Anticipating D&O claims: a rise in environmental securities actions against companies is spurring an influx of pollution claims by policyholders.

With the unique legal obligations of federal and state environmental regimes dramatically impacting major U.S. corporations' bottom lines, more and more securities-related litigation has been filed against companies as a result of their pollution activities or failure to disclose such activities to stockholders.

To protect themselves, executives and board members are looking beyond their standard commercial general-liability policies and steadily increasing demand for pollution coverage under their directors and officers liability policies.

However, the unique regulatory scheme that governs liability for environmental damage is very different than the civil litigation model that most D&O policies are written to anticipate and that adjusters respond to most often. While almost all currently written D&O policies contain pollution exclusions, the adjusters who regularly handle D&O claims may find environmentally related claims more difficult to adjust and respond to than more standard claims.

In preparing for such claims, insurers and their coverage counsel should be aware of the limited case law interpreting pollution exclusions in D&O policies.

Late last year an Ohio appellate court issued an opinion in Danis vs. Great American Insurance Co., holding that an insurer has no obligation to pay defense costs under a D&O policy to a policyholder who allegedly reorganized its business to avoid paying pollution-related liabilities; the policy's pollution exclusion bars coverage for such allegations.

The claimants, stockholders of Danis' successor corporation, alleged that Danis, and certain of its directors and officers, reorganized the business just before executing agreements to indemnify the successor corporation for state-mandated environmental response costs. These costs arose out of government-mandated environmental remediation related to Danis' historic operation of a landfill transferred to the successor corporation. The reorganization allegedly left the stockholders of Danis' successor corporation without sufficient assets to satisfy their obligations for these costs, and they brought suit against Danis.

Danis demanded defense costs under its directors, officers, insured entity and employment practices liability policy, and the insurer denied coverage based on the policy's pollution exclusion. That exclusion barred coverage for any claim "based upon, arising out of, relating to, directly or indirectly resulting from, in consequence of, or in any way involving actual or alleged seepage, pollution, radiation, emission or contamination of any kind."

Because the original pollution and related indemnity agreements were necessary for the stockholders' claim, the court held that the claim fell within the policy's pollution exclusion and therefore excluded coverage. Danis had argued that the pollution exclusion should only preclude claims for actual environmental damage, not related nonpolluting corporate misconduct. The appellate court disagreed, Finding that the words in the pollution exclusion "directly or indirectly" indicated that an indirect, causal relationship is sufficient for the exclusion to apply.

Danis petitioned the Ohio Supreme Court to grant review of that decision and review was denied on March 23, 2005, in Diversified Environmental Management Co. vs. Great American Insurance Co.

Very few other courts have issued published opinions interpreting the pollution exclusions in D&O policies. To date, the trend has been toward a liberal interpretation that takes into account the unique regulatory and statutory ways that directors and officers can be held liable for pollution problems.

For example, in National Union Fire Insurance Co. of Pittsburgh, Pa. vs. US. Liquids, Inc., the court held a D&O policy did not provide coverage for an investor's securities fraud action and related shareholder's derivative suit for the corporation's failure to disclose of pollution activities; the D&O policy excluded loss "arising out of" actual discharge of pollutants.

Likewise, in Employers Insurance Co. of Wausau vs. Duplan Corp., the court referred to the pollution exclusion and decided there was no D&O coverage for a consolidated class securities and shareholder derivative suit resulting from the insured's failure to disclose criminal pollution practices.

In the face of perceived corporate misconduct, environmentally related D&O policy claims are likely to increase and courts beyond Texas, New York and Ohio may have to tackle these issues. Assembling a team of people well versed in both environmental regulations and D&O and environmental coverage case law is vital as insurers and their adjusters face these emerging claims.

Contributor Jamie Clausen is an associate at Cozen O'Connor, Seattle. She can be reached at [e-mail].