Understanding The Many Facets Of Side A DIC D&O
Side A coverage is the insuring agreement within a D&O policy that provides first dollar coverage (in the form of defense costs and settlements) for claims asserted against directors and officers, whose costs are not indemnified or advanced by the corporate entity. We have outlined some of the most common claim scenarios in which Side A coverage may be triggered (below). For those interested, Chubb has also published a nice brochure outlining specific Side-A claim examples (here).
- Bankruptcy claims (the entity does not have the funds to indemnify)
- Derivative litigation (the entity may be prohibited from indemnifying)
- Regulatory and criminal proceedings, and investigations against insured individuals
- Acts of “bad faith” committed by directors or officers
- Refusal (and wrongful refusal) to indemnify by the corporate entity
- Claims in which the entity is prohibited from providing indemnification due to other applicable laws or statutes
We recently published a risk assessment and D&O insurance guide for public companies which outlines the current risk environment public companies must navigate in 2019, while addressing the role Side-A DIC policies can play in insulating against some of those risks. One such risk: an uptick in derivative claims, as companies are now seeing follow on derivative actions following the announcement of FCPA investigations, data breaches and sexual misconduct allegations. New regulatory initiatives such as the “Yates Memo” which has emphasized individual accountability, has also increased the importance of strong Side-A coverage. Since traditional D&O policies already include a Side-A insuring agreement, what is the benefit of a separate Side-A DIC (difference in condition) policy?
Provides Excess Limits: One of the benefits of a Side-A DIC policy, is the excess limit provided. When an underlying policy is exhausted, the Side-A policy provides excess coverage. As an example, a company purchasing a 25 Mill underlying full (A-B-C) D&O policy with a separate 10 Mill Side-A DIC policy effectively has a 35 Mill total limit for a non-indemnifiable loss against its directors and officers. This is of course assuming other claims do not first exhaust or reduce the 25 Mill limit provided by the policy under it.
Provides Broad “Drop Down” Primary Coverage: The most alluring benefit of a Side-A policy is its broad coverage and “drop down” feature. This is in contrast to a standard “follow form” Excess Side A policy which only provides excess coverage. Where traditional D&O policies contain numerous exclusions, Side-A DIC policies generally only contain a single exclusion: the conduct exclusion, which precludes coverage for fraudulent acts, intentional violations of the law, malicious conduct, and gaining of illegal profit (subject to a final adjudication by the courts). Since Side-A DIC policies “drop down” to provide primary coverage effectively filling the coverage gaps of the underlying policy, this allows the directors and officers to navigate around otherwise problematic exclusions such as; regulatory exclusions, pollution exclusions, ERISA exclusions, professional services exclusions, bodily injury exclusions, and/ or the insured vs insured exclusion (among others). Additionally, Side-A DIC policies provide broader protection than the Side-A insuring agreement of the underlying policy, by containing numerous coverage enhancements such as:
- Broader coverage for investigations of insured persons: This includes investigations at the informal stage, a coverage element generally unavailable on a traditional D&O policy.
- Broader range of covered “Damages”: Among other enhancements, Side-A DIC policies can also include coverage for pre-claim inquiries, costs to produce documents, affirmative coverage for fines and penalties against insured individuals, and plaintiff’s attorney’s fees against insured persons.
- Coverage for defense costs associated with compensation claw back claims under SOX (304) and Dodd Frank (954)
- Fully non rescindable, non voidable side-A coverage. Eliminating the chances of coverage being rescinded or voided back to the inception date, due to representations made during the application process.
- Automatic coverage to directors/officers of new subsidiaries (that would otherwise not qualify under the underlying policy’s ownership threshold)
Reduces wrongful coverage declinations: While insurance carriers are generally fair when it comes to making coverage determinations, situations can always arise where it is believed that the underlying carrier is wrongfully declining an otherwise covered claim or attempting to rescind or void coverage. When these situations arise, and payment isn’t provided in a timely manner, the Side-A DIC carrier will step in to provide coverage – they will then in turn, subrogate against the underlying carrier if it is determined the loss should in fact be covered. This in effect incentivizes payment by the underlying carrier. Pillsbury Winthrop and D&O Diary have a good explanation (here) of what they refer to as the “cramdown provision”.
Protection Against Refusal To Indemnify By The Company: The “presumptive indemnification” clause within a D&O policy, assumes that, during a claim, the corporate entity has indemnified its directors/officers to the fullest extent of the law. But what if the company has not, and instead, wrongfully refuses to provide indemnification? This could subject the directors/officers to a large retention (of 250k or more), requiring them to incur significant costs before coverage will respond. Sometimes this clause can be removed or narrowed to ensure executives have access to first dollar (Side-A) coverage if the company refuses to indemnify. However in some cases, policyholders may not be able to remove this clause or narrow its scope. In such situations, a Side-A DIC policy will drop down to ensure first dollar coverage to those directors or officers (with no required retention).
Protection Against Carrier Insolvency: The Side A insuring agreement of a traditional D&O policy provides coverage for claims asserted during bankruptcy, but what happens if the insuring carrier itself goes bankrupt? Side-A DIC insurance is intended for just that; the underlying carrier either refuses to, or cannot provide claim payments (in this case due to insolvency). While insureds can of course minimize some of that risk by only working with highly rated carriers, companies in difficult to write markets or those with distressed financials may find that the only carriers willing to provide terms have slightly weaker financial ratings.
Stronger Bankruptcy Protection: One of the intentions when placing D&O insurance, is to protect the personal assets of the directors and officers for claims asserted against them during insolvency. In some cases however, that coverage may be pulled out from under them, as the bankruptcy courts may determine the proceeds of the D&O policy are property of the estate, leaving no coverage available to the directors/officers. Whereas traditional D&O policies (with entity coverage) can run the risk of being seized by the courts, Side-A only policies do not carry that same risk. In fact, Side-A policies are uniquely designed to provide coverage in such an event. Many Side A policies contain among their definition of a “DIC Event”:
“a liquidation or reorganization proceeding is commenced by or against the Company pursuant to the U.S. Bankruptcy Code, as amended, or any similar federal, state, foreign or common law and as a result of such proceeding the insurer(s) of the Underlying Insurance fails or refuses to indemnify or advance such Loss because the proceeds of such Underlying Insurance are or allegedly are subject to an injunction, automatic stay or similar legal restriction prohibiting payment of such proceeds”
Stronger Asset Protection: As part of their broader coverage feature, many Side A DIC policies often contain an absolute carve-back for defense costs, within the fraud/conduct exclusions. Where full D&O packaged policies stipulate that the carrier can recoup defense costs from an individual director or officer following an adjudication of guilt, most Side A DIC policies conversely will not attempt to recoup such costs. This provides further protection of directors' and officers' personal assets in cases involving allegations of fraud or intentional wrongdoing.
Ensures Directors/Officers are Covered: Since a Side-A policy only provides coverage for non-indemnifiable claims, it does not run the risk of being exhausted by corporate reimbursement or securities claims. Consider this, a small public company has purchased a full (A-B-C) D&O policy with a 10 Mill limit. During the policy period the entity experiences a securities claim which results in 23 Million in damages (inclusive of defense costs). This quickly exhausts the limits of the underlying policy, and forces the company into bankruptcy. The bankruptcy proceedings in turn trigger claims from creditors and the bankruptcy trustee. Since the underlying policy has been exhausted, there is no Side-A coverage available in the underlying policy. And since the corporate entity is insolvent, it also cannot provide indemnification, therefore there is no coverage available to provide the directors/officers for defense costs or damages related to the claims asserted. Incorporating a separate Side-A DIC policy ensures that there is always a pool of funds available to cover the directors/officers and protect their assets for claims that generally concern them most.
Not all Side-A policies are created equal however. Like all professional and management liability policies, terms and conditions can differ. There are also best practices that should be employed when purchasing a Side-A policy. Due to the fact that the policy is protecting against refusals to pay by the underlying carrier, it’s wise to purchase coverage from a carrier that is not contributing to the underlying program – placing DIC coverage with a carrier participating in the underlying insurance means the insurer would then be providing coverage against its own insolvency and coverage declinations. Policyholders should also ensure that the Side-A carrier has a strong financial rating and a good reputation when it comes to handling claims. Lastly, companies looking to purchase Side A coverage only, without a full underlying D&O program should be aware of the potential ability to purchase coverage on a carriers’ Side A DIC form (vs their standard Side A Form) which will likely yield better terms and conditions. The ABA has some additional placement tips (here) for those interested.