Hunton Insurance Recovery Blog

Earlier this month, current and former Boeing Company directors agreed to a $237.5 million settlement to resolve claims that they ignored safety issues concerning Boeing’s 737 MAX aircraft. While the settlement, which came quickly on the heels of the Delaware Chancery Court’s September denial of the defendants’ motion to dismiss, ranks as one of the largest derivative settlements of all time, the silver lining for the directors and officers named in the suit is that the entire settlement is to be funded by the company’s D&O insurers. The Boeing case is yet another example of the necessity for public companies to purchase sufficient D&O liability coverage, particularly “Side A” insurance coverage, to protect officers and directors implicated in derivative claims, securities class actions, enforcement actions, and similar claims. Because many states, including Delaware, prohibit companies from indemnifying officers and directors for payments made to the company in settlement of stockholder derivative claims or other suits brought on behalf of the company, securing Side A coverage to protect individuals for non-indemnified loss is essential.

Side A coverage is intended to insure individual directors and officers against losses that are not indemnified or advanced by the company. It provides “first dollar” coverage not subject to any retention or deductible in the form of both defense costs and settlements when the company is unable to unwilling to provide indemnification in the event of a D&O claim. Side A policies also typically provide “Difference in Conditions” or “DIC” coverage, which affords greater protection for directors and officers by  dropping down to fill in gaps in the company’s D&O tower when the underlying insurers fail or refuse to pay, rescind coverage, or become insolvent. Here are six common scenarios where Side A DIC coverage may be particularly beneficial.

1. Prioritizing Access to Scarce Insurance Assets

Traditional Side A, B, and C D&O policies have three components, all of which can be implicated in a particular claim:

• Side A protects individuals, usually directors, officers, and employees, against claims that are not indemnified by the company.
• Side B reimburses the company for loss it pays as indemnification on behalf of individual insureds for claims made against those individual insureds.
• Side C provides coverage for claims made against the company, which for public companies is usually limited to alleged violations of securities laws.

In the typical “Side ABC” D&O program, director and officers share the policy limits, whether on a per-claim or aggregate basis, with the corporate entity (and any other subsidiaries and affiliates that are also insureds). Companies purchasing Side ABC policies should confirm that the policies include an “order of payments” provision, which requires the insurer to prioritize payment of non-indemnified loss of the individuals before reimbursing the company for its own losses.

However, situations can arise that leave directors and officers vulnerable—large exposures implicating numerous entities and individuals can quickly erode the policy’s available limits; or claims may not be asserted against individual insureds until long after claims against the company have been settled through insurance proceeds that have exhausted limits that otherwise would have been available to protect individuals. Purchasing Side A-only coverage, either through separate policies or as endorsements to existing Side ABC policies, can provide a dedicated source of recovery for directors and officers to draw upon without the risk that the coverage will be exhausted by claims against the company.

2. Maximizing Coverage and Minimizing Exclusions for Directors and Officers.

Side A policies typically afford broader coverage than a Side ABC policy. Side A policies often delete or limit exclusions often included in Side ABC policies, such as pollution exclusions and employment law exclusions. Affirmative coverage grants also may be broader in Side A policies by, for example, defining “claim” to encompass regulatory investigations prior to any formal charges or indictments being brought. Policies may also offer DIC coverage that “drops down” to respond to claims when an underlying insurer is unable or unwilling to pay covered loss on behalf of directors and officers, as when the company becomes bankrupt.

The Boeing derivative suit also highlights the potential utility of Side A-only policies. Because plaintiffs in derivative lawsuits sue individual officers and directors “on behalf of” the company, many states prohibit the company from indemnifying the director and officers defendants for derivative suit losses. When faced with potentially significant derivative suit exposures, Side A-only policies can respond to cover non-indemnifiable losses of officers and directors.

3. Protecting Individual Insureds During Bankruptcy.

Companies and their directors and officers always face a risk of claims, but those exposures are particularly heightened when a company becomes insolvent or files for bankruptcy. Insolvency-related claims can come from creditors, shareholders, the bankruptcy trustee (particularly in the case of a Chapter 7 liquidation), and other stakeholders.

Individual insureds often turn to the company’s insurance policies to protect them during bankruptcy, only to receive objections by the bankruptcy trustee trying to bar or limit the ability of individuals to access D&O policies as an asset of the estate. Those problems are eliminated, however, if the company purchased Side A-only policies, as those policies are secured solely for the benefit of the individual directors and officers and should not be considered part of the bankruptcy estate. Furthermore, most Side-A policies contain broad provisions requiring that the policy will insure the individual insureds against claims by trustees, receivers, and creditors.

4. Preserving Insurance In the Event of Rescission.

When a corporation makes a material misrepresentation on an insurance application, the insurer will typically have the right to rescind the policy once it is discovered. If the policy is rescinded, the director or officer will no longer have access to the benefits of the policy, leaving them unprotected in the event of a claim. This is particularly punitive where the misrepresentation may be due to no fault on the part of a particular director or officer. Side A-only policies commonly contain provisions stating that the policy cannot be rescinded and that the policy will remain in effect, even if the company goes into bankruptcy.

D&O policies may also contain severability provisions, which state that knowledge of false statements in an application by one insured will not be imputed to other insureds for the purposes of rescission. These provisions protect innocent officers and directors from losing coverage if another insured was aware that an application contained false information. Not all severability provisions are created equal, however, as some provisions afford severability only where the relevant knowledge is possessed by persons other than the signatory in the application or other executive officers. Negotiating full severability or non-rescindable coverage can protect innocent insureds from losing coverage due to bad acts by other insureds.

5. Filling the Gap When Insolvent Insurers Cannot Pay.

As noted above, a Side A-only policy that includes DIC coverage may be able to drop down and fill gaps where the underlying Side ABC policies are inadequate. One common occurrence implicating DIC coverage is where an underlying Side ABC insurer becomes insolvent and is rendered unable to live up to its obligations to provide coverage under its policy. In that situation, excess insurers in Side ABC towers may not automatically respond until the insureds step up and pay the unfunded losses that otherwise would have satisfied insolvent insurer’s limits. A Side A DIC policy can respond in that situation by dropping down to fill in the gap created by the underlying insurer’s insolvency.

6. Preparing for Adversity on a “Stormy Day”

It is often noncontroversial to discuss D&O insurance limits on a “clear day,” such as a yearly renewal, under the assumption that the various stakeholders—companies, current and former directors, officers, employees, and other insureds—who may seek protection under the company’s policies will have interests that align and lead to the orderly resolution of claims. However, when a claim arises, the relationship between the corporation and director or officer may quickly sour.

The company may cooperate against an insured individual with a government enforcement authority. The company may aggressively pursue settlement in a civil or criminal action prior to any claims being asserted against an individual, resulting in exhausted or severely eroded limits when the claim against the individual arises. It also is not unheard of for a corporation to wrongfully refuse to indemnify a director or officer. In these scenarios, Side A policies may provide coverage where it would otherwise not be available. Directors and officers should consider other practical implications in identifying and accessing Side A only policies, including whether executives, particularly former executives, can access D&O policies; and whether individual insureds have a right under the policies to notice claims or must rely on the company, as the authorized representative of all insureds, to provide notice to the insurer.

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In any of the above scenarios, additional Side A DIC coverage will ensure that the company’s directors and officers are adequately protected. As the Boeing derivative settlement showed, claims against individual insureds can be significant, and having adequate Side A coverage tailored specifically for their protection is essential to mitigating against uninsured losses.