OUTSIDE POSITION LIABILITY AND INDEMNIFICATION
The D&O exposure least understood by both insureds and, in some instances, insurers is liability arising out of a person serving at the request of a corporation as a director, officer, employee or agent of another organization. That exposure is referred to as outside position liability (OPL) or outside directorship liability (ODL). This issue of The ACE Report is devoted entirely to that increasingly important subject.
Historically, insureds frequently requested blanket OPL coverage and insurers granted the coverage extension with very little, if any, risk analysis and for relatively minimal premiums. Many corporations unknowingly mandated blanket indemnification protection for all outside positions without controls over the process.
As director and officer liability exposure has continually increased over the last decade, OPL exposures have similarly increased. This exposure is particularly acute today in the financial institution area. Regulators who are searching for deep pocket recoveries are now frequently unable to recover under the financial institution's D&O policy because the regulatory exclusion is being consistently upheld by the courts. Thus, regulators are finding the OPL indemnification and insurance coverage, which typically does not have a regulatory exclusion, as the only available D&O deep pocket.
To avoid unnecessary and unintended corporate liability and dilution of policy limits, corporations need to better understand and manage this risk. Although outside positions are very useful and important concepts in appropriate situations, they create complicated issues, operational dilemmas and unintended losses of not properly administered and controlled.
A. OPL LIABILITY
Service in an outside position is troublesome not only because of the numberous liability exposures faced by any D&O, but also because of several liability theories particularly applicable to OPL claims.
1. Joint and Several Liability
Most D&O claims, if proven, created joint and several liability among the defendant directors and/or officers. Therefore, a plaintiff can choose to pursue any one or more of the prospective defendant D&Os for the entire amount of the liability imposed. The existence of OPL indemnification or insurance coverage for a director of an outside entity may make that director a more inviting target, particularly if the outside entity maintains little or no D&O coverage directly.
If plaintiffs successfully obtain recovery from one individual for a joint and several liability claim, that individual has a claim for contribution against his joint tortfeasors. However, this contribution claim generally provides little solace for the target defendant and is frequently little more than a theoretical right. Asserting a contribution claim against one's joint tortfeasors is difficult and expensive. In addition, the joint tortfeasors may have limited resources and therefore be unable to pay the contribution claim even if proven.
2. Duty of Loyalty
Outside positions are often with entities which have common business interests or other dealings with the corporation that requested the outside position service. These situations can be particularly problematic to the person serving in the outside position since that person has dual loyalties. Some of the areas of concern include the following:
INTERCORPORATE TRANSACTIONS. When directors are on both side of a transaction, they are required to demonstrate their utmost good faith and "entire fairness" of any intercorporate transaction. Courts will apply careful scrutiny to determine whether the common director's actions were fair to both companies. The business judgment rule is not available to such a director, who may have the burden of overcoming a presumption against the validity of the transaction.
MAINTAINING CONFIDENCES. A director has a duty to use reasonable diligence to protect and safeguard the property of the corporation, including confidential information. If the director either knowingly or inadvertently discloses confidential information to a third party, including an outside entity for which he or she serves in an outside position, the director can be liable for any resulting loss.
CORPORATE OPPORTUNITY. A director is required to avoid usurping or misappropriating business opportunities belonging to his corporation. The director generally must refrain from directly or indirectly seizing a business opportunity for which the corporation has a reasonable expectancy and capability to perform. A common director runs the risk of either corporation he serves complaining that he usurped for the benefit of the other corporation a business opportunity available to the first corporation.
INTERLOCKING DIRECTORS. If the outside position is with an actual or potential competitor of the requesting corporation, anti-trust liability may arise. Section 8 of the Clayton Act, 15 U.S.C.§19, prohibits a corporation or individual from serving as an officer or director in certain non-banking, competing corporations.
3. Liability of the Requesting Corporation and its D&Os.
DEPUTIZATION THEORY. When a corporation requests a person to serve in an outside position, that person may be considered the "deputy" of the requesting corporation and thus the requesting corporation itself may be considered the person serving in the outside position. In that case, the requesting corporation would have the same liability exposure as any other person serving in that outside position.
This deputation theory has been approved by some courts, at least in the context of Section 16(b) of the Securities Exchange Act of 1934 and Section 8 of the Clayton Act. See, e.g. Lanza v. Drexel & Co., CCH Fed. Sec. L. Rep. ¶ 92,826 (S.D.N.Y.), aff'd 479 F.2d 1277 (2d Cir.1973); Feder v. Martin Marietta Corp., 406 F.2d 260 (2d Cir. 1969), cert. denied 396 U.S. 1036 (1970); Blau v. Lehman, 368 U.S. 403 (1962); Marquette Cement Manufacturing Co. v. Andreas, 239 F. Supp. 962 (S.D.N.Y. 1965).
CAPACITY. A director or officer who incurs loss as a result of service in an outside directorship may be considered to have incurred that loss in his capacity as a director or officer of the requesting corporation and thus be entitled to insurance protection even without expressed OPL coverage under the requesting corporation's D&O policy. In Continental Copper & Steel Industries, Inc,. v. Johnson, 491 F. Supp. 360 (S.D.N.Y. 1980), aff'd 641 F.2d 59 (2d Cir. 1981), the court ruled that directors of Continental who were serving on the board of Halliwell Mines, Ltd. at the request of Continental and who were sued for alleged wrongful acts as directors of Halliwell were entitled to coverage under the Continental D&O policy even though such policy did not contain an expressed OPL coverage. The court reasoned that the defendants gained their positions as directors of Halliwell only because of their responsibilities as directors of Continental and thus were acting in those outside positions in their capacity as directors of Continental.
B. OPL INDEMNIFICATION
Virtually every state indemnification statute permits corporations to indemnify persons serving at the request of the corporation as directors, officers, employees or agents of an outside entity. The Delaware statute (Section 145 (a), Delaware General Corporation Law) is typical and states in part as follows:
A corporation may indemnify any person who was or is a party…to any threatened, pending or completed action, suit or proceeding…by reason of the fact that he…is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise….
The following summarizes some of the important aspects of this statute.
1. Protected Persons
The statute applies to any person (not just directors and officers of the requesting corporation) serving in an outside position at the request of the corporation.
The statute applies to any position with an outside entity. Although the term "outside directorship" is frequently used, it is somewhat of a misnomer since a person serving at the request of the corporation as a director, officer, employee or agent of the outside entity is eligible for protection. For example, if a person provides consultation or other assistance to an outside entity such that the person is deemed to be an agent of that outside entity, OPL indemnification protection may apply.
The statute applies to service with any enterprise, including a corporation, partnership, joint venture, trust and employee benefit plan. For example, OPL indemnification can be afforded by a parent corporation to all directors and officers of all subsidiaries or affiliates, thereby providing backstop indemnification protection to the subsidiary D&Os in the event the subsidiary is legally or financially unable to provide indemnification.
2. Request
The statute does not require a written request by the corporation for service in the outside position. Presumably, an oral request, if sufficiently proven, can trigger the indemnification authorization.
The statute does not require the request for service to be by the corporation's board of directors, officers or any particular person. Presumably, any person with actual or apparent authority to make the request on behalf of the corporation can bind the corporation.
In light of the foregoing, anyone with an expectation of OPL indemnification protection may have a basis for seeking indemnification since the statute alone contains virtually no controls or limitations. For example, comments by an employee's superior or written policy statements encouraging employees to be active in civic or community organizations or suggesting to employees that they "support" or "help out" another entity may be sufficient to invoke OPL indemnification liability.
3. Indemnified Claim
The statute applies to any claim against a person serving in an outside position. When evaluating this indemnification exposure, one should consider not only the breach of duty and statutory claims typically covered under a D&O insurance policy, but also claims typically excluded by D&O insurance. Most notably, bodily injury and property damage claims against the outside position can create potentially enormous indemnification liability to the requesting corporation, particularly if the outside entity maintains no or inadequate general liability insurance coverage. The requesting corporation's general liability insurance may not cover this exposure because such insurance typically does not include OPL coverage.
4. Mandatory Protection
The Delaware statute as quoted above, like all other state indemnification statutes in this regard, merely permits, but does not require corporations to indemnify OPL loss. However, many corporations in their by-laws or charter either mandate indemnification to the fullest extent permitted by law or restate verbatim the state indemnification statute and simply change the word "may" to "shall". Under these types of corporate indemnification provisions, this extremely broad, largely uncontrolled OPL exposure becomes a legal obligation of the corporation. Such a legal obligation, which may or may not be covered by insurance, may arise as a result of conduct at any level within the corporate structure, including conduct by virtually any employee of the parent corporation or any subsidiary.
C. CONCLUSIONS
Although largely ignored for many years, OPL exposure is not being asserted with sufficient frequency and success that it behooves corporations to address the many issues in this area. Properly managed, outside positions can serve as an important extension of corporate activity and OPL protection can serve as an additional layer of financial protection for persons performing those extended corporate activities and for D&Os of subsidiaries or affiliates. If ignored, though, OPL exposures can ruin an otherwise well conceived risk management program for executives and result in embarrassing (at best) and devastating (at worst) liability exposure to the corporation.
To manage this exposure, a corporation can implement and enforce an outside position program pursuant to which only those outside positions specifically approved by a designated committee or person according to defined criteria qualify for corporate indemnification. From an insurance perceptive, numerous alternatives exist, including either blanket or specifically listed ODL coverage; either double excess (coverage excess the outside entity's indemnification and insurance) or triple excess (coverage excess the outside entity's indemnification and insurance and excess the requesting corporation's indemnification); and subject to limits either separate from, a sublimit of or the full limits otherwise available under the requesting corporation's D&O policy. This coverage is typically afforded through an endorsement to the D&O policy. For example, since its inception CODA has offered triple excess ODL coverage by endorsement, subject to the same broad terms and conditions applicable in its D&O policy form. In March, 1992, the Chubb Group of Insurance Companies introduced a new free-standing double excess ODL policy, highlighting the increased attention being given by insurers to this exposure.