Increased Vulnerability of Executive Suite Makes D&O a Critical Coverage

Public, Private and Non-Profits Cannot Afford To Be Without Management Liability Coverage Today

At last year’s PLUS conference, who among us would have ever predicted the current financial market upheaval? Certainly the subprime mortgage crisis was a key discussion topic, but it is safe to say that anyone who speculated that in a year’s time American International Group (AIG) would receive an $85 billion bridge loan from the federal government would have been laughed out of the room. Yet as bizarre as that scenario seemed in 2007, the reality is that Wall Street today has a distinctly different look and there may be a considerably wider circle of targets for the securities plaintiffs bar.

Given where we are today, can companies view directors and officers (D&O) liability protection as either not needed or not affordable? Today’s global financial situation will only exacerbate what directors and officers of public companies have experienced in the past 10 years — significant D&O and errors and omissions (E&O) claims arising from the technology meltdown, IPO laddering, Enron and WorldCom, options backdating and, most recently, the credit crisis. These and other events have resulted in what could be the most litigious and most expensive decade in the history of U.S. D&O litigation.

In addition to large financial institutions continuing to be a target of the plaintiffs’ bar, smaller public and non-public companies that were not direct participants in the current crisis may start to be scrutinized. These companies may not have sufficient D&O coverage and, as a result, may spend millions on legal fees for a lawsuit that is ultimately dismissed against company directors and officers who may not have intentionally violated any laws.

Private, Non-Profits Also at Risk

In the past, private companies may have tended to underestimate their own risk when, in fact, they possess some of the same exposures to D&O-related claims as public companies and can face suits by a variety of plaintiffs, including customers, government agencies, vendors or equity owners. As a result, it is not inconceivable that all companies may have to operate in an environment where litigation against directors and officers is likely to become commonplace.

Increased litigation risk can also extend to nonprofit companies, which face budget pressures from decreasing donations during difficult economic times. Even though demand for nonprofit services goes up when the economy goes down, staff reductions are often the first budget cut as payroll is a nonprofit’s largest expense. The result is that the remaining employees are asked to provide more services with fewer resources. The stress from this situation can develop into increased employment practices liability (EPL) claims from clients or employees.

Homeowners and Condo Associations

With much of the current economic condition caused by problems in the mortgage industry and the resulting decline in the housing market, one type of nonprofit — homeowners and condominium owners associations — could be especially vulnerable to increased litigation. These community associations are typically responsible for establishing and enforcing covenants, conditions and restrictions (CC&Rs) — the legal obligations imposed on all buyers that are enforceable on all subsequent buyers. Certain types of these covenants deal with the maintenance and appearance of the units and members who are experiencing difficulty in selling their homes may sue the board, claiming the CC&Rs are overly restrictive or not restrictive enough, thereby making their units less marketable.

For example, someone in a community association builds a detached garage in his backyard for his truck and detached garages are forbidden by the CC&Rs, but the board has failed to enforce the rule. A neighbor can sue the board claiming that the failure to enforce the rules has impacted his ability to sell his home. However, if the board is consistent in its enforcement, such a strategy may not be successful. Still, desperate owners may look to blame the board for the loss of value in their home (or investment in the case of speculators). Therefore, a responsive D&O policy, which can include first dollar defense, can take on an even greater importance during a depressed real estate market.

What to Look For?

So what should executives of public, private, and not-for-profit firms look for in a carrier and coverage?

Obviously, the first step is to work with a broker who can help vet the financials of any potential insurance carrier. Insurers under consideration should be able to offer broad private company management coverage for D&O liability, employment practices liability (EPL), fiduciary liability and standard ISO crime fidelity. A policy that fully protects a company’s executives will also include a broad definition of EPL wrongful act, claim, loss and insured person as well as a broad definition of claim and loss for fiduciary liability.

Equally important is a Side A DIC (difference-in-condition) D&O policy. This coverage generally protects individual directors and officers, rather than the corporation, in situations where the company cannot, or is unable to indemnify management and when traditional D&O insurance is depleted or otherwise unavailable.

Side A DIC insurance is especially relevant as it can prevent personal bankruptcies of a director or officer for conduct related to their operation of the insured organization, where the insured organization is unable to indemnify its directors and officers as a result of a company’s financial exposure to the credit crisis.

The past six months have dramatically changed how we view financial institutions, and people are understandably more cautious in how they invest their money. While directors and officers liability insurance has always been a wise investment, it has not always been given the consideration it deserves. The increased vulnerability of the executive suite may now make it as necessary as workers’ compensation coverage or general liability.

Topics Lawsuits