Presented to: Jenifer M. Robbins General Counsel FPL Advisory Group Finance 341 Property & Liability Insurance Professor Stephen D’Arcy April 24, 2003 Presented by:

Background  University of Illinois, B.A. in Finance & Political Science  Harvard Law School, J.D  Corporate Attorney, Katten Muchin Zavis – 1998 – 2002  General Counsel, FPL Advisory Group – Present

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What is Director and Officer Liability Insurance (“D&O”)? Broadly speaking, D&O insurance is insurance designed to shift to the insurer the risk of certain third-party liabilities arising from the acts or omissions of the directors and officers of a corporation acting in their official capacity.

Why Should D&O Be Important to You?  Importance to insurance companies  Importance to all companies in terms of attracting talented directors and officers  Service as a director or officer  Networking conversation

Why is D&O Such a Hot Topic?  Economic downturn  Corporate scandals: Enron, WorldCom, etc.  Increased potential for liability: Sarbanes- Oxley Act of 2002  Enormous judgments and settlements involving director and officer liability  Under-pricing in the D&O market in the 1990s

Liability Of Directors and Officers

The Issue of “Agency”  A corporation has most of the legal rights of an individual person.  But think about how those rights are exercised - how actions are carried out by a “person” that cannot act for itself.

Delaware Corporate Law  Delaware is the premier jurisdiction for incorporation.  DE Section 141: “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors…”  DE Section 142: “Every corporation organized under this chapter shall have such officers with such titles and duties as shall be stated in the bylaws or in a resolution of the board of directors…”

Liability  It’s EVERYWHERE!  Contract liability  Tort liability  Regulatory liability  Distinguish between the liability of the corporation and the liability of directors and officers.  Directors and officers have additional worries that arise from the agency issues already discussed.

Shlensky v. Wrigley  Minority stockholder sued (on behalf of the corporation) the directors of the corporation that owns the Chicago Cubs.  Suit alleged that the directors were negligent and were mismanaging and wasting corporate assets by failing to install lights and schedule night games at Wrigley Field.

Business Judgment Rule “The judgment of the directors of corporations enjoys the benefit of a presumption that it was formed in good faith and was designed to promote the best interests of the corporation they serve.”

Francis v. United Jersey Bank  Trustees in bankruptcy sued director to recover funds taken out of a reinsurance company by the other directors.  Suit alleged the director was negligent in failing to prevent the misappropriation of funds where the director had taken no interest in the business.

Fiduciary Duties  Duty of Care: Directors must “discharge their duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions.”  Duty of Loyalty: Directors may not take advantage of the corporation, its shareholders or other beneficiaries by means of fraudulent or unfair transactions.

Director and Officer Liability Indemnification and Insurance

Indemnification (Delaware)  Mandatory: “To the extent that a... director or officer of a corporation has been successful on the merits or otherwise in defense of any action...such person shall be indemnified against expenses (including attorneys’ fees)... reasonably incurred by such person in connection therewith.” DE §145(c)  Permissive: “A corporation shall have the power to indemnify [a person party to a lawsuit by reason of being a director, officer, etc.] against expenses (including attorneys’ fees), judgments, fines...if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.” DE §145(a)

Limits on Indemnification  Behavior not meeting the standards of mandatory or permissive indemnification under state corporate law cannot result in indemnification.  Corporate law in different states may prohibit indemnification for certain matters including damages in a shareholder derivative suit.  Typically, corporate law does allow D&O insurance to provide director reimbursement even when corporate indemnification would not have been permissible.

Parts of D&O Insurance Coverage  Side A: Insures directors and officers as individuals when they are not indemnified by the corporation for losses.  Side B: Insures the corporation, reimbursing it for losses it incurs as a result of indemnifying officers and directors.  Side C: Insures the corporation for losses caused by actions taken by directors and officers but attributed to the corporation itself (“entity coverage”).

Coverage  Typically, the D&O policy covers liabilities arising from third-party claims against an insured that arise from the insured’s “wrongful acts.”  “Wrongful Act” is defined in the policy, but a common formulation is: “any error, misstatement, misleading statement, act, omission, neglect, or breach of duty committed, attempted, or allegedly committed or attempted by [an insured in his or her official capacity].” - FPL’s Chubb D&O policy

Typical Coverage Exclusions  Illegal personal profit  Regulatory exclusion  Intellectual property claims  Securities violations (frequently insider trading)  Unauthorized remuneration  Insured vs. Insured  Established fraud, dishonesty or criminal acts  Bodily injury

Other Coverage Issues  Fraud in the inducement theories  Severability Issues  “Claims-made” policies  “Wasting” policies

Defense Issues  Selection of defense counsel  Control of defense strategy  Control over settlement – “hammer clauses”

Allocation Issues  In the early 1990s D&O policies only offered Side A and Side B coverage.  Lengthy battles ensued over what part of the loss would be allocated to the directors and officers (and thereby be covered by the D&O policy) and what part of the loss would be allocated to the corporation itself (and thereby not be covered by the D&O policy). The D&O industry’s answer was to offer the Side C coverage: entity coverage.

Bankruptcy Issues  In the wake of recent corporate scandals, entity coverage has been revealed as a potentially damaging component of D&O policies in a bankruptcy setting.  Entity coverage may mean that the D&O policy is deemed an asset of the bankruptcy estate, making it difficult for directors and officers to collect under the policy.

Questions and Answers