Director And Officer Insurance And The Gulf Oil Spill
August, 2010
by Michael R. Grimm and Harvey R. Herman and Timothy R. Herman
I. Introduction
To date, three Shareholder Derivative Lawsuits have been filed against the Directors and Officers of BP, arising out of the Gulf Oil Spill. The applicability and availability of Director and Officer ("D&O") liability insurance in these types of derivative lawsuits raise many issues:
• What types of insurance policies protect directors and officers?
• Whether companies can indemnify their directors and officers in shareholder derivative actions?
• What type of policy provides the most protection to directors and officers in shareholder derivative suits?
Defending shareholder derivative actions can be difficult for those unfamiliar with the insurance products available to protect directors and officers in these types of lawsuits. It is extremely important to retain counsel familiar with D&O insurance policies in order to minimize the costs of defending a shareholder derivative lawsuit.
II. What Are Shareholder Derivative Actions?
A derivative action is actually two causes of action: it is an action to compel the corporation to sue the directors and/or officers of the corporation and it is an action brought by a shareholder of the corporation to redress harm to the corporation. See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984). Shareholder derivative suits are brought by shareholders on behalf of a company against the company's directors and officers alleging that the company's directors and officers violated one or more fiduciary duties owed to the company and its shareholders. Meyer v. Fleming, 327 U.S. 161, 167 (1946). Typically, plaintiffs don't seek monetary damages, but rather they seek to protect their long-term interest in the company by imposing corporate governance and management changes.
An action is derivative when brought by a shareholder on behalf of the corporation for harm suffered by all shareholders in common. Levine v. Smith, 591 A.2d 194, 200 (Del. 1991). A derivative action "shall not be dismissed or compromised without the approval of the court." Fed. R. Civ. P. 23.1. Any money that is recovered is paid directly to the company after a deduction for attorney's fees. While relatively few derivative actions result in monetary recoveries, the recent trend is that shareholder derivative lawsuits hold the potential for very large recoveries.
III. Shareholder Derivative Actions Against The Directors And Officers Of BP
The three shareholder derivative lawsuits brought against the directors and officers of BP all allege similar facts in the complaints. The lawsuits allege that the DEEPWATER HORIZON blowout, fire and oil spill could have been prevented if the directors and officers of BP had paid more attention to safety issues. For example, in SE Penn. Trans. Auth., the plaintiffs allege that the ongoing Gulf disaster could have been prevented if BP abided by the safeguards it agreed to as part of the 2006 settlement of a shareholder suit over a "massive oil spill and complete pipeline shutdown" at Prudhoe Bay in Alaska.
The plaintiffs allege that the directors and officers have a fiduciary duty to put in place and monitor systems that will detect and address those problems, but the defendant BP officials only "went through the motions." They further allege a pattern of accidents and other close calls should have alerted BP CEO Tony Heyward and other high-level employees that their cost-cutting measures left the company vulnerable, but they still ignored the red flags.
The suits allege breach of fiduciary duty and waste of corporate assets. The plaintiffs ask the court to force the individual defendants to account for unspecified damages and unjust enrichment. The complaints also ask the court to force BP's board to institute a long list of corporate governance changes aimed at improving accountability and transparency at BP. It is important to note that any recovery will go back to BP to implement policies and procedures, which will prevent such oil spills and other accidents in the future. It should be noted that the directors and officers of other corporations which contributed to the disaster may find themselves facing shareholder derivative lawsuits soon.
IV. How D&O Policies Protect Directors And Officers In Shareholder Derivative Suits
Recent shareholder derivative lawsuits have been filed in conjunction with securities class action suits. See Greenfield v. BP, et al., No. 10-1683 (E.D. La. June 8, 2010) (brought on behalf of BP investors alleging that they paid greatly inflated stock prices because the BP directors and officers intentionally hid safety problems). This trend should be of concern to corporate directors and officers. If the securities class action suit exhausts the insurance recoveries available from a company's traditional D&O policy, directors and officers may find themselves without coverage for the defense costs and monetary settlement associated with a shareholder derivative lawsuit. A comparatively new type of D&O policy, the Side A-only policy, can provide additional protection in this situation.
Prior to a recent surge in large settlements in derivative suits, the major exposure to D&O insurance policies resulting from derivative actions were defense costs and awards for plaintiff attorney's fees. This can still be of concern to directors and officers because these defense costs and fees may limit, reduce or completely erode the traditional D&O policy. Now, corporate directors and officers and their insurers also must be concerned with large monetary settlements. D&O insurance policies typically do not cover judgments in which there is a determination of dishonesty on the part of directors and officers, as often is alleged in shareholder derivative suits. Therefore, many settlements are structured such that management does not admit to dishonesty and thereby can retain insurance coverage. Individual defendants often prefer to settle rather than risk the expenses of personal liability in case of an unfavorable judgment.
D&O insurance is designed to provide coverage for most derivative action settlements and defense expenses. Public-company D&O policies (such as the ones at issue in the BP shareholder derivative cases) typically have three distinct insuring agreements, often referred to as Side A, Side B and Side C. Side A applies when the company cannot indemnify directors or officers for claims against them. This is normally the case in shareholder derivative suits. The Side A agreement usually does not require the individual insured to pay a deductible. Martin O'Leary, Directors & Officers Liability Insurance Deskbook 36 (2007). The language of the insuring clause may take several forms, but includes the following concepts:
The insurer shall pay, on behalf of the D&Os, loss resulting from any claim first made against the directors and officers during the policy period for a wrongful act, except loss which the company may be required or permitted by law to pay on behalf of the D&Os.
Under Side B, the insurer reimburses the company for indemnifying its directors or officers as a result of claims made against them. Side C coverage insures the company for claims made directly against it.
Since companies typically are prohibited by law from reimbursing their directors and officers for monetary judgments and settlements in shareholder derivative suits, Sides B and C generally do not come into play in a shareholder derivative suit. See TLC Beatrice Holdings, Inc. v. CIGNA Ins. Co., No. 97-Civ. 8589 (MBM), 1999 WL 33454 (S.D.N.Y. Jan. 27, 1999) (when TLC Beatrice sought reimbursement of settlement funds paid to resolve a shareholder derivative lawsuit, the court held that Delaware law expressly prohibited the type of insurance payment that was being sought). However, corporations usually are allowed to indemnify D&Os for the costs of defending shareholder derivative lawsuits. See, e.g., Delaware Corporations Code, Del. Code Ann. Tit. 8 § 145 (2006). Additionally, companies are allowed to purchase insurance to protect directors and officers in these instances. D&O insurance recoveries may be available from Side A of traditional D&O insurance policies. However, directors and officers may find that they are competing against themselves for limited insurance protection if a derivative settlement or judgment devours the D&O policy limit.
V. Stand Alone Side A-Only D&O Policies
Directors and officers can reduce the problems created by standard D&O policies through a stand alone Side A-only D&O policy. An increasing trend in D&O coverage is for a company to provide its directors and officers with policies providing Side A-only coverage. Side A-only policies can provide coverage directly to individual directors and officers when recoveries under the standard D&O policy are limited, such as the case may be in the BP-related derivative lawsuits. Side A-only policies also may provide broader coverage than is available under standard D&O policies.
Learning Point
Directors and officers faced with shareholder derivative lawsuits arising from the Gulf Oil Spill should consult and retain counsel that is knowledgeable about the coverage afforded under their D&O policies or risk being personally liable for damage awards that are not covered by insurance. Liability exposure for future events may be diminished by purchasing stand alone Side A policies.
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