Is Your D&O Coverage Adequate - Strategies To Avoid Personal Contribution By Outside Directors In The Event Of Claims.

Last month a federal court preliminarily approved a $55.95 settlement involving securities claims against outside directors in In re Peregrine Systems, Inc. Securities Litigation, Case No. 02-CV-0870-BEN (S.D. Calif.). Pursuant to this settlement, one of the largest ever recorded involving outside directors, six former Peregrine directors agreed to settle claims for $55.95 million.

While the outside directors' counsel has stated that the insurers did contribute to the settlement, and the outside directors purportedly are pursuing coverage from the excess insurers, the payment terms of the settlement confirms the observation by industry experts that a large portion of the settlement will be funded out of one or more directors' personal assets.

Peregrine Systems Litigation

In 2002, plaintiffs filed securities class action lawsuits against Peregrine, certain Peregrine officers and directors, and various other defendants.

The outside directors settled these claims for $55.95 million. Like prior settlements involving personal contributions from outside directors, such as the Just for Feet, Enron, and WorldCom litigations, the Peregrine case featured the following bad facts:

a bankrupt company

insider trading allegations

a massive accounting restatement

officers who pleaded guilty to criminal charges

Why Peregrine's D&O Coverage Proved Inadequate To Fully Cover Losses of The Outside Directors

Bankruptcy court records reveal that Peregrine Systems Inc. maintained $20 million of D&O insurance: $10 million primary, and two $5 million excess policies. The total $20 million limits, in the face of massive litigation, proved insufficient to meet all of the insureds' defense and settlement costs.

Court records also show that Peregrine's primary policy did not contain application "severability" or other non-rescission wording to protect innocent directors. Therefore, the D&O insurers sought to rescind coverage as to all named insureds under the policies, rather than just the officer defendants who pleaded guilty to criminal charges.

Steps You Can Take To Avoid Personal Contribution by Outside Directors In The Event of Claims

Insert "severability" provisions to carve back coverage for outside directors in the event officer conduct triggers fraud, criminal conduct, or illegal profit exclusions. These exclusions should include a "final adjudication" requirement, ensuring they are not triggered until after a court determines that insured persons engaged in the excluded conduct.

Make sure that "priority of payment" provisions are included to ensure that Side A director losses are paid before the policy pays for covered losses of the company, either through its indemnity obligation under Side B or for covered Side C claims directly against the company.

Provide adequate and "non-rescindable" Side-A only excess "difference in conditions" (DIC) coverage to insure directors have sufficient insurance in the event indemnification is unavailable from the company, the underlying limits are eroded by company claims, or the underlying insurers deny coverage to the directors. Include in the Side A policies automatic "reinstatement of limits" for outside directors only.

Consider purchasing independent director liability (IDL) policies that can apply to a single non-officer director, or group of such directors.

Consult experienced coverage counsel when negotiating your company's D&O coverage.

This article provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice.

Ms Meghan Magruder

King & Spalding

1180 Peachtree Street, NE

Atlanta

GA

30309-3521

UNITED STATES

E-mail: [e-mail]

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