As usual, I have taken my cue from Kevin LaCroix’s DandODiary.com, here, and then attempt to provide the Canadian perspective. Kevin’s recent post, here, on bankruptcy statistics and D&O insurance is very detailed, and if you don’t let the US stats deter you, the risk and insurance comments are equally applicable to Canadian companies. Kevin refers to the American Bankruptcy Institute, here, and a record number of business bankruptcies (60,000) in 2009, “nearly 200% greater than in 2006”. He also refers to the ACE Insurance Report, here, “Financial Crisis: Bankruptcy Implications for D&O Insurance, by Keith Lavigne, Scott Meyer, Carol A.N. Zacharias”
Not surprisingly, the Canadian statistics are much different. According to Industry Canada, here, January, which is historically a higher month for bankruptcies than December, insolvencies (bankruptcies and proposals) were down 6.7%, the largest January decline in 20 years. This includes both business and consumer insolvencies. January 2010 over January 2009 showed a business insolvency decrease of 18.5%. The 12 month periods ending January 31, 2010 and 2009, respectively, showed a 10.3% decrease in business insolvencies (6,624 total, including 5,326 bankruptcies.) These insolvency figures do not include filings under the Companies’ Creditors Arrangement Act, here, which includes 35 filings between September 18, 2009 and April 30, 2010. Another helpful website is BankruptcyCanada.com, here.
These statistics, coupled with the fact that business bankruptcies in Canada have been on a steady decline for the last ten years, half what they were ten years ago, may make Canadian company stakeholders more comfortable. However, consumer bankruptcies are up 25% year-over-year ending January 31, 2010, and consumer proposals are up 41%. And, based on CCAA, for stakeholders of Canwest, Winalta, Tagish Lake Goldcorp, etc., comfort is a luxury they don’t have.
The value of a D&O policy should never be greater than when approaching creditor protection or bankruptcy. On the surface, one method for a director to reduce personal liability is to resign immediately from the board, so that even if statutory obligations are levied against the director, they will stop accumulating the date they resign. Hopefully, this is when the D&O Insurer and/or the insurance broker should be stepping-in to remind the current board that they have insurance to cover their personal liability and that staying on the board and turning their mind to the challenges presented (of restructuring and corporate turn-around) is probably the only way to avoid the overall business failure and potential personal liability.
Here is an excerpt from the ACE Report, “When a corporation files for bankruptcy, the D&O risk appreciably rises. Because indemnification from the corporation may not be available, defendant directors and officers risk their personal assets in litigation, unless quality insurance exists.” The report also quotes Dan A. Bailey, partner and chair of the D&O practice group at law firm Bailey Cavalieri, here, “Bankruptcy is the big driver of non-indemnified D&O lawsuits. It is the single biggest personal asset exposure that directors and officers need to be worried about, and that Side A D&O insurance companies, which absorb risk, must carefully evaluate from an underwriting perspective.”
I remember a situation from my underwriting days, when a building materials manufacturing company realized that a significant batch of product, manufactured and installed many years early, was failing well before the warranty period ended. Sales dropped immediately because of reputation risk; liquidity risk became a reality because of debt servicing and credit risk; insurance risk surfaced because product liability policies were based on occurrence forms and therefore administratively more difficult to handle and, based on the size of the loss, slower to respond. The creditors would not have been flexible if the senior management did not have a plan and did not stay to handle the significant challenges, the senior management wouldn’t stay if the board resigned, and the board would likely have resigned if the D&O underwriters did not meet with them and provide the comfort that the D&O policy was there to respond to personal liability should the directors and management fail in their attempt to turn the company around. The limit of liability of the D&O policy was no-where large enough to backstop the company assets (and the policy is not designed to do that), but it was large enough to provide comfort that statutory liabilities, defence costs for potential creditor and shareholder claims, and some contribution (in addition to the entity and other third parties) to settlements would be covered. This comfort provided the necessary time to organize, strategize, and gather necessary resources. One of these resources was the product liability policy, which by itself was not large enough to cover the entire loss, but, its existence provided assurance to customers, creditors and shareholders that the overall risk was manageable. The result was that over 200 employees kept their jobs and pensions, customers came back, and shareholder value was restored. And my seemingly altruistic employer did not incur a dime in loss (but we were not the product liability insurer.)
If the necessary comfort is not volunteered by the Insurer, the policy wording can still do the job (it just needs broker support and, when appropriate, legal advice.) Here are ten comments I have extracted from my much larger list of D&O policy review points (if you would the whole list, please feel free to call me directly):
- Coverage for the entity be limited and fully transparent
- Extensions of coverage should be fully understood, as they expose the policy to loss other than personal liability of directors and officers which creates limit sharing and limit exhaustion
- Limit-of-Liability management should consider PML (probable maximum loss from stakeholders: employees for wages, severance; shareholders; creditors; government for unremitted taxes, pollution liability; etc.), as well as entity coverage and other extensions
- Priority-of-Payments provisions may be necessary but should not provide too much comfort, because there is no precedent in Canada, and the Canadian courts apply a ‘first-past-the-post’ doctrine which could negate the provision. And, it doesn’t come without risk because some wordings might create liability for a specific officer and expose that individual to further loss (after limits have been exhausted)
- Insured vs Insured exclusion should at minimum contain specific ‘carved-back’ language (eg. Trustees in bankruptcy) and there is no common wording in Canada
- Affirmative coverage for regulatory proceedings should be confirmed, and the extent of this coverage should be highlighted in the ‘entity coverage’ transparency
- Financing of D&O premium should be avoided because it usually requires assignment of cancellation rights, which means the policy is cancelled by the finance company prior to a claim being made
- Automatic run-off should be maintained, and policy made fully-earned and non-cancellable at any change in control (not just for bankruptcy, but any time, because some Insurers will suggest that removal of automatic run-off is in your best interest – always be careful of Insurers bearing gifts)
- Repeat to yourself, “there are D&O losses in Canada”, “there are D&O losses in Canada”, five more times
- No matter what they say, plaintiff lawyers do exist in Canada, they have sufficient motivation to pursue claims, and lawyers on both sides of the claim are well paid
Please note this is not an exhaustive list of things to consider with your directors’ and officers’ liability coverage and the possibility of creditor protection or bankruptcy. Bankruptcies are commonly a slow and painful ordeal, with years worth of financial and business indicators. Many D&O underwriters are business grads, MBA’s, CFA’s, CA’s, and their job is to identify future bankruptcies and reduce their employer’s risk. D&O policies are annual and very rarely written with multi-year policies (no, an intent-to-renew letter is not a multi-year policy), and clauses in some policies state that any offer to renew the policy, with any change in terms, conditions or premium, will not constitute a refusal to renew, so extended reporting provisions (ERP) cannot be triggered.
Negotiation of these renewals should be a very demanding process, but my experience is that Insured’s management has already heard such bad news from clients, bankers and suppliers, that they don’t have the energy (or proper advice) to aggressively negotiate an acceptable policy wording. There are dozen’s of different ‘bankruptcy’ exclusions, and rarely does the most onerous one have to be accepted by the Insured.
Please feel free to call me to expand on any of these issues, or provide you with other documents, like the Pitfalls of Indemnification, or Lightening of Continuity.
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Greg Shields, Partner, Mitchell Sandham Insurance Brokers, 416 862-5626, firstname.lastname@example.org