Legal Developments and Emerging Risks in the D&O Market

February 28, 2011

Greg Shields appreciated the generous offer to contribute a guest blog article to the widely-followed Recovery Partners Blog.  Please see introduction from Alex Jurshevski at Recovery Partners and the link to the article below.

In this latest blog posting, Recovery Partners welcomes a contribution from Greg Shields, an Insurance Professional and Partner at Mitchell Sandham Insurance Services. Greg’s blog is timely and examines the linkage between US Bank failures and the market for Director’s and Officer’s (D&O) insurance. The article details legal developments and emerging risks in the D&O market and we suggest that all Company Executives, Directors and their Advisors read this cogent analysis of how these might affect them and the companies with which they are associated.

Please hit this link www.recoverypartners.biz/blog to go to the article without delay.

If you or your clients need advice in the area of crisis management, risk advisory, debt restructuring, distressed M&A; loan buyouts or Sovereign Debt management then please do not hesitate to contact Alex Jurshevski at www.recoverypartners.biz .

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Canadian Directors’ and Officers’ Liability Insurance (D&O) and the Recent IMAX Decision

February 22, 2011

Canada is seeing a material change in home-grown D&O loss experience. On Valentines day we saw a new decision in the first case to be brought under Ontario’s new, at the time, “Bill 198”, aka, part XXIII.1 of the Ontario Securities Act (the “Act”), section 138.3, which provides a statutory cause of action for secondary market misrepresentation. In the IMAX case, the underlying securities litigation commenced September 20, 2006, when Siskinds LLP, here, and Stutts, Strosberg LLP, here, brought their case alleging misrepresentation and breach of duty of care. Justice K. van Rensburg, in her decision, here, certify class proceedings. The defendants appealed this decision,  here, and on Feb. 14, 2010, Justice D.L. Corbett denied the defendants motion for leave to appeal.

We all know what happens to settlement amounts when a court decision goes in favour of the plaintiff class, but here we can consider what could be material to directors and officers in Canada. The IMAX 2005 information circular listed a D&O policy with a $70 million limit of liability. Though the circular does not provide a lot of detail, it does say they had a split deductible of $100,000 “for each claim under the policy other than claims made under U.S. securities law as to which a deductible of $500,000 applies”, and paid an annual premium of $962,240. This split deductible suggests at least some portion of that tower of D&O coverage was extended to cover the corporate entity for some of its individual loss and expenses.

There is a lot of litigation left in this case, but a full limit loss should not come as a surprise to anyone. Outside of the magnitude of an insured loss on this size of D&O coverage in Canada, the materiality of the case will depend on potential for loss above the limit. More importantly, loss above the limit if any part of it is borne by the individual directors and officers.

In 2005-2006, and even today, Excess Side A DIC (Side A = loss not indemnified by the corporate entity, DIC = difference in conditions, or an excess policy written to be broader than the underlying policy) was not a guaranteed purchase for public corporations of this size in Canada. Therefore, if the (assumed)  A, B, C primary policy extended through the entire limits of the tower, then the comfort level of the individual directors would be largely based on the size of the limit of liability. (In case it needs explaining, A is the insuring agreement in the D&O policy that responds to loss not indemnified by the corporation; B is the insuring agreement that protects the corporate entity for loss it incurs on behalf of the individual directors and officers; C is the insurance agreement that protects the corporate entity for its own loss and expenses in certain claims, like securities claims. But, this is just a glancing overview because an appropriate explanation requires discussion on “presumptive indemnification”, “hidden entity coverage” and many other D&O coverage issues.)

 Now we can start to see the very reasonable misconception in the D&O policy. It is marketed as a D&O policy, when, much to the surprise of individual directors, it is in fact a corporate entity policy.

The problem (for individual directors): $70 million may seem like a large limit, and may have looked good on a benchmarking chart, but there  was, and is, no legal precedent of insurability of a Bill 198 claim in Canada. From the little I know of Strosberg, here, and Lascaris, here, I will be shocked if they settle this case at policy limits. As far as I know there is no institutional plaintiff, but, the entire class pool has yet to be identified, and I imagine Silver and Cohen would be willing to bough-out in favour of a large pension plan, if that is what is necessary to fund a “scienter” position and a removal of the liability cap. Though there are only a few cases of personal (unindemnified, uninsured) director contribution settlements in Canada, institutional plaintiffs in the US are known to agree to a settlement only after they have won some level of personal contribution.

The directors might also seek comfort in the “priority of payment” provisions in the policy, but, these were not as common in 2005-2006, and there is limited precedent. My concern for their use is they may motivate a follow-on shareholders claim, or a (current) shareholder attempt to block proceeds of the policy from being eroded by individual director’s defence. Thanks to the Insured vs. Insured exclusions, or other policy limitations, this follow-on claim may be excluded, or further erode the available policy limits.

There may be some critics who will suggest that IMAX will not have a material effect on Canadian directors and officers. For those people I will include a link to some light reading of the recent NERA report, here, on Canadian securities class actions.

I think IMAX will have a material effect on directors, officers, and D&O premiums in Canada, but it might take years for it to play out. If you are not willing to wait that long to fully understand your D&O policy coverage, and the key issues of “continuity”, “sharing of limits”, “limit erosion and exhaustion”, “severability” and the 96 other important terms, please don’t hesitate to contact me directly; Greg Shields, Partner, Mitchell Sandham Insurance Brokers, 416 862-5626, gshields@mitchellsandham.com.

CAUTION: The information contained in the Mitchell Sandham website or blog does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult an experienced and truly independent registered insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this site from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com


Directors’ and Officers’ Insurance – Entity Coverage and the Blogosphere

November 2, 2010

 

Recently, while perusing the Canadian D&O Blogosphere, I came across the website of an Ontario insurance broker, who pointed out that “not all D&O policies provide Entity Coverage” and that that coverage is “critical to your insurance program.” It ends with “if your broker can’t do this… find one that will.”

I appreciate every attempt to understand and communicate the technical minefield of D&O risk and loss control, but this proves that the really important issues cannot be provided on a website. I decided not to provide a public reply on their blog, but since education on the subject of Directors’ and Officers’ liability is insufficient (by insurance brokers, or available to insurance buyers) I decided to send him the response I was going to put on his blog, and post this same response to you.

Dear blogger, I think this blog has the potential to do more harm than good. The D&O policy was always intended to cover the personal liability of directors and officers, because a relatively small loss could be catastrophic to an individual person, but even a much larger loss might not be catastrophic to their corporation.

The insurance brokerage industry has done a very poor job of explaining D&O coverage in general, and many Insured Persons have been put at great risk by purchasing D&O policies that have too many extensions to the corporate entity. Following your example, it may be great to have entity coverage when there is a $10 million total loss on a $25 million policy, but it is catastrophic to the individual Directors and Officers if that $10 million total loss is made against a $5 million policy. In this second example, many brokers will point to ‘coverage enhancements’ (I use this term very carefully) to protect against ‘limit exhaustion’, like ‘Priority of Payments’ or ‘Built-in Additional Excess Side A’, but these could be window-dressing hiding a bigger problem. I know of no Canadian precedent surrounding the actual trigger of Priority of Payments, but many versions of that wording might actually create more financial risk for certain Insured Persons. And regarding Built-in Additional Excess Side A (Side A is the Insuring Agreement that responds when the Corporate Entity is not legally or financially able to indemnify the individual Insured Persons), this small additional limit is shared by many individuals, and is not adequate protection when you consider that it will likely be the only insurance available for the remainder of that particular claim and for every future claim that is in any way related to the same underlying circumstances. The other problem with Built-in Additional Excess Side A is that it doesn’t include protection from failure of the Insurer, or provide Difference in Conditions (DIC – fewer exclusions) features.

 There may be many examples of the Corporate Entity being uninsured by the D&O policy, but there are also many examples of D&O policies being fully exhausted on defences costs alone, long before the exposures to individual Directors and Officers have stopped (it has been suggested that that the vivendityclassaction (try it with dot com) defence costs will fully exhaust their $200 million policy limit.)

 I am not suggesting that Entity Coverage should not be available in the D&O policy, but all forms of Entity Coverage should be fully explained to the client, and they should know the degree to which they are sharing their limit of liability (perhaps the only limit of liability available to any and all claims that could arise from their tenure as a Director or Officer) and therefore increasing the possibility of ‘limit exhaustion.’ My second warning is that it is very difficult to identify all areas of ‘limit sharing’ in a modern D&O policy. This form of ‘Insurance Risk’ is not isolated to the Insuring Agreements, it can be found within any section of the policy, every endorsement and even in the applications. This analysis has to include definitions, allocation, severability, exclusions and insuring agreements.

Any broker can help you buy a broad D&O policy, but that does not make it a good policy. They first need to understand your industry, your company, and your priorities, long before they present a D&O policy.

 If your broker isn’t doing this, find someone who can and will.

If you would like an explanation of this post with specific reference to your company, or if you have questions about D&O risks, insurance coverage, limits adequacy, program structure, risk management or loss control, please call me directly.

Greg Shields, Partner, Mitchell Sandham Insurance Brokers, 416 862-5626, gshields@mitchellsandham.com

CAUTION: The information contained in the Mitchell Sandham website or blog does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All comments and opinions are copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this site from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.