Insurance Impact of Disney Case on Directors, Officers

In August 2005, the Delaware Court of Chancery in the shareholder derivative suit In re The Walt Disney Company Derivative Litigation that Disney directors did not breach their fiduciary duties regarding to former Disney President Michael Ovitz’s hiring and controversial termination (which carried with it an enormous severance package).

Since the enactment of the Sarbanes-Oxley Act and the downfall of Enron, WorldCom and others, Disney represents perhaps the strongest judicial pronouncement that corporate executives and directors continue to be protected by the so-called “business judgment rule.”

In its decision, the court emphasized that “times may change, but fiduciary duties do not. Indeed other institutions may develop, pronounce and urge adherence to ideals of corporate best practices. But the development of aspirational ideals, however worthy as goals for human behavior, should not work to distort the legal requirements by which human behavior is actually measured.”

Although the directors ultimately prevailed in Disney, corporate executives and board members should carefully scrutinize the court’s decision.

Chancellor Chandler’s lengthy opinion in the case emphasizes that modern day standards cannot be applied retroactively to a claim arising 10 years ago. In addition, he confirmed prior rulings that director liability is determined on an individual director basis, rather than on the basis of the conduct of the board as a whole.

Disney leaves many critical questions unanswered. Namely, would the decision have been different if the Ovitz hiring and termination occurred following the enactment of Sarbanes-Oxley or post-Enron and WorldCom? Is it possible that certain officers and directors may face greater exposure relative to certain actions or inactions when their counterparts may not? Without clear guidance, trends in escalating litigation targeting corporate leaders are not likely to be reversed any time soon.

In light of these questions, it is as important for corporations, officers and directors to evaluate their Directors’ and Officers’ Liability policy to ensure that it adequately addresses management liability risks. In general, traditional D&O policies may not provide executives and board members with the fullest extent of protection they think they may otherwise have.

The traditional D&O policy provides coverage to the corporation itself for securities claims only (“Side C coverage”) and for the reimbursement of the corporation’s obligations to indemnify its directors and officers (“Side B coverage”).

The traditional D&O policy will also provide coverage to the directors and officers in non-indemnifiable situations, such as derivative matters, bankruptcy or when the corporation is unwilling or unable to indemnify (“Side A coverage”).

In the traditional “ABC-sided” D&O policy the entity and the directors and officers “share” the total available limit of liability. As you would expect, this traditional D&O policy has exclusionary language potentially limiting the extent of coverage.

In many cases, enormous defense costs may deplete the limits under a D&O policy and ultimately the financial resources of a corporation. Directors and officers, therefore, may find themselves confronting the very real threat of personal financial exposure in cases like Disney.

Corporations would be wise to structure D&O programs that provide the broadest terms and conditions available in the marketplace at the time of their purchase. You may want to consider products designed to fill the gaps that can exist in traditional D&O policies to provide the company and the board with options on program design.

For instance, consideration should be given to purchasing excess “Side-A” coverage. This excess coverage tracks the form of the primary Side-A coverage and preserves an excess limit solely for directors and officers in those non-indemnifiable situations that can not be drained by the entity’s coverage.

The limitations and exclusions, however, of excess Side-A coverage are typically the same as those set forth in the underlying policy. Accordingly, even this type of additional coverage may not afford directors and officers the protection they are seeking.

Alternative products are available in the insurance marketplace to broaden the traditional Side-A coverage. Excess Side-A coverage with DIC (Differences-In-Conditions) includes “drop down” features that can respond for directors and officers when an underlying insurer is insolvent, or when of the underlying insurer rescinds coverage, or when an underlying insurer wrongfully denies coverage.

Excess Side-A DIC can also provide “fill in the gap” coverage for exclusionary provisions in the primary D&O policy (i.e., broader coverage if one insured sues another insured). In addition, individual directors may purchase an Independent Directors Liability policy, which is specifically designed to provide an individual independent director with his or her own limit of liability, not shared with other directors, officers or the entity. The most attractive benefit to these products is the non-rescindable feature of the coverage.

While the Disney case leaves many questions unanswered, it is another example that directors and officers continue to be prime targets for disgruntled shareholders. The rise in derivative suits continues to make executive positions and board seats less attractive to many talented business leaders. Well structured D&O policies are one important way to help corporations confront this growing challenge.

Michael Talmanson, Esq., is an account executive at William Gallagher Associates (www.WGAins.com), New England’s largest independent broker, providing insurance brokerage, risk management and employee benefit services to companies with complex risks.