Delaware Approves Captive Use for D&O

On February 3, 2022, Delaware Governor John Carney signed into law Senate Bill 203, which enables corporations to purchase and maintain directors and officers (D&O) liability insurance through captive insurance companies. This law applies to any corporation domiciled in Delaware.

Delaware is traditionally thought of as a pro-business state, and as such many companies have chosen to incorporate there. Because this bill provides for a potential alternative D&O insurance solution, it has generated significant interest.

In order to understand the changes Senate Bill 203 represents, we need to understand the traditional approach for insuring D&O.

Traditional D&O Insurance

Traditionally, D&O insurance has three basic insuring provisions:

• Side A protects the directors and officers for claims against them for which the corporation is either legally prohibited from providing indemnification or the corporation is financially unable to do so.
• Side B also protects the directors and officers for claims against them for which the corporation is legally required to and has the financial ability to indemnify them.
• Side C protects the corporation as an entity.

Section 145(g) of the Delaware General Corporation Law permits Delaware corporations to purchase D&O insurance for directors, officers and other indemnified persons for liabilities asserted against them regardless of whether the corporations would be able to indemnify them. This has been interpreted to permit companies to buy traditional coverage that insures Sides A, B and C.

Prior to Senate Bill 203, Section 145(g) generally meant that Delaware directors and officers had to rely on either traditional D&O insurance or, in its absence, on indemnification provided by their corporations. This meant that the only way to protect Side A liability was through traditional insurance. While corporations have always been able to insure Sides B and C liability through a captive, the vast majority of companies opted for the traditional approach, by purchasing insurance from a third party insurer which included Side A.

Key Provisions of Senate Bill 203

Senate Bill 203 now explicitly permits corporations to utilize captives to insure Side A in addition to Sides B and C. The key provisions of Senate Bill 203 include:

• Corporations may provide insurance through a wholly owned subsidiary (e.g, a captive) funded by the corporation.
• The captive subsidiary can be licensed under the laws of any state or other jurisdiction.
• The captive subsidiary may indemnify directors and officers whether or not the corporations would have the ability to indemnify them.

Limitations and Considerations

Senate Bill 203 includes several limitations. Most notably, Section 145(g)(1) requires that captive insurance must contain several exclusions mirroring equivalent provisions in third-party D&O insurance policies including personal conduct exclusions for illegal personal profit, deliberate criminal or fraudulent acts, or any knowing violation of law.

Section 145(g)(1) requires that any payment made by a captive must be determined by an independent claims administrator, by a majority of directors not a party to the proceeding, independent counsel or the shareholders.

Utilization of captives generally require significant capital infusions, which may make them less attractive than traditional insurance. Though captives are flexible and can be created to cover a variety of losses, including D&O, a captive is not a short-term solution. It should be considered a long-term, strategic option to align business goals with insurance solutions.

It should be noted that, while Senate Bill 203 has generated much discussion, it is not the first state to permit captives to fully insure D&O risks. For example, Indiana-domiciled companies have been able to utilize captives in this manner for some time but largely have continued to purchase traditional D&O insurance instead.