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Protection For Directors And Officers From Shareholder Litigation

Merrill Disclosure Solutions | October 29, 2013

Getting medieval on those at the top. Public companies should carefully consider how to protect their directors and officers from the upsurge in shareholder litigation generated by conflicts over M&A deals, corporate conduct abroad, executive compensation, proxy disclosure, and computer-related losses, as well as by the earlier financial crisis. Also rising are enforcement actions by the SEC and the Department of Justice related to the financial crisis and violations of the Foreign Corrupt Practices Act, among other concerns. Attorneys John Olson, Jonathan Dickey, Amy Goodman, and Gillian McPhee explain that public companies typically use three types of protection. One is a charter provision that is permitted by corporation statutes in Delaware and some other states, which absolves directors from pecuniary liability for breaching the duty of care, but not for breaching the duty of loyalty or acting in bad faith. Another is a charter provision, bylaw, or agreement that indemnifies directors and officers when, despite their having acted in good faith, they lose a legal proceeding. The third type of protection, D&O insurance, covers directors and officers in the absence of indemnification and advancement rights.

Deciding how much armor they need. Public companies usually provide-and Delaware courts usually construe- indemnification and advancement rights to the full extent the law allows. Provisions granting rights in the charter, bylaws, and agreements should be consistent, the authors advise. A charter provision does not necessarily supersede provisions elsewhere, and all provisions normally state that the rights granted therein do not exclude rights granted elsewhere. All provisions ought to exclude rights related to claims that the director or officer instigates. Even absent any provision, Delaware's statute grants rights to directors or officers who succeed in defending claims. Most companies' charters, bylaws, or both require directors and officers (but merely allow employees and agents) to receive rights, so provisions should spell out who is an officer. Compulsory rights can attract competent individuals but are costly when extended downward. Larger companies have recently been granting rights in agreements, which can be tailored to the beneficiaries. If there are several rights provisions (for example, because directors and officers serve a company and its subsidiaries), each should specify which takes precedence. Priority issues also affect D&O insurance.

Insuring them against running the gauntlet. The wording of D&O policies is heavily negotiated, the authors note. Coverage improves as premiums rise, and minute redrafts can affect coverage drastically. A company normally has a primary policy plus excess policies from different insurers, supplying three kinds of coverage: Side A covers losses the company is not permitted, declines, or cannot afford to indemnify; Side B refunds indemnification payments it does make; and Side C covers securities claims against the company. Policies frequently cover non-officers and always include defense costs, so large legal fees might deplete a policy long before resolution of a claim. Directors and officers share coverage with other parties, whose claims could also deplete a policy. To avert depletion, a company can increase coverage amounts; buy dedicated Side A coverage, which directors and officers do not share with the company; or buy Side A difference-in-conditions coverage, which shields them from catastrophic losses due to, e.g., the company's or an insurer's bankruptcy.

Expecting jousts with insurers. Coverage by the excess policies usually equals that of the underlying policy but often has “trigger” wording limiting the availability of coverage. More and more courts are enforcing one trigger-the underlying insurer's payment of the entire policy amount-by letting an excess insurer deny coverage when the company settles for under that amount. Market demand has prompted some excess insurers to reword their triggers, obligating them to provide coverage after the underlying insurer, the company, any other insurer or entity, or some combination pays the underlying policy's entire amount. To address changes in the insurance market and the growing dangers of shareholder lawsuits and government inquiries, the authors urge companies to review their D&O coverage yearly and with the assistance of insurance professionals and lawyers.

Abstracted from: Current Issues In Director And Officer Indemnification And Insurance By: John Olson, Jonathan Dickey, Amy Goodman, and Gillian McPhee, Gibson Dunn & Crutcher, Washington DC (JO, AG, GM) and Palo Alto CA (JD)

Insights: Corporate & Securities Law Advisor, Vol. 27, No. 7, Pgs. 12-21,

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