Many corporate executives, including directors, believe they would be fully indemnified from the cost of defending against a government investigation or prosecution. They find solace in articles of incorporation or bylaws that require their corporation to fully indemnify them from criminal, civil, administrative and other claims for actions taken on behalf of the corporation. In addition, many executives have been told that their corporation has millions of dollars in directors and officers (D&O) insurance that will cover any costs that aren’t indemnified. Unfortunately, such generalizations may not come true when executives need them the most.
Consequently, executives should make it a top priority to review corporate indemnities and D&O insurance in order to mitigate the oftentimes significant cost of government investigations and prosecutions. Executives should also consider purchasing excess difference-in-conditions D&O insurance.
The promise to be indemnified is only as strong as the corporation’s balance sheet. A corporation with limited funds or on the verge of bankruptcy may not be able to pay for the corporate executive’s defense. In addition, absent some limitation, a new board of directors can amend the articles and bylaws to prevent or significantly curtail the right to be indemnified. In Blankenship v. Alpha Appalachia Holdings, Inc., but for former Massey Energy Company CEO and Chairman of the Board Donald Blankenship having certain protections in place as described in his retirement agreement and other documents, the new board of Massey’s successor-in-interest would have severely limited his right to be indemnified. [The Delaware Court of Chancery held that Massey’s successor could not avoid its obligation to indemnify Blankenship by unilaterally conditioning payment of defense costs on representations of good faith and lawful conduct when it had previously agreed to provide mandatory advancement of litigation expenses to the fullest extent as permitted by law. Blankenship v. Alpha Appalachia Holdings, Inc., C.A. No. 10610-CB, 2015 WL 3408255 (Del. Ch. May 28, 2015).]
Further, a corporation’s D&O insurance may be fraught with exclusions, limitations and restrictions that undercut the ability to pay for an executive’s robust legal defense. D&O insurance provides three separate coverages, referred to as Side A, Side B and Side C.
- Side A reimburses directors and officers when the corporation is unable or unwilling to indemnify them; for example, in response to a shareholder derivative claim in which the shareholder asserts a claim on behalf of the corporation or when the corporation lacks the funds to reimburse the directors and officers.
- Side B reimburses the corporation for payments it is legally obligated or allowed to make for liability claims against directors and officers.
- Side C provides defense and indemnity coverage for the corporation in response to security claims.
A corporation will often purchase D&O insurance with all three sides of coverage, naming the corporation as the insured for Side B and Side C coverage and individual officers and directors for Side A coverage, requiring all insureds to share coverage limits. Typically, defense costs erode the policy limits. A problem arises when many of the named insureds are defending multiple lawsuits, as well as criminal or administrative agency investigations and prosecutions, while having to share the coverage limits. For instance, in the case involving MF Global Holdings, the bankruptcy court was shocked to learn that the defense of multiple lawsuits against the corporation and executives eroded more than $48 million in defense costs and legal expenses before “a single deposition ha[d] been taken in the [multiple district litigation] proceedings in the district court.” In re MF Global Holdings, Ltd., 515 F.R. 193 (Bank. Ct. Sept. 4, 2014).
Moreover, under the new “Individual Accountability for Corporate Wrongdoing” policy issued by Deputy Attorney General Sally Yates on Sept. 9, 2015, the DOJ will focus on the prosecution of individuals for corporate criminal conduct. For instance, the DOJ entered into deferred prosecution agreements with IAP Worldwide Services in June 2015 and Louis Berger International in July 2015, in part because of the companies’ extensive remediation efforts that included terminating the employees responsible for corrupt payments under the Foreign Corrupt Practices Act. Corporations that often stood shoulder-to-shoulder with their executives in defending false charges may now find it more expedient to enter into deferred prosecution agreements while casting the blame on former executives. In practice, this may result in a greater number of insured executives splitting the policy limits to defend against the more extensive and costlier government investigations and prosecutions.
For these reasons, executives should consider purchasing a separate (or excess) stand-alone D&O policy, referred to in the industry as a Side A Excess Difference-in-Conditions D&O policy. These policies can provide an executive coverage 1) when the corporation’s Side A policy limits are exhausted; 2) when the corporation files for bankruptcy and the bankruptcy trustee claims that the corporation is entitled to the D&O coverage; 3) when the corporation’s D&O insurance refuses to defend the executive; and 4) when an exclusion, restriction or limitation would otherwise preclude coverage under the underlying D&O policies.
In short, there are a host of issues that should be explored by an attorney and insurance broker when preparing a program to protect you as an executive for such an emergency. The time to review corporate indemnities and D&O insurance is now, before it’s too late to protect yourself from the tremendous cost of a government investigation or prosecution.