Dep’t 2005); TIG Specialty Ins. Co. v. Koken, 855 A.2d 900 (Cw. Ct. Pa. 2004), aff’d 2005 Pa. Lexis 3206 (Pa. 2005).

3 See e.g., TIG Specialty Ins. Co. v. PinkMonkey.com Inc., 375 F.3d 365 (5th Cir. 2004) (holding fact that one officer had gained personal profit allowed insurer to deny coverage for all officers).