By Russ Banham
With revenues tumbling, companies across many industry sectors confront a heightened risk of bankruptcy, spurring possible class action lawsuits brought by creditors against corporate directors and officers. In expectation of this growing threat, the D&O market is hardening like quick-setting concrete.
Depending on the industry, D&O liability insurance premiums have increased 40 percent or more, in some cases doubling in price. Some carriers also are trying—and mostly failing—to exclude bankruptcy and pandemic coverage. No other insurance market, including workers compensation, employment practices liability and property/business interruption, is experiencing this price upheaval.
Battered both directly and indirectly by COVID-19 and the business repercussions it set in motion, D&O liability looks to be the most problematic insurance market for businesses going forward. Six securities class action lawsuits referencing the coronavirus had been filed (as of the date this article was written in late May), but it is the prospect of bankruptcy-related litigation brought by creditors that has set the market on edge.
“The expectation for an uptick in bankruptcy-related D&O litigation is affecting premiums in virtually all segments, and for some industries the situation is acute,” said Priya Cherian Huskins, senior vice president, management liability, at insurance broker Woodruff Sawyer. “The market was in free-fall prior to the pandemic and has landed in a dumpster fire.”
Unlike traditional securities class action lawsuits filed by shareholders and investors against directors and officers, creditor committees bring litigation against the directors and officers derivatively—on behalf of the company—for a breach in their fiduciary duties.“Whereas lawyers for shareholders and investors look at the risk disclosures to find ways to sue directors and officers, bankruptcy lawyers are likely to scrutinize a company’s conduct—business decisions that indicate directors and officers were not sufficiently attentive to the risks of the pandemic,”said attorney Dan Rabinowitz, partner at Kramer Kevin Naftalis & Frankel.
The specter of wide-scale insolvencies in embattled sectors like hospitality, airlines, oil companies, cruise lines, restaurant chains, REITS, retailers and gaming establishments, among others, promises a field day for bankruptcy attorneys.
“Trial lawyers are salivating over the prospect of suing the widest range of D&O defendants in history,” said Robert Hartwig, clinical associate professor of finance at the University of South Carolina’s Darla Moore School of Business, whose research focuses on insurance markets. “Insurers are bracing for what may be a ‘tsunami’ of bankruptcy-related claims against directors and officers.”
Non-Disclosures and MisrepresentationsThis expected litigation joins the traditional securities class action lawsuits filed by investors against six companies at press time: Zoom, Norwegian Cruise Lines, Inovio, Phoenix Tree Holdings Ltd., SCWorx and iAnthus Capital Holdings. More such suits are expected.
“As businesses struggle to reopen and cope with the impact of COVID-19 on their revenues and operations, plaintiffs lawyers will look for prior statements they made about the impact of the pandemic that can be construed as misrepresentations, kicking the door open for more D&O litigation ahead,” said attorney Kevin LaCroix, executive vice president of RT ProExec, a specialty insurance intermediary.
The six securities class actions filed to date are dissimilar in their allegations, which may be instructive insofar as possible future litigation trends, said veteran D&O attorney Dan Bailey, partner at Bailey Cavalieri. The claims against Inovio, he explained, involve the CEO’s public statements regarding the testing of a COVID-19 vaccine, whereas the lawsuit against Zoom alleges the company failed to disclose pre-existing weaknesses in its privacy and security protocols prior to the mass use of its video conferencing platform.
Alternatively, the case against Norwegian Cruise Lines alleges that directors and officers failed to disclose misleading and improper sales tactics to investors regarding COVID-19 risks to increase its bookings. “Going forward, I’m sure we’ll see some similar lawsuits directly arising from the pandemic,” Bailey said.
Nevertheless, providers of D&O insurance are said to be more leery about the indirect impact of COVID-19 on client solvency. “The concern among D&O carriers is that bankruptcy trustees will decide the best way to collect money for the bankruptcy estate is to sue the directors and officers,” said Huskins.
Assuming a company files for bankruptcy protection, attorneys representing the creditors committee will have ample opportunity to blame directors and officers for not sufficiently taking actions related to the impact of the coronavirus on the business, Rabinowitz said.“Creditors will argue that the directors and officers should have looked at the risks of the pandemic and hedged against them,” he explained. “The company should have anticipated the possibility of a civil authority imposing a shutdown of either the company or the suppliers and other businesses deemed important to its solvency. If insurance was available to buffer these risks, such as a parametric policy absorbing pandemic risks, attorneys will argue the company should have bought it.”
He emphasized that these arguments may not be “winning,” but they will nonetheless be made. “We’re on the frontier of negligence law here, with the lawyers representing creditors or plaintiffs trying to show fault on the part of the directors and officers, and the carriers and defense lawyers saying there was no way the company’s sophisticated risk managers and brokers could anticipate a risk of this nature,” Rabinowitz said.
While the defense argument may play out well with a court jury, other optics are at play in federal bankruptcy proceedings. “A jury may have different sensitivities than the perceptions of a federal bankruptcy judge, who is, after all, a government employee more insulated from economic risks,” Rabinowitz said. “That’s a stereotype, but it illustrates what is often an uphill climb for plaintiff attorneys in D&O bankruptcy-related cases. It’s a different ecosystem altogether.”
It’s also one that can be very costly. “Bankruptcy lawyers are tasked with recovering as much as they can for litigants, whether they’re creditors, the estate, purported tort victims or employees, and will be looking closely at the D&O policy,” he said.
At present, carriers are preparing for a surge in such litigation. “The fact that something is inevitable doesn’t mean it is imminent,” said Huskins. “The D&O market knows that bankruptcy proceedings progress slowly, meaning the impact will take some time before it is fully felt. Carriers know the insolvencies are coming.”
D&O insurers also are on guard for the financial impact of securities class action lawsuits filed by investors in companies that have incurred significant financial challenges in the current economic environment. “When an economic crisis rears, it frequently results in securities litigation alleging the challenges were not properly anticipated and disclosed to investors,” said Bailey.
Hartwig agreed. “One of the core elements driving D&O litigation is an economic downturn, which results in share price collapses and a greater number of bankruptcies,” he said.
The highly volatile stock market also may fuel so-called stock-drop lawsuits. Bailey provided the example of a company that discloses disappointing information on the same day the entire stock market endures a precipitous fall. “Plaintiffs will argue the large drop in the company’s stock price that day was due to its corrective disclosure of adverse information, even though in reality the stock drop was due to the broader economic and market conditions,” Hartwig said.
Other factors directly or indirectly created by the pandemic that could generate claims against directors and officers include a large reduction in a company’s workforce, failure to satisfy debt covenants, a need to raise additional capital, failure to pay or comply with contractual obligations and failure to respond to acquisition opportunities, Bailey said.
These factors are writ large across more industry sectors than in previous D&O litigation scenarios this century. Litigation ensuing from the bursting of the so-called dotcom bubble in the early 2000s, for example, focused on directors and officers of technology companies, whereas litigation following the 2008 financial crisis primarily targeted directors and officers of financial institutions.
“Each economic downturn is idiosyncratic from a D&O standpoint,” said Hartwig. “Due to the pandemic’s universal effect on virtually all businesses and government actions closing down much of the economy, a much larger pool of companies is under duress. Many defendants will hold themselves harmless, of course, which may, in fact, be a fairly effective defense. Even so, the defense costs borne by insurers in defending the lawsuits will be substantial.”
Tough Times Ahead
Added up, the D&O insurance market is in for one heck of a ride. “I honestly cannot remember having a single upbeat meeting with a client where we delivered a decrease in their cost of D&O insurance last year and the year before,” said Huskins.
She provided the example of two clients, each receiving a 40 percent premium increase. “For one company, the increase equated to an additional $100,000 in premium; for the other, it cost much, much more.”
Even “run of the mill policy renewals” in the past have suddenly become “much trickier,” said Devin Beresheim, executive vice president, specialty practices, at insurance broker Lockton Companies. “We’re seeing retail and restaurants getting hit with increases from 50 percent to 100 percent. No insurer is coming in with a 10 percent or 20 percent premium increase to win over the business.”
Some providers of D&O insurance also are trying to impose coverage restrictions, tacking on pandemic and bankruptcy exclusions, said Christine Williams, CEO of broker Aon’s financial services group. “The pandemic exclusions started circulating in the first week of May, but on behalf of our clients we have not accepted them,” Williams said. Not all carriers in the U.S. are demanding the exclusions, which appears to be tempering the situation, she said.
With regard to bankruptcy exclusions, Huskins said, “To date, we’ve been able to preserve coverage for bankruptcy, although there are certainly pressures to exclude it.”
Beresheim summed up the coverage restrictions as being less of an issue for brokers and insureds than the skyrocketing premiums. “From what we’ve seen, this hasn’t been a coverage problem. It’s a rate problem that started before COVID and has accelerated, with no end in sight,” he said. “The market is tightening on a week-by-week basis. It’s incredible, but many buyers have few choices other than to buy.”
Some companies are turning their backs. Tesla, for example, recently replaced its D&O insurance policy with a promise made by the company’s founder and CEO Elon Musk that he will “personally provide…equivalent coverage” to the automaker’s directors and officers.
Other D&O risk financing alternatives like trust funds, finite risk arrangements and captive insurance companies also have been floated over the years. While Bailey said these solutions “provide meaningful protections,” he cautioned that they also involve “complex issues and are somewhat less protective and reliable than traditional D&O coverage.”
As for Musk’s maverick decision, La Croix warned that directors and officers are entirely dependent on the CEO’s ability to honor his stated commitment. “A set of circumstances could arise undermining his pledge,” he said.
As risk managers prepare for their D&O policy renewals, they need to ready themselves for difficult discussions. In Woodruff Sawyer’s meetings with corporate risk managers to discuss the upcoming D&O policy renewal, Huskins said companies unable to demonstrate a positive outlook through the next 12-18 months will see the most pressure on pricing, as well as more restrictive coverage terms and conditions.
“You need to come to the meetings with a sober, realistic attitude,” she said. “Show up with organized information about the company’s financial solvency. If carriers express concerns, don’t be insulted. If your tone reflects an accurate level of pessimism, carriers understandably will try to get as far away from the risk as possible. If your tone is cavalier, they’ll think you’re delusional.”
In other words, truth and transparency are crucial.
Williams offered similar advice. “Risk managers need to be transparent about the financial impact of COVID-19 now and in the future,” she said. “Expect to hear tough questions around cyber, infrastructure, workforce, security risks and so on, and have a straightforward response ready.”
Then, gird for the dumpster fire.
Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.