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

by Jessica Panza November 3 2005, 23:59

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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