Stephen J. Weiss Partner, Holland & Knight LLP

Due Diligence on D&O

Six insurance questions you should ask before joining a board.

You have been invited to become a director of TitanTech Corp. This is one of the most exciting growth companies in the world, and, if truth be told, you are eager to rub elbows with TitanTech‘s current directors -- captains of industry and former top government officials. You want to accept the invitation but have a nagging concern that your personal assets could be exposed if the company becomes embroiled in potentially devastating litigation. You are smart to be concerned. But you may be able to allay your fears if you know the right questions to ask.

Does TitanTech have D&O insurance? This is the place to start your due diligence, and the answer of course should be “yes.” You need insurance to supplement TitanTech’s agreement to indemnify you against losses arising out of your service as a director. TitanTech may declare bankruptcy down the road and thus not be able to honor this agreement, or indemnification may not be permitted for public policy reasons.

Is the policy limit of TitanTech’s D&O insurance program adequate? There is no scientific way to determine the right policy limit. Even so, ask TitanTech’s risk manager for data on policy limits purchased by companies in TitanTech’s peer group and compare the size of TitanTech’s D&O program with that of its peer group. In addition, ask for data on settlements of securities class-action lawsuits and defense costs. This, too, can prove helpful in judging the adequacy of the aggregate policy limit of TitanTech’s D&O program.

Is the policy limit intact? To make sure that TitanTech’s D&O insurance program will be available for your needs, ask the company’s risk manager whether any D&O claim has been filed during the current policy year and whether the insurer has made any payments on the claim. If there has been such a claim or payment, you will need legal assistance to take the next step -- to determine whether the claim could exhaust or seriously erode the policy limit on which you plan to rely.

Which insurers are part of TitanTech’s D&O program? Given TitanTech’s size, it had to purchase the $300 million of D&O insurance it wanted from 15 insurers. When there are multiple insurers in a D&O program, you should get the names of all of them and check their financial strength. A.M. Best Co. (www.ambest.com) is a leading provider of insurance company ratings. The top four ratings are A++, A+, A, and A-. You should be concerned if any insurer in TitanTech’s D&O program does not have one of these ratings.

Can the insurers rescind the policies in TitanTech’s D&O program after a suit has been filed? Rescission -- an insurer’s assertion that a policy is null and void from inception -- is your worst nightmare as a director. This situation is most likely to arise if an insurer believes there was a material misstatement in the D&O insurance application (which typically includes the applicant’s recent SEC filings and other materials supplied with the application).

There are two ways a director may be protected against rescission. The first is through a policy provision known as a “full application severability clause.” If your policy has a true full “app sev” clause, the insurer may not rescind the policy as to any director and officer who did not know the application contained material misstatements or omissions. (Some insurers claim that their policies include a full “app sev” clause but, upon closer reading, this is not the case. Read the clause yourself or consult with counsel.) The second is by means of a non-rescindable Side A policy, a type of D&O policy that insures only the directors and officers, not the company. Since not all Side A policies are non-rescindable, look for a policy provision along the following lines: “The Insurer shall not be entitled under any circumstances to rescind this Policy.” (For more information about Side A policies, see “Why You Should Know About Side A Insurance,” Directors & Boards, Summer 2003.)

Does the D&O insurance program provide broad protection? More than 30 insurers offer D&O policies. With no standard form, terms and conditions vary tremendously from policy to policy. For example, conduct excluded from coverage in one policy may be covered in another. You need the assistance of an insurance professional to do a complete policy evaluation. Despite the time and expense that this analysis entails, a growing number of prospective directors are requesting it from companies before they join their boards. (For a description of available evaluation services, see “Overcoming Prospective Directors‘ Concerns,” Directors & Boards, Spring 2003.)

If the answer to any of these questions gives you pause, that’s an important sign that you might be better off walking away from TitanTech’s flattering invitation. You’ve worked for decades to accumulate a nest egg for your well-deserved retirement. Don’t let inadequate D&O insurance destroy your dreams.

Ed. Note: To obtain complimentary copies of the articles cited in the text, contact Wendy Johnson at Holland & Knight LLP at wendy.johnson@ hklaw.com.