Reality Check: Private Companies Need Directors’ and Officers’ Insurance Too

Most public companies consider the need to procure D&O insurance coverage a given—the reality of an increased number of derivative, securities, and fiduciary lawsuits. Private companies however, have been more reluctant to acknowledge and protect against a risk they feel is unlikely to present itself. As a result, private companies do not universally procure D&O insurance. This business decision may in fact be a mistake.

According to a 2016 Chubb report, private companies that have experienced D&O losses reported an average reported loss of $387,000 and a maximum reported loss of $17 million.¹ Of the private companies that experienced a D&O loss, 96 percent suffered a financial loss, 42 percent incurred a loss of productivity or man-hours, 36 percent faced a negative impact to morale/company culture, and 31 percent suffered a negative impact to their brand or reputation or both.² The top reasons a private company did not purchase D&O insurance include the following: 33 percent believed D&O coverage was not necessary because their business is privately held, 33 percent had no historical experience with such claims and therefore did not purchase D&O insurance, and 30 percent believed coverage was not necessary because their business is family run.³ Private companies’ justification for failing to purchase D&O coverage is misguided.

Private company D&O coverage is broader than public company coverage and often covers many of the concerns or risks private companies face, including claims by investors, competitors, customers, employees, or government agencies, and D&O insurance may provide protection against such losses. Companies, both public and private, must identify potential liability risks and determine what insurance policy may meet the general needs of their business.

D&O Insurance Offers More Than Executive Protection

D&O insurance is one of the most important safeguards a company and its executives have against allegations of wrongdoing, aggressive plaintiffs’ firms, and government investigations. Public and private companies purchase D&O coverage to protect management and outside directors against the ever-changing risks of litigation. It is critical that companies be able to attract and retain strong directors and officers, particularly in a climate in which such individuals’ decisions are frequently second-guessed. 

D&O policies are claims-made, as opposed to occurrence-based policies, and generally provide coverage for claims made and reported during the policy period (or within the extended reporting period), regardless of when the underlying conduct may have occurred. D&O liability policies provide three distinct coverage parts. Under Side A coverage, the insurance company promises to indemnify individual directors and officers. Under Side B coverage, the insurance company agrees to reimburse the corporate policyholders for “loss” indemnified by the company. Last, under Side C coverage, the insurance company agrees to reimburse the corporate policyholder for liability arising out of certain types of claims made against the corporation itself. It is important to note that Side C coverage may reduce the limits available to protect the individual officers and directors. The D&O policy limits are generally depreciated on a first-come-first-served basis, and this asset may be depleted more quickly than companies anticipate.

Private and Public Companies Have Different Coverage Opportunities

Public companies maintain significantly higher limits of liability in their insurance program. Moreover, “[f]or large public companies, it is common to separate D&O and EPL exposures whereas the majority of private organizations prefer to bundle such coverages.”⁴ It is interesting, however, that “11% of private organizations reported that they were unsure of the structure of their program.”⁵

But the D&O marketplace continues to evolve: “The trend over recent years has been towards a general broadening of cover afforded to private companies, their management and their employees. This broadening has been driven by the ever-changing economic, litigious, and regulatory environment in which corporations operate as well as an increasingly competitive insurance underwrit­ing environment.”⁶ Changes have been made to policy wording: (a) broadening coverage to include co-indemnity between private equity investors and their portfolio company; (b) amending insured versus insured exclusions to protect coverage for derivative claims and cross-claims; and (c) revising coverage for claims relating to the Fair Labor Standards Act, pre-initial public offerings, anti-trust, and fraud.⁷ At renewal, effort must be made to understand whether or not a business is purchasing the best and most comprehensive coverage for its business.

Lawsuits Are Often Not the Only Mechanism Triggering D&O Coverage

Private companies’ misconception that D&O is superfluous (because these businesses are privately held or family-run) ignores the various events that may cause financial harm to a business. Lawsuits are not necessarily the only events that lead to a drain on company resources—investigations, document requests, and dealing with disgruntled customers, vendors, or competitors may also lead to financial loss—for which insurance coverage may be available. In the D&O context, tremendous litigation has focused on what triggers coverage, i.e., what constitutes a “claim. 

A significant number of D&O policies define “claim” as follows:

(1) a written demand for monetary, nonmonetary, or injunctive relief;

(2) a civil, criminal, administrative, regulatory, or arbitration proceeding for monetary, nonmonetary, or injunctive relief that is commenced by (i) service of a complaint or similar pleading; (ii) return of an indictment, information, or similar document (in the case of a criminal proceeding); or (iii) receipt or filing of a notice of charges; or

(3) a civil, criminal, administrative, or regulatory investigation of any Insured Person:

(i) once such Insured Person is identified in writing by such investigating

authority as a person against whom a proceeding described in Definition (b)(2) may be commenced; or

(ii) in the case of an investigation by the Securities and Exchange Commission (SEC) or a similar state or foreign government authority, after service of a subpoena upon such Insured Person.

Some policies define “claim” broadly and specifically list lawsuits, administrative proceedings, investigations, and target letters. Others however, are more narrow and may define “claim” to include only demands for monetary and nonmonetary relief, civil or criminal proceedings, or actions commenced by the return of an indictment. 

A lawsuit is only one mechanism by which coverage may be triggered. For example, policyholders frequently assert that a governmental subpoena or civil investigative demand (CID) constitutes a claim.⁸ Courts have varied with respect to whether a governmental subpoena or CID constitutes a claim. 

While certain jurisdictions have reasoned that governmental subpoenas may constitute a written demand for nonmonetary relief, others have reasoned that a demand for information or for documents is not a claim triggering event.⁹ For example, in Richardson Electronics, Ltd. v. Federal Insurance Co.,¹⁰ the court held that subpoenas and investigative demands did constitute “claims,” where the policyholder was required to produce testimony and documents relating to an ongoing investigation. Importantly, the policy at issue did not define “claim.” Relying on the definition of “claim” in Webster’s Dictionary, the court held that “claim” meant “a demand for something due or believed to be due.” In an attempt to circumvent its coverage obligation, Federal Insurance Co. argued that the Department of Justice’s investigation did not constitute a claim because it did not demand money. This argument was rejected by the Northern District of Illinois.

Similarly, in ACE American Insurance Co. v. Ascend One Corp.,¹¹ a subpoena and investigative demand were made for the production of documents related to the insured Amerix Corporation’s corporate activities. To respond, Amerix retained counsel and paid more than $140,000 in fees and expenses. ACE denied coverage, asserting in part that the subpoena and investigative demand did not constitute claims. The court disagreed, reasoning that because the investigation related to potential violations of the Maryland Consumer Protection Act, coverage was triggered. 

Whether coverage is trigged for the legal fees and costs incurred by a policyholder that result from responding to subpoenas or CIDs frequently depends on the facts and circumstances surrounding the government action, the specific language of the policy at issue, and the law of the relevant jurisdiction.

Court decisions unquestionably turn on the facts and the specific language of the policy. The same holds true with respect to whether costs incurred from informal governmental investigations are covered. Two decisions—Office Depot, Inc. v. National Union Fire Insurance Co.,¹² and MBIA Inc. v. Federal Insurance Co.,¹³ —are frequently cited by insurers and policyholders, respectively. In Office Depot, the Eleventh Circuit held there was no D&O coverage for an SEC investigation until a subpoena and Wells notices (notification from the SEC that it intends to recommend that enforcement proceedings be brought against a prospective defendant or respondent) were formally issued. In contrast, the Second Circuit in MBIA rejected the insurer’s argument that because documents were produced voluntarily in response to an oral request rather than pursuant to a subpoena or other formal means, it did not constitute a “claim.” The court reasoned, under New York law, that subpoenas were a vehicle used by the Attorney General’s Office to conduct investigations and were not simply discovery devices. The Second Circuit held that the Special Litigation Committee inves­tigative expenses and independent consultant costs were indeed covered by the policy.

The potential expense associated with responding to government subpoenas and investi­gative demands should not be underestimated. A policyholder should consider and understand whether coverage is available for such incurred costs. 

Maximize Insurance Coverage

D&O policies do more than offer securities litigation coverage and can offer coverage that addresses the risks private companies face. Insurance policies can and should be designed to match the policyholder’s business and industry—there is no one-size-fits-all approach to insurance coverage. The scope of coverage, as reflected in the terms and conditions of a D&O policy, is highly negotiable. While a policy may initially exclude various coverages under the general policy form, brokers can also negotiate and purchase on behalf of the insured extensive “endorsements”—customized amendments that materially enhance the scope of coverage. Similarly, coverage terms may be tailored to a company’s unique circumstances, such as a merger or sale, an initial public offering, or a liquidation. It is important to be proactive rather than reactive as companies will become increasingly more likely to seek protection under their D&O insurance programs.

It is a company’s obligation to understand its insurance policy and obtain the best available coverage:

• Are the policy limits adequate given the foreseeable liabilities? Multiple claims and large defense costs can quickly reduce available coverage.
• Are defense costs in addition to, or do they erode, available limits? If available, how are defense costs paid?
• Is there entity coverage (i.e., is there coverage for claims directly against the corporation) or is coverage limited to protect against claims made only against individual directors and officers?
• Is coverage available for investigations made by the government? Is coverage available for special litigation committees and other internal investigations?

1. Chubb, 2016 Private Company Risk Survey D&O Risks and Risk Management (2016).

2. Chubb 2016 survey, supra note 1.

3. Chubb 2016 survey, supra note 1.

4. JLT Specialty US, Directors and Officers Liability Survey, 2015 Summary of Results 12 (2015).

5. JLT Specialty US 2015 survey, supra note 4.

6. AIG & Advisen, The Private Eye: Spotlight on the US Private D&O Market 29 (Aug. 2013).

7. AIG & Advisen, supra note 6, at 29-30.

8. The overwhelming majority of courts to address this issue have held in favor of the policyholder. See Polychron v. Crum & Forster Ins. Cos., 916 F.2d 461 (8th Cir. 1990); Joseph P. Bornstein, Ltd. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 828 F.2d 242, 245 (4th Cir. 1987) (subpoenas duces tecum and grand jury subpoenas constituted demand for “nonpecuniary relief”); Prot. Strategies, Inc. v. Starr Indem. & Liab. Co., No. 13-cv-00763, 2013 U.S. Dist. LEXIS 187451 (E.D. Va. Sept. 10, 2013); Dan Nelson Auto. Grp., Inc. v. Universal Underwriters Grp., No. 05-cv-4044, 2008 U.S. Dist. LEXIS 4987, at *16 (D.S.D. Jan. 15, 2008) (subpoenas from state attorney general constitute claim under errors and omissions policy because they “command the Plaintiffs to produce documents and provide information”); Minuteman Int’l, Inc. v. Great Am. Ins. Co., No. 03-C-6067, 2004 U.S. Dist. LEXIS 4660, at *22 (N.D. Ill. Mar. 18, 2004) (SEC subpoenas constitute a “demand for something due” and therefore were a demand for “non-monetary relief” pursuant to claim definition); Richardson Elecs., Ltd. v. Fed. Ins. Co., 120 F. Supp. 2d 698, 701 (N.D. Ill. 2000) (“A claim is a demand for something due,” therefore subpoenas received during antitrust investigation triggered coverage); Agilis Benefit Servs., LLC v. Travelers Cas. & Sur. Co. of Am., No. 5:08-CV-213, 2010 U.S. Dist. LEXIS 144499 (E.D. Tex. 2010).

9. See, e.g., Emp’rs’ Fire Ins. Co. v. ProMedica Health Sys., Inc., No. 12-3104, 524 F. App’x 241 (6th Cir. Apr. 30, 2013); Minuteman International, No. 03-C-6067, 2004 U.S. Dist. LEXIS 4660.

10. Richardson Electronics, Ltd., 120 F. Supp. 2d 698.

11. ACE Am. Ins. Co. v. Ascend One Corp., 570 F. Supp. 2d 789 (D. Md. 2008).

12. Office Depot, Inc. v. Nat’l Union Fire Ins. Co., 734 F. Supp. 2d 1304 (S.D. Fla. 2010), aff’d, 453 F. App’x 871 (11th Cir. Oct. 13, 2011).

13. MBIA Inc. v. Fed. Ins. Co., 652 F.3d 154 (2d Cir. 2011).