Corporate directors and officers have a long list of things that can keep them up at night. Personal liability for civil fines and penalties arising out of negligence should not be one of them. Companies often must or will agree to indemnify their directors and officers for claims arising from negligent conduct and for civil fines and penalties levied against them, and this is a critical line of defense against unwanted personal liability arising out of an individual’s service to the company. Even so, the company may be unable to fulfill its responsibilities, for instance because of insolvency. Also possible: a government regulator may fine or penalize corporate directors and officers personally for the acts of the company if there are no company assets to pursue. Corporate or contractual indemnity for directors and officers therefore may be insufficient to protect against personal liability. A strong directors’ and officers’ liability (“D&O”) insurance program, which includes comprehensive coverage for non-indemnifiable claims against corporate directors and officers (“Side A” coverage), and which may also include an excess Side A-only/ Difference-in-Conditions (“DIC”) policy, may provide a critical backstop to personal liability in the event the company is unable or unwilling to pay or indemnify for negligence claims and civil fines and penalties.
A recent case from the U.S. Court of Appeals for the Federal Circuit highlights the pressures and potential liabilities faced by officers and directors, particularly in heavily regulated industries. In United States v. Trek Leather, Inc., 767 F.3d 1288 (Fed. Cir. 2014) (en banc), a company imported men’s suits manufactured using cloth provided by the importer at reduced cost. When importing the suits, the company’s president failed to convey this cost reduction to the customs brokerage, which in turn reported an artificially low value to U.S. Customs. As a result, the company paid too little in customs duties. The government sued both the company and its president, seeking civil penalties under a statute providing that “no person by fraud, gross negligence, or negligence” may “enter, introduce or attempt to introduce any merchandise into the United States by means of” misrepresentations or omissions. Although the government did not seek to pierce the corporate veil or establish fraud, the trial court found both the company and its president liable on a theory of gross negligence.
The Federal Circuit upheld the trial court’s judgment, essentially holding that corporate officers may be held personally liable to pay a civil customs penalty without the government having to pierce the corporate veil or prove fraudulent intent, even when the officers themselves do not act in a manner that violates the customs statute. All that is required to impose personal liability, the court reasoned, is for the officer or his or her agent to take some action that “introduce[s]” goods into the customs system. Thus, according to the court, the company's president could be held personally liable for the civil customs penalty where he and his agents were grossly negligent in forwarding pricing information from the manufacturer to the company's customs broker. In the wake of Trek Leather, a Department of Justice lawyer speaking at a conference stated that the decision will not result in an “open season” on corporate officers. That said, the Justice Department's lawyer also stated that Trek Leather simply reaffirms a long-standing government policy - a statement that should be cold comfort to corporate officers.
For directors and officers facing similar risks, it is thus important to ensure that the company’s D&O insurance program includes both coverage for civil fines and penalties (to the extent insurable under applicable law), and Side A coverage that likewise extends to civil fines and penalties to the extent insurable under applicable law. In addition, a comprehensive DIC policy may provide both excess Side A D&O coverage, and may also “drop down” and serve as primary Side A D&O coverage in the event insurable civil fines and penalties assessed against directors and officers cannot be indemnified and are otherwise excluded under the primary D&O policy.
Don’t wait to determine whether your officers and directors are covered. Review your D&O insurance program to ensure that your directors and officers will not be left personally on the hook for the company’s potential liabilities. If your company’s D&O insurance program lacks this coverage, request that your carriers extend coverage for civil fines and penalties levied against directors and officers at the company’s next renewal or placement. If your company is inheriting or potentially inheriting liabilities through a transaction or merger, assess and address these risks during negotiations, and put in place (or require the seller to put in place) adequate indemnification and insurance protections to shield directors and officers from personal liability. Reed Smith’s Insurance Recovery Group can help your company navigate these issues. Please contact the authors of this Alert or any Reed Smith Insurance Recovery Group attorney with whom you routinely work with any questions.
As the insurance maxim goes, you’ll be glad you have it when you need it.
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Client Alert 2014-321