Swiss Cheese D&O Insurance

Originally published in Lexpert Magazine

Directors' and officers' insurance contracts are often riddled with clauses that, while seemingly reasonable and well-intentioned, can lead to bizarre court decisions

PREVIOUS COLUMNS have discussed how directors' and officers' insurance programs are "just contracts." Al-though the exercise may seem surreal, in circumstances in which the actual insurance policies are typically not available for months after they have been purchased, courts apply normal contract interpretation principles to insurance programs, seeking to discern the "intentions of the parties." You must, therefore, insist upon receiving your policy documents and you should read them carefully.

An example of what can happen otherwise is illustrated by "insured vs. insured" clauses, which find their way into virtually every D&O policy form in the first instance. These provisions state that there is no insurance coverage in a lawsuit brought by a person or company potentially insured under the policy against anyone else also named in the policy. The purpose of these clauses is obvious and, at one level, not unworthy: they exist to prevent collusion between insureds who could manufacture disagreements for the purpose of accessing insurance proceeds.

Unfortunately, the clauses have been construed to mean precisely, and fully, what they say, and that can produce strange results. In a recent US case, a former director who resigned to pursue a takeover bid sued his former director colleagues who had taken steps to thwart the bid. Because all parties had been directors at one point, and therefore "insureds" under the policy, there was no coverage.

The effects of the insured vs. insured exclusion are often exacerbated by another common clause, the "major

shareholder exclusion," under which insurance is not available in lawsuits by shareholders holding a specified percentage of the company (typically 10, 20 or 25 per cent).

Most policies contain a number of exceptions to these exclusions and, if they do not, exceptions are usually readily available for the asking, and at no cost. So, for instance, many policies extend coverage to lawsuits by insureds such as trustees in bankruptcy, whistleblowers and suits by the company (derivative suits) despite the plaintiff being an "insured."

But where an exception is not available, there can be serious holes in coverage. Many officers may be protected under the policy, so suits by them are not covered...