“While policy language differs, coverage for individual insureds in a D&O policy provides coverage for duly elected officers and directors for loss that has not been otherwise indemnified. The grant is limited by a number of factors, most often that the claim must be made and reported within a certain time frame. D&O policies also include conditions and exclusions that further affect coverage, such as limitations on claims alleging bodily injury and business-related causes of action.”
Directors and Officers (D&O) liability insurance provides coverage under a number of separate coverage grants. Often overlooked as boilerplate, coverage grants are the heart of an insurance policy. While policy language differs, insurance coverage for individual insureds in a D&O liability policy provides coverage for duly elected officers and directors for loss that has not been otherwise indemnified. The grant is limited by a number of factors, most often that the claim must be made and reported within a certain time frame. D&O liability policies also include conditions and exclusions that further affect coverage, such as limitations on claims alleging bodily injury and business-related causes of action.
This insurance coverage grant is called Side A. Sides B and C provide insurance coverage for the corporation, for its indemnification of individuals and its own liability, respectively. If the coverage grant is the heart of insurance policies, Side A provisions are the heart of traditional D&O. This provision is found in all D&O liability policies and even gives the insurance its name.
In recent years, Side A coverage has expanded. Exclusions for loss arising from claims of dishonesty, fraud and personal gain have been narrowed, and often amended to provide defense cost coverage until the misconduct has been proven by a final adjudication in the underlying claim. Some incidental coverage has been added for certain, very specific fines and penalties. Pre-claim or investigation coverage for individual insureds is found in certain D&O policies.
At the same time, corporate indemnification provisions (usually found in the bylaws) and employment agreements have also broadened protection for individuals. A common misconception is that D&O insurance matches corporate indemnification provisions, but that is seldom the case. Indemnification agreements can be much broader than any D&O liability policy and without insurance’s stringent conditions, such as notice provisions.
What is Side A-only coverage?
In the early 2000s, two major lawsuits changed the D&O landscape. In both the Enron and WorldCom suits, outside directors agreed to pay a portion of the settlement of the class action. This portion could be neither insured nor indemnified. While this amount was small compared to that paid by D&O insurance carriers on the directors’ behalf, the requirement that it had to be paid by the individuals caused a panic—at least as reported by legal and insurance commentators. Carriers responded by offering Side A-only policies, which purported to protect directors and officers from personal liability. While no policy would have paid the directors’ share of the Enron and WorldCom cases, carriers used those cases to advertise the benefit of the new insurance coverage.
The original Side A-only policies offered limited insurance coverage, often restricted to non-indemnifiable loss. Even a cursory comparison revealed that non-indemnifiable loss is much narrower than the insurance coverage provided by most traditional D&O policies, which only required that loss be non-indemnified. Non-indemnifiable loss is usually defined as loss for which indemnification is neither permitted nor required. Most state law and corporate bylaws leave little that would fall into that category. In addition, insurance carriers toyed with variations of Side A-only coverage: policies that would only cover outside or independent directors, which was only excess of completely exhausted traditional D&O and other limitations.
The original Side A-only policies offered limited coverage, often restricted to non-indemnifiable loss. Even a cursory comparison revealed that non-indemnifiable loss is much narrower than the coverage provided by most traditional D&O policies, which only required that loss be unindemnified. Non-indemnifiable loss is usually defined as loss for which indemnification is neither permitted nor required. Most state law and corporate bylaws leave little that would fall into that category.
Eventually, insurance carriers drafted Side A-only policies that provided much broader coverage. Current forms may offer coverage for investigations and meetings with regulators, and even some protection for fines, penalties and taxes—insurance coverage that would have been unthinkable a few years ago.
Insurance coverage under these policies can be triggered by the refusal or inability of the corporation to indemnify, the bankruptcy of the corporation or a carrier, or the exhaustion of underlying insurance, among other triggers. Moreover, many Side A-only policies have fewer exclusions than underlying policies, providing coverage for claims under ERISA, for example. Some Side A-only policies also provide coverage for extradition costs, responding to subpoenas, bodily injury and property damage. They may be full-featured difference in condition (DIC) forms—that is, they respond to a wide variety of claims that are not covered by the underlying policies.
Until recently, Side A-only policies were seldom tapped. Yet, as insurance coverage expanded, payouts increased. For example, in the litigation surrounding the failed bank IndyMac, several layers of Side A-only coverage were called upon to pay claims.
Should corporations purchase Side A-only coverage?
From a corporate balance sheet perspective, Side A-only policies may seem to offer little benefit. Insurance coverage might only be triggered if the corporation were not obligated to or financially capable of indemnifying individuals, and any traditional D&O policy was exhausted or inapplicable.
Yet balance sheet relief is not the only reason to purchase Side A-only coverage. Many qualified individuals are reluctant to serve on corporate boards, citing concern over litigation. It is routine for executives to demand extensive promises of indemnification and defense. Even when the corporation is solvent and well-run, potential directors may fear that the corporation’s own liability will drain all available coverage, and the corporation will be unwilling or unable to honor those promises. At times, directors have no present concern, but have simply heard about Side A-only policies and believe they should have that coverage.
The COVID-19 pandemic has sent tremors through businesses public and private. Public company stock prices cratered for many, and both public and private companies saw business fall. Established retailers have filed for bankruptcy, and other companies face shareholder suits arising from virus-related allegations. Other companies are likely to follow them. A number of COVID-19-related securities class actions have been filed against various companies. Individual executives have been named in those suits, opening the possibility that Side A-only coverage could be triggered.
A recurring issue for directors and officers is what happens to their D&O coverage if the company files for bankruptcy. While the issue has been litigated, most bankruptcy courts have held that the proceeds of a D&O policy belong, in whole or in part, to the insureds. This may be of small comfort, however, if the proceeds have been exhausted by payment of claims against the corporate entity, and there are no corporate funds to indemnify individual officers and directors.
That issue should not arise with a Side A-only policy, as the policy does not respond to claims against the corporate entity. Moreover, Side A policies routinely contain provisions that anticipate the possibility of insolvency. Again, while no insurance will respond to every eventuality, Side A-only policies provide coverage that is reserved to individual officers and directors.
Side A coverage—either in a traditional form or in a stand-alone policy—can be useful in managing risk and protecting individuals. It should not be a casual purchase.
Side A-only policies have significant exclusions that could limit coverage for claims arising from bodily injury and illnesses, but those exclusions are generally narrower than in traditional D&O policies.
The many facets of Side A-only policies
The only certainty about Side A-only policies is that they will change. Many insurance carriers offer multiple varieties of this coverage, and almost all will negotiate significant amendments through endorsements.
Recent policy form enhancements include coverage for duly elected officers and directors, but also any de facto or shadow director, general counsel, risk manager, investment relations director, or any person in a comparable position. It also provides coverage for costs arising from extradition, bail or regulatory hearings, investigations, subpoenas, asset and reputation protection, and some taxes and penalties, with very few exclusions. The policy follows the form of underlying policies, and drops down to fill gaps created by differences in conditions between the underlying and the excess.
To an individual director or officer, this might seem like a wonderful idea – and it might be. Virtually perfect protection for one’s own assets, provided when the corporation can’t or won’t indemnify and other insurance is unavailable.
What could go wrong with Side A-only coverage?
First, all policies have conditions, exclusions, limits and sublimits. Even the broadest policy will not cover claims that do not arise from wrongful acts committed in a non-insured capacity.
What does that mean? As an example, in a recent case, the court determined that a D&O policy did not cover the insured’s liability under a personal guarantee of a corporate debt. A personal guarantee is just that — personal. The individual did not sign it in his capacity as a director or officer, so coverage was not triggered.
Second, insurance carriers are not arbiters of liability. When coverage is extended to individuals, the carrier will not determine which individual is more deserving of coverage. That means that a policy may be completely exhausted by defending people who committed civil and even criminal misdeeds, leaving less culpable and even “innocent” insureds without coverage.
Some carriers have tried to remedy this, giving the board of directors the right to direct payment, but the idea has not been widely adopted. Regardless, this underscores the importance of discussing limit adequacy with your broker.
What is the best Side A-only policy?
Unfortunately, no one can answer that question. While these forms and endorsements continue to evolve, coverage depends on actual claims and real facts. Without a crystal ball, the most prudent course of action is to encourage good corporate governance, vigilant oversight and director independence, reducing the risk of successful claims. Insurance, while a valuable tool, cannot replace sound corporate practice.