Directors' and Officers' Liability

Federal courts have recently issued noteworthy decisions yielding important lessons about directors and officers liability insurance policies. This column examines decisions addressing: (i) the meaning of a conduct exclusion with an “in fact” trigger; (ii) whether D&O policies cover costs incurred by a company in responding to regulatory subpoenas and in a special litigation committee’s investigation of shareholder derivative demands; (iii) the potential exclusionary effect of a warranty letter signed by a D&O policyholder; and (iv) showing that not every settlement of securities fraud litigation qualifies as insurable loss.

‘In Fact’ Exclusion Trigger

Advisors to directors and officers have long emphasized the importance to insureds that conduct exclusions be triggered only upon a “final adjudication” in the underlying suit as opposed to a looser “in fact” standard, which arguably would permit the insurer to deny coverage based on its independent determination that coverage was sought for excluded conduct, such as fraud. Insureds will not discard this preference any time soon, but last month’s decision in Holt v. Certain Underwriters at Lloyd’s of London¹ suggests that in practice the “in fact” standard is not appreciably easier for an insurer to meet. In Holt, a Houston federal court last month granted preliminary injunctive relief sought by R. Allen Stanford and three officers of the Houston-based broker-dealer and investment adviser Stanford Financial Group to require their primary D&O insurer, Lloyd’s, to fund on an ongoing basis defense costs incurred by the four individuals in criminal and SEC enforcement actions against them. The criminal and enforcement actions assert a variety of fraud-related claims concerning an alleged multi-billion dollar investment scheme centering on an $8 billion CD program anchored in an investment portfolio which was not invested in liquid financial instruments as represented. Although Lloyd’s initially funded the defense pursuant to a reservation of rights, when the chief financial officer of the Group pleaded guilty to criminal charges in August 2009, Lloyd’s announced that it would not cover the criminal and enforcement actions. The individuals immediately filed a declaratory judgment action before the judge supervising the criminal case, and sought a preliminary injunction requiring the insurers to fund the defense of the criminal and SEC actions pending resolution of the coverage dispute in the declaratory judgment action.