Posted on:Features, Insights, R&W Insurance
Despite the initial glee of the prospect of a United States that was independent of Middle East oil, beginning in the fourth quarter of 2014, the price of oil started dropping precipitously. As noted in a recent article, over 80 bankruptcies in the oil industry were filed in 2015, up 471 % over calendar year 2014. More are predicted in 2016 if things do not improve. We have unfortunately seen this sort of economic swing before, and it is generally not pretty.
Some of the earliest advice we give when times are tough is “check your directors and officers (”D&O”) insurance as soon as possible. You may need it.” This is because, at the end of the day in a corporate restructuring, all that directors and officers might have left to pay their defense costs and satisfy any litigation exposure is their D&O insurance. By checking their coverage early, the directors and officers can hopefully put their best foot forward before the situation gets so dire over time that a carrier will not want to continue writing their coverage or making the necessary adjustments to coverage that directors and officers may need. We have a checklist that we ask our clients to consider to help them with their D&O insurance. Though we have written about this issue before, and there are other elements of a D&O policy that are important to evaluate, we felt it as a good time for even us to refresh everyone’s recollection of the 5 most important aspects of D&O insurance that should be considered prior to entering into a restructuring setting:
- Will my carrier pay my claim? We know this question sounds bad, but it is a reality that not all D&O carriers are business-minded, and not all D&O carriers like to pay claims. Coupled with this fact is that economic uncertainty in the marketplace or an industry sector tends to make carriers even more skittish. There is no good answer to this question, but directors and officer should ask their risk and insurance professionals about the claims paying and claims handling reputation of their primary D&O carrier. It also is a real good idea to ask whether or not your primary carrier has real, wartime experience dealing with complicated bankruptcies and restructurings. Some of the name brand D&O carriers have this experience and we have personally seen a various range of conduct by D&O carriers over the last 15 years. Not all of the conduct has been good. Ask this question before you file and before it is too late to do anything about it. Your insurance broker is a fertile source of information for a question like this. So is your counsel.
- Do I have enough policy limits to pay potential claims? This is another hard question, but we suggest you ask it anyway. Intuition provides good guidance here. Is $40 million in D&O insurance enough for a publicly traded oil driller that has $3 billion in debt? The answer is probably “no.” Again, your counsel and your broker can potentially help you with an exposure analysis that takes your publicly traded status and debt exposure into account. You might get back a range of numbers to that question (say for instance, $60-120 million), but at least there will be some actionable intelligence on which to make a judgment.
- Will I have coverage if a creditors committee (or similar entity) sues me for breach of fiduciary duty on behalf of the Debtor? There seems to be as many D&O carriers today as airplanes in the sky. And unfortunately they have not standardized their wording when it comes to coverage for claims for breach of fiduciary duty that are “derivative in nature.” This means that these claims are not “direct” claims of creditors (meaning e.g. creditors v. directors), but claims they are bringing on behalf of the company in bankruptcy (i.e., the bankruptcy estate) in an attempt to recover money for creditors based on the alleged misconduct. At first blush this claim sounds like it should be covered. But it might not be. You would first have to check the carve-out of the “insured versus insured” exclusion of the D&O policy, which serves to exclude most claims by one insured (like an entity that purchased D&O insurance) versus another insured (like a director of the aforementioned entity). The general rule in the United States is that either there is a carve-out for the committee bringing suit on behalf of the entity, or there potentially is no coverage. We recommend an exhaustive carve-out, which generally (subject to any other term, condition or exclusion of the D&O policy) would provide coverage for claims brought by creditors, debtholder, noteholders, equity holders, or similarly formed bankruptcy constituencies of the company (which could even include a liquidating trust, a vehicle that is commonly formed in chapter 11 plans). Many brokers already use similar wording. Some do not. Some do not even know this is a big issue. It is. The insured versus insured exclusion should thus be checked before entering any restructuring process.
- Does my policy cover me though the bankruptcy process? Does my policy provide for “tail coverage?” These are related questions so we will handle them together. Though some restructurings tend to be short ones (like pre-packaged or pre-negotiated bankruptcies), others tend to last longer (especially if there is no consensus by the debtor and its major creditors going into the process). And sometimes the D&O policy (if no one is watching) will expire right in the middle of a bankruptcy process. Needless to say, that is not a good thing. Going in, the directors and officers should check with their risk professionals to make sure the policy will cover the length of the restructuring process. If it does not, a extension of the policy period may be required. Further, at the end of the bankruptcy process, the policy should provide for an extended period of time (called “a tail”) to report claims, as not all lawsuits triggered by a restructuring are filed instantaneously. The normal length of the tail period is 3-6 years.
- Do I have Side A Excess Difference in Conditions (“DIC”) Coverage for the Directors and Officers only? Side A Excess DIC coverage is coverage for the directors and officers only. It is not shared with the entity. It is also for non-indemnifiable Loss only, meaning Loss that a Company is either legally unable to advance or indemnify, or financially unable to advance or indemnify. A bankruptcy filing will normally trigger the “financially unable to indemnify” element and thus trigger coverage for directors and officers. This sort of coverage is also good for sometimes filling a gap in coverage somewhere in the tower of insurance left by a carrier that has refused to pay on a claim. In situations where it is determined that there is not enough coverage to pay all the claims that could be filed against directors and officers, Side A Excess DIC coverage can sometimes be added to an existing tower of insurance to give the directors and officers comfort that they can safely proceed through a restructuring process.
We have all been on “bumpy flights” in our lifetime. They are uncomfortable. They cause a queasy feeling in your stomach. They are not fun flights. Nor too is a restructuring for a company and its directors and officers. But having good holistic and comprehensive D&O coverage can provide some comfort to the management team and the board of directors. We often get involved in situations where it is too late to make changes to a D&O program structure, or to fix the wording of a primary D&O policy that has too broad an exclusion. That is why we always counsel clients to be prepared. To work with your D&O advisor and broker proactively. To use peacetime wisely. To check their D&O coverage before they step on the plane.
 See “Gloomy Forecast: Oil Industry Bankruptcies Increase 471%,”
 See e.g., “Oil and Gas Exploration Bankruptcies Could Sextuple This Year,”
 See “Guest Post: Securing the Director and Officers Liability Insurance Lifelines! What Every Director Needs to Know – Before Entering Troubled Waters,”