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What Is Not Covered by a D&O Insurance Policy?

Running a company comes with a lot of responsibility. People in positions of authority have to make decisions that have far-reaching consequences. If employees, shareholders, creditors, or other parties take issue with the decisions made by a director or officer, they will typically sue that person directly along with the company. That is particularly so if the company ends up in bankruptcy, which exposes the individuals because the company then has no ability to provide them indemnification. 

Directors and officers’ liability insurance (commonly referred to as a “D&O” policy) exists to protect those who serve in prominent positions from claims for breach of fiduciary duty, mismanagement, impairment of stock value, and other claims. If they are personally sued for a covered claim, this type of insurance will pay their defense costs and help protect their personal assets from loss up to the limits of coverage. 

This is an essential form of risk-management insurance to have for a mid-size or larger company—and even a small business—as well as non-profit organizations who need to attract persons to serve as an officer or director, since most high-level management candidates will want that protection as a non-negotiable requirement.

In the event of a lawsuit against a director or officer, it is crucial to know which situations are covered and those which are not, as that can lead to an additional lawsuit with the insurance carrier who wishes to escape its commitments by way of a coverage action. 

Fraud

Most D&O policies exclude coverage for acts of fraud, dishonesty, or intentional misrepresentation, often with a qualification that they are deliberate. However, rarely is it the case where the only claim in a suit is one based on fraud. In Texas, generally, the existence of at least one covered claim requires the insurance company to provide a defense even though there may be many others that are not covered.

Either way, much like indemnification by a company, an insurance carrier generally would be obligated to provide a defense against fraud claims—subject to recoupment—based essentially on the standard that one is presumed innocent until proven guilty. Fraud claims can be baseless just as much as any other.

There is typically a question in most cases alleging fraud by an officer or director though as to whether the insurance company must pay a settlement before there has been an adjudication on fraud, and how much. It gets tricky as well if a director or officer is ultimately found to have committed fraud as the D&O insurance is not liable to pay that judgment—potentially leaving the company alone on the hook if there is indemnification that does still apply—and, if fraud was the only claim, it will likely try to recoup defense costs based on a reservation of rights letter issued at the outset. If there is a judgment for multiple claims and it is not clear what portion is necessarily attributable to fraud, you can expect there to be follow-on litigation with the insurance company trying to prove what a jury must have decided if it can limit the payout.

Take note that some states also prohibit insurance from covering “willful acts” and many do not allow a company to do so either. However, in March 2021, a Delaware court ruled that while the Delaware General Corporation Law (which is where many larger companies are incorporated and what a lot of states based their own corporation law on) may not allow a company to indemnify bad faith conduct, it did not prohibit one from procuring private insurance to cover something like fraud.

Criminal Activity

Unlawful conduct that rises to the level of a crime is the other main category of claims not covered by a standard D&O policy. In the corporate context, that can refer to a wide range of actions involving illegal profit or remuneration, intentional or grossly reckless harm to others, or even just non-compliance with things like environmental or employment regulations. Common types of criminal activity causing financial losses that could end up part of a civil suit include:

  • Theft
  • Embezzlement
  • Bribes and kickbacks
  • Wire fraud
  • Honest services

Both criminal activity and fraud are misconduct excluded from a D&O policy based on the rationale that one should not encourage such bad conduct to occur by providing insurance if it does. There are some policies that can be construed, however, depending on the language and facts of a case, to require an insurance carrier to both defend and indemnify. That is because all insurance contracts in Texas, even those for corporations, are, if ambiguous, construed in the way most favorable to an insured.

There are other forms of insurance available to protect a company from the dishonest conduct of its own officers and directors (often called “crime” policies), which is a matter distinct from what a D&O policy protects: the individual director or officer.

Other Exclusions

D&O policies come in a wide variety of forms with some other types of coverage, such as Employment Practices Liability (EPL), sometimes included at no additional cost.

Otherwise, there are several other types of standard exclusions, as follows. 

Lawsuits Among Management

If one director or officer brings a lawsuit against another at the same company, this is regarded as “insured v. insured” situation, and a D&O policy will usually not cover that dispute in any regard. This is said to be necessary to protect against collusion by such persons against the insurance company. 

There are some exceptions though. If legal action is brought against a whistleblower by another company employee or vice versa, D&O then might provide coverage. 

Personal Injury or Physical Damage to Property

D&O insurance does not provide coverage for claims of bodily harm or damage to another person’s property, because those types of claims are intended to be covered under a Commercial General Liability (CGL) policy.

Employment and Labor Practices

Claims for wrongful termination, discrimination, harassment, labor law violations, or ERISA-based claims are not covered by the standard D&O policy alone. Those are, like others on this list of exclusions, meant to be covered by other types of policies.

Talk to an Insurance Coverage Lawyer in Dallas-Fort Worth

If you are an individual officer or director with D&O coverage (or a company who may be required to provide them indemnification otherwise) who is facing a civil lawsuit from shareholders, distributors, vendors, a purchaser, or creditor, and your insurance carrier is denying rights to which you are entitled, then contact Wright Commercial Litigation for a free evaluation of your policy and consultation to determine whether it is a coverage matter that the firm may be able to help with on a contingency basis.