Being an independent director is both a privilege and an obligation of a high degree. The director is responsible for guiding the corporate strategy, as well as ensuring the compliance of regulatory requirements, and protecting shareholders’ interests. With these responsibilities come personal risks to financial, legal and reputational risk.
Although many boards cover Directors & Officers (D&O) liability insurance, the coverage tends to focus on protecting the company along with its executive directors. Independent Directors Liability (IDL) policies are designed to bridge the gaps by providing personal, direct protection to directors who are independent from the possibility of claims in their personal capacities.
But, the benefit in an IDL policy isn’t just in the fact that it exists, but also in knowing what’s contained within it. The fine print defines what coverage is available, what’s excluded and how well you’re covered if something goes wrong.
Why the Fine Print Matters
Independent directors are often appointed to boards with the assurance of “insurance is in place.” But it is possible for assumptions about coverage to be risky. The wording of a policy could mean the key to getting your defense costs completely paid for or being forced to pay the cost out of your own pocket.
The fine print is important because:
- Legal disputes are often based on the definitions of policy.
- Exclusions may be a way to eliminate insurance for dangers you thought were covered.
- Claim reporting deadlines can make or break a payout.
In litigation with high stakes, an insurer will be relying on the contract entirely as it is written, and should you.
Key Sections to Review in an IDL Policy
1. Definitions
Each IDL policy starts with the definition of key terms. These definitions determine the protection you receive. Take a close look at:
- “Claim” – Does it comprise arbitration, regulatory investigations or only formal lawsuits?
- “Loss” – Are settlements and judgments, legal costs and punitive damages covered?
- “Wrongful Act” – Is it broadly defined to mean mistakes, omissions, false statements or breaches of duty or even negligence?
A strict scope for “claim” or “wrongful act” will significantly limit the time the insurer will step in.
2. Insuring Clause
This section provides the insurer’s promise to pay for what they will cover and in what conditions. A strong IDL policies must:
- Make clear that coverage is applicable to directors who are independent in their personal capacity.
- First-dollar defense cost (without needing first indemnification of the company).
- Apply globally for membership on international boards.
3. Exclusions
This is where many directors are caught off guard. Some common exclusions include:
- Fraud or dishonesty: Most policies do not cover intentional wrongdoing however, some policies also prohibit the claims of a definitive judgement by a court.
- Previous Acts: Infractions that occurred prior to the policy’s date of commencement could be exempted.
- Insured vs. Insured: Claims brought by the insurance company or other insured individuals against you could be excluded if the carve-backs have been in place.
- Bodily Injury/Property Damage: Usually not covered unless it is caused by certain managemental decisions.
Always verify if exclusions include exemptions (“carve-backs”) which restore coverage in certain situations.
4. Limit of Liability
The policy will define an amount that the insurance company will cover for all claims during the policy term. Important considerations:
- Shared Vs. Separate Limits: If the IDL limitation is shared among other directors, the limit could be exhausted by another’s claim. Separate limits provide your security.
- Defense Costs Inside Limits: If legal fees reduce your coverage, high defense costs can leave little for settlements or judgments
5. Retention (Deductible)
It is the sum that you must pay before the insurance company contributes. A lot of IDL policies offer no retention if the company is unable to compensate you (common when you’re in bankruptcy). If there’s a requirement for an option for a retention, be sure it’s reasonable.
6. Defense Provisions
Your ability to manage your defense could affect costs and outcomes. You should look for:
- Right to choose a Counsel: Do the policies allow you to choose your own attorney or do you have to use the panel counsel of the insurer?
- Advancement of Costs for Defense: Are expenses financed as they are incurred, or later reimbursed?
- Consent to Settle: The insurer will require your permission prior to settling? Or is it possible to settle without your consent?
7. Reporting Requirements
Most IDL policies are claims-made, coverage applies only if the claim is made and reported during the policy period.
- Make sure you know the deadline to report a claim.
- Be aware of the implications of “circumstance notifications” (alerting the insurer of potential claims) can protect your rights.
The absence of a deadline to report, even by a few days, can result in the cancellation of claim.
8. Territory and Jurisdiction
If you are a member of boards that have international operations, be sure to:
- The policy covers claims made anywhere around the globe.
- The governing law and jurisdiction clauses align with where you may be sued.
Certain policy provisions exclude specific countries, or require endorsements to provide transborder coverage.
9. Run-Off Coverage
When you quit an organization, it could be still triggered from your prior participation. Be aware of:
- Automatic run-off-coverage: for a number of years following your leave.
- Tail coverage: An optional extension that you can buy to keep your protection.
10. Bankruptcy Protection
In the event of corporate insolvency companies are often unable to indemnify directors. A strong IDL policy must:
- Incorporate non-rescindable insurance in bankruptcy.
- Make sure that the proceeds go to directors who are independent, not those who are the creditors of the business.
Common Pitfalls in IDL Policy Fine Print
- Assuming that D&O as well as IDL are the same thing: D&O frequently leaves directors that are independent from competing for limits with executive directors.
- Overlooking sub-limits: Some clauses limit payouts for certain risks (e.g. penalties for violations of regulations) at less than the limit of the policy.
- Missing out renewal terms: The wording may alter between renewals, which can limit your coverage and you may not even realize it.
- Believing that indemnification agreements are enough: In fact, company indemnification can not be enforceable in bankruptcy or in certain legal situations.
Best Practices for Reviewing Your IDL Policy
- Ask a specialist review: Get an insurance consultant who is knowledgeable about director liability insurance.
- Benchmark Coverage: Check your policy against market standards applicable to your industry and size of the board.
- Ask “What If” Questions: Explore possible scenarios with your insurance company to find out how your policy will react.
- Document Everything: Make copies of all policy documents as well as amendments and communications.
- Review annually: Your risks change and so should your insurance coverage.
Final Thoughts
The Independent Directors Liability policy is an essential safety net for those as corporate board members. Like any safety net, it’s only as effective as the specifics that are included in the policies.
The fine print of the IDL policy will determine if you’ll receive swift, complete protection in the event of a crisis, or face personal financial exposures.
By knowing the key definitions, exclusions, limits and obligations, you’ll be able to make sure that your insurance coverage is in line with the risk you are facing.
At Keen Coverage, we assist independent directors navigate through legal jargon, find hidden pitfalls and establish policies to protect their reputation, assets and peace of mind. So you can concentrate on your governance, not on legal defense.