Increasing Anxiety for Directors and Officers

In the wake of securities litigation, corporate accounting scandals, and Sarbanes-Oxley, the news for directors and officers of corporations continues to be troublesome. Directors and officers continue to face increased risk of lawsuits and increased responsibility and accountability. Adding to the anxiety level is a recent decision from a federal court in New York, which ruled that officers and directors of a privately-held company had the same fiduciary duty to their company normally associated with public companies. The court held individual officers and directors personally liable for failing to take appropriate action while the owner drained the company of tens of millions of dollars.¹

These trends have created a significant dilemma for boards of directors. On the one hand, boards need, perhaps more than ever, talented new board candidates. At the same time, potential board candidates are reluctant to join boards. According to a recent study by the research firm Korn/Ferry International and Corporate Board Member magazine, 48% of board members surveyed responded that they have turned down a board position because they felt the risk of being sued was too great. 49% responded that directors and officers insurance coverage was an important factor in their decision whether to join a particular board. ²

While the need for directors and officers insurance coverage is as acute as ever, the availability of directors and officers insurance coverage is becoming increasingly problematic. The rise in securities litigation and other claims against directors and officers has resulted in substantially increased premium costs for directors and officers coverage. In addition, the corporate scandals that stem from “accounting irregularities,” massive restated earnings, and outright fraud have prompted insurance companies to rescind D&O policies for some companies.³ Some insurance companies are also adding “restatement exclusions,” which exclude coverage for claims arising from restated earnings. Yet another problem arises if a corporation declares bankruptcy. In many cases, the D&O insurance policy is declared an asset of the bankruptcy estate, which may leave individual directors and officers without access to that coverage.

New Insurance Policies

Insurance companies are responding to this dilemma with new insurance products designed to protect the individual director – – the Personal Director’s Liability Insurance policy and the Independent Director’s Liability Insurance policy. Each policy is designed to protect the individual board member and to sit as an excess policy over the corporation’s existing D&O coverage. Depending on the policy structure purchased, the Personal Director’s Liability policy and Independent Director’s Liability policy would “drop down” and go into effect if the corporation’s D&O coverage becomes unavailable for one or more of the following reasons:

• The corporation’s D&O policy was rescinded because of a restatement of earnings;
• The corporation’s D&O coverage has been rescinded for all directors and officers by virtue of the conduct of one or a few individual directors or officers;
• The corporation’s D&O policy was declared part of the bankruptcy estate of a bankrupt corpora tion;
• The corporation’s D&O coverage limits have been exhausted.
• The D&O insurance company is financially unable to pay.

These two new insurance products are not identical. One of the key differences is that Independent Director’s Liability coverage, as its name implies, covers only independent, i.e., non-employee directors. Personal Director’s Liability insurance covers any board member or officer.

Another distinguishing feature of the Personal Director’s Liability policy is that it covers an individual who serves on multiple boards for his/her service on each of those boards. The individual can pick and choose for which directorship he/she would like the extra coverage. The policy would list each corporation, including publicly held companies, privately held companies, and non-profit companies, in the schedule of underlying insurance. The policy would then sit as excess over each entity’s own D&O coverage.

Individuals who are serving on boards or have been asked to serve on a board should take a close look at the corporation’s D&O coverage. Board members and candidates are also well advised to consider one of these new insurance products, the Personal Director’s Liability policy and the Independent Director’s Liability policy, to be certain that his/her own personal assets will be protected, even if someone else’s malfeasance or company bankruptcy puts the corporation’s coverage at risk. Corporations who want to attract talented new directors may want to consider providing this additional insurance coverage for board members.

Darwin Boyd at Cameron M. Harris & Company specializes in D&O coverage and notes that the current insurance market has created a shift in focus from buying D&O insurance to help protect the corporation’s assets to one of buying the insurance to protect the individual director or officer. Given the current environment for corporations and their boards, Mr. Boyd observes that one of these new policies may be “a perfect way to keep your current directors secure and a necessary tool to attract new ones.”

¹ See Private Concern, Public Consequences,
The New York Times (June 15, 2003).

² Chubb Insurance News Alert
(December 18, 2002).

³ See, e.g. Insurers Seek to Trim Their Exposure on Directors Policies, The Wall Street Journal (January 28, 2003); Enron Board’s Actions Raise Liability Questions, The Wall Street Journal (January 17, 2002)


For additional information, please contact:

Josephine Hicks 704.335.9025
josephinehicks@parkerpoe.com


Parker Poe’s Torts and Insurance Group provides litigation and dispute resolution services and advice on torts and insurance matters throughout the Carolinas.

This Alert is intended to inform readers of recent events in insurance law. It should not be considered as providing conclusive answers to specific legal problems.