Important Update for Delaware Incorporated Companies
Feb 2, 2022
Last week, the Delaware General Assembly passed a bill that, when signed by the Governor, will expand the risk management tools Delaware corporations can use to transfer the risks their directors and officers have as a result of their service. Let’s break down what we know from the basics to the complicated.
As most of you are aware, directors and officers have fiduciary duties which, if breached, can result in personal liability. For that reason, these individuals need and deserve adequate protections so that in the event they are alleged to have breached their fiduciary duties, the company they serve will indemnify them. Indemnification comes in a number of forms including statutory grants. In general, Delaware statutory law requires indemnification of directors and officers in most instances, and permits it in others. What Delaware law does not allow, however, is the indemnification of individuals for judgments and settlements of derivative actions (actions brought by shareholders in the name of the company which request that the company itself be made whole by individuals because they breached their fiduciary duties). Up until last week, the only way that companies could transfer this derivative-related risk was via the purchase of directors and officers liability insurance from third party insurers.
The amendment to Delaware law expanded the meaning of insurance to “…include any insurance provided directly or indirectly (including pursuant to any fronting or reinsurance arrangement) by or through a captive insurance company organized and licensed in compliance with the laws of any jurisdiction”. The text of the legislation specifies that the captive cannot respond in the event of a final adjudication in the underlying action of illegal personal profit and/or deliberate fraudulent or criminal conduct and/or intentional violation of law (basically a tightly worded personal conduct exclusion that we commonly see in directors and officers liability policies). Additionally, the text requires that a third-party administrator be involved in the payment of proceeds and that, in certain situations, the company’s stockholders be informed prior to any payment from the captive.
CAC is putting together a webinar on this topic in the coming weeks, but for now, we think it is important to keep in mind the following:
- Delaware’s new law is not unique. Other states, including but not limited to Texas, Pennsylvania and Nevada, have already enacted laws that permit companies incorporated in those states to transfer side A derivative losses that appear circular in nature to captives and/or other risk transfer mechanisms.
- The change in law is NOT a change in the strict indemnification guardrails that exist for Delaware companies. As many of you know, some states already allow for the indemnification by the company of derivative settlements and/or judgments. Delaware does not.
- Although Delaware’s law basically says “OK, captives can be used for judgements and settlements in derivative actions,” it does not say that all A side loss can cleanly be paid by a captive. The law does not change the fact that an analysis must be performed to ensure that the captive itself is bankruptcy remote and not an insolvency risk.
Senior Vice President & Claims Counsel