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Difficult disputes over insurance policies for directors and officers can arise when multiple claimants seek coverage under the company’s D&O policy. Typically, D&O policies cover both the company and its directors, officers, and employees. The policies generally place a single limit on the total of all defense costs, damages, and/or settlements to be paid. The risk is that the bucket of available money will be depleted by defense costs for these multiple claimants before all liability issues have been determined or settlement costs resolved. Some of the policyholders may be left short of coverage. While coverage litigation is the all-too-common response to a rapidly depleting D&O insurance fund, cautious lawyers will seek common ground through negotiated settlements before throwing down the gauntlet. RUSHING FOR THE LIMITS When a company and its officers become embroiled in serious financial difficulties or allegations of fraud, as did, for example, Enron and Tyco in 2002, multiple policyholders under the company’s D&O policy may quickly develop adverse interests. Corporate leaders may be alleged to be the most significant “wrongful actors” and hence may become the major targets for civil and criminal liability. But plaintiffs often file lawsuits against the company and a wide range of other officers and directors, as well. All these parties may be entitled to indemnity or reimbursement of their defense costs under the D&O policies, yet some may feel they are more entitled to the D&O proceeds than others. Believing their defense will be the most expensive, and that the outcome of their cases will have a significant effect on all others, the lead actors may argue for a larger share of the pie. They may also argue that because they are subject to criminal liability, their liberty interests trump the pecuniary interests of parties subject only to civil liability. Moreover, the Securities and Exchange Commission recently has been requiring that certain lead corporate actors give up their right to corporate indemnification under their settlements with the commission. Without corporate indemnification, the lead actors’ only protection may be their rights to insurance coverage. Other actors, including outside directors, may believe that they are most deserving of insurance protection precisely because of their more attenuated involvement in the alleged wrongdoing. Moreover, specific policy provisions may require the policy to apply differently to the various actors depending on their role in the company or their alleged involvement in the wrongdoing. In addition to the individual policyholders, the company itself may have coverage for the costs of defending itself against allegations of corporate liability, as well as for any damages or settlements that result. Unfortunately for all the different policyholders with rights to a single policy, the amount of money available for reimbursement may well be less than the total costs of defense and settlement when the company is facing serious trouble. Often, different policyholder groups will align against one other in a rush for the limits to ensure that their own costs and liabilities are funded before the insurance bucket runs dry. NO COVERAGE FOR YOU Insurance companies also can have interests adverse to their policyholders in D&O coverage cases. First, they almost always will reserve their rights to deny coverage based upon the many complex exclusions in the standard D&O policy. For example, insurance companies may argue that the policyholder’s liability is based on behavior that is not covered under the policy. In recent years insurers have sought to rescind D&O policies more frequently. They have alleged that the policyholder’s financial problems were known and not properly disclosed in the application for insurance. Sometimes insurance companies find that their interests are in conflict with one another. D&O insurance usually is sold in layers. If the primary insurance policy’s limits are exhausted early due to payment of defense costs in the underlying litigation, the excess insurers get stuck with the costs of negotiating or litigating the tough coverage issues. Also, some D&O insurance policies may require mandatory arbitration of coverage disputes, while others do not. Thus, while insurance companies usually try to circle the wagons when faced with multiple claimants and extensive liability, their differing interests may not permit a united front in disputes over D&O coverage. Policyholder attorneys may be able to negotiate individual settlements with some insurers while litigating or arbitrating with others. Insurance companies must be very wary of how they deal with the different groups of claimants under a single policy. Depending upon the applicable state law, insurers may be prohibited from favoring some policyholders over others. They may face allegations of bad faith if they reach settlements with certain policyholders that leave other policyholders in harm’s way. A final set of parties with potentially adverse interests are the plaintiffs in the underlying litigation. Although they generally cannot make direct claims under the D&O policy, plaintiffs realize that some defendants will not be able to pay a settlement without indemnification from their D&O insurance. Thus, plaintiffs often insert their interests in coverage disputes through the settlement negotiations for the underlying dispute. Indeed, plaintiffs have been known to use the adverse interests of policyholder groups to gain a tactical advantage. For example, plaintiffs may settle with the least potentially culpable group first for a large figure that eats up a substantial amount of policy limits, knowing that the potentially more culpable defendants (with deeper personal pockets) remain in the case and on the hook. PAYING COSTS Coverage disputes over D&O insurance can be triggered by a number of issues. One early concern is the insurance company’s obligation to pay defense costs on an ongoing basis. In recent years courts have made it abundantly clear that a D&O insurer is obligated to pay its policyholders’ defense costs as incurred, even if the insurer is seeking to rescind the policy or believes that a particular insured’s liability is not completely covered. For example, in March an appellate division panel of the Supreme Court of New York held unanimously that Tyco’s Dennis Kozlowski was entitled to ongoing reimbursement of his defense costs (subject to the insurer’s right of recoupment for uncovered claims) even though the insurance company was seeking to rescind the policy and to obtain a declaration of no coverage for Kozlowski under the policy’s personal-profit exclusion. This clear right to ongoing payment is complicated when multiple policyholders, including the company, seek payment. The defense burn rate for lead actors likely will be significantly higher than that of the outside directors or even the company. Thus, policyholders should negotiate early with the insurance company on guidelines for payment of ongoing defense costs. Usually, the insurance companies are more willing to pay on a first-come, first-served basis than in accordance with specific amounts proportionate to, say, the amount of a policyholder’s potential liability. Often, such early negotiations can create a relationship more conducive to resolving more complex coverage disputes down the road. It is also crucial that policyholders work out arrangements with the insurance company at a very early stage over what specific costs will be reimbursed as defense costs. The issue is especially complex when some, but not all, policyholders are facing both civil and criminal proceedings. Insurance companies usually take the position that criminal proceedings are not covered, but that determination is not always correct. In any event, there may be overlap in preparing for the civil and criminal cases. The carrier’s determination of which costs are related to the criminal proceeding and thus will not be reimbursed can be critical. BAD FAITH Because policyholders often cannot afford the cost of their defense without insurance reimbursement, they often find themselves on an unequal footing with their insurance company in negotiating particular coverage issues. One weapon in a policyholder’s negotiation arsenal, however, is the threat of a bad faith claim against the insurance company. An insurance company may be found liable for bad faith, for example, if it fails without reason to reimburse defense costs as incurred, if it withholds consent to a settlement unreasonably, or if it engages unjustifiably in other conduct that might prejudice the policyholder’s defense of the underlying action. Bad faith often entitles the policyholder to additional damages. Claims of bad faith often arise when multiple policyholders have claims for defense costs or indemnity that, in the aggregate, clearly would exhaust the policy limits. A typical problem situation develops when some groups of officers or directors negotiate settlements that, if indemnified under the D&O policy, would significantly deplete the insurance available to the nonsettling officers and directors. The nonsettling officers and directors argue that the insurance company has a duty to treat its policyholders equitably; therefore, they say, it cannot deplete the available funds to indemnify one group of policyholders at the expense of the others. The law in certain states supports this position. Other states have ruled that when an insurance policy covers more than one insured, all policyholders have equal rights to coverage on a first-come, first-served basis and that each policyholder has the right to seek coverage for settlements until the policy is exhausted. This issue is not settled in most jurisdictions. THE INTERPLEADER THREAT When faced with a situation where multiple policyholder claimants clearly will exhaust the insurance company’s policy limits, insurance companies also have a powerful weapon: the threat of interpleader. In an interpleader proceeding, the insurance company relinquishes its own interests in the policy proceeds and asks the court to determine the disputing policyholders’ rights to coverage under the policy. The insurance company may choose to interplead the policy proceeds when one group of policyholders argues that it would be bad faith for the insurance company to fund a settlement, and another group of policyholders argues that it would be bad faith for the insurance company not to fund the settlement. In this situation the insurer may choose to place the allocation of policy money in the hands of a court. Courts in different jurisdictions take different approaches to distributing the insurance funds. The majority distribute the proceeds on a first-come, first-served basis according to priority of judgment — in other words, in the order in which the policyholders settle or have judgments against them in the underlying litigation. Interpleader is an effective threat against policyholders because they know that it would substitute a costly judicial process involving complex proceedings and multiple parties for the possibility of one-on-one negotiations with an insurance company concerned about bad faith claims. In general, because of the multiple competing interests among policyholders and insurers, D&O coverage disputes often are better resolved through negotiation or alternative dispute resolution than drawn-out litigation. When there’s only so much water in the bucket, insurance lawyers must act expeditiously lest their clients be left high and dry.
David L. Cox is an associate and Barry J. Fleishman is a partner in the insurance coverage practice of the D.C. office of Dickstein, Shapiro, Morin & Oshinsky. They appreciate the assistance of colleagues Michael T. Sharkey, Frank C. Razzano, and Amy Y. Spencer in preparing this article.

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