Mind the Gap: Avoiding the Pitfalls of Presumptive Idemnification

When considering whether to serve as a fiduciary of a company, prospective officers and directors need to look beyond D&O liability insurance. Prospective directors and officers also need to be aware of any limitations that exist in the indemnification provided by the company. Seemingly innocuous deviations in language can lead to profound economic impact for officers and directors in the event of a claim.

If the indemnification that a company provides stops short of giving the maximum protection permissible under law, the company’s directors and officers may find themselves facing a large, uninsured loss at claim time. That is because many D&O insurance policies contain “presumptive indemnification” clauses.

These clauses state that, for purposes of providing coverage under the policy, it will be assumed that the company will indemnify its directors and officers to the “fullest extent permitted by law”. In other words, it does not matter what the company actually does. When a claim is made, the insurance only covers claims relating to matters beyond those for which a director could legally have been indemnified, leaving the directors exposed to personal liability beyond that.

Fortunately, under most D&O policies, the presumptive indemnification provision is not an “all or nothing” proposition. But there is still significant risk associated with these provisions. Most companies purchase D&O insurance with self-insured retentions, which operate like a deductible that only applies to losses where the insurance company reimburses the insured for indemnification that it provided to its directors and officers. Although the retention does not typically apply in the case where directors and officers are not indemnified by the company, the “presumptive indemnification” provision often states that if a company is legally permitted to indemnify a director or officer but fails to do so for any reason other than financial insolvency, then the large company retention applies to the claim. Thus, the policy provides coverage, but only after satisfaction of the retention. Given that these retentions are often very substantial, the effect may be to eviscerate the intended coverage for directors and officers.