Unraveling Allocation Challenges with D&O Insurance Amid Legal Battles

A recent article by Risk Management Magazine looks at the complexities of Directors and Officers (D&O) insurance, using the legal proceedings involving Sam Bankman-Fried and FTX as a focal point. Bankman-Fried’s legal battles, including a lawsuit against a D&O insurance company, underscore the critical question of how funds should be allocated when multiple policyholders face claims exceeding available liability limits.

Three primary rules governing fund distribution are discussed: the first judgment rule, which prioritizes those with judgments against the insurance claimant; the first to settle rule, predominant in many jurisdictions, allowing selective settlements regardless of known or resolved claims, potentially depleting policy limits; and equitable allocation, followed by some states, dividing limits based on relative legal exposure and requiring resolution of all claims before payouts.

The article emphasizes the shift towards the first-to-settle rule in various jurisdictions, highlighting its efficiency while acknowledging the fairness concerns for co-defendants still entangled in litigation. Notably, New York and Texas permit insurers to settle on a first-come basis if acting in good faith, recognizing the benefits of prompt reporting of claims.

The concept of insurance companies filing interpleader actions is introduced as a strategic mechanism, allowing them to involve multiple claimants in a single proceeding and seek court guidance on fund allocation. The choice of which rule to apply depends on the policyholder’s priorities, whether favoring immediate settlement or preserving coverage for future settlements or defense costs.

Companies need to secure sufficient D&O insurance limits to ensure comprehensive coverage for directors, officers, and the company in the face of legal challenges. The evolving dynamics and rules in D&O insurance underscore the complexity of financial protection in the corporate world, requiring careful consideration and strategic decision-making.