Indemnification and Advancement: Don’t Forget The D&O Insurance

| William A. Schreiner, Jr.

My colleague Ellen Marcus has written a great piece about Sergey Aleynikov, a vice president and computer programmer at Goldman Sachs who allegedly stole its proprietary computer code as he was heading out the door to work at a competitor.  Aleynikov was indicted and convicted for breaking Federal law when he did so – but a Federal appellate court overturned his conviction.  Now, though, he’s about to face New York State charges for the same alleged theft.  Aleynikov has sued Goldman Sachs, arguing the investment bank has an obligation to reimburse him for the legal fees he’s already incurred (indemnification) and pay his new legal bills as he fights the state charges (advancement).    

Ellen noted in her piece that the Aleynikov story “illustrates key concepts about indemnification and advancement.”  There is, though, another piece of this puzzle that the Aleynikov matter also illustrates.    

As an insurance coverage lawyer, I suppose I could be offended that Ellen didn’t raise the possibility Aleynikov can be indemnified and have his defense fees advanced by Goldman Sachs’ directors and officers’ (D&O) insurer (or insurers) if the bank is unwilling or unable to do so.  But I’m used to this: insurance is often overlooked in these sorts of things, as is the help insurance coverage lawyers can provide.  Maybe people in my industry need more than a green lizard or a retro and perpetually cheerful saleslady to promote insurance.  As it stands now, though, you’ve got me to explain the concept. 

There’s a lot to say about this topic, but for today I’m going to: 1) write about how D&O works generally; and 2) write about why D&O insurance likely won’t help Aleynikov get his defense bills paid in this case.  Number 2 is subject to an important caveat: D&O insurance policies are not standard form policies – they are individually negotiated between companies and insurers, and no two policies are going to be identical.  I haven’t seen Goldman’s policies, but as set out below some basic guesswork can lead me to conclude he would have an uphill struggle to have his defense bills paid by Goldman’s D&O insurers.

I’ll expand on these topics in future posts.  There’s a lot I could say on them, but today, I’ll keep it as short and general as possible.  Not everyone agrees with these folks about insurance.       

Let’s start with what D&O insurance does as a general matter.  Whenever executives talk about indemnification or advancement, D&O insurance should be a part of that discussion.  A basic D&O policy covers an individual director or officer for “Loss” (including defense costs, judgments or settlements) arising from a “claim” (usually a demand or lawsuit) arising out of a “Wrongful Act” (often defined as a “breach of duty, neglect, error, misstatement, misleading statement, or omission [by the insured] committed in his or her capacity as such.”).  This is usually called “Coverage A” in a D&O policy, and it indemnifies and advances defense costs to the director or officer when her company can’t do so (maybe because it’s bankrupt) or won’t do so (if the alleged wrongdoing falls outside of the company’s bylaws or is otherwise not permitted by law). 

Unlike most other insurance policies, D&O policies give an individual executive charged with a crime or sued for an intentional act the benefit of the doubt: they advance defense costs against a criminal allegation up until it’s proven (usually by a guilty plea or conviction) that the executive committed the crime or the intentional act.  That coverage is unique because it turns a cornerstone principle of insurance – “fortuity,” or the notion that insurance only covers pure accidents, not intentional conduct – on its head. 

Beyond this “Coverage A” for individuals, most D&O policies include a “Coverage B” that reimburses the company when the company indemnifies its directors and officers for the same types of claims and “Wrongful Acts.”  Think of it this way: under Coverage A, the insurer pays the defense bills for director and officer directly.  Under “B,” the company pays them, and then turns around to the insurer to get its money back.  Either way, the insurer pays for the defense bills and any ultimate judgment or settlement that is covered. 

This is making a long story very short.  There are other coverages available in D&O policies, and all sorts of variations with the limits of liability that can apply. 

Significantly, the key words used in these policies varies greatly.  Some D&O policies limit the individuals covered to the highest ranking directors and officers of the company (these policies were initially created, after all, to get people to serve on corporate boards without fear of liability).  Other policies extend the coverage for individuals down to any managerial employee. 

This brings us to the issue of whether Aleynikov would be covered under Goldman’s D&O policies, if we could review copies of them.  First of all, we’d need to figure out whether he’s an insured – banks have lots of “Vice Presidents,” and a policy could be drafted to either include them all, or limit coverage only to the board and C-suite executives, quite easily.  Next, we’d have to consider whether stealing computer code as you are leaving the company counts as a “Wrongful Act” that would trigger coverage, which the covered officer has to “commit in [his] capacity as” an officer.  Aleynikov would have an uphill argument to convince an insurer (and, likely, a court when the insurer balks at his claim) that the allegations against him of stealing computer code were acts in his capacity as an officer.  See, for instance, Hoffman v. Benson, where a Minnesota appellate court held that a D&O policy didn’t cover the owner of a construction company when an employee sued him after he was injured during a ski trip at a business convention: “There is no suggestion that the skiing vacation was necessary or integral to running the construction business.”   

Of course, there may also be exclusions in the policy that could apply.  So, even if Aleynikov could establish that he was a covered person under the policy, and that stealing computer code was a covered “Wrongful Act,” the insurer could still decline to provide coverage.  An exclusion that comes to mind is the one for intentional acts: as discussed above, D&O policies advance defense costs for criminal allegations up until (and if) it is proven that the insured committed the crime.  In this case, the insurer might point to that exclusion and say Aleynikov was convicted of a crime – but the Second Circuit’s opinion reversing the conviction and the trial court’s judgment of acquittal would likely knock out the insurer’s argument.  This issue could be further complicated, though, by Aleynikov’s apparent willingness to admit that his conduct violated Goldman’s confidentiality rules, even if not the criminal law. 

What’s really significant is that Aleynikov didn’t name an insurer as a defendant in his suit against Goldman.  If he thought he had a shot at getting coverage, as a practical matter he likely would have brought the insurer in.  Clearly, the insurer hasn’t agreed to cover him: Aleynikov alleges in his complaint that he is out of money and relying on the charity of his friends. 

Of course, all of this is only to illustrate the possible issues surrounding coverage.  We don’t know what Goldman’s policies say, but the facts we do know can lead us to some supportable guesses. 

I’ll be writing more on these issues in the future.  The takeaway for today, though, is that when a company’s executives are thinking about indemnification or advancement under bylaws or statutes, they should also be looking at their company’s D&O insurance policies to get a complete picture of what benefits are available to them.