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D&O insurance: is there any coverage?

D&O Insurance: Is There Any Coverage?

Directors and officers liability insurance was a little-noticed product until the mid-1980s. It was at that time that risk managers began reporting to senior management that there were serious problems being experienced in trying to arrange renewal coverage. After years of vigorous competition and steadily decreasing premiums, underwriters awoke to the reality of increased activity in the courts and escalating settlements which historic pricing practices had not anticipated. The volatility of this line of insurance became painfully clear to buyers and insurers alike as capacity plummeted, scope of coverage diminished, and prices skyrocketed.

One area of exposure that did not play any appreciable part in this unsettling period of change was that of environmental liability. This was so because D&O underwriters traditionally have excluded coverage for these claims.

Clearly, the liability exposure to directors and officers of corporations is expanding - especially so for liability pertaining to environmental exposure. Recently enacted environmental laws and court decisions interpreting those laws now form a virtual minefield of potential D&O liability exposure.

The centerpiece of these laws is the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), which can impose liability without fault on a single party for all cleanup costs of a hazardous waste site even though the environmental damage was caused by others many years ago. Because CERCLA and other environmental laws impose liability on certain "persons," officers and directors are squarely in the cross hairs of environmental litigants. At the same time, finding coverage for environmental damage under traditional insurance products, such as General Liability and Environmental Impairment Liability policies, has proved elusive, fueling increased efforts to locate new "deep pocket" sources to pay for extraordinarily expensive environmental damages.

Where will directors and officers find protection from these increasing personal liabilities? Primarily from their corporations, through indemnification. State indemnification statutes permit, and most corporate bylaws require, indemnification of directors and officers for defense costs, settlements, and judgments in a variety of contexts.

Typically, to qualify for indemnification, the individual must have acted "in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interest of the corporation, and with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful" (Section 145(a), Delaware General Corporation Law). Court decisions have held that when determining a person's "good faith," the court should not only consider that person's subjective reasoning but also objectively examine the relevant facts and circumstances. Thus, liability for a negligent violation of the environmental laws or liability based upon the strict liability provisions of those laws may be fully idemnifiable, although liability for an intentional violation of the environmental statutes probably is not idemnifiable.

While it is possible that indemnification for violation of some of the environmental statutes may be prohibited because such indemnification would violate public policy and the deterrence effect intended by the statute, that possibility is expressly refuted in the primary liability section of CERCLA.

Importance of indemnification

Therefore, most liability under CERCLA, which constitutes a large portion of the potential D&O exposure for environmental claims, can be indemnified if such indemnification is otherwise permitted by the applicable state indemnification statute. This presumes, of course, that the corporation has the financial ability to fund the indemnification obligation. As an aside, it should be said that D&O underwriters provide coverage with the expectation that an insured will do everything within its power, legally and procedurally, to provide corporate indemnification to its officers and directors to the fullest extent possible.

D&O policies traditionally exclude claims related to pollution. Rare exceptions exist, though. At least one industry-specific captive D&O insurance company has been known to provide D&O coverage without a specific pollution exclusion. Of course, even in the absence of a pollution exclusion, coverage may be limited by other policy conditions and exclusions. For example, the bodily injury/property damage and the fines/penalties exclusions common to D&O policies would eliminate coverage for many types of pollution losses.

Underwriters' concerns

The challenge to D&O underwriters is that of attempting to provide some measure of personal protection while not becoming a "deep pocket" target by plaintiffs. Given the enormous magnitude of costs involved in correcting environmental problems; the increasing pressure by regulations, the courts, and the public to get on with the task; and the limited availability of insurance coverage (under general liability and environmental liability policies, among others) to fund the problem, there is significant concern on the part of D&O underwriters that any attempt to afford even a small window of coverage under a D&O policy will result in an increase in the frequency of pollution-related claims brought against officers and directors. Because the severity of these claims, in absolute dollar amounts, would in all likelihood be substantial, such a result could adversely affect the availability and pricing of D&O insurance for all insureds - a development no one wants.

Many of the reported environmental lawsuits that name directors and officers as defendants involve corporations that are insolvent or financially frail. The directors and officers are probably targeted because they are the only viable remaining defendant. Where the corporation is financially strong, a major motivation for the government and regulators to name directors and officers in environmental suits is to criminally punish those individuals and to deter future misconduct. Were D&O insurance policy proceeds to become available, there would, without doubt, develop a greater incentive to also pursue the directors and officers for significant monetary recovery.

Just as general liability insurance underwriters have witnessed the judicial emasculation of the "sudden and accidental" policy language in the context of pollution cases, D&O insurance underwriters view with trepidation the outcome of future disputes that may involve pollution exclusions in their policies. While general liability insurance underwriters generally responded to liberal judicial interpretations of their policies by moving to an "absolute" exclusion for environmental incidents, D&O underwriters have already strengthened their environmental exclusions in recent years in anticipation of similar attacks. The result, under most D&O policies, is the elimination of coverage for matters that are in any way connected with an environmental situation.

On occasion, though rarely, underwriters will consider providing an exception to the pollution exclusion to allow some protection for suits brought by shareholders. Depending on the carrier and specific policyholder, the extension may be limited to loss incurred in derivative actions, or to defense costs and settlements - but not judgments.

In today's marketplace, this "shareholder carve-out" feature, if available at all, is typically restricted to the "direct" side of the D&O insurance policy, which insures loss not idemnifiable by the corporation. This preserves some ultimate protection for the personal assets of management in circumstances in which it is not possible to obtain corporate indemnification for a pollution-related matter. The idea here is to insure the odd, unintended, and unforeseen situation that infrequently occurs - not ongoing compliance with known standards set forth in statutes.

One hopes the insurance industry will find this "window" of coverage manageable over time, and that enterprising plaintiffs won't "use" the coverage simply because it exists. Underwriters will usually offer such a modified pollution exclusion only to their most desirable accounts, where confidence in management's ability is high and environmental exposures do not appear overly onerous.

John P. Coonan is a Vice President of Chubb & Son Inc. and is the Assistant National Manager of Chubb's Executive Protection Department, which underwrites directors and officers liability, fiduciary liability, commercial crime, and kidnap ransom insurance coverages.
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Chairman's Agenda: Managing Environmental Responsibility; directors and officers
Author:Coonan, John P.
Publication:Directors & Boards
Date:Jun 22, 1991
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