Del. Passes Legislation Approving Use of Captive Insurance for Non-Indemnifiable D&O Loss

Delaware Business Court Insider

Large companies with strong financial conditions may opt to forgo purchasing Side B (coverage for claims made against directors or officers that are indemnified by the company) and Side C (coverage for claims made directly against a company) D&O coverages in favor of funding out-of-pocket losses they can legally indemnify. Corporations may prefer to pay these costs rather than face a rock-hard D&O insurance market and the seemingly “deny first and ask questions later” attitude of many claims handlers nowadays, or go through the hassle of creating a trust or other alternative arrangement for indemnification.

However, not all losses are legally indemnifiable. For example, pursuant to Delaware General Corporation Law, Section 145(b), corporations cannot provide indemnification to its directors or officers for breach of fiduciary duty suits brought derivatively. The frequent solution for even the largest companies that would otherwise be able to self-fund has been to purchase Side A D&O policies that provide coverage to these individuals for non-indemnifiable, but insurable, loss without the need to first satisfy any retention.

So, what’s the problem, you may ask? In the past several years, the cost of standalone Side A D&O policies has skyrocketed.

Delaware Legislation Amends Section 145

On Jan. 27, 2022, the Delaware General Assembly passed Senate Bill No. 203 amending the Delaware General Corporation Law, Section 145 (Section 145) to clarify that the term “insurance” as used in Section 145 includes captive insurance. Meaning, Delaware permits its companies to self-fund captive insurance for the purpose of paying non-indemnifiable loss and obviating the need to purchase Side A insurance through the commercial market.

To the extent that many large companies that are able to afford capitalizing a captive on their own or through a credit facility take advantage of the flexibility in Section 145 underscored by the General Assembly’s recent amendment, it may result in lowering the cost of commercial Side A insurance for those companies that are not well-positioned for using a captive to insure this risk.

The amendment notes that a Delaware corporation electing to use captive insurance for its non-indemnifiable losses must satisfy certain requirements:

  • The captive insurance shall include what are commonly referred to—and detailed in Section 145(g)—as conduct exclusions, if such alleged conduct is established by a final, non-appealable adjudication in the underlying proceeding;
  • Payment from the captive insurance to a current director or officer shall be determined by a third-party administrator; and
  • The corporation shall give notice to its shareholders prior to payment from the captive insurance to dismiss or settle a claim, if notice is otherwise required to dismiss or settle a claim.

The amendment also makes clear that any corporation using captive insurance in this regard will not subject the corporation to the insurance provisions of the Delaware code. It also notes that captive insurance is broader than just the commonly referred to captive program and includes other alternative means by which a company may transfer its non-indemnifiable risk including fronting and reinsurance arrangements.  The amendment states that if using a captive insurer, it may be organized and licensed in compliance with the laws of any jurisdiction.

The Amendment Clarifies Section 145(g)’s Breadth

Prior to the amendment, Section 145(g) permitted Delaware corporations to “purchase and maintain insurance” to protect its directors, officers, and other indemnified persons “against any liability asserted against such person … whether or not the corporation would have the power to indemnify such person against such liability.” Meaning, pursuant to Section 145, companies have been permitted to use all forms of insurance, including but not limited to traditional D&O insurance including Side A protection for non-indemnifiable loss.

There is no reason to think that captive insurance would not fall within Section 145’s use of the term “insurance” prior to the amendment’s clarification. To the contrary, Delaware’s existing Captive Insurance Program highlights that Delaware recognized the formation and use of captives, including for D&O insurance, for more than 15 years and beginning at least in 2005 when the Delaware General Assembly modernized the state’s captive laws.

In sum, this amendment clarifies the flexibility enjoyed by Delaware corporations that can financially afford to insure their non-indemnifiable loss by way of alternative means of insurance, such as captives. It may have the added benefits of underscoring this flexibility to companies seeking an alternative approach, and lowering the cost of traditional Side A policies for everyone else.

“Del. Passes Legislation Approving Use of Captive Insurance for Non-Indemnifiable D&O Loss,” by Jared Zola was published in Delaware Business Court Insider on February 10, 2022. It was also published in Insurance Coverage Law Center on February 11, 2022.

Reprinted with permission from the February 10, 2022, edition of Delaware Business Court Insider © 2022 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.