Archive for June 2018

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.

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