A Brief Primer on D&O and Why You Need Side A Excess

by Jeffrey Cavignac, CPCU, ARM, RPLU, CRIS, MLIS – President, Cavignac & Associates
Directors and Officers (D&O) liability policies provide three distinct coverages. The first (known as Side A) is liability coverage for individual directors and officers of the parent organization (termed “directors and officers liability insurance”). The second (known as Side B) is corporate reimbursement coverage, which reimburses the parent organization for payments it is legally obligated (or permitted) to make in indemnifying its directors and officers for liability claims made against the directors and officers. The third (known as Side C), is coverage for the parent organization for claims relating to the securities of the corporation, also termed “entity securities coverage.”As noted above, Side A of a D&O policy insures losses that are not indemnified by the corporate entity, a situation most frequently occurring (1) when the corporate entity is financially unable to indemnify its directors and officers, (2) when the defendant directors and officers must pay a settlement or judgment in a shareholder derivative lawsuit or (3) when a claim is made against directors and officers for which, according to its bylaws or the applicable statute, the corporation is not required to provide indemnification.

Recognizing the importance of these exposures, beginning in the early part of the 2000s, insurers began to offer what are known as “Side A-only” policies. Such policies are written in conjunction with “primary” D&O policies and provide coverage on an excess basis to those policies.

The intent of Side A-only policies is twofold:

  • To provide excess limits in the event the limits under the primary form are exhausted by claim payments and defense costs
  • To “drop down” over primary forms, in the event that an exclusion or other coverage restriction applies, that would otherwise defeat coverage

Side A-only policies provide coverage for the directors and officers—not for the corporate organization’s obligation to indemnify such persons.

Advantages of Side A-Only Coverage Forms

Coverage Assured in Bankruptcy Situations

One of the most important advantages of a Side A-only policy is that under a standard D&O form, there is sometimes uncertainty as to whether directors and officers have access to the proceeds of such policies in the event a company declares bankruptcy. With Side A-only forms coverage for the directors is not in doubt, even when a company is insolvent and a bankruptcy trustee seeks access to policy proceeds.

Inapplicability of Severable Warranties

Another obstacle to a director’s obtaining access to D&O policy proceeds is the application of non-severable warranties. This refers to a situation in which coverage for a director is barred because of fraud or concealment by a corporation’s CEO or CFO in providing information within the application for coverage. Under Side A-only policy forms, this otherwise non-severable warranty, which ordinarily defeats coverage for non-culpable directors and officers, does not apply so coverage would be available under such circumstances.

Exclusions for Financial Restatements

Yet another coverage gap is created by exclusions for coverage of claims produced by financial restatements.  Again, such exclusions do not appear in Side A-only policy forms. Therefore, despite the presence of such an exclusion in a primary D&O form, coverage would nonetheless apply to directors insured by a Side A-only policy, because the Side A-only form would “drop down” over the coverage gap caused by the financial restatement exclusion in the primary policy.

Non-Rescindable Policy

Unlike most “traditional” D&O policies,  a Side A-only forms cannot be rescinded based on fraud committed by “inside” directors and officers (i.e., directors and officers who are also employees of the corporation). Therefore, coverage under Side-A policies will always be available for its independent director-insureds, even if the underlying corporate policy has been rescinded by an insurer.

Additional Policy Limits Available for Mega-Claim Situations

Since D&O policies are written with a combined single limit for all three insuring agreements, when the corporate entity is named in mega-securities litigation (e.g., $100+ million), policy limits are usually depleted by the claim applicable to Coverage C (entity securities coverage), leaving little or no monies available for claims that also name directors and officers. However, the presence of a Side A-only policy, which contains a “dedicated” limit for directors and officers—and is not accessible by the corporate entity—solves this problem.