Although the directors’ and officers’ liability environment is always changing, the current economic, political and social climate presents a new landscape of potential D&O liabilities that may increase the frequency and severity of claims. In addition to stock market volatility, inflation, pandemic-induced bankruptcies and growing regulatory scrutiny, companies are facing increased litigation relating to special purpose acquisition companies (SPACs) and environmental, social and governance (ESG) issues. Companies may face new challenges from the lack of clarity on how courts will rule on these claims, as well as recent decisions that signal courts may be interpreting D&O policy provisions more restrictively.
The Expanded Landscape for D&O Claims
SPACs are a popular “fast track” alternative to an initial public offering (IPO). SPACs have two years to acquire a private company and then take it public via the acquisition. If the SPAC fails to complete the transaction in the required time period, it must dissolve and return the money raised by the IPO back to shareholders. SPACs are therefore incentivized to make quick deals, which creates a risk that such IPOs are sloppy, premature or both.
SPAC IPO activity and related litigation have increased exponentially in recent years. These cases have only just begun to be filed so it is difficult to predict how they will ultimately fare in court. However, early developments indicate that companies will not be able to easily shake these lawsuits.
Public companies are also confronting new risks associated with the changing ESG landscape. They are being pressured to take stands on social and political issues such as racial inequality, gun control, women’s reproductive rights and voting rights. When companies make statements about their efforts to address these issues, no matter their content, shareholder litigation may follow.
Shareholders and activist investors are also targeting corporate boards for failing to address ESG-related concerns and for misrepresenting ESG-related efforts. Shareholders have brought lawsuits against companies for exaggerating a company’s sustainability practices or efforts, also known as “greenwashing.” Other shareholders have accused companies of “social washing,” or failing to meet their diversity commitments. Meanwhile, government regulators have signaled a greater interest in ESG-related disclosure and enforcement. Both U.S. and European regulators have recently released new rules and enforcement mechanisms for ESG-related conduct.
Proactive Steps for Preventing Future Coverage Disputes
Many experts expect a flurry of future claims. To prepare, risk managers should closely examine their D&O insurance to ensure that their company has the coverage it needs, and that they are doing everything in their power to preserve and maximize coverage once a claim comes in.
Although D&O insurance should generally apply to SPAC and ESG-related claims, the rise in the number of these claims and the uncertainty about the potential losses associated with them means that insurance companies have an incentive to deny claims or delay payments. To get ahead of these issues, risk managers should work closely with brokers and coverage counsel to evaluate existing limits and coverage for these new risks. You may also need to negotiate new terms to better position the organization for future coverage fights.
Private companies typically purchase much smaller D&O limits than public companies. Private companies should consider whether their D&O limits are sufficient to protect the company and its pre-closing directors and officers before signing a business combination agreement involving a SPAC. Private companies should also review the common “publicly traded securities” exclusion. Depending on its wording, this may or may not preclude coverage for SPAC-related lawsuits arising from statements made between the signing of the business combination agreement and the transaction’s closing. Ideally, a private company should address any concerns about limits or policy provisions before entering into an agreement with a SPAC. However, there may be other ways to protect the private company afterwards. This may be done through amendments to a tail policy or ensuring that “prior acts” will be covered under the new public company’s D&O insurance.
Companies facing potential ESG-related claims should do a side-by-side comparison of their largest areas of ESG-related risks alongside their D&O policy exclusions. For example, a company at risk for climate change or sustainability-related lawsuits should look closely at the pollution exclusions commonly contained in D&O policies. Insurers may rely on an over-broad interpretation of these exclusions to deny coverage for climate change-related lawsuits. Though such an argument is unlikely to be successful, policyholders can reduce the potential for such a defense by narrowing the exclusion. This could entail adding a specific carve-out for climate change lawsuits or by removing the broad “directly or indirectly arising out of” language in the exclusion.
Ensuring Coverage of Defense Costs
Because SPAC- and ESG-related lawsuits are just beginning to move through the courts, we do not yet have a sense of how high (or low) judgments and settlements from these suits may be. However, defending against these claims will definitely not be cheap. At least initially, the most important aspect of a D&O policy is therefore defense cost coverage.
Although D&O policies typically reimburse defense costs for covered claims, risk managers should be mindful of common policy provisions regarding coverage for defense costs. One typical provision is a “conduct” exclusion that precludes coverage for intentional or deliberate wrongful conduct. Insurers may argue that these exclusions preclude coverage for some lawsuits related to ESG disclosures, such as a lawsuit alleging that a company or its directors and officers misrepresented its diversity or sustainability practices.
Risk managers can get ahead of this issue by making sure that the conduct exclusions contain language limiting their application to situations where there has been a final and non-appealable judgment against the policyholder in the underlying action. This language can help to ensure that the policyholder will be entitled to defense costs for any claims alleging intentional misrepresentations on ESG issues.
Given the increased regulatory scrutiny, risk managers should also try to determine exactly when their policies will provide defense cost coverage for any regulatory investigation. Insurers often take the position that regulatory investigations are not covered under standard D&O policies, so consider seeking policy amendments that clarify and preserve coverage for these investigations.
Preserving Coverage at the Outset
Companies should immediately provide notice to their D&O carriers of any lawsuits, demand letters, regulatory subpoenas or other informal inquiries as soon as the company learns of it. They should also work with their brokers and experienced coverage counsel to assess whether to provide notice of “circumstance” for certain situations that are likely to give rise to a claim.
Companies should be especially careful in a multi-claim scenario that may span several years of government investigations and lawsuits. Whether two claims are “related” determines whether the policyholder is entitled to coverage under one or two policy periods. If treating two claims as related means that an insurer will only need to pay out under one policy period instead of two, insurers will broadly interpret what makes those claims related. But when the applicable self-insured retention is larger than the value of any single claim, the insurer may narrowly interpret these same provisions in the hopes that multiple claims with multiple retentions will put coverage out of reach.
Fighting Coverage Denials
With D&O insurers facing increased liability across the board, coverage denials are possible. Companies should never take no for an answer. Especially if one does not take into account case law interpreting a particular provision, a cursory reading of a policy often leads to the erroneous conclusion that fighting an initial coverage position is not worthwhile.
Another mistaken assumption is that contesting an unfavorable coverage position will automatically lead to a protracted battle with the carrier. That is often not the case. Rebutting the carrier’s initial arguments often leads to successful insurance recovery of at least some of the funds at issue, so failing to do so can mean leaving money on the table.