As discussed in Part I of this series, financial instability and uncertainty continue to be present in today's business environment. The past 18 months have seen a dramatic increase in litigation filings, bankruptcies, as well as regulatory and administrative investigations and proceedings. While Part I discussed various types of common claims and the insurance coverage potentially available for each, Part II in this series outlines what companies can do now to help ensure future claims are covered by insurance.
Companies renewing their policies or changing insurers should consider not only the types of coverage, premium amounts, retentions and limits, but also the solvency of their insurers and the specific policy language available. Coverage provisions can often be broadened and exclusions narrowed through targeted requests and negotiation. In addition, special considerations exist in providing notice and in protecting insurance assets in case of bankruptcy, and coverage can be negotiated to fit the policyholder's needs and expectations.
Key Policy Provisions
In light of the current economic climate, it is critical that policyholders consider not only premiums, limits and retentions, but also that they review available policy language with their brokers and legal advisors. As discussed in Part I, many typical claims arising from the financial downturn and consequent market and credit concerns can be covered by Directors' and Officers' ("D&O"), Errors and Omissions ("E&O"), Employment Practices Liability ("EPL") or Investment Advisors Professional Liability insurance policies. Policyholders and their advisors can often negotiate enhancements to each of these lines of coverage. Policy provisions that insureds should pay particular attention to include:
• "Claims" covered . Since most D&O, E&O, and EPL policies are written on a "claims-made" basis, covering "claims" made during the policy period, the definition of what constitutes a claim is important. While all policies will include lawsuits and written demands for money damages, many insurers will agree to also cover costs incurred as a result of regulatory and administrative proceedings, certain civil and criminal investigations, demands for non-monetary relief, and even Wells notices or other preliminary actions taken by regulatory bodies. In addition, since many D&O policies only cover the company for "securities claims," this definition too should be reviewed. Broader definitions will include not only claims arising from federal securities laws (such as Rule 10b-5), but state equivalents and common law claims.
• The Definition of "Loss." Policyholders should ensure that the definition of Loss includes, for example, punitive, multiplied and exemplary damages where allowable by law, and that the law used to determine insurability is the "most favorable" to the insured. In addition, many policies contain buried exclusions limiting what is covered.For example, provisions excluding "amounts uninsurable as a matter of law" may appear innocuous. However, insurers may argue that these provisions restrict coverage for actions brought under Section 11 and 12 of the Securities Act of 1933. Many insurers, if requested, will add an endorsement expressly covering Section 11 and 12 claims. Further, while many policy forms exclude civil fines or penalties, some insurers will cover such fines or penalties that are imposed under the Foreign Corrupt Practices Act, imposed outside the U.S. and/or imposed on individual insureds and covered under "side A" non-indemnifiable coverage.
• Conduct Exclusions. Conduct exclusions generally provide that no coverage is available for loss arising out of fraud, dishonesty, advantage to which the insured was not entitled, or personal profit. These should be limited to apply only after final adjudications, so that defense costs and settlements are covered. These and other exclusions should also contain a "severability" clause ensuring that the bad acts of one individual insured will not bar coverage for other "innocent"insureds.
• Defense Provisions. Coverage that gives the insurer both a right and "duty" to defend may be a double-edged sword. While the duty to defend provides the insured with the benefit of obligating the insurer to defend the entire claim if any of the allegations are even "potentially" covered, it may also give the insurer the right to choose defense counsel and control the policyholder's defense.
• Settlement Approval Provisions and Hammer Provisions. Policies should allow the insureds maximum flexibility in making their own settlement decisions. While many policies require insurer approval of settlements, some allow policyholders to reject settlement offers that the insurer would have otherwise accepted. However, if the policyholder rejects a settlement offer, the insurer may often cap its liability at the amount of the settlement offer.
• Allocation Provisions. Allocation provisions dealing with covered and non-covered claims or parties can have a significant impact on the amount of coverage for defense costs and settlements. For example, where a single claim includes as defendants insured directors and officers as well as uninsured employees, some policies may allocate based on the "relative financial and legal exposures" of the defendants. This standard is the minority rule in the law and often benefits the insurer. Policyholders can seek to delete this standard from the policy. In absence of such a provision, many courts would instead impose the "larger settlement rule," requiring the insurer to prove that the inclusion of the uninsured employees as defendants made any settlement more expensive. This is often a difficult burden to meet.
• Non-Rescindable Coverage and Severability of Application. Policyholders should also explore whether their D&O coverage can be written on a non-rescindable basis, meaning that even if there is an alleged misrepresentation or omission in the application process, the insurance company cannot void the policy, at least for "innocent" insureds who did not know of the facts or omissions. In any event, companies should look closely for any statements that the insured is "relying" on the application, and the definition of application itself. Often, insurers will define the application to include SEC filings, sometimes for several years prior. These should be limited as much as possible. Finally, the application should be "severable," such that knowledge of one insured is not imputed to any others. Knowledge of only top executives, such as CEO, CFO and Chairman, should be imputed to the company itself.
• Excess Insurance . Excess policies may contain additional exclusions to coverage and may not be consistent with the primary policy. Brokers and risk managers can assure that seamless coverage exists up the entire tower of coverage.
Solvency Risks And Bankruptcy-Related Actions
At renewal time, policyholders can also take steps to protect themselves against problems that may arise if their insurers become insolvent or the insured companies themselves are subject to bankruptcy proceedings. For example, some excess policies are designed to drop down to cover an insolvent carrier below it. Policyholders may also strategically structure their excess insurance programs to reduce their risks by including smaller coverage layers and greater numbers of carriers in each layer.
Policyholders should be aware that bankruptcy cases present an array of issues that can immensely complicate insurance coverage concerns. For example, D&O policy proceeds may become tied up in bankruptcy for years pending a determination regarding whether the policy is an asset of the bankrupt estate. In order to foreclose this possibility, policies can either provide no coverage to the entity itself or specify that the individual insureds have first access to the proceeds. "Side A Only" D&O coverage, for example, provides coverage for directors and officers separate from coverage for the company. Alternatively, policies can include "order of payments" clauses to require proceeds be paid in full, first to individual natural person insureds, then to the company for indemnity payments to individuals, and finally to cover payment for claims against the company. In the event that the policy limits are insufficient to cover all of the claims, the individual insureds should have their claims paid first - outside the bankruptcy context.
Notice And Renewal Issues
Finally, at renewal time as well as during the policy period, special attention should be paid to the notice provisions and the ability to give notice of circumstances that may lead to claims. Both claims-made and occurrence-based policies require insureds to give prompt notice to their insurers, and coverage, in some cases, may be contingent upon timely notice. In some jurisdictions, a policyholder's failure to give reasonably prompt notice may preclude coverage even if the insurer was not prejudiced by the delay. Depending on the definition of "claim," notice under D&O and E&O policies may be required upon receipt of any written demand, not merely once a formal suit is filed, and notice of an EEOC charge may be required under some EPL policies. Notice may also be required promptly after any "insured" becomes aware of a claim or occurrence. In large, multinational corporations, this may include hundreds of individuals whose knowledge can trigger notice requirements. Therefore, policyholders should request that their policies require notice only upon the knowledge of certain key individuals such as risk manager, general counsel, or others in the organization likely to know of claims.
In addition, most claims-made policies allow, and some require, insureds to give notice of "circumstances" that may lead to, but have not yet, resulted in a claim. This benefits policyholders by allowing them to link subsequent claims to expiring policies and not burden the limits of their new policies. In the policy renewal context, renewal applications often require policyholders to broadly disclose any event that may lead to a claim, and exclusions in the renewal policy may preclude coverage for claims or circumstances that the insureds knew about before the policy's inception. Thus, policyholders should be diligent in identifying and providing notice of existing claims and circumstances under an expiring policy by the appropriate deadline. Otherwise, insureds may be left without coverage under either the expiring policy or the new policy. Policyholders should also remember to keep an internal "paper trail" of their notice efforts.
Conclusion
In these economic times, companies should be especially diligent in recognizing insurance coverage as a valuable asset. Claims by shareholders, borrowers, employees and others may well be covered under current or historic insurance. Companies not immediately faced with litigation should carefully consider their coverage needs and tailor their insurance programs accordingly. Many types of coverage, including D&O, E&O and EPL, are written on standard forms that vary significantly from insurer to insurer. Language in these form polices can often be changed by negotiation, giving the insureds significantly broader coverage and narrowed exclusions. At renewal, risk managers should discuss these options with their brokers, as well as insurance and legal advisors. Obtaining favorable terms at today's renewal may lead to significant insurance recoveries for tomorrow's claims.
Published December 1, 2009.
