For Directors and Officers: Read Your Insurance Policy

Company directors, officers and managers must take responsibility for knowing exactly what their directors and officers insurance policy covers. This means doing more than asking the insurance broker for assurance that all is in order — it means reading and understanding the details of the policy and negotiating for better protection.

With management under increased scrutiny for a wide range of matters, unexpected coverage gaps can be a major problem, not only for the company but for individuals, too.

Our firm's review of D&O policies reveals wide variation in coverage. Unlike standard-form policies for comprehensive general liability, D&O policy terms are unique to each underwriter, although they share some concepts. Courts pay close attention to the language. Insured parties should as well, because a close review invariably reveals issues. Moreover, our experience shows underwriters are willing to discuss and consider revising their policies. Not only is a thorough annual review upon renewal prudent, it typically will result in the underwriter working in good faith to revise the policy to eliminate unintended results. A good broker will be valuable in working with the underwriter to achieve the best results.

An insurer's liability for payment of defense or investigation costs is an example of a policy term that usually gets little review on the front end. But that can become important after a claim is made or a potential claim is identified. In recent years, underwriters intentionally have reduced the scope of covered-defense costs to eliminate reimbursement for internal investigations and responses to government inquiries, which typically require expensive forensic consultants. While a company isn't going to forgo vigorous investigation by its audit committee or fail to respond to the Securities and Exchange Commission based on whether it will be reimbursed by its insurer, the benefits of a broader definition of defense costs are worth negotiating.

A policy we recently reviewed for a large, newly formed investment fund failed to include a waiver of subrogation. Under the doctrine of subrogation, an insurer that pays a claim can step into the shoes of the insured and pursue the party who caused the loss. As this policy was written, the insurer could have paid some directors' losses and then sued the other directors to recover what it paid. When we discovered this, our client requested the insurer waive its subrogation right against parties who also were insureds. The underwriter proposed a compromise. It would be allowed to pursue only an insured who committed a deliberately fraudulent act. Although this appears reasonable, it limits a company's ability to settle with an individual involved in creating the claim, because the company would not be able to offer a full release without violating the policy. This point was made to the underwriter, and it agreed to turn the partial waiver into a full waiver of subrogation against any insured.

Policy language relating to the bankruptcy of the covered organization should be reviewed. There has been a recent rash of litigation over whether the proceeds of a D&O policy are property of the bankruptcy estate. Court cases in Delaware and elsewhere confirm the language of the policy is determinative. Failure to tailor the language of the applicable sections to protect the interest of the individual insureds could, if the company collapses, leave former management paying out of their own pockets to defend unmeritorious claims while a bankruptcy trustee clings to the proceeds of the D&O policy.

For these and other reasons, it's essential for a business to review its D&O policies at renewal to ensure there are no unintended gaps in coverage. Each individual director or manager should do likewise.