Mitigating D&O Spending Sprees

Even before the current COVID-19 crisis, the public company D&O world was ablaze with controversy and commentary about the hardening market for this line and concomitant increases in pricing for such insurance. It is probably fair to say that the COVID-19 crisis will only exacerbate and accelerate the hardening of the public company D&O world, and likely several other areas of insurance as well.

To a lesser extent, this hardening was already infiltrating the financial institutions private company D&O market, and management liability generally. Broadly speaking, it seems a lot of insurance will get either more expensive or more restrictive going forward. Previously, the pundits had weighed in on causes of, and several possible solutions to, the hardening market in the public company D&O world. The most obvious suggestion has been to find a way to rein in defense expenses: Narrowing coverage does not seem to be a favored option by insureds, and doing so often leads to conflict when claims occur.

Aside from simply giving more control of the defense arrangement to insurers, we believe that there are several aspects of the defense-expenditure argument that are not properly understood, and perhaps some solutions to the perceived conflict can be found.

Traditionally, insureds have gone to great lengths to prove that their defense expenses are “reasonable and necessary” so as to comply with the terms of their non-duty-to-defend D&O policies. Generally, judges have accepted the various arguments offered by insureds for these expenses and have instructed them to be paid. We posit that these have often been pyrrhic victories for insureds. Outside of perhaps genuine securities class-action lawsuits against the target company and its directors and officers, insureds are both overpaying and over-lawyering. Unlike the numerous reports of auto and medical malpractice insurance, no definite, publicly available data articulating D&O defense costs exists. However, when speaking directly with employees of major D&O insurances companies, the situation is clear: Insurers have almost no control over an insured’s defense expenses, and large law firms have taken note.

Nowhere is this more apparent than in employment claims, where insureds often insist on using the same firms that they would use for securities class actions at rates approaching four times the cost of typical employment practices defense firms. Employment stands out due to the existence of many seasoned insurance defense litigators, costing significantly less, who may actually be better choices based on their experience and prior success in this area. But employment is not the only area. Less complex, private company D&O claims are similar to employment in that there are multiple, less expensive—but equally experienced—attorneys who are qualified to defend such cases.

 We have often been confronted with the argument in various investigation claims and non-public company D&O claims that the cost will be justified by the results. We have almost always been disappointed, however, and have been left with the belief that the insured probably could have attained the same poor result at half the cost since the exposure to fines, penalties (or therapeutics), or other types of loss is often comically minimal compared to the expense exposure. Texas and Louisiana have developed tests to determine “reasonableness” of fees, which include a results component (i.e., that the high cost of a particular law firm is at least partially reasonable due to the favorable result it obtained). It is impossible to know the result at the initial phase, and there is no way to know for certain if a less-expensive firm could have obtained the same result at a lesser cost. But at least these tests pay credence to the possibility that a good result may not have been obtained by a less-expensive firm or perhaps that the same poor result could have been achieved by a much-less-expensive firm.

Insurance carriers are fearful of denying anyone their right to independent counsel. But is independent counsel really needed for every single individual named defendant in any given D&O claim? ABA Model Rule 1.7 offers guidance on when an attorney cannot represent multiple clients in the same event. Clients may consent to the use of the same attorney except when clients are directly adverse to each other. The parameters for what truly constitutes “non-consentable” are very narrow. Cleary, every case and individual insured is different, but one has to question the need for seven (or more) different law firms representing seven different defendants where several defendants have aligned interests or are marginal targets.

For instance, in Schwartz v. Cognizant Technology Solutions Corp., it was the company, not the insurance carrier, that took issue with one individual using three law firms for one event. Towers of insurance burn where several insureds have several groups of pricey attorneys doing redundant work, and this is a fast way to exhaust a smaller tower of insurance that may be needed for settlement purposes down the road. In the case of a company that is not financially stable or is underinsured, the issue is magnified. Once the insurance tower is gone and the company is insolvent, individuals will be left to pay their own defense fees and settlements. Perhaps some discussion at the company level about this possibility is warranted at the inception of the event before blindly accepting a multiple defense arrangement.

Insureds’ risk managers vary dramatically in terms of their skills in appreciating the expense exposure at the inception of an event. Often, they view a new claim from a very optimistic perspective, whereas insurance-carrier adjusters often have a better viewpoint of claims based on their sheer volume of experience. In a rising-rate environment (and with a desire not to restrict coverage), perhaps now is the time to re-evaluate the role of the risk manager or in-house counsel. Instead, the adjuster assigned to the claim should be viewed as a valuable resource with a better chance of being objective because the adjuster is not a member of the company at issue or saddled with the task of reporting to someone who only wants to hear the “good news.” Instead of ignoring the adjuster, perhaps incorporating an insurance specialist in defense-arrangement decisions makes more sense. A D&O renewal without a claim in a hard market is one thing, but with a claim that rips deep into a tower, the insured is going to be looking at vastly different pricing. Anything the insured can do to mitigate that defense exposure is simply going to save them money (or terms) at the renewal table.

This article is provided for general informational purposes only and does not constitute and is not intended to take the place of legal or risk management advice. Readers should consult their own counsel or other representatives for any such advice.