D&O Insurance Coverage: Understanding the Role of Outside Directors

D&O Insurance Coverage is Essential to Reduce Your Financial Risk.

(March 29, 2010): A Federal court recently preliminarily approved a $55.95 million settlement involving securities claims against outside directors in a case against Peregrine Systems, Inc. This is one of the largest ever recorded settlements involving outside directors, and is significant in D&O insurance issues. Pursuant to the settlement, several former Peregrine directors agreed to settle claims for $55.95 million. It has been reported that the Peregrine’s insurers contributed to the settlement, and the outside directors are pursuing coverage from the excess insurers. However, the payment terms of the settlement indicate that a large part of the settlement will be paid from the outside directors’ personal assets. So how do you respond when your outside directors ask you about your company’s D&O insurance?

I. An Overview of the Peregrine Systems Litigation:

In 2002, plaintiffs filed securities class action lawsuits against Peregrine, certain Peregrine officers and directors, and various other defendants. The outside directors settled these claims for $55.95 million. Like prior settlements involving personal contributions from outside directors, the case featured elements including a bankrupt company, insider trading allegations, a huge accounting restatement and officers guilty of criminal charges.

II. Why Peregrine’s D&O Insurance Proved Inadequate to Fully Cover Losses of the Outside Directors:

Court records reveal that Peregrine Systems maintained $20 million of D&O insurance: $10 million primary, and two $5 million excess policies. The total $20 million limits, in the face of massive litigation, proved insufficient to meet all of the defense and settlement costs. Court records also show that Peregrine’s primary policy did not contain application “severability” or other non-rescission wording to protect innocent directors. Therefore, the D&O insurance carrier sought to rescind coverage as to all named insureds under the policies, rather than just the officer defendants who pleaded guilty to crimes.

III. How to Avoid Personal Contribution by Outside Directors In The Event of Claims:

One thing that can be done to prevent personal contribution by outside directors in the event of claims is to insert “severability” provisions to carve back coverage for outside directors if that officer's conduct triggers allegations of fraud, criminal conduct, or the exclusion of illegal profits. These exclusions should include a “final adjudication” requirement, ensuring they are not triggered until after a court determines that the insured persons engaged in the excluded conduct. In addition, companies should make sure that “priority of payment” provisions are included to ensure that Side A director losses are paid before the policy pays for covered losses of the company, either through its indemnity obligation under Side B or for covered Side C claims directly against the company. Furthermore, companies should provide adequate and “non-rescindable” Side-A only excess “difference in conditions” (DIC) coverage to insure directors have sufficient insurance in the event indemnification is unavailable from the company, the underlying limits are eroded by company claims, or the underlying insurers deny coverage to the directors. Include in the Side A policies automatic “reinstatement of limits” for outside directors only. Finally, consider purchasing independent director liability (IDL) policies that can apply to a single non-officer director, or group of such directors. D&O Insurance is a complex area, yet crucial for any director who may be exposed to liability.

Health Care Attorney

David Parker has extensive experience representing corporations, their officers and / or directors in connection with corporate-related litigation. Should you have questions about these issues, call Mr. Parker for a complimentary consultation at: 1 (800) 475-1906.