Brief notes on D&O coverage for directors of public companies

Recently I was contacted by someone who was about to join a pre-IPO company as a director. They wanted to know what they needed to know about liability coverage for directors in the United States. Here is the skinny outline:

1. Exculpatory clauses in corporate charters: An exculpation clause is a clause included in a corporate charter (certificate of incorporation) that is drafted to protect directors from monetary liability arising from derivative shareholder claims. Here, much depends on state law. Some states provide the option for certificates of incorporation to include exculpation provisions. Others do not. In Delaware, such a clause is optional. Of note here is that exculpation clauses usually do not cover officers. So, if you are an officer of a public company, you will have to look at whether the company will provide you with indemnification and/or whether the company's D&O coverage extends to cover you.
2. Under state law, indemnification may be exclusive (mandatory) or not (permissive) -- that is, under an exclusive indemnification regime, a corporation may not otherwise enter into contracts with a director or officer that would cover their liability exposure. While permissive indemnification depends on the nature of the claim (whether it is filed on behalf of the corporation), mandatory indemnification awards coverage to prevailing parties. Regardless of classification, indemnification extends beyond directors to officers and, in certain cases, also to employees. Indemnification provides protection from claims arising out of actions engaged in at the corporation's request or related to a director's status. Indemnification also may provide that expenses for defense costs be covered. Coverage for defense expenses usually comes with strings, however -- including that the director or officer be ultimately vindicated or exculpated. As a policy matter, fraud and intentional criminal actions are excluded. And, given America's anti-corruption tradition, indemnification statutes will also exclude claims arising from illicit financial benefits gained from activities engaged in on behalf of the corporation. Nonetheless, coverage can extend to criminal and investigatory proceeds (where the defendant is exonerated) and may provide coverage for arbitration. Of note here, directors entering into indemnification agreements should check whether the corporation has set aside an escrow fund or otherwise secured coverage in the event the indemnification terms are triggered. Sometimes, corporations won't set aside such reserves or retention and directors will be left to fend for themselves until they can enforce the contractual terms of their indemnification agreement.
3. Where the corporation incorporates will also have an effect on the type of D&O coverage available to directors or officers. In Delaware, for example, coverage will be available for any liability that is not excluded. In contrast, in New York, coverage will only be available for defense costs. Where available, D&O coverage is provided in 3 classes: Coverage A extends individual coverage, Coverage B is company reimbursement coverage which reimburses the company for expenses incurred in specific cases (such as SEC investigations), and Coverage C is entity coverage that covers corporate liability only (Coverage C is expensive and premiums can be reduced through self-insured retention). Here it may also be worth your while to understand how many excess layers of coverage your company has purchased -- as that will define the limit of coverage available to you, both in terms of available resources for defense as well as how much of a final judgment will be covered.
4. Some words of caution - if you are a director to a U.S. Company but you reside abroad, make sure that both indemnification provisions and liability coverage extend extraterritorially. If not, make sure your company purchases appropriate coverage in the jurisdiction where you reside -- especially in situations where you could be exposed to your country's authorities cooperating with SEC or other investigations. Also make sure that any coverage provided extends to investigations and not just to claims. If the coverage only extends to claims, you may end up having to cover the costs of an investigation and that can be devastating to you, especially if the investigation drags on for years. And, finally, make sure you have an insurance coverage attorney read through the indemnification contract and D&O coverage. You don't want to be the director who ends up having no coverage because of the fine print of an exclusion that the insurance company inserted with the coverage it provided.