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Key14 On being sued personally: directors without insurance

There are some types of conduct by directors that all the D & O insurance in the world will not cover because D & O insurers have been smart enough to exclude it. Basically, directors will not be covered by insurance if they engage in conduct that is intentionally bad or dishonest. For example, Phar-Mor, Inc. experienced all sort of setbacks, including a Chapter 11 bankruptcy, when it was discovered that the company was keeping two sets of books. Insiders called one set of books the “cookies.” The other was called “cookies with raisins.” The cookies with raisins were the accurate set of books.

The reason for the two varieties of cookies was simple. Michael Monus, the former president and a director who has since been sentenced to prison, was funneling corporate funds to his pet project, the World Basketball League, an alternative league for “short” players in which all the players are 6’7” or under. Directors are held personally liable for their conduct when they are embezzling. Who wants to insure an embezzler?

Other types of conduct not covered by D & O insurance include securities fraud, check kiting, RICO violations (racketeering), price fixing and other intentional antitrust activities, and bribery. In other words, criminal conduct is not covered by D & O insurance. In those situations, directors and officers are not only on their own for their own criminal defense, they are on their own when shareholder suits come rolling in against them. Corporations don’t indemnify directors for criminal conduct and D & O policies do not cover directors in shareholder suits based on criminal conduct.

In addition to the criminal types of conduct excluded from coverage, D & O policies may place limitations on coverage. For example, some policies will not cover certain environmental liabilities. If the company learns that it sits upon a site with a great deal of hazardous, but buried, waste and the clean-up will by costly, shareholders may bring suit because such an announcement is bound to bring the stock price down. But some policies specifically exclude environmental liability issues because they are such a great unknown and because the costs of clean up can be so extensive. Many corporations’ regular insurance policies exclude coverage for such environmental clean-up liabilities. Special riders for coverage of such environmental liabilities can be purchased.

As managers of a company’s pension plan, directors also have extensive liability for missteps. Boards may carry additional coverage or separate riders for the management of pension plans. While directors can hire help to assist them in pension fund management, they cannot delegate the duty away.

There are other types of conduct for which directors and officers are held personally liable and for which there is no D & O coverage. Those include the failure to pay wage taxes.

Sexual harassment is another common area of litigation. A suit against a company may be covered under an EPL rider or policy. But an individual director or officer found liable for personal sexual harassment would not be covered under the D & O policy. That’s an area of personal liability that no officer or director can escape.