Sixth AnnualIn-House Counsel

Conference

General Counsel RoundtableD&O Coverage in the 21st

Century – A Survivor’s Guide to Understanding Your Coverage

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Catherine (Kit) Chaskin, Partner, Reed Smith LLP

Chris Crawford, Senior Vice President & Regional Practice Leader, Willis Executive Risks Practice

Michael (Mickey) Green, VP, General Counsel, Vitesse Semiconductor Corporation

Monika McCarthy, fmr General Counsel, New Century Mortgage Corporation

Ronald Morrison, EVP, General Counsel, Impac Mortgage Holdings, Inc.

Moderator–Douglas Rawles, Partner, Reed Smith LLP

Presenters

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What we will cover:The current landscape for coverageWhat your D&O policy typically looks

likeIssues that arise in the BoardroomWhen to tender a claim and why notice

is keyIssues and provisions you must

understandTop 10 take-aways!

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Current Landscape for D&O

What did 2009 look like?

What can we look forward to?

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Federal Securities Class Actions – Frequency of Filings 1996 to 2009

169223

177

119

182

239227

266

498

209241

173

111

216

Prepared by Stanford Law School utilizing data supplied by Securities Class Action Clearinghouse.

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2010 D&O LandscapeThe Finance sector (53% in 2009) has

dominated securities litigation since the start of the credit crisis in 2007 Health technology and services has

overtaken Electronic technology as a secondary target

In 2009, there were more standard (non-credit or ponzi scheme) cases filed in the Ninth Circuit than any other region

32 individuals were named in FCPA enforcement actions brought by the DOJ or SECThe most for any year since the

enactment of the law in 1977* NERA Recent Trends in Securities Class Action Litigation: 2009 Year-End Update and the 2009 FCPA Enforcement Index

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2010 D&O LandscapeDeloitte C-suite poll released 12/7/09:

37% say they are at least as concerned and 18% state they are more concerned about their company becoming the target of securities litigation than they were two years ago

Korn/Ferry’s 34th Annual Board of Directors Survey: While only 38% of respondents in 2001 stated they were finding it more difficult to recruit high-quality Directors, by 2008 the number had risen to 55%

Have you ever turned down a Board position because you felt your personal risk was too great? 59% = YES

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THE D&O CONTRACT OVERVIEW

CLAIMS AGAINST ENTITY

CorporateBalance Sheet

Self InsuredRetention

Entity Coverage

D&O Insurance Policy

NOTINDEMNIFIABLE

Executives’Personal Assets

NO Self InsuredRetention

Executives’Personal

Asset Protection

D&O Insurance Policy

D&O CLAIMD&O CLAIM

INDEMNIFIABLE

CorporateBalance Sheet

Self InsuredRetention

CorporateReimbursement

Coverage

D&O Insurance Policy

“Side A”

“Side B”

“Side C”

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Typical D&O Program

$1M RETENTIONNO RETENTION

Broad Form A-Side DIC CoverageDrops down to primary if:

underlying insurance or the company refuses to indemnify underlying is financially unable to indemnify underlying insurance is rescinded underlying insurance is subject to automatic stay under the

U.S. Bankruptcy Code underlying exclusions are broader than DIC exclusions

Is non-rescindable for any reason

BROAD FORM DIC(Difference in Conditions)

EXCESS A-SIDE COVERAGE

A-SIDE COVERAGE

EXECUTIVES’PERSONAL ASSETS

PROTECTION

B-SIDE COVERAGE

CORPORATEBALANCE SHEET

PROTECTION

C-SIDE COVERAGE

CORPORATEENTITY

PROTECTION(Securities Claims

only)

Annual, Aggregate Limit

+ $10 Mil

e.g., $10m - $50 Mil

Excess Independent Director Side-A Coverage

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Typical Key DefinitionsInsured Persons: Past, present or future duly

elected or appointed director or officerWrongful Act: Any error, misstatement,

misleading statement, act or omission or neglect or breach of duty in their capacity as such

Claim: Written demand; civil, criminal or administrative proceeding; may include formal investigation (Note: writing does not need to be a lawsuit to qualify as a “claim”)

Loss: Defense costs, damages, settlements, judgments, punitives (if insurable). No coverage for fines, penalties or taxes

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D&O Coverage – In the BoardroomCoverage is a “must have”Outside Directors insist on itIssues to watch for

Priority of PaymentsExcess or Separate Side-A CoverageNot all Insurers are the sameAllocation of Defense CostsAbility to select counsel of choice

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D&O Coverage – In the BoardroomMergers, acquisitions, spin-offs create

issues for D&O coverageDuty to reportLiabilities that stay or goLiabilities that arise from conduct prior

to separation or mergerRun-off insurance – protection for

claims made after for conduct that occurs before transaction

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Notice of Claims“Claims–made” coveragePolicy responds to claims first made

during policy period May also require claims to be reported in writing during policy period or within specified time after policy period – “Claims Made and Reported” coverage

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Timely Notice Is Critical1. Notice frequently stated as a

condition precedent to coverage

2. Failure to adhere to notice provisions can void coverage in certain jurisdictions even if the insurer wasn’t prejudiced

3. Insurer may refuse to pay defense costs incurred prior to time Claim is reported

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2009 Developments in Notice LawTwo Texas cases setting trend in

“claims-made” noticeFinancial Indus. Corp. v. XL Specialty Ins.

Co.: Insurer must show prejudice when denial is based upon breach of prompt-notice provision, where notice is given during the policy’s coverage period.

Prodigy Communications Corp. v. Agricultural Excess & Surplus Ins. Co.: When insured gave notice within specified reporting period, the failure to provide prompt-notice will not defeat coverage absent prejudice to the insurer.

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Considerations in BankruptcyLikelihood of claims being filed

Bankruptcy TrusteeCreditors’ CommitteeLitigation CommitteeStockholders seeking recovery for

elimination or reduction in the value of their holdings

Consumers/attorneys’ generalGovernment agencies

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Issue: Who Owns the Policy, and Who Has a Right to the Proceeds?The filing of a bankruptcy petition

operates as a stay of “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” 11 U.S.C. §362(a)(3)

Property of the estate is defined to include “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. §541(a)

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Issue: Who Owns the Policy, and Who Has a Right to the Proceeds?Purchased by CompanyOwned by Company (even though the

directors and officers may be the intended beneficiaries)

Policies typically property of the estate, but proceeds of policies may not be. Key: What claims are being asserted,

against whom, by whom?

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Issue: Who Owns the Policy, and Who Has a Right to the Proceeds?In the event of a Loss arising from a Claim

or Claims for which payment is due under the provisions of this policy, then the Underwriter shall:first, pay such non-indemnifiable Loss for

which coverage is provided under the Directors & Officers Liability (Individual) Section of this policy, and

then, with respect to whatever remaining amount of the Limit of Liability is available after payment of such non- indemnifiable Loss, at the written request of the chief executive officer of the Entity, either pay or withhold payment of such other Loss for which coverage is provided under this policy…

2020

Rescission of D&O PolicyInsurer argues that the policy is void

ab initio, or from the beginning.Conceptually, the policy never existed.CONTEXT: Where insured knowingly in

bad faith made a false representation or omission that was material to the insured risk in the application for coverage.

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Common bases for rescission:False statements submitted in or in conjunction with the application, especially with respect to financial statements.e.g., “Cooking the books”

Failure to disclose knowledge of potential claims.

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Obligation to DiscloseGenerally, the insured has no affirmative obligation to volunteer information not requested by the insurer.

The insured should not, however, withhold responsive information -- it can be argued that it was done in bad faith with the intent to deceive.

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SeverabilityTip to avoid rescission:

The insurer’s ability to avoid a policy ab initio may or may not be limited by language in the policy providing that knowledge of a material misrepresentation or omission will not be imputed to innocent Directors or Officers

It is important to negotiate a severability clause

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Top Ten Take-Aways1. Make sure your team understands

policy notice requirements and has a plan in place to meet them, early!

2. When you make a recommendation to place D&O insurance, know your audience in the boardroom and have your data ready.

3. Always compare current operations versus limits—too little coverage can create problems.

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Top Ten Take-Aways4. Anticipate and plan against

coverage gaps that might occur as a result of corporate transactions.

5. Make sure that your excess exhaustion language gives you flexibility in settling cases.

6. Make sure that your broker understands the risks and coverage needs.

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Top Ten Take-Aways7. Customize your coverage as much

as possible and select your carriers strategically.

8. Carefully review the application materials and make sure disclosures are accurate.

9. Protect the policy with good severability language – try to prevent one “bad apple” from spoiling the whole bunch.

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Top Ten Take-Aways10.D&O insurance is an

asset that should be used; don’t treat it like a collectible not to be touched!

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QUESTIONS?

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Douglas Rawles, Reed Smith LLPdrawles@reedsmith.com , 213-457-8128

Kit Chaskin, Reed Smith LLPkchaskin@reedsmith.com, 312-207-6478

Chris Crawford, Willis Executive Risks Practicechris.crawford@willis.com, 213-607-6294

Mickey Green, Vitesse Semiconductor Corporationmgreen@vitesse.com, 805-388-7541

Monika McCarthy, New Century Liquidating TrustMMcCarth@ncen.com, 949-517-1725

Ron Morrison, Impac Mortgage Holdings, Inc.Ron.Morrison@impaccompanies.com, 949-475-

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Contact Information