The financial crisis of 2008 led to a wave of federal and state investigations into the events giving rise to the crisis. These in turn have spawned shareholder derivative suits and similar private litigation. Because of the staggering economic stakes and the prospect of criminal liability for the individual directors and officers involved, the companies and individuals involved in these proceedings have spared no expense in defending them.

Directors and officers (D&O) insurance is purchased for the purpose of protecting individuals and the entity in such instances. Policyholders have claimed hundreds of millions of dollars in coverage under D&O policies in the past three and a half years. One hotly disputed coverage issue involves the attorneys fees incurred in defending investigations or other proceedings that might not meet the definition of “claim,” either due to their nature or their timing. The definition of “claim” has always included lawsuits, and often “formal or informal administrative or regulatory proceedings.”

But early stage investigations often have an aura of informality, which prompts insurers to argue that there is not yet a claim, and therefore there is no coverage. Regardless of the level of formality, the stakes are high and the ultimate outcome of a proceeding frequently is determined during the early stages of an investigation. Therefore, coverage for these early stage defense costs has become one of the most important issues in the area of D&O coverage.

This issue has surfaced in two recent courts of appeals cases. In the first case, MBIA Inc. v. FIC,MBIA was investigated for its accounting practices by the New York Attorney General and the Securities and Exchange Commission (SEC), and then later was the subject of shareholder derivative suits based upon the government investigations.

MBIA's insurer raised numerous defenses to coverage, which the 2nd Circuit ultimately decided in MBIA's favor. First, the court held that MBIA was covered for the costs of responding to a subpoena served by the NY Attorney General. Next, the court rejected the insurer's attempted application of a “voluntary payments” exclusion. It held that there was coverage for defense fees responding to the SEC investigation, even though MBIA offered to cooperate with the investigation voluntarily.

The 2nd Circuit also held that costs billed by outside counsel to a special litigation committee (SLC) appointed by the board of directors to investigate the shareholder derivative suits were covered, rejecting the insurer's argument that the SLC did not qualify as an insured party under the policy.

The 11th Circuit reached a different result in the case Office Depot, Inc. vs. National Union Fire. Office Depot was reported to have violated federal securities laws by selectively disclosing certain nonpublic information, and as a result the SEC instigated an investigation. Office Depot cooperated in the investigation by voluntarily producing documents and making its key employees available for sworn testimony. Despite the informal nature of the investigation, the legal fees and costs were astronomical, running more than $20 million.

In contrast to MBIA, the 11th Circuit held that the insurer was not required to pay the majority of those fees, on the grounds that they were incurred to defend against a mere investigation rather than a formal proceeding. However, the policy language in this case was different than that in the MBIA policy (and different from many D&O policies). The language at issue drew an explicit distinction between “proceedings” and “investigations,” and compelled the result reached by the court.

In fact, the divergent results in these cases, and in many prior cases, are due in large part to the non-standardized nature of D&O insurance policy language. Unlike liability policies, which tend to be more standardized, D&O insurers frequently use their own policy forms, which often leads to decisions that, on their surface, appear to be conflicting. To a lesser extent, differences in state law can account for differing outcomes as well.

There are two main takeaways from these cases for policyholders:

1. Policyholders should be more inclusive and aggressive than ever when deciding which costs to submit for coverage from their D&O insurers.
2. Policyholders should read their policies carefully at the underwriting stage and know what they are buying.

Coverage is most certainly available for the cost of investigations, subpoenas and the like, and if policyholders want such coverage, then they need to be proactive in selecting insurers that will provide it. This may require risk managers to consult with in-house counsel or outside coverage counsel as part of the purchasing process. In all likelihood Office Depot believed it had coverage for an SEC investigation, and did not learn otherwise until it was too late. Wise policyholders should avoid the same fate.