Getting a Second Opinion
7 reasons why independent coverage counsel are called upon to review D&O insurance programs
General counsel and corporate directors are increasingly consulting specialized independent coverage counsel about their directors and officers liability insurance programs. Why not solely rely on insurance brokers? And what can brokers learn from these consultations?
Outside counsel are being asked to take a “second look” at what brokers have procured for several reasons. The primary concern is whether the broker has identified the major risks affecting the entities and executives being insured. Have they procured the most comprehensive available coverage to address those exposures, having regard to the jurisdictions in which the corporation and its subsidiaries operate, and what are the gaps? Sometimes the concern is that the broker is becoming complacent, treating the insurance coverage like a commodity and adopting a superficial approach without due regard to the specific issues that might arise given the named insured’s business sector, potential differences or changes in the laws of the territories in which it operates and the particular statutory liabilities to which its executives may be subject in each jurisdiction.
1) Increased Director Sophistication:
Prospective directors are now seeking independent legal advice regarding the adequacy of an insurance program of public and private companies before joining their boards, performing their own due diligence, and frequently commission an independent review of the indemnification protection available to them. If the fit between the insurance and indemnification is poor, then prospective directors will seek to remedy any misalignment through the purchase of enhanced Side A protections and by negotiating individualized indemnity agreements. Independent coverage counsel provide such advice.
2) Global Focus:
As Canadian businesses become increasingly global in their operations, their executives are concerned about being protected wherever the exposures may arise. Just like prospective directors, existing boards and senior officers want to be sure that their personal asset protection will be seamless wherever claims are made and frequently ask external counsel to review their bylaw protections to identify any gaps that need to be addressed through indemnity agreements and insurance. This last area of inquiry is one where legal counsel need to be involved as it is beyond the scope of the broker’s expertise and, depending on the geographic reach of the business, may require consultation with lawyers in other legal systems. How frequently do brokers recommend that this type of independent review be conducted? Not often enough.
3) A Balanced Structure:
With increased regulatory scrutiny and enforcement in US and Canadian capital markets and the proliferation of cross-border securities class actions and regulatory proceedings, corporate policyholders are becoming highly sensitized to the significant expenses that can be incurred responding to informal inquiries, formal investigations, regulatory proceedings, derivative demands and class action proceedings, regardless of the merits. Individual insureds are concerned that there be dedicated coverage for their protection, while boards of directors worry about balance sheet protection for the corporation for the costs of responding to these demands, investigations and proceedings.
As a result, coverage counsel are asked to look at the structure of programs to determine whether the coverage will be available for its primary purpose under the corporation statutes, namely the protection of directors and officers, and secondarily for the protection of the corporation. Has the right balance been struck? Are the limits realistic in light of the potential costs and damages that might ultimately be sustained? How has access to the insurance limits been prioritized? Have boards discharged their fiduciary obligations in the procurement of the D&O liability insurance?
There is no question that due to the tenacity and negotiating power of the broker community—plus the soft insurance market—there are new D&O insurance product offerings with substantial enhancements to protect both individual and corporate insureds. However, there remain a number of areas of vulnerability and room for improvement in D&O insurance programs for Canadian corporations with international operations. Clients are worried about the issues the brokers have not addressed which frequently arise in insolvencies, change of control or crisis. Here are some of the issues that independent coverage counsel are grappling with because brokers may have dropped the ball.
4) US-Procured Programs
Frequently, Canadian subsidiaries of US companies have D&O liability insurance policies that have been procured by US brokers who are oblivious to the unique statutory liabilities Canadian directors face in the tax and employment law context, typically triggered in an insolvency. These US-designed programs have exclusions for taxes and wages that, depending on the governing law, potentially eviscerate coverage for directors of Canadian subsidiaries who have personal liability when the corporation has failed to pay its income and excise tax obligations, withhold and remit income tax from wages and foreign-bound dividends, or honour its severance, wage and vacation pay obligations.
5) The Governing Law Problem
There can be significantly different outcomes in the enforceability and interpretation of an insurance policy depending on the law that governs it. Insurance brokers—Canadian and US—have not demonstrated an appreciation of this issue. Complex, multi-tiered insurance programs are often put in place without it being clear which law governs the interpretation of the tower. Coverage counsel must then go to extraordinary efforts to figure out (usually litigate) which jurisdiction’s law was intended to apply to determine coverage obligations. It is possible, depending on the fact situation, for multiple courts in different states or countries to be in a position to assume jurisdiction over an insurance dispute with dramatically different outcomes. Policyholders need certainty when it comes to which law will govern their rights and the insurer’s obligations. The problem of determining governing law is exacerbated where the broker has not ensured that excess policies strictly follow form on this key element.
6) Lack of Uniformity in Dispute Resolution Provisions
Continuity up the tower is critical when it comes to how coverage disputes will be resolved. There are a number of programs where a mandatory arbitration provision is tucked away in an excess policy with no such provision in the underlying or subsequent policies. How is the policyholder to obtain a uniform binding resolution of disputes if one of the carriers is entitled to insist on a radically different process that won’t bind the carriers above it? Sometimes there is no provision at all in the primary policy where the insurer submits to the jurisdiction of a particular court. What, then, are the excess policies supposed to follow? In the absence of a clear answer, chaos ensues.
7) Mandatory Arbitration Provisions
This is the most neglected section of the primary insurance policy and one that brokers frequently gloss over because they don’t understand it. These provisions will often require that in the event of a dispute the policyholder must either (a) mediate the dispute and be subject to a lengthy cooling off period after any failed mediation before it may sue to enforce its rights, or (b) arbitrate the dispute, typically with a three-person arbitration panel, and bear half the costs of that dispute resolution process. In myopinion, the arbitration provisions are often poorly drafted, ill-defined in terms of the mediation or arbitration rules, time parameters and processes that apply and are typically designed, or at least have the effect, to prevent the policyholder from obtaining timely access to the courts to protect its interests and enforce its rights.
This issue is of particular concern to an individual insured who does not have the luxury of mediating or arbitrating these disputes when they need their defence costs covered immediately. Mediation and arbitration are important dispute resolution mechanisms, and privacy and confidentiality concerns often militate in favour of those processes. However, mandatory mediation and arbitration provisions seldom advance the interests of individual insureds. For that reason, experienced independent coverage counsel will negotiate these provisions off of policies. Named insureds and insurers can always agree after the fact on an alternative dispute resolution process if there is a bona fide basis for doing so.
These are some of the issues that independent coverage counsel may need to address that affect the timely resolution of insurance coverage disputes, prompt payment of insurance monies and certainty of outcomes. Brokers spend a lot of time negotiating insurance programs that look great on paper. However, if they want to deliver real value, brokers need to focus on the issues that impact whether insurance will respond effectively when it matters and be more receptive to collaboration with experienced coverage counsel.
Mary Jane Stitt is a senior litigation partner at Blakes in Toronto who acts as a policyholder coverage counsel in the mediation, arbitration and litigation of significant commercial insurance disputes.
Copyright 2012 Rogers Publishing Ltd. This article first appeared in the May 2012 edition of Canadian Insurance Top Broker magazine.