Category: Business Law Blog

Are directors entitled to defense expenses when D&O policy is subject to asset freeze and held in receivership?

June 28th, 2018 — 6:55pm

By Joseph P. Kelly and Shelly Hall

Scenario: An oil-and-gas company and its directors and officers (D&O’s) are charged by the SEC with securities law violations. The Company has a $1 million private-company D&O policy with entity coverage. Defense expenses are paid to the D&O’s first under a priority of payments provision. The Court froze Company’s assets and placed them in receivership.

While the SEC and Receiver, on one hand, and the D&O’s, on the other, fought about whether the directors and officers could tap into the policy for their defense, insurer paid out nearly the full $1 million limit as some of the directors and officers submitted defense expense bills. Then a different D&O submits two years of unpaid defense expenses, saying that he was not aware of the D&O policy. SEC and Receiver want to halt the distribution of the remaining policy proceeds. D&O’s want the remaining limit paid out to fund their defense.

Who gets the proceeds? If it’s the D&O’s, who gets what?

Answer: The D&Os submitting defense expenses got the proceeds in Securities and Exchange Commission v. Faulkner, Civil Action No. 3:16-cv-1735-D, United States District Court, N.D. Texas, Dallas Division, June 6, 2018.


The harm of not receiving the D&O policy funds balanced in favor of D&Os and it was not in the court’s jurisdiction to redistribute those funds after the fact.

  • The actual harm to the D&Os by not allowing them to access the limits was greater than the theoretical harm to the SEC.

The Court balanced “the potential harm facing the defendants moving for defense costs with the harm to the receivership estate if such funds are released”, looked to harms that are “clear and immediate rather than hypothetical or speculative”, and “examine[d] the contractual terms of the policy to ensure that the defendant retains contractual rights to the contested proceeds.”

The D&Os argued that the “real harms” they faced—e.g. a costly defense—were greater than the concerns of the SEC and the Receiver. In support, the D&O’s cited their reliance on the existence and payment from the $1M D&O Policy and that fact that they had incurred so much in defense costs. The court sided with the D&O’s noting that that the Receiver’s and SEC’s claims to the proceeds are speculative at this time; that the Receiver cannot negate the insureds’ contractual rights to coverage under the D&O Policy; that the insurance proceeds were not obtained through fraud; and that depriving the insureds of insurance proceeds would have a chilling effect upon the ability of companies to retain officers to serve in their companies.

  • Redistribution was not in the court’s jurisdiction

The late-coming D&O also wanted the “court to resolve, not whether, but how D&O policy proceeds should be distributed.” However, the Court found that the allocation of the proceeds was not “sufficiently related to a securities-law violation or other claim” to trigger the court’s powers. The Court noted too that the late coming director failed to cite to any case where a court “reallocated D&O policy proceeds that were otherwise allocated in accordance with that policy’s terms.”


  • Is there policy language that could be drafted to ensure all individual D&Os get policy proceeds in equal share?

The insurer here paid out the bulk of the limits in defense expenses to three D&Os. After the late-coming D&O sought his fees, the Insurer paid out the remaining limits in equal shares. The priority of payments provision in the policy didn’t address whether multiple insureds share equally in the defense. The late coming D&O wanted an equitable reallocation of those amounts paid so that he got an equal share. The Court avoided the issue on jurisdiction grounds and we don’t have enough facts and backstory to say whether the late-coming director’s reallocation argument had merit. Perhaps an amendment to the priority of payments provision would be marketable and allow D&O insurers to distinguish themselves in a commoditized D&O market.

  • Will this case be the one that encourages private companies to purchase D&O insurance, or higher limits?

From an underwriting perspective, this case could be cited to as a reason sell a private company on higher limits, even without any change to the priority of payments language. Defense outside limits is something that could have helped the directors and officers in this case, but that would obviously drastically increase the exposure for the insurer and the policy cost to the insured, if offered at all by underwriting. For D&Os, be sure there is a D&O policy in place if you are serving at any company, even if a private company, and, if there is a claim, report it and also report defense costs as they are incurred to avoid being left bare like the late submitting D&O here.

Comment » | Business Law Blog, D&O Digest

Failure to properly report claim means no defense for law firm under successive policies for law firm.

April 26th, 2018 — 7:39pm

By Joseph P. Kelly and Shelly Hall

Scenario: Law Firm creates employee stock ownership program, or ESOP, per Client’s request. Seven years later, ESOP asks Firm to conduct a risk analysis based on how the ESOP was created. Firm tells ESOP that Client engaged in prohibited ERISA transactions when the ESOP was established. Firm doesn’t notify its malpractice carrier. ESOP eventually sues Client. ESOP’s attorney then sends a letter to Firm stating that Client-Defendant “remembers receiving advice from [Firm]” that he should take ERISA prohibited actions and if Client’s statement is true, Firm probably needed to notify its malpractice carrier.

Firm still doesn’t provide notice of a claim, but it does provide a brief summary about the matter in its next two annual renewal applications. Firm then decides to change malpractice carriers. The application asked about any circumstances that could reasonably give rise to a professional liability claim and Firm identified the ESOP matter. The application then asked whether notice was given to its current insurer. Firm answered “Yes” and “concurrently, or immediately succeeding this application, written notice will be given to the current insurer.”

The application states that there will be no coverage for any matter listed as potentially giving rise to a claim that was reported to another insurer. Despite its application answer, Firm didn’t give written notice to its current insurer. A few months later, Client sues Firm for malpractice. Firm quickly notifies its current carrier of the suit. Carrier says no coverage based on the application. Firm doesn’t notify its prior insurer until over a year later. Prior insurer denies coverage based on its policy’s reporting requirement.

Question: Both insurers were aware of the ESOP matter. Did Firm do enough to trigger coverage for Client’s malpractice suit?

The answer was “No” in Ironshore Specialty Co. v. Callister, Nebeker & McCullogh, P.C., et al, Case No. 2:15-cv-00677-RJS-BCW (D. Utah Dec. 21, 2017). Let’s take a look at the policies to see why the Court said no coverage.

• Policy #1 The front page of the first insurer’s policy states “This is a Claims Made and Reported Policy, please read it carefully.” The court highlighted the importance of reporting a claim during the relevant coverage period. The court found that Firm’s reporting obligations under the policy were clear based on the cover page disclosure, along with a statement in the Insuring Agreement that there’s coverage for claims “first made against the Insured during the Policy Period and reported to the Insurer during the Policy Period.” Accordingly, the Court found that Firm had to strictly comply with the policy’s reporting requirements and that it did not. It wasn’t enough to just list a potential claim in its renewal applications. A formal notice of claim during the Policy Period was required for coverage.

• Policy #2 The application contained a disclaimer stating “NOTICE: THE POLICY BEING APPLIED FOR WILL NOT PROVIDE COVERAGE FOR ANY CLAIM ARISING OUT OF THE MATTERS REQUIRED TO BE LISTED IN 30(a) AND 30(b) ABOVE.” The matters referred to are matters that could reasonably give rise to a claim and matters for which notice had been given to a current insurer. The Court disagreed with Firm that the the disclaimer was just a warning statement of sorts and wasn’t enough to bar coverage. The disclaimer unambiguously stated there wouldn’t be coverage for those matters.

Lesson #1: Report, report, report!

Perhaps Firm thought it should wait for a “Claim” by Client – either a written demand of sorts or a lawsuit – before giving notice to the first insurer. Maybe Firm just hoped it all would go away. Bottom line – best practice is to err on the side of caution and report potential malpractice claims. “Claims made and reported” policies like the first policy here only provide coverage if the claim is made during the coverage period and it’s reported to the insurer during the coverage period. Most policies, including the first policy, provide for reporting of a potential claim as soon as an Insured is aware and, by reporting right away, an insured can trigger coverage once there’s a “Claim”, even if the “Claim” doesn’t come occur after the coverage period. Then it wouldn’t matter that coverage was excluded in the second policy, because coverage under the first policy was secured by notice of potential claim.

Lesson #2: Comply with the policy’s reporting requirements!

Firm told the first insurer about the ESOP matter in two renewal applications. But the first policy had particular requirements for notice of a potential claim. More details were required than what was asked for in the renewal application. If Firm had complied with the first policy’s notice requirements, coverage for Client’s eventual malpractice suit likely would have been triggered.

Comment » | Business Law Blog, Lawyers Malpractice Digest, Professional Liability Insurance Digest, Uncategorized

Much ado about nothing? Illinois’s new law “requiring” private retirement plan or enrollment in state plan

January 21st, 2015 — 2:50pm

by Christopher Graham and Joseph Kelly.

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On his way out of office, now former Governor Quinn, with much fanfare, signed the “Illinois Secure Choice Savings Program Act”(820 ILCS 80/1 et. seq.), supposedly making Illinois the first state to require employers to either offer employees a retirement plan or enroll them in a State program. Sounds great if your an employee, right? But is it really a monumental piece of legislation as suggested when announced? Or was this just more Illinois politics?

Although the Act is the law, it isn’t effective until June 1, 2015. Even then, the Act provides that “the Program shall be implemented, and enrollment of employees shall begin, within 24 months after the effective date . . .”–so perhaps not until June 1, 2017.

There’s also an exception to that June 1, 2017 deadline, providing for “delay” of “implementation” “[i]if the [Illinois Secure Choice Savings] Board does not obtain adequate funds to implement the Program . . . .” Given the sorry state of Illinois finances, that delay is a realistic possibility, if not a likelihood.

The Board also may not implement the program “if the IRA arrangements offered under the Program fail to qualify for the favorable income tax treatment ordinarily accorded to IRAs under the Internal Revenue Code or if it is determined that the Program is an employee benefit plan and State or employer liability is established under [ERISA].” 820 ILCS 80/95. We’re not sure where things stand on resolving those issues.

If your company offers a qualified retirement plan, moreover, the new law will have no effect on your company, even if implemented. That means it’s meaningless for a huge number of employees and employers.

Assuming implementation occurs, if your company has no qualified retirement plan, but has been in business for less than two years or employed less than 25 employees at any time during the previous calendar year, your company will not be required to participate in the State program at least until the two-year and 25-employee thresholds are reached.

Once the State program–“an automatic enrollment payroll deduction IRA”–is created, a covered company will be required to auto-enroll employees, unless it then creates its own plan, such as a 401K, SEP or SIMPLE.

If your company has no qualified retirement plan and doesn’t meet the two-year and 25 employee thresholds, it will be considered a “small employer” and have the option of participating in the State program. We’re not sure why an employer would opt into the State program, rather than choose a low-cost private plan.

If your company is required to offer the State program or chooses to participate as a “small employer”, it won’t be required to contribute to any plan. Employees auto-enrolled will have a payroll deduction of 3% of their earnings earmarked for the State program; this isn’t a mandatory additional contribution by an employer. Employees also may choose to contribute more than 3%. But, if they need or prefer to have the money to use immediately, they can opt out of the State program. We wonder how many employees will prefer to opt out–especially when it’s highly likely that most, if not all employees in State-sponsored programs will be low-wage earners who may need the money just to cover everyday necessitates.

There will be Board-prepared employer and employee information packets, with background information, disclosures for employees, and information about a vendor Internet website. Employers required to participate will be required to provide information packets to employees when the program is launched and to new employees at hiring thereafter. An employee who opts out may participate later by electing to do so during an employer’s annual designated enrollment period or an earlier time if the employer allows.

If your company is required to auto-enroll an employee, but doesn’t, the company will be subject to a penalty of $250 per employee for each calendar year during which the employee neither was enrolled in the program nor opted out–and then $500 for each calendar year after the date a penalty was assessed. So, a company required to auto-enroll better do so, even if most of it’s employees opt out anyway.

It will be interesting to see how many employees really benefit from this program and how much it costs this already-financially-challenged State to administer it, assuming it even is implemented. Stay tuned.

Tags: Illinois, Secure Choice Savings Program Act, employer, private sector, mandatory retirement program, ERISA

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What you need to know about background checks for hiring, firing, and other employment decisions

December 2nd, 2014 — 3:39pm

by Christopher Graham and Joseph Kelly

[background check]

You own a business. Business is booming! So you need to hire more employees. But you want to know whether anyone you may hire has skeletons in the closet. Is it okay to run background checks? Yes, but be there are limitations.

If you don’t have or follow a policy for background checks that follows state and federal law, you could end up in hot water.

The Equal Employment Opportunity Commission and Federal Trade Commission issued a joint publication earlier this year entitled “Background Checks: What Employers Need to Know”.

Why the EEOC? Because it’s charged with enforcing federal laws that protect applicants and employees from discrimination based on race, color, national origin, sex, or religion, disability, genetic information (including family medical history) and age (40 and older).

Why the FTC? If you use a company in the business of compiling information for background checks, such as a credit or criminal background report), you must follow the Fair Credit Reporting Act or “FCRA”, which is enforced by the FTC.

The joint statement covers what you need to do before you get background information, using that information, and disposing of it. If you run background checks, read it carefully.

Some of the statement’s key EEOC takeaways:

  • “In all cases, make sure that you treat everyone equally.” So, if you run checks, run them on everyone.
  • Don’t try to get an applicant’s or employees’ genetic information, including family medical history.
  • Don’t ask medical questions before making a conditional job offer.
  • Although it seems obvious, “Any background information you receive from any source must not be used to discriminate in violation of federal law.” So . . .
  • “[A]pply the same standards for everyone . . . .”
  • “Take special care when basing employment decisions on background problems that may be more common among people” in a protected class.
  • “Be prepared to make exceptions for problems revealed during a background check that were caused by a disability.”
  • For criminal background checks, “employers should not use a policy or practice that excludes people with certain criminal records if the policy or practice significantly disadvantages individuals of a particular race, national origin, or another protected characteristic, and does not accurately predict who will be a responsible, reliable, or safe employee.”
  • Keep employment records until either 1-year after creation or 1-year after a personnel action, whichever is later—unless you’re a state or local government, educational institution, or federal contractor and, thus, subject to longer record keeping requirements. If you’ve been charged with discrimination or been sued, you’ll have additional preservation obligations.

Some key FTC takeaways about reports from third parties:

  • Tell the applicant or employee you might use the information for decisions about his or her employment” – in a stand-alone written notice, not in an employment application.
  • Get the applicant’s or employee’s written permission for the background check (okay to include in the written notice).
  • For reports based on personal interviews about a person’s character, reputation, characteristics and lifestyle, you must tell the applicant or employee of his or her right to a description of the investigation’s nature and scope.
  • Certify to the third-party investigator that you provided the required notice, have permission, complied with the FCRA, and won’t discriminate against the applicant or employee, or otherwise misuse the information contrary to federal or state equal opportunity laws or regulations.
  • You must provide the applicant or employee notices if you intend to make an adverse employment action (such as firing or not hiring someone) based on the third-party background information, including (1) the consumer report you relied on and (2) a copy of “A Summary of Your Rights under the Fair Credit Reporting Act” which should have been provided by the company selling you the report.
  • After you take an adverse employment action based on the third-party background information, you must notify the applicant or employee that he or she was rejected because of information in the report, certain contact information about the company that sold the report, and other related information.
  • You may dispose of third-party reports if you’ve met all other recordkeeping requirements, but disposal must be secure.

What else do you need to know? You also better check the law in each state where your business intends to hire employees. State law likely has additional requirements.

For example, where we’re located, the Illinois Human Rights Act, subject to certain exceptions, restricts employers, potential employers, and others from inquiring into or using the fact of an arrest or criminal record information for hiring and other employment-related decisions. See 775 ILCS 5/2-103. The Human Rights Act, however, doesn’t prohibit the employer and others “from obtaining or using other information which indicates that a person actually engaged in the conduct for which he or she was arrested” Id.

Since 2011, the Illinois Credit Privacy Act, subject to certain exceptions, has restricted “employers” from inquiring about an applicant’s or employee’s credit history, ordering or obtaining an applicant’s or employee’s credit report from a consumer reporting agency, or discriminating against any person concerning employment, compensation, or a term, condition or privilege of employment because of the person’s credit history or credit report. See 820 ILCS 70/10(a).

The Credit Privacy Act excludes certain types of employers from being “employers” under the Act, such as banks, insurance companies, debt collectors, and certain state and local government entities. And it “does not prevent an inquiry or employment action if a satisfactory credit history is an established bona fide occupational requirement of a particular position or a particular group of an employer’s employees.” Id. at 70/10(b).

But if you think that you get to decide whether credit history is a “bona fide occupational requirement,” think again. The Act tells you whether it is or isn’t. Examples of when it’s bona fide include when state or federal law requires bonding for the position or the job duties include custody of or unsupervised access to cash or marketable assets of at least $2500 or signatory power of business assets of at least $100 per transaction, setting the direction or control of the business, or access to personal or confidential information, financial information trade secrets.

For an overview of background check legal variations nationwide, see an excellent post by Jackson Lewis law firm here.

Bottom line: if you’re going to do background checks, make sure you know what you’re doing. Consult qualified counsel about state, federal and any local requirements.

Tags: employee background checks, applicant background checks, Fair Credit Reporting Act, FCRA, Federal Trade Commission, EEOC, criminal background checks, credit reports, Illinois Credit Privacy Act, Illinois Human Rights Act

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Taxpayers lose: United States Supreme Court says severance pay is taxable

April 2nd, 2014 — 12:32am

by Christopher Graham and Joseph Kelly


We wrote here about the United States Supreme Court decision to consider whether severance payments are taxable. Seven days ago the Court answered “yes” in United States v. Quality Stores, Case No. 12-1408 (S. Ct. Mar. 25, 2014). Severance payments are taxable wages. Taxpayers lose another one to the IRS.

Tags: Severance pay, tax, employment law

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The importance of a well-drafted sales representative agreement – Part 2

January 22nd, 2014 — 3:49am

by Christopher Graham and Joseph Kelly


As discussed in an earlier post, Illinois businesses are subject to severe penalties if commissions due sales representatives aren’t paid consistent with the Illinois Sales Representative Act. Businesses run into trouble when they have an agreement with a sales representative that doesn’t address with specificity how sales commissions will be addressed when the relationship ends. Sales representatives sometimes even will argue for a commission in perpetuity for sales to a customer the representative initially brought to the business. More frequently, disputes concern a sale in progress, but not consummated until after the sales representative’s relationship with the business terminated.

The common law “procuring cause” doctrine exists in Illinois and other states to resolve the issue where the parties’ agreement doesn’t do the job. Under the “procuring cause” doctrine, sales representatives earn commissions on a sale finalized after termination if the sales representative “procured” the sale through actions before termination. See, *i.e., Scheduling Corp. of America v. Massello, 151 Ill. App. 3d 565, 568, 503 N.E.2d 806 (1st Dist. 1987). A main purpose of “procuring cause” is to prevent businesses from shirking their commission obligations right before a particular sale concludes. Id. Under “procuring cause”, a sales representative that has done everything to effect a sale is entitled to a commission. Id.. But the “procuring cause” doctrine doesn’t apply when parties have an unambiguous written agreement stating when commissions are earned. Solo Sales, Inc. v. North America OMCG Inc., 299 Ill. App.3d 849 (2nd Dist. 1998). The trick is to draft the agreement to address the issue with particularity, so there’s no debate about what was intended.

As we’ll explain in another post next month, a well-drafted sales representative agreement that clearly defines when commissions are earned also will help a business avoid the Act’s severe penalties.

Tags: Illinois, Illinois Sales Representative Act, procuring cause

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Illinois businsses must post approved sign to keep concealed weapons out

January 12th, 2014 — 7:50pm

by Christopher Graham and Joseph Kelly


As we’ve posted about previously, concealed carry is now the law in Illinois. Illinois businesses wanting to keep concealed weapons out of their business must post the sign approved by the Illinois State Police.

A link to a pdf of the approved sign as well as more information can be found on the Illinois State Police website here.

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The importance of a well-drafted sales representative agreement

November 21st, 2013 — 2:53pm

by Christopher Graham and Joseph Kelly


The Illinois Sales Representative Act protects sales representatives upon termination of their relationship with a company.

There’s no shortage of litigation under that statute and similar state statutes. Much of it involves disagreement over commissions owed when a business and independent sales representative end their relationship. See, e.g., Penzell v. Taylor, 219 Ill.App.3d 680 (1st Dist. 1991). Those suits often arise because parties have no contract or their contract doesn’t address payment of commissions upon termination with sufficient precision. Id. If the contract doesn’t expressly provide when commissions will be paid, the procuring cause rule may apply. Under that rule, “a party may be entitled to commissions on sales made after the termination of a contract if that party procured the sales through its activities prior to termination.” Id.

The Illinois Sales Representative Act provides that:

[a]ll commissions due at the time of termination of a contract between a sales representative and principal shall be paid within 13 days of termination, and commissions that become due after termination shall be paid within 13 days of the date on which such commissions become due. 820 ILCS 120/2

If commissions due at termination aren’t timely paid, the principal:

  • “shall be liable in a civil action for exemplary damages in an amount which does not exceed 3 times the amount of the commissions owed to the sales representative”; and
  • shall pay the sales representative’s reasonable attorney’s fees and court costs.

820 ILCS 120/3

The Act thus is a powerful weapon for an independent sales representative who claims a failure to pay commissions. As a Google search will show, potential exemplary damages and attorneys’ fees is an incentive for numerous attorneys to seek these cases and take them on a contingent fee basis. If the company is in Illinois but the sales representative is out-of-state, the out-of-state statute where the employee is located may apply.

A well-drafted sales representative agreement is the best solution for all concerned. And we will cover this topic in a later blog post.

Tags: Illinois, Sales Representative Act,

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Protecting Trade Secrets and Confidential Information

November 11th, 2013 — 3:31pm

by Christopher Graham and Joseph Kelly


Unfortunately for some companies their trade secrets don’t stay secret. (Not sure if information is a trade secret? See our post “What’s a trade secret?”)

Too often companies fail to take the necessary steps to protect that information.

Here are some of the steps businesses can take to protect trade secrets and confidential information:

  • Stamp documents as confidential;
  • Limit access to trade secrets and confidential information to employees on a need-to-know basis;
  • Password-protect electronic files containing trade secrets or confidential information;
  • Restrict physical access to documents containing trade secrets;
  • Require employees and contractors to sign confidentiality or non-disclosure agreements.
  • Establish a written confidentiality policy and enforce it.

Companies that don’t take proactive protective measures run the risk of the losing their most valuable assets.

Tags: Trade secrets, confidential information

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What’s a trade secret?

November 11th, 2013 — 3:14pm

by Christopher Graham and Joseph Kelly


Trade secrets are often a company’s most valuable assets.

Illinois (and most other states) have adopted the Uniform Trade Secrets Act which defines a trade secret as:

information, including but not limited to, technical or non-technical data, a formula, pattern, compilation, program, device, method, technique, drawing, process, financial data, or list of actual or potential customers or suppliers, that:

(1) is sufficiently secret to derive economic value, actual or potential, from not being generally known to other persons who can obtain economic value from its disclosure or use; and

(2) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy or confidentiality. 765 ILCS 1065/2(d)

In simpler terms, a trade secret is valuable information kept confidential. Common examples are Col. Sander’s recipe for fried chicken and the formula for Coca-Cola.

But most employers aren’t in the fast food or soft drink industry.

A more common example of a trade secret is a customer list.

Is a list that only contains customer names and contact info. publicly available likely a trade secret? No.

But what if a customer list contains other information that makes the list distinctive? Customer lists that include things like sales history, pricing information, contact info. for decision-makers, product preferences are much more likely to be trade secrets.

A company’s ability to succeed often depends on its ability keep its trade secrets protected. For more information on how to protect trade secrets, please see our post – “Protecting Trade Secrets and Confidential Information”

Tags: Trade secrets, confidential information, customer lists, Illinois, Uniform Trade Secrets Act

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