September 30, 2013

TRAINING FOR TOMORROW: 2013 Checklist for Corporate Counsel Supervising the Creation or Renewal of an Executive Protection Program

James D. Wing

The corporation laws of every U.S. jurisdiction permit corporations to advance defense costs, indemnify, and insure innocent directors and officers against risks of liability that arise out of their good faith service to the corporation. They do so to encourage responsible and talented individuals to accept the weighty responsibilities these positions impose. Last year, Business Law Today published a checklist created by the Director and Officer Liability Committee to assist corporate counsel in supervising the creation or renewal of an executive protection program to implement that policy. Both before and after its first publication, the checklist was vetted through exposure to and comment by attendees at ABA live and webinar programs and at a webinar given to members of the Association of Corporate Counsel. The Committee promised that it would update the checklist each year to reflect changes in the law and insurance markets. This is that update. 

The checklist was created by the Committee in response to requests by corporate counsel who had communicated their practical inability to master the nuances of this ethically dangerous, highly complex, and specialized area, much less keep up with new developments in the law and the insurance markets. They asked for a document that would assist them in managing the creation or renewal of an executive protection program to provide at least the maximum protections that the law and insurance markets allow. They asked for a compendium of issues that they could give their risk manager, insurance brokers, and outside counsel to use to vet the adequacy and breadth of the corporation's executive protection program. The checklist's objective is to assist professionals to meet the statutory goal of protecting innocent executives while not overly burdening shareholders with massive and unlimited defense cost obligations to perceived miscreants. The checklist highlights issues and suggests alternatives intended to meet the statutory objectives in a commonsense and balanced manner. 

This year, the Committee has given particular attention to the increased frequency of cases where executives find that their behavior is the subject of potential criminal liability arising out of corporate internal investigations. The Committee has concluded that there are significant gaps in both advancement and insurance protection in this area, and is exploring ameliorative measures. As a result, it expects to further update the checklist next year to further address these issues in the context of developing law and changes in the insurance market. The Committee has also just published, through the ABA, an annotated Model Indemnification Agreement based on Delaware law. The provisions of that agreement are consistent with the checklist. 

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The Checklist

A comprehensive director and officer's protection program has four elements, regardless of whether the corporation is for-profit or not-for-profit: (1) statutory immunity of directors of for-profit corporations from claims for damages by shareholders resulting from directors' failure to exercise "due care," and statutory protection against liability for (typically) volunteer executives of non-profits; (2) advancement to selected executives of defense costs and expenses until claims are resolved and then relief from any duty to repay the amounts advanced in a proper case; (3) indemnity from the corporation for any amount an executive may agree to pay in settlement of such a claim or that the executive may be compelled to pay by judgment in a proper case; and (4) a comprehensive program of D&O insurance that meshes with the corporation's advancement and indemnity by-laws to cover legitimate risks that state statutes leave uncovered. This checklist addresses these elements in turn. 

I.            Director Exculpation under Certificate/Articles of Incorporation; Statutory Protections for Volunteers of Non-Profits. Under most states' corporation laws, directors may be exculpated in advance from civil liability for damages for breach of the fiduciary duty of due care they owe to the corporation and its shareholders. This is a corporate articles/certificate of incorporation matter that requires no further checklist. Volunteers for not-for-profit corporations may additionally be entitled to exculpation or immunity from suit under federal and state laws. Taking the legal steps necessary to allow directors to avail themselves of exculpatory provisions permitted by governing law is an important component of any comprehensive director protection program. Guaranteeing this protection is a classic duty of in-house or regular corporate counsel. 

II.            Advancement and Indemnity. Executives may be given a right to advancement from the corporation of reasonable defense costs for all claims against them arising from their service, and a mandatory right to be relieved from repaying these advances. They may also be indemnified for any ultimate settlement or judgment against them under corporate by-laws or formal indemnification agreements. In all cases, however, these rights exist only if and to the extent that advancement and indemnity is permitted by governing law. No jurisdiction's statute expressly permits an executive to obtain advancement of defense costs if the executive asserts Fifth Amendment privileges in response to inquiries by a corporation including those made during a corporate internal investigation. No statute expressly permits an executive's counsel to assert work product privileges in respect of the attorney's billing entries when the reasonableness of the attorney's charges are at issue. These two privileges are generally critical to an innocent executive's defense, and to the extent they are compromised, the executive is at risk. These considerations give rise to the following issues: 

A.     Are the advancement and indemnity rights contractually mandatory, or are they only to be conferred by separate action of the board on a discretionary basis after a claim arises? If they are mandatory, do they cover the correct executives? 

B.     If mandatory rights are granted in by-laws, is the board prohibited from amending the by-laws to eliminate protection for circumstances that accrue during the executive's tenure but before a claim is made? (Some state statutes cover this question, but many do not.) 

C.     Does the right to advancement accrue at a sufficiently early stage to protect the executive without causing premature "lawyering up" that is detrimental to corporate collegiality and informal communication? 

D.     Does the right to advancement cover derivative and corporate internal investigations? 

E.      If the corporation has foreign subsidiaries on whose boards executives are expected to serve or if they are expected to otherwise supervise foreign operations, is the corporation obligated to post bonds or otherwise pay to secure the release of the executive's person from physical arrest and his personal assets from sequestration orders issued by a foreign court or governmental agency? May the corporation indemnify and advance defense costs, or even buy insurance for such executives, if the substantive law governing the subsidiary forbids advancement, indemnification, or insurance? 

F.      If the executive is in any way implicated in a matter that creates potential personal criminal exposure, does the executive: 

i.      have access to (but not possession, custody or control over) all relevant corporate documents useful to his defense?

ii.      have the express contractual right to assert Fifth Amendment privileges (and his lawyer work product privileges) without jeopardizing his advancement and indemnity rights or limiting the amount of defense costs for which he is entitled to advancement? Does the by-law specify a mechanism for resolving privilege disputes?

iii.      have the right to receive advancement of defense costs until at least the first "final adjudication" (i.e., after appeal) of facts that forbid the corporation from indemnifying him under the relevant corporate law? Must these facts be found in the criminal or civil case for which advancement is sought or may they also be found in any U.S. case in which the executive has participated without the assertion of Fifth Amendment privileges by himself or a witness material to his defense? Is the corporation prohibited from instituting or continuing any civil case against the executive that requires him to waive his Fifth Amendment rights or the executive's counsel work product privileges before final adjudication of at least the first claim that gives rise to the need for advancement?

iv.      have the right to subrogate himself to the corporation's Side B coverage should the corporation refuse to advance him defense costs and the executive pay such a cost directly?

v.      have the right to judicially compel advancement at the corporation's expense using summary procedures, i.e., without having to make any assertions of fact, good faith, or innocence that can prompt an evidentiary hearing? 

G.     Assuming that the executive's advancement and indemnity rights cover claims that are broad in scope, does each director understand that a broad definition may include a duty to advance reasonable defense costs in an unlimited amount and in respect of claims for insider trading, embezzlement, diversion of corporate opportunities, or otherwise receiving improper personal benefits, leaving the corporation in a delicate public relations or financial position should uninsured defense costs rise to a substantial level? If the corporation elects not to assume a mandatory contractual duty to advance or indemnify for the latter claims, is that intention adequately expressed in the bylaws and is it consistent with similar exclusionary language contained in the corporation's D&O insurance policies? 

H.     Should the corporation leave its advancement and indemnity exposure unlimited in amount in respect of third-party claims in which the corporation and executive cooperate in the defense? In cases where the interests of the corporation and its executives are adverse so as to prohibit a joint defense on the merits of the claim, should the corporation limit its advancement and indemnity duty to the sum of insurance cover and the corporation's deductible? 

I.        Are executives permitted to be advanced and indemnified against all legal costs in any matter that includes non-indemnifiable claims or parties so long as the facts or issues relevant to the covered and uncovered claims overlap?

III.            D&O Insurance. A corporation may obtain Side B insurance to cover its advancement and indemnity obligations to its executives and Side A cover to protect its executives directly from claims for matters in which the corporation and executives are joint defendants and are united in the defense. ABC policies may also cover claims where the interests of the executive and the corporation are in conflict. A corporation may purchase DIC insurance to cover defense costs arising from situations of adversity and also to cover claims for which the corporation may not legally indemnify, financially cannot indemnify, or for which the corporation refuses to indemnify. 

Checklist issues are: 

A.     Are all individuals that the board wishes to insure in fact covered? Are those it does not wish to cover excluded from the policy definition of "Insured"? 

B.     Has the board made a reasoned and appropriate decision on policy limits, particularly given that under its Side B coverage, it seeks to cover its complete advancement and indemnity exposure to all covered executives beyond an agreed retention? Are all parties cognizant of the phenomenon of competition among insureds for access to policy limits and the accepted means for reducing such competition? Are litigation costs covered when they are incurred in board members' efforts to preserve policy limits for themselves? 

C.     Does the policy cover defense costs within overall limits or through sublimits for matters such as derivative investigations (both those that arise immediately after demand and those that arise after the creation of a special litigation committee) and corporate internal investigations? 

D.     Where advancement coverage incepts under C. above but before a defined "claim" arises, does the policy give each insured the separate option of not treating the event as a reportable claim or mandatorily-reportable circumstance? May individual insureds give notice of circumstance to cement cover under the policy in effect for that year over the objection of the corporation? 

E.      Does the policy cover employment practice claims, crisis management costs, searches and raids by enforcement authorities, and claims against employed lawyers? If the latter have separate professional liability cover, is it clear which cover is primary? 

F.      Is the policy definition of "wrongful act" sufficiently expansive so that "all risk" coverage is obtained, assuming such is the desire? Does the insurer agree that such cover includes claims by opposing parties for attorney's fees? Claims for personal injury and property damage arising from a wrongful act as defined? Section 11 and 12 securities law liability? All insurable fines and penalties and punitive, moral, and multiple damages to the extent permitted by law? Amounts paid to mitigate or reduce the likelihood of a claim? Personal liability for corporate taxes and statutory insurance contributions? 

G.     Does advancement coverage expressly continue until there has been a final adjudication of facts in the underlying proceeding for which advancement is given that permits the application of the "willful or intentional act" policy exception? Is the insurer prohibited from bringing any suit to accelerate that process? Are the "deliberate and intentional act" or "improper personal benefit" exclusions limited to cases where the act or gain was the result of deliberate misconduct? 

H.     Is the insurer prohibited from recovering its advances should the executive's conduct fall within the "willful or intentional act" exclusion? 

I.        Is the definition of "loss" sufficiently expansive? Does it exclude the types of claims for which the board may not wish to insure against such as insider trading, embezzlement, diversion of corporate opportunity, and other claims in which the executive is accused of receiving an improper personal gain or benefit? 

J.       Does the policy contain an exclusion for claims against executives that seek to recover amounts that the corporation should have paid in addition to amounts it did pay in a merger, share exchange, or sale transaction? If so, are executives entitled to advancement and indemnity if personally sued in such a case without being required to allocate their defense costs between other covered claims and the claims seeking an increase in consideration? Generally, are executives permitted to be advanced and indemnified against all legal costs in any matter that also includes uncovered claims or parties so long as the facts or issues relevant to the covered and uncovered claims overlap? 

K.     Are the exclusions for illegal conduct, "other insurance," and timing of claims (including the provisions relating to giving of notice of claim or circumstance), reasonable and readily understandable? Are the "notice of circumstance" provisions objective, subjective, or both; mandatory or permissive? Does the policy provide for an extended notice period should the corporation become insolvent? 

L.      Is there an "insured-versus-insured" exclusion and, if so, is it phrased narrowly to exclude only truly collusive claims? 

M.    Does the policy contain a clause that conditions or otherwise bases the executive's Side A cover on the corporation's fulfillment of an obligation to advance and indemnify "to the fullest extent permitted by law" or comparable language? Is this provision limited to prohibit the insurer from placing on the insured executive the duty to assume the corporation's Side B retention or deductible in a case where the corporation breaches its statutory or by-law advancement or indemnity obligations? 

N.     Does the insured corporation have in place reporting mechanisms to ensure that the risk manager is kept fully informed of any potential claim or circumstance requiring notice to the insurer? Does the insurer bear the burden of establishing prejudice from late notice and is its remedy for late notice limited to the actual damage it sustains as a result? Do the executives have the ability to notice claims or circumstances directly to the insurer under their Side A cover and are they entitled to receive notices of cancellation or changes in coverage? 

O.     Does the policy permit an executive subject to potential or actual criminal charges to assert against the insurer Fifth Amendment privileges, and the executive's counsel work product privileges, without violating the policy or limiting the executive's recovery of defense costs due to a claim by the insurer that the executive's counsel has provided insufficient billing detail? Is there an agreed mechanism for resolving privilege disputes by a court (not an arbitration) that requires advancement while any dispute is being resolved? Is there a severability clause that protects "cooperating" executives should "non-cooperating" executives be held to violate the policy's cooperation clause? 

P.      Is the policy's definition of "application" reasonably narrow and understandable? Are the covenants and representations made by the corporation and any insureds in either the application or the policy reasonable and understandable? 

Q.     Is there an application severability provision that insulates innocent executives from a claim of application fraud due to the guilty knowledge of less than all of their number? 

R.     Is there an incontestability or similar clause that limits the insurer's right to rescind a policy? Is the insurer's right to cancel the policy appropriately limited? Must it notify all affected insureds, or at least all current insureds? 

S.      Is there a settlement "hammer" clause and has it been appropriately drafted to avoid unfair and unintended results? 

T.      Does the policy sufficiently define the parameters of the consent-to-settlement clause and the clause permitting the insurer to associate counsel to eliminate micro-management of the defense? Do these clauses specifically exclude criminal matters and matters where the insurer pays defense costs while reserving its right to deny coverage? 

U.     Does the policy contain an "order of payments" provision sufficient to reasonably mitigate the effects of a corporate insolvency? 

V.     Are the claim reporting time limits reasonable? Does a broad definition of "claim" result in an undesirable expansion of the insureds' duties to give notice of claims or circumstance? Does the right to advancement of defense costs arise within a period of less than 60 days after demand is made on the underlying insurer or corporation? 

W.   Have the implications of "DIC" or "dedicated limits" coverage been explored to provide advancement and indemnity coverage (1) for risks that the corporation and the underlying ABC policy do not cover, (2) where the corporation refuses or is unable to advance defense costs and indemnify, (3) to mitigate the risk of program failure due to competition among competing insureds for policy limits, (4) to avoid loss of coverage in respect of criminal matters in which the executive or his counsel assert Fifth Amendment or work product privileges; (5) to cover cases where an underlying carrier may not a pay a claim arising in a foreign country due to its unlicensed status; and (6) to provide reinstated limits or separate limits for boards? 

X.     Does the policy insure executives for the costs of obtaining release from incarceration and release of sequestered personal assets if they act as directors or agents of a foreign subsidiary or for the parent corporation in a foreign country? Does the policy contain coverage for reputation restoration and cover crisis management public relations services? 

Y.     Does the policy contain appropriate cover for the costs of resisting Dodd-Frank/SOX claw-back claims? 

Z.      Does the carrier selected have a reasonable financial rating and a good reputation for claims handling and payment? 

AA.           Do the insureds have the right to recover their attorneys' fees under applicable law should they be required to litigate coverage with the insurer? 

BB.            If a DIC policy contains a choice of law clause, does it choose as the applicable law the law of the underlying ABC policy? What law is chosen in the ABC policy? If the policy contains an arbitration clause, is the legal seat of the arbitration (not just the hearing locale) a venue that understands American plea bargaining practices? 

CC.            Are there to be one or more excess policies above the negotiated first-tier policy that do not "follow the form" of the first-tier policy, and, if so, have questions B. through BB. above been asked in respect of each of the excess policies? Do these policies have appropriate provisions relating to when each layer of excess coverage attaches so as to avoid gaps in protection, including provisions requiring that upper tiers "drop down" should insureds reach a settlement with the lower tier carrier below its policy limits? 

DD.           Have the appropriate locally issued D&O policies been obtained in respect of foreign subsidiaries and operations and will all applicable foreign taxes be paid? 


The time has long passed when executive protection programs could be evaluated by boards based simply on an inquiry into the limits of ABC insurance cover and the amount of the premium. The number and complexity of the issues listed above together with the potentially catastrophic results that can obtain when criminal charges are threatened against individual executives prove that this is no longer an issue that can safely be treated cavalierly. The amelioration of these risks can only be left to professionals. The Committee hopes that both corporate counsel and practitioners will find the Checklist a useful resource to guide their professional advice. 

Additional Resources

A suggested practical approach for boards attempting to implement the suggestions contained in this checklist is found in Wing, J.D., and Dixon, W., "Designing Liability Protection for Directors and Officers," The John Liner Review 25, no. 1, Spring, 2011, 27–42.

James D. Wing

Co-Chair, D&O Insurance Subcommittee

James D. Wing is co-chairman, D&O Insurance Subcommittee of the Director and Officer Liability Committee of the Business Law Section. Mr. Wing acknowledges the extensive contributions to the checklist of his partner, Thomas H. Bentz, Jr.