Directors and Officers Insurance, Backdating and Effective Coverage Counsel

Sometimes when I give seminars on directors and officers coverage, I like to pass along a story I once heard of a law professor who gives his students what he considers an impossible hypothetical, namely, how would you respond to a client who walks in the door saying that she has been asked to join a board of directors and needs to know whether the company’s directors and officers insurance is sufficient protection for her. The reason the hypothetical is impossible, the professor posits, is because no one can say whether the directors and officers policy is sufficient in the abstract, and the scope of its coverage can only be understood by waiting to see the latest theories of liability being asserted against directors, and then examining how insurers are responding to them under the language of the directors and officers policies that they issue.

Now I have always thought that story overstates the case a little bit, in that certainly most areas of directors and officers exposure are sufficiently well developed that one can look at a directors and officers policy and provide a present or future board member with at least some general sense of the scope of their insurance protection. This is, after all, why people and companies hire insurance coverage lawyers: because they have the experience and knowledge base to understand a policy and provide some guidance, even in the abstract, as to what it covers and what it does not.

That said though, the story I noted above rang clearly in my head - and rang true - the other day when I came across a New York Times piece (only available by subscription or to those of you who still have Friday’s paper lying about) on the expanding risk of personal liability for directors based on backdated option grants. Two things jumped out at me. The first is that if there was ever an object lesson as to the need for directors and officers coverage, and why no one should ever leave home for a board meeting without it, this is it. Counsel to board members must look in advance, preferably at each renewal, at the scope of coverage being acquired for directors and officers exposures and the potential exposures of the board members, and make sure that the best product available on the market, the one that is best suited for those board members and their exposure risks, is obtained.

The second thing that really drew my attention was that the story fit perfectly with the law professor’s hypothetical, although in a way that may reflect insurers being at risk as much as the directors. To what extent are lawsuits and liabilities arising out of this newest scandal, if that is in fact what we should call it, within the coverages provided by directors and officers policies, most of which were drafted before the expansion of this fast growing risk? Does it fit within standard coverages that were already in play, or within standard exclusions already contained in the policies? Or is it a risk of a nature no one anticipated, and insurers are sitting there with policies that don’t have language that controls this risk? The answers to these questions are going to make a big difference in who actually ends up paying if directors are personally liable for these type of stock option manipulations - the officers themselves (or the companies they serve if they are obligated to indemnify the directors) or the insurers who issued directors and officers policies to those companies.