How Does D&O Insurance Work?

i. Side A Coverage – Directors & Officers / Insured Persons
ii. Side B Coverage – Company Reimbursement
iii. Side C Coverage – Entity Coverage

• The CEO of a company that is at risk of insolvency has to sell the company’s assets to avoid insolvency.
• Shareholders allege a breach in fiduciary duty and lodge a claim against the board of directors arguing there was insufficient supervision of the asset sale. Therefore, the director’s actions were inadequate in avoiding insolvency.
• The corporation is unable to indemnify the board of directors as it is insolvent. Side A coverage would directly indemnify the directors.

It’s important to note that Side B coverage comes with a ‘deductible’, also referred to as an excess.

• A disgruntled employee makes a claim against a company officer and effectively sues for alleged misconduct.
• The company covers the costs of court proceedings for its company officer throughout the proceeding.
• The company then approaches its D&O insurer to reimburse the costs it’s incurred to indemnify its officer. In doing, the company helps protect its balance sheet and is required to pay a deductible as set out in the policy terms and conditions.

Australia’s ever-increasing regulatory system, and most recently the unpredictable impacts of COVID-19, have seen corporations operating in an environment with frequent regulatory change and increased regulatory oversight. The rise in Royal Commissions and public awareness has also brought about heightened community scrutiny, which opens more windows of opportunity for claims and investigations brought against not only directors and officers but claims specific to securities law against the company, too.

It’s important to note that the scope of protection that Side C offers is different between policies that are for private companies and those for publicly traded companies.

For private companies, Side C coverage provides entity coverage for lawsuits against the corporation itself. This also includes not-for-profit organisations or strata corporations such as homeowner associations. Publicly traded companies however benefit from Side C coverage’s protections for its own liability arising from securities claims.

• Consider an organisation that became a publicly listed company and had recently undergone a significant merger by acquiring a smaller competitor.
• It becomes apparent to shareholders that there was insufficient communication regarding the merger and investors were not provided timely access to information about the company; information which could have affected its market price or share value.
• A class action is raised that alleges the company breached its continuous disclosure obligations and results in a securities claim.

The company would then make a claim under its D&O policy, where Side C would cover the expenses associated with defending itself throughout the class action. This helps protect the entity’s balance sheet.

• Personal Conduct Exclusion
  This exclusion is part of every Directors and Officers policy and excludes dishonest or fraudulent acts committed by an insured. It can extend to exclude intentional violation or breach of law/regulation and unfair profit or gain to which an insured has no legal entitlement. It is worth noting that most policies defend the Directors & Officers until final adjudication.. Policies typically include severability clauses that isolate the Wrongful Act or conduct by one insured so that it is not imputed to other insureds.

• Bodily Injury/Property Damage
  The policy will not respond to a claim for Bodily Injury & Property Damage claim as this exposure is typically covered by a Public Liability policy.  This exclusion may have a write back (gives coverage back) for Defence Costs, Employment-Related Wrongful Acts and Security Claims.

• Prior & Pending Exclusion
  Prior & Pending Exclusion excludes cover for any pending or prior litigation involving the Company that has begun before the Prior & Pending date of the policy.

• Insured Versus Insured for USA Claims
  There are many variations to this exclusion, but the main purpose is to exclude cover for dispute between insureds / the company and an insured in the USA.

• Future Offering Exclusion
  This exclusion states that any future offering of securities is excluded.  There can be amendments to this exclusion to include a threshold and jurisdiction limitation. This is important for the managers of the D&O insurance, as they must notify the broker/insurer to ensure future capital raisings are underwritten and can be covered.

• Major Shareholder Exclusion
  This exclusion has a threshold for major shareholders (i.e. 10/15/20%) and the policy will not cover a claim brought by a major shareholder against the Directors & Officers. This exclusion may havea requirement that the major shareholder has a holding above a threshold together with a board position to trigger the exclusion.

• Retroactive Date Exclusion
  This excludes any wrongful act committed or alleged to have been committed prior to the inception of the policy. This is a way for insurers to exclude past acts and make the policy only forward-looking.

• Insolvency Exclusion
  This exclusion removes any coverage for claims arising out of insolvency. This exclusion can typically be removed if the company shows they are in a good financial position and can internally fund the company’s operations for 12-18+ months.

• Political Risks Exclusion
  This excludes claims connected with nationalisation of a Company or any part of a Company’s business. It will also exclude the seizure, reversion, appropriation of a company’s assets by a governing body.

• Failure to Maintain Insurance
  This excludes any claim which alleges the mismanagement of the company’s insurance program.

• Professional Services Exclusion
  This exclusion removes coverage in connection to the performance of or failure to perform professional services.

• Pollution/Environmental Exclusion
  This excludes any claim or allegation due to pollution or environmental event.