D&O Insurance Coverage: What is it good for?

Corporate scandals over the past few years have been numerous and high-profile.  As a result, the conduct of directors and officers of corporations have become subject to a high level of scrutiny.  In
addition to the public keeping a keener eye on the activities of
corporations, the Sarbanes-Oxley Act of 2002 has increased the
potential liability of directors and officers. [1] The Act, having
established new fines and penalties for the corporate board, has had
the incidental effects of causing the price of director and officers
(D&O) liability insurance to rise dramatically and of creating a
need for more sophisticated D&O insurance.  While
D&O coverage does exist, albeit it with higher deductible and
limited coverage, a recent case demonstrates how directors may still
bear the costs of litigation even with a policy. [2]

In
a recent case from the U.S. district of Arizona dismissed the bad faith
and abuse of process claims of a corporate officer against his
insurance company.  [3] The suit was filed by Thomas Grabinski, an officer of the Baptist Foundation of Arizona.  He
was seeking reimbursement from National Insurance Fire Insurance Co.
for the defense of his criminal charges stemming from an alleged $550M
fraud by Grabinski and other company officers that ultimately led to
the bankruptcy of the foundation.  [4]

Grabinski,
like many corporate officers and directors was protected from the costs
of litigation by his D & O insurance. [5] Such policies provide
protection from the personal liability and financial loss that may
arise from allegations of wrongful acts committed in their capacity of
being a corporate officer to director.  The costs in defending these types of actions can be quite costly, but until recently rare.  However,
given the increased allegations of corporate scandals the claims have
risen, the average settlement cost has doubled and the D&O
insurance market has radically changed.  [6]
Insurance companies have put in provisions that do not allow for
recovery if a director or officer is found guilty of any part of an
action or other provisions that limit recovery of costs.   The
result is that many directors and officers are exposed too much greater
personal and financial risk than they might realized despite their
being “covered” by insurance. [7]

 

Thomas Grabinski has yet to recover his litigation cots despite his D&O coverage.  Having
escaped criminal charges brought against him, he is still waiting to
see the return of the money he spent defending himself.  Even
after bring suit against National Union and wining a judgment for the
$2.5M, he has not been able to collect the sum. [8] National Union has
continued to initiate various motions and appeals so much that
Grabinski charged that National Union has abused the litigation process
and breach the duty of good faith through the numerous delays. [9]
Grabinski feels the insurance company has engaged in these delay
causing tactics as a means to make him exhaust his own assets and
accept a lesser amount than the 2.5M.  However,
as the court ruled there is no case for bad faith just because the
insurance company has exercised normal litigation tactics. [10]  The
Judge opined “It is not enough to establish a defendant’s ulterior
purpose in the use of process, … To sustain an abuse of process action,
the claimant must show that the use of process ‘could not logically be
explained without reference to  … improper motives.”” [11]

 

While
the result of the Grabinski litigation is not surprising, the impact it
might have on officers and directors may be interesting.  For
one, Grabinski’s plight should serve as a reminder to directors and
officers that they may not be as protected by their policies as they
might think.  Secondly, given the difficulty of
recouping litigation costs from insurance, companies should think
carefully about how their policies are structured and perhaps opt for
those that will pay the costs ahead of time and require the funds to be
paid back only if the case is lost as opposed to the individual paying
the full cost up front and subsequently getting reimbursed.  Finally, the case is instructive that D&O insurance cannot be wholly relied on.  Thus,
individuals may want to ensure that they have indemnification from
their own company or some other means to protect both themselves and
their assets.  Being a director or an officer has
always been high profile, but now more than ever, it is a risky
position to be in, especially without the guarantee of D&O coverage.

 

[1] See Sarbanes-Oxley Act of 2002 §305 available at http://sec.gov/about/laws/soa2002.pdf.

[2] Frank Reynolds, Litigation Strategy in D&O Dispute is Not Bad Faith (2005), http://news.findlaw.com/andrews/bf/cod/20051018/20051018grabinski.html.

[3] Grabinski et al. v. National Union Fire Ins. Co. of Pittsburgh et al., No. 04-1751, 2005 WL 2412784, *3-4 (D. Ariz. Sept. 23, 2005).

[4] Frank Reynolds, Litigation Strategy in D&O Dispute is Not Bad Faith (2005), http://news.findlaw.com/andrews/bf/cod/20051018/20051018grabinski.html.

[5] Id. 

[6] Directors & Officers Liability Insurance, http://www.aon.com/risk_management/d_and_o.jsp.

[7] Id. 

[8] Frank Reynolds, Litigation Strategy in D&O Dispute is Not Bad Faith (2005), http://news.findlaw.com/andrews/bf/cod/20051018/20051018grabinski.html.

[9] Grabinski, No. 04-1751, 2005 WL 2412784, *3-4.

[10] Id.  at *18.

[11] Id.  at *15-16.

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