Most insurance policies are sold on a take-it-or-leave-it basis, leaving policyholders with little opportunity to proactively maximize coverage. Directors and officers insurance may be an exception to this rule, but only if policyholders understand the bargaining power that comes with paying the large premiums they have to offer. Now more than ever, D&O coverage can be a critical risk transfer mechanism for businesses seeking protection from the evolving maze of common law statutes, regulations and rules. Whether policyholders are negotiating next year’s policy or pursuing coverage under their current policy, they need to know how to recognize weak points in standard language. This article discusses a few examples where language that may seem standardized can, with the right knowledge base, be shaped to the benefit of the insured.
Definition of “securities claim”
While the name suggests that D&O insurance is a tool to protect directors and officers from liability, modern D&O coverage can also provide valuable protection for the business itself, through so-called “Side C” coverage. (sides A and B cover the directors and officers or the company in its capacity as indemnificator of the directors and officers). Side C coverage is often limited to “claims of title,” so policyholders need to understand exactly what a claim of title is. Unsurprisingly, the scope of the term has been a constant source of dispute between policyholders and their A&D insurers. The good news for policyholders is that not all definitions of securities claims are created equal.
For example, some courts have interpreted a common definition of securities claim (which requires an alleged “breach” of a “regulation, statute or rule governing securities”) as not encompassing common law claims such as breach of fiduciary duty. However, other D&O policies available on the market do not require the law in question to be “securities regulating”. A seemingly minor distinction like this can be the difference between covering tens of millions of dollars in defense costs and outright denial. As such, the devil is in the details when negotiating a policy renewal or facing the prospect of litigation over a pre-existing policy.
Even when an insured files an eligible claim, there are still exclusions to navigate. Many exclusions are straightforward, but others are less so. The so-called “conduct” exclusion is intended to exclude coverage for certain types of wrongdoing. Like the definitions of securities claims, not all conduct exclusions are created equal. Consider two exclusions, from actual policies, excluding coverage for: “willful violations of any law or regulation”; and “deliberately fraudulent or criminal acts”. Policy (2) is clearly narrower and therefore more policyholder friendly. Most of the underlying cases allege a violation of a “law or regulation”, and often a willful violation, so a court could read policy (1) to encompass a wide range of otherwise covered claims . This is a perfect example of where a savvy insured can recognize and leverage the power of their premium, rather than simply accepting the policy form offered by the insurer.
And there are other ways that driving exclusions vary significantly. As an example, any well-negotiated conduct exclusion should include an “exception” for the policyholder’s attorney’s fees in the underlying action – policyholders should benefit from the presumption of innocence (and a funded defense) unless and until it is determined that they in fact committed the acts charged. The ability to maximize the likelihood of hedging issues What constitutes such a finding. Consider two actual provisions, in which the exclusion applies if there is: a “finding of fact” that the conduct took place; or a “final and binding decision in any underlying action”. Policy (2) is clearly more favorable – it is only when the underlying lawsuit is adjudicated in court and the legal process is exhausted that the exclusion can potentially apply. Meanwhile, insurers may claim that the exclusion in policy (1) is activated by a trial court decision that was later overturned, or even by a finding of fact in a lawsuit brought by the A&D insurer itself. Again, the devil is in the details – astute policyholders need to be aware of this landscape when negotiating coverage or contesting a denial of claim.
Even if the policyholder can establish an eligible claim and the absence of any applicable exclusions, the insurer can still try to use other tools to avoid or limit coverage. A tricky example is that of allocation. The underlying litigation may allege uncovered claims alongside covered claims (whether because they are against an uninsured person the person or because they are against an insured person for uninsured reasons conduct). Most A&D policies include “breakdown” provisions for this situation but, unsurprisingly, they are not all created equal. Particularly where the underlying defense costs cannot be clearly allocated between covered and uncovered issues or parties, litigation is likely.
Particularly unfavorable provisions allow the insurer to decide which claims are covered and to allocate defense costs as it sees fit. Consider a situation where the insurer decides that 90% of the claims are not covered and that the lawsuit will cost $25 million to defend: the impact of the apportionment is huge. And even if the policyholder can convince a court that a larger percentage of claims are covered, it could cost the policyholder millions in additional legal fees just to make it happen.
The good news is that insurer-friendly allocation language can often be changed through negotiation. For example, policyholders may request language providing that in the event of a dispute over apportionment, the insurer will advance 100% of defense costs subject to subsequent determination of relative liability. Where the underlying stock is resolved by unaffected settlement (as are the majority), the insurer must decide whether it is worth taking action against the policyholder just to – potentially – recover a certain percentage of the previously advanced defense costs.
Notice clauses are another example of conditions that can jeopardize coverage even after the policyholder has made an otherwise covered claim. Historically, late notice from an insured could be fatal to coverage. More recently, many states have modernized their laws to require the insurer to prove that the notice was late. and that he has caused damage to the insurer in one way or another. Even still, there continues to be a steady stream of late notice litigation, particularly in the context of claims-based policies that may have stricter notice rules. Sophisticated D&O insurers and policyholders have begun to address this uncertainty through policy language defining what is and is not “harm”. Consider two actual provisions of the policy: coverage is excluded if the late notice “has actually and materially prejudiced the rights of the insurer”; or if the underlying action ends before notification, there is an “irrebuttable presumption of harm”. Policy (2) may be narrower, but it provides greater certainty and, by implication, gives the policyholder a tool to defeat the insurer’s prejudice argument if notice is given before the end of the underlying action.
D&O policies may initially appear to be standardized, but a knowledgeable policyholder can recognize opportunities to negotiate more favorable language. Whether discussing next year’s policy or seeking coverage under a current policy, knowing this ever-changing landscape can help policyholders maximize their chances of recovery.
Nicholas R. Maxwell is advice and Amber N. Morris is a partner at the law firm Cohen Ziffer Frenchman & McKenna in New York. They represent a wide range of corporate policyholders in high-stakes insurance coverage disputes.