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Directors and Officers (D&O) Policies: Insuring Books and Records Inspection Claims

By Melissa R. Selke, RPLU, CIC, CRM, MLIS

While they are not new, Section 220 demands are on the rise. Often, they are a precursor to derivative investigations and class action lawsuits against the company, its directors and its officers. Are you prepared? Are you insured?

What Is a Section 220 Demand?
According to Delaware General Corporation Law (DGCL) Section 220, stockholders of companies incorporated in this state are entitled to request in writing an inspection of a company’s books and records to obtain additional information about the company. Books and records include but are not limited to the corporation’s stock ledger and list of shareholders. Other states, such as Florida, Michigan and New York, have similar laws.

The person making the Section 220 demand must prove that he or she is a stockholder of the company and must have “a purpose reasonably related to such person’s interest as a stockholder” for making the request. Typically, a stockholder wants to inspect the books and records in an attempt either to value stock (in the case of privately held companies) or to investigate corporate mismanagement or alleged wrongdoing. The purpose cannot be contrary to the interests of the corporation.

A company has five days to respond to a Section 220 demand, or the request will be deemed rejected. The stockholder can then sue to force the company to allow the inspection.

D&O Policy Language to Address Section 220 Demand Costs
A company will incur legal fees and other expenses in responding to a Section 220 demand. If the corporation’s D&O liability policy is amended to include the right language, these costs can be covered by insurance. There are two ways to do this.

The first way is to include books and records inspection costs in the definition of derivative investigation costs—costs already covered by the policy. Derivative investigation costs are in most cases subject to a $250,000 sublimit, so the coverage for books and records costs is also subject to the sublimit. Most primary D&O insurers currently take this approach by adding language to the existing policy.

The second way books and records demand costs may be covered by a D&O policy is by amending the definition of defense costs to include the costs associated with a books and records request, when they are relevant to a securities claim brought as a derivative action. Because the costs are not tied to derivative investigation costs, the full policy limit—not just the sublimit—is available to cover books and records costs.

This approach, however, could be detrimental to the company: The books and records demand will typically occur prior to a securities claim or derivative action—if one is even brought at all. In addition, the company would be responsible for paying its self-insured retention amount, which does not apply to the derivative investigative costs coverage sublimit.

Conceptually the best way to address this risk would be to amend the definition of claim to specifically include these costs. However, insurers have been reluctant to do so. This is likely because a books and records demand could be entirely unrelated to a traditional D&O claim, such as securities litigation.

Next Steps
Before you are faced with addressing a books and records demand, review your D&O policy with your insurance professional. Together, determine how coverage is being afforded or whether your policy needs to be amended to add this important coverage. Avoid the uncertainty that comes with having to negotiate coverage at the time of a demand.

If you have any questions regarding D&O insurance or need assistance, contact a Hylant expert.