Directors' and officers' insurance contracts are often
riddled with clauses that, while seemingly reasonable and
well-intentioned, can lead to bizarre court decisions
PREVIOUS COLUMNS have discussed how
directors' and officers' insurance programs are "just
contracts." Al-though the exercise may seem surreal, in
circumstances in which the actual insurance policies are typically
not available for months after they have been purchased, courts
apply normal contract interpretation principles to insurance
programs, seeking to discern the "intentions of the
parties." You must, therefore, insist upon receiving your
policy documents and you should read them carefully.
An example of what can happen otherwise is illustrated by
"insured vs. insured" clauses, which find their way into
virtually every D&O policy form in the first instance. These
provisions state that there is no insurance coverage in a lawsuit
brought by a person or company potentially insured under the policy
against anyone else also named in the policy. The purpose of these
clauses is obvious and, at one level, not unworthy: they exist to
prevent collusion between insureds who could manufacture
disagreements for the purpose of accessing insurance proceeds.
Unfortunately, the clauses have been construed to mean
precisely, and fully, what they say, and that can produce strange
results. In a recent US case, a former director who resigned to
pursue a takeover bid sued his former director colleagues who had
taken steps to thwart the bid. Because all parties had been
directors at one point, and therefore "insureds" under
the policy, there was no coverage.
The effects of the insured vs. insured exclusion are often
exacerbated by another common clause, the "major
shareholder exclusion," under which insurance is not
available in lawsuits by shareholders holding a specified
percentage of the company (typically 10, 20 or 25 per cent).
Most policies contain a number of exceptions to these exclusions
and, if they do not, exceptions are usually readily available for
the asking, and at no cost. So, for instance, many policies extend
coverage to lawsuits by insureds such as trustees in bankruptcy,
whistleblowers and suits by the company (derivative suits) despite
the plaintiff being an "insured."
But where an exception is not available, there can be serious
holes in coverage. Many officers may be protected under the policy,
so suits by them are not covered. Suits between feuding directors
will not be covered. Suits by shareholders may well not be covered
where, for instance, the shareholder is also a director.
This can be particularly problematic in the context of a private
company, since these lawsuits are realistically the only things
that directors fear. The insured vs. insured problem also puts
tension on the breadth of coverage sought in the program: the
broader the coverage, the greater the number of individuals covered
under the program, but the greater the relevance of the
It is important to address the issue. Some insurers will agree
to remove the exclusion, or at least to limit it. For instance, it
is often possible to have the exclusion limited to claims by the
company, leaving coverage available for suits by officers and
directors. Sometimes the matter can be addressed through additional
insurance coverage, particularly a "difference in
conditions" (DIC) policy: DIC policies usually do not contain
insured vs. insured or major shareholder exclusions. It may also be
possible to limit these exclusions so that defence costs are
covered, although substantive liability would not be. The risk to a
conscientious director or officer is less losing and paying damages
at the end of a lawsuit than it is the costs of defending the suit
to the point of exoneration.
If these techniques fail, a remedy may have to be sought outside
of insurance programs. In some cases, directors will obtain waivers
from parties who might otherwise claim against them. For instance,
a majority shareholder/director of a private company could agree
with incoming directors that he or she will not sue them, thus
eradicating the relevance of insured vs. insured and major
shareholder exclusions. Waivers can be given as directors join, but
are more frequently the case in the context of runoff insurance,
when directors are leaving the company.
In the absence of these solutions, the company can establish a
protective trust fund under which a sum of cash is put in escrow
for the benefit of the directors. Given that the amount escrowed
will not be available to the company, these arrangements are
typically established to ensure that funds adequate for defence are
available, and they rarely extend to substantive liability
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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