What Michigan Businesses Should Know About Directors and Officers (D&O) Insurance Coverage. Originally Published in the State Bar of Michigan Journal of Insurance and Indemnity Law.

Directors and officers liability insurance, also known as “D&O” insurance, is a form of management liability insurance. It is unique, but still falls in to the general category of professional liability coverage and shares many of the same traits, including claims made coverage triggers, extended reporting periods, payment of defense costs and indemnity, and strict claim reporting requirements.

Management liability is a constantly evolving risk for organizations and includes litigation concerning regulated and non-regulated securities, management fraud, non-disclosure, merger and acquisition transactions, fiduciary responsibility, SEC investigations, and direct shareholder claims.

Today, D&O insurance generally protects against management exposures to business entities, and not just their directors and officers. The original purpose of D&O coverage was to facilitate unfettered but sound business judgments by management, who would know they were protected from a direct shareholder claim even if the organization were to become insolvent and unable to fulfill its indemnity obligations to management. As the types of claims being brought have evolved, so has the coverage provided, which has resulted in some changes that make the policy broader than the protection for organization leaders.

D&O coverage may be purchased by for-profit enterprises, both private and public, as well as non-profit businesses, and is generally characterized by a unique coverage form split into separate parts or “sides”. The first part provides direct coverage to directors and officers when the organization is not legally obligated to indemnify them for a loss (side A), the second part reimburses the insured organization when it is legally obligated to indemnify its directors and officers for loss (side B) and a third optional part (entity coverage) provides coverage for securities related and other types of claims when the company itself is a defendant (side C).

To avoid stacking of coverage, side A is usually limited to losses for which the entity does not or cannot provide indemnity to the management insureds. In other words, if there is management liability, but no right to indemnity from the organization, side A will cover the loss. Conversely, if there is management liability and the director or officer insured is entitled to indemnity from the organization, side B is triggered.

Side C or “entity coverage,” which is usually optional, provides direct insurance coverage to the organization as opposed to coverage for the organization’s indemnity obligations to its management. Although Side C is optional, and most prudent organizations purchase it, entity coverage may not always be in the directors and officers interest because it could erode the limits available to them.

D&O policies are written on unique forms developed by each individual carrier, which requires insureds to take an active role in negotiating the appropriate policy based upon the intended risk management goals. As indicated above, the original purpose of D&O insurance was to protect the individual directors and officers of the corporation from suits in which they are personally named. This same purpose is usually a good starting point for evaluating the appropriate coverage to obtain.

Especially for non-profit organizations, as in health care, for which securities law and derivative suits are unlikely, D&O coverage has become as sort of gap liability policy covering risks that property, personal injury and professional liability policies do not cover. Typical coverages added for entities and employees in addition to the directors and officers include antitrust, civil rights, criminal defense costs, and employee benefit errors and omissions. Often the D&O policy by endorsement furnishes employment practices liability coverage relied upon by the organization; in fact, the primary reason many smaller organization buy D&O insurance is to get access to cost-effective EPL coverage.

As might be expected of a policy designed to fill gaps, the insurer does not want to expand liability beyond the gaps – as a result, D&O liability insurance is characterized by very limiting definitions and exclusions to coverage. These exceptions achieved by definition or exclusion are for any claim involving bodily injury, a claim for payment of fraudulently obtained gain, knowing violations of the law, claims by one insured against another insured, and punitive damages, including multiplied damages such a for antitrust judgments. Moreover, even if a claim is covered, the corresponding trigger may be limited. A classic example is that although defense costs for criminal or regulatory violations may be covered, those costs may not be payable unless formal charges like an indictment or regulatory complaint are brought. Typically today when dealing with corporations, the government and the corporation will try to settle before those formalities are invoked and while the costs at the pre-indictment phase are very substantial and prevent formal action ever being taken, they are not covered because the trigger has not been met.

Also presumably because of the gap coverage nature, empirically there seem to be more technical denials and reservation of rights with D&O than any other type of insurance. Notice is a big issue and it is not unusual for the D&O carrier to deny coverage based on technicalities in a way that other insurers do not. For example, D&O carriers may deny coverage for a regulatory matter based upon “late notice” after determining that a plaintiff brought a personal injury claim 4 years earlier, despite the fact that the personal injury claim would not have been covered by the D&O policy. Because the personal injury plaintiff alleged the same wrongdoing as the government alleged in its claim, the D&O carrier claims that it was entitled to notice of the prior claim. Truly, an insured looking to assure coverage needs to be very aggressive in reporting anything that sounds like it could be a matter within the scope of D&O coverage.

In summary, the D&O policy is something much broader than coverage for directors and officers of businesses. While it always includes directors and officers, the policy by option – an option that most sizable corporations think they must elect – extends coverage to the corporation and all of its employees. While the policy’s original intent focused on securities liability, today it is a source of many coverages, so that even many organizations that have little securities law risk buy entity coverage to cover risks that are difficult to cover in any other way. Because of the technical way in which D&O polices are written and sensitivities of the policy issuers to being stuck with more coverage than they intended, more often than other types of liability policies there tends to be a clash of expectations and intentions between the insurer and insured.