Table of Contents. CHAPTER II Contra Preferentum and the Rules of Insurance Policy Construction 5

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2 Table of Contents CHAPTER I New Decision Clarifies New Jersey Law on Insurer s Duty to Defend 1 New Jersey Appellate Division Estops Insurers From Denying Coverage Based on Faulty Reservation of Rights 3 CHAPTER II Contra Preferentum and the Rules of Insurance Policy Construction 5 CHAPTER III Trigger of Coverage 7 Benjamin Moore & Co. v. Aetna Cas. & Sur. Co., 179 N.J CHAPTER IV Losing Insurance Coverage in Corporate Transactions 11 CHAPTER V D&O Insurance 13 Survey of Recent D&O Insurance Case Law: Recent D&O Insurance Cases of Note 17 Lions and Tigers and Notice: Notice Requirements Under Claims-Made Insurance Policies 35 Does a Subpoena Constitute a Claim for Purposes of D&O Insurance Coverage? 38 CHAPTER VI New Jersey Environmental Insurance Law: The Scorecard 42 Natural Resource Damage Claims Remain at the Forefront of New Jersey Environmental Law 49 CHAPTER VII Understanding and Maximizing Your Company s Insurance Coverage for Asbestos Claims 50 Northern Insurance: Coverage for Preventive Measures in Cell Phone Case 54 CHAPTER VIII Number of Occurrences 57 CHAPTER IX How to Locate Missing Insurance Policies 59 CHAPTER X Notice 64 i 2011 Lowenstein Sandler PC. In California, Lowenstein Sandler LLP.

3 CHAPTER XI Broad Coverage for Construction Defects 67 Court Adds Clarity to Your Work Exclusion 69 CHAPTER XII Privacy Liability Are You Covered? 71 Filling the Gaps in Your Coverage Portfolio With Cyber Policies: Lost or Damaged Data 75 CHAPTER XIII Insurance Coverage for Intellectual Property Infringement 79 Navigating the Cyber-Insurance Marketplace 83 CHAPTER XIV Business Interruption 87 New Jersey Court Expansively Interprets Term Physical Damage in Property Policy 92 CHAPTER XV New Jersey Supreme Court Creates Sweeping Broker Liability 93 The Insurance Broker and Coverage Disputes: Emerging Issues 99 CHAPTER XVI Panel Counsel 109 CHAPTER XVII Court Casts Doubt on Effectiveness of Additional Insurance Coverage 111 CHAPTER XVIII Practical Insurance Tips for Risk Managers and In-House Lawyers 113 ii

4 INTRODUCTION Lowenstein Sandler represents insurance policyholders. Period. Not insurers, not brokers, not anyone else whose interests aren't aligned with yours. We've been by your side since 1983 and have never represented an insurer in coverage litigation. And we never will. Insurance is a big business that has a big impact on your business. There are many types of policies, many ways to write them, and they can affect your bottom line in many ways. For almost three decades, businesses have relied on Lowenstein Sandler for advice on their liability and property, business interruption, and directors and officers insurance issues. We can also help you make the most of today's new, cutting-edge policies, like cyber-insurance. We're on top of all new developments in insurance coverage and are pleased to share with you the Lowenstein Sandler Insurance Claims Handling Guide. Robert D. Chesler and Michael D. Lichtenstein co-chair Lowenstein Sandler's insurance coverage practice group, and are resident in the firm's New Jersey office. Joseph D. Jean and Rachel M. Wrightson have recently joined the practice, and are resident in the New York office. We hope you find this review helpful and invite you to call us if you have questions or need additional information. iii

5 CHAPTER I New Decision Clarifies New Jersey Law on Insurer s Duty to Defend In 1992, the New Jersey Supreme Court established that when an insurer agrees to defend its insured, the insurer has the right to allocate defense costs between covered and uncovered claims in the complaint. The court opined that such allocation should not prove difficult. In fact, it has proven a nightmare. Most complaints bundle together covered and uncovered allegations. In pleading a negligence claim, plaintiffs do not hesitate to add counts of intentional wrongdoing or fraud. Plaintiffs frequently allege both negligence and breach of contract. In directors and officers ( D&O ) cases, some claims may be within the insured v. insured exclusion, while others are not. The Supreme Court did not give guidance on how the parties were supposed to allocate. Insurers can often find an argument that they should pay less than 100% of defense costs because of uncovered allegations. Indeed, insurers sometimes simply count the number of counts and pay the percentage of covered counts to the total number of counts: if a complaint alleges negligence, breach of contract, intentional conduct and fraud, all arising from the same facts and seeking the same damages, the insurer may offer to pay 25% of defense costs. These are difficult issues for the insured to contest. If an insurer offers to pay 40% of defense costs, should the insured refuse and file suit, thereby paying all the defense costs itself until the court rules? If the insurer offers 40% and the insured believes that the insurer s correct share is 75%, can the insured cost-effectively litigate over the difference? In Hebela v. Healthcare Ins. Co., 370 N.J. Super. 260 (App. Div. 2004), the New Jersey Appellate Division sets forth a clear allocation standard that is very favorable for insureds. In Hebela, a doctor sued a hospital for employment claims, and the hospital counterclaimed. The doctor sought coverage for the counterclaim under the hospital s directors and officers policy. The insurer denied coverage on an unusual public policy ground. Both the doctor and the hospital were insureds under the D&O policy, but the policy s insured v. insured exclusion applied solely to claims by individuals, not by the hospital. Nonetheless, the insurer argued that public policy prevented coverage for a claim by one insured against another. The court dismissed this defense and next turned to the issue of allocation between the insured s uncovered defense costs in prosecuting its claim and the covered defense costs in defending against the counterclaim. The Appellate Division stated that the trial judge found apportionment to be difficult and unworthy of more than a cursory effort. Id. at 275. Though the Appellate Division was sympathetic to the practical difficulties of apportionment, it found that the trial court needed to make a diligent effort to reach a fair and reasonable estimate. Id. 1

6 The court recognized that the case before it, involving a claim and a counterclaim, was easier than cases in which the court needed to allocate between covered and uncovered claims within the same complaint. Still, the court found defense costs incurred by the insured in Hebela that overlapped between the claim and the counterclaim. The court set forth the standard that the insurer had to pay all overlapping costs. The court found that the insurer had agreed fully to defend against any covered claim and should not benefit from the fact that its defense incidentally aided the insured on uncovered claims. The court next turned to the mechanics of allocation. The court recognized two distinct situations. Sometimes, the insurer agreed to defend and was seeking reimbursement of uncovered costs from the insured. Other times, as in Hebela, the insurer had refused to defend. In the latter case, the court placed only a slight burden on the insured to come forward with evidence of its costs. The insurer had the burden of demonstrating which costs were incurred solely with respect to uncovered claims. The court thus held that, presumptively, all defense costs are covered. The insurer has the burden of demonstrating which defense costs were incurred solely with respect to uncovered claims. The insurer must pay mixed costs incurred with respect to both covered and uncovered claims. Thus, if a complaint asserts clearly unrelated claims of negligence and breach of contract, seeking separate damages, the insurer may need to pay only for the negligence claim. However, if the complaint alleges negligence, breach of contract, intentional wrongdoing and fraud, seeking the same damages arising from the same operative facts, the insurer must pay all the defense costs. 2

7 New Jersey Appellate Division Estops Insurers From Denying Coverage Based on Faulty Reservations of Rights It is well-established in New Jersey that if an insurer agrees to defend an insured without reserving its rights, the insurer is estopped from denying coverage. In Nazario v. The Lobster House, et al., Docket No. A T1 (App. Div. May 5, 2009), the Appellate Division expounded on that doctrine and held that two insurers were estopped from denying coverage because their reservation of rights letters were inadequate. The Nazario case involved a bodily injury claim by a contractor s employee against Cold Spring Fish & Supply Co., d/b/a The Lobster House. Cold Spring had two primary policies that could potentially provide coverage: one from Essex Insurance Company and one from Sirius America Insurance Company. Both insurers responded to the notice of claim by Cold Spring with reservation of rights letters. Essex advised Cold Spring that it was disclaiming coverage but would investigate and defend while retaining its right to deny coverage. Essex appointed counsel, who filed an answer for Cold Spring and asserted defenses and cross-claims. Shortly thereafter, Essex sued Cold Spring for a declaration that it had no duty to defend or indemnify. Sirius responded by assigning counsel under a full and complete reservation of any and all rights. Sirius further recommended to Cold Spring that it retain separate counsel. Several months later, Sirius also sued Cold Spring for a declaration of no coverage. The cases were consolidated, and Cold Spring, Essex and Sirius all moved for summary judgment. The court found that Essex and Sirius were both right and that Cold Spring did not have coverage under either policy. However, the court held that both insurers were estopped from withdrawing coverage because both reservation of rights letters failed to inform [Cold Spring] that the offer[s] (to defend) may be accepted or rejected. The Appellate Division affirmed. Like the trial court, the Appellate Division relied on the simple rule that unless a reservation of rights letter specifically stated that the insured had the right to accept or reject the defense under those terms, it was inadequate. The court relied principally on the New Jersey Supreme Court s decision in Merchants Indem. Corp. v. Eggleston, 37 N.J. 114 (1962), which, while clearly on point, had not been cited for this legal principle for many years. The court dealt decisively with two defenses raised by the insurers. First, the insurers basically argued that they had done everything right. They had written timely reservation of rights letters. They had set forth that they might deny coverage. They had instituted coverage litigation to determine their rights. Sirius recommended that the insured retain separate counsel, which it did. From the insurers perspective, they had done everything by the book. The court was simply uninterested. Since the insurers did not inform the insured that it had the right to reject the defense that they offered, the court found that the insured was in the same position as though the insurers had assumed the defense without a reservation of rights. Second, the insurers asserted that Cold Spring had not incurred prejudice. The court dealt with this defense by holding that no requirement of actual prejudice existed but rather that 3

8 prejudice was presumed when an insurer defended without adequately advising the insured of its rights. We find nothing in Eggleston or its progeny which suggests that the insured must prove actual prejudice to create coverage, or that the carrier may prove lack of prejudice to avoid coverage by estoppel, when a fully informed written consent is lacking. Nazario is a major statement of the rights of insureds when an insurer seeks to impose a defense under a reservation of rights. Almost all insurers have acted in recent years as did Essex and Sirius, taking certain measures when reserving rights but not heeding the requirement of Eggleston. It is extremely rare for an insurer to advise an insured that it has the right to accept or deny a defense offered under a reservation of rights. As a result, in most current cases in which the insurer is defending under a reservation of rights, the insurer will be estopped from denying coverage. 4

9 CHAPTER II Contra Preferentum and the Rules of Insurance Policy Construction New Jersey courts have long held that where policy language is susceptible to more than one interpretation, the ambiguity must be resolved in favor of the insured. Voorhees v. Preferred Mut. Ins. Co., 128 N.J. 165 (1992) at 175; Kievit v. Loyal Protective Life Ins. Co., 34 N.J. 475, (1961); Sparks v. St. Paul Ins. Co., 100 N.J. 325, 336 (1985) (holding that the recognition that insurance policies are not readily understood has impelled courts to resolve ambiguities in such contracts against the insurance companies. ). The reasonable expectation standard compels courts to enforce only those terms and restrictions in the contract language that are consistent with the objectively reasonable understanding of an average insured. A recent New Jersey Supreme Court decision reinforces New Jersey s long-standing rule of reasonable expectations or contra preferentum in construing a contract of insurance. In President v. Jenkins, 180 N.J. 550 (2004), a doctor sued his insurance company and insurance broker. The doctor discovered, upon renewing his medical malpractice policy, that he was left with a gap in insurance coverage. The gap resulted from the doctor s failure to tell his insurance broker that his prior year s policy had been canceled for failure to pay the premium. However, the doctor stated that because his renewal policy had an effective date of January 1998, he was unaware that the retroactive date of February 1, 1998, prohibited coverage prior to that time. The doctor claimed that he failed to understand the significance of that term and that the broker had breached his duty by failing to provide adequate insurance coverage to suit the doctor s needs. Dr. Jenkins argued that the Zurich policy was ambiguous and should therefore be construed in his favor, since the use of the term retroactive was misleading and neither the agent nor the policy language explained its significance. Dr. Jenkins further argued that he reasonably expected that the claims made policy would cover all claims reported during the policy period, regardless of when those incidents arose. The insurance carrier argued that the terms clearly and unambiguously limited coverage to incidents occurring on or after the retroactive date. The court explained that the reasonable expectations doctrine would govern this dispute, citing to the language in its seminal decision, Kievit v. Loyal Protective Life Ins. Co., 34 N.J. 475, 482 (1961): When members of the public purchase policies of insurance they are entitled to the broad measure of protection necessary to fulfill their reasonable expectations. They should not be subjected to technical encumbrances or to hidden pitfalls and their policies should be construed liberally in their favor to the end that coverage is afforded to the full extent that any fair interpretation will allow. 5

10 Applying this rule of construction to the policy at issue, the court stated that the declaration page of the policy indicated that only those claims arising out of incidents occurring on or after the retroactive date would be covered, and that this was particularly significant since the courts place particular emphasis on the declarations page when determining the reasonable expectations of the insured. However, there were two named insureds, Dr. Jenkins and Garden State Physicians Alliance ( GSPA ), with different retroactive dates applicable to each. The court found that this was not clearly delineated in the policy and thus created an ambiguity. Moreover, the policy did not define the term retroactive date, and so the court looked to its ordinary meaning as defined in the dictionary influencing or applying to a period prior to enactment. The court held that the different retroactive dates in the policy, the failure to provide a clear definition of the term retroactive date, and the different policy periods and effective dates combined to render the policy ambiguous. However, material issues of fact remained as to whether the policy comported with Dr. Jenkins reasonable expectations. The holding in President v. Jenkins reinforces that despite insurer protests that insureds are sophisticated participants in negotiating a contract of insurance, New Jersey courts will listen to an insured s argument that it misunderstood the nature and terms of its policy and will enforce the insured s reasonable expectations as to coverage. 6

11 CHAPTER III Trigger of Coverage Trigger is the deceptively straightforward concept of which insurance policy applies to a particular occurrence. Typically, for general liability policies, the policy in effect when the damage or injury occurs is the triggered policy. If a carpenter negligently repairs a staircase on December 31, and someone slips and breaks his or her leg on January 1, the policy in effect on January 1 applies. In the normal auto accident or slip and fall, the time of the damage is easily ascertained. Modern trigger of coverage litigation began with asbestos bodily injury claims; an insurance company filed the first suit in In a typical asbestos case, a worker is exposed to asbestos for a period of time, and then a period follows in which the worker is no longer directly exposed but has an asbestos fiber in his lung creating progressive injury, followed by a manifestation of an asbestos-related illness during a visit to a doctor. Insurance companies took divergent positions on what constituted injury in these cases, depending upon the insurance coverage profile and where its coverage lay. In the first leading case, the court adopted the exposure trigger, holding that coverage existed only during the years in which the claimant was exposed to asbestos in the workplace. A second court adopted the manifestation trigger, holding that coverage was triggered when the injury was reasonably diagnosable. Certain states still maintain these approaches. In a third major case, at least apocryphally, one insurer argued for manifestation and another for exposure. The court exclaimed that if the insurers could not agree, then the policy was ambiguous and all policies from first exposure to manifestation were triggered, thus giving birth to the continuous trigger theory. Most states have adopted some form of the continuous trigger. It is often called injury in fact or actual injury to emphasize that a factual determination of when the injury occurred may be necessary. The concept quickly moved from asbestos to other types of bodily injury claims and then to environmental claims. It is now used in a broad variety of claims, including construction, employment and intellectual property. There is a push and pull between the tendency to assume that injuries are continuous and the fact that this inquiry is fact-specific. Not every injury is continuous. Noise-induced hearing loss ceases when exposure to noise ceases. Brain damage from ingesting lead paint chips occurs only while the ingestion continues. DDT adheres to soil particles and does not move thereafter in the soil and groundwater. Substantial amounts of discovery and expert testimony may be necessary to establish trigger dates; one example is establishing when contaminants first hit the groundwater. In a case involving claims between two insurance companies, one insurance company introduced an expert to testify on how long it would take liquid contaminants 7

12 placed on top of a landfill to penetrate through the landfill into the groundwater. The New Jersey Supreme Court was not impressed. The court held that the trigger occurred when the injurious process began (i.e., when the contaminants were placed in the landfill). The court admitted that its decision was based on public policy and not the policy language, and it is unclear if courts in other states would agree. In any situation in which an issue exists as to when the damage or injury occurred, the insured should place on notice any insurance policy that could possibly be triggered. 8

13 Benjamin Moore & Co. v. Aetna Cas. & Sur. Co., 179 N.J. 87 When multiple insurance policies are triggered, an issue arises as to how to allocate among insurance companies and, in some cases, with the insured also. Two basic approaches have developed. One, known as all sums, pick and choose or joint and several, holds that the insured can collect all its damages under any one triggered policy. This is obviously very favorable to the insured. The other approach, known as pro rata, states that the damages must be prorated across all the triggered years, with the insured usually bearing responsibility for those years in which insurance coverage does not exist. For example, if 10 consecutive years are triggered, each year is allocated 10%, regardless of the amount of insurance coverage available in that year. New Jersey is a pro rata state but with important differences. It is the only state where allocation is by both years and limits. For example, assume the insured has $100,000 of primary insurance in Years One and Two but has excess coverage only in Year Two, in the amount of $800,000. Since the insured has a total of $1,000,000 of insurance, with $100,000 in Year One and $900,000 in Year Two, 10% is allocated to Year One and 90% to Year Two. Also, New Jersey will not allocate to the insured for years in which it does not have insurance if the insured was unable to purchase applicable insurance in the marketplace. This usually means that the insured is not responsible for years in which it could not obtain coverage because of an absolute pollution or asbestos exclusion. Champion Dyeing & Finishing Co., Inc. v. Centennial Ins. Co., 355 N.J. Super. 262 (App. Div. 2002); Owens-Illinois, Inc. v. United Ins. Company, 138 N.J. 437 (1994); Carter-Wallace, Inc. v. Admiral Ins. Co., 154 N.J. 312 (1998). In Benjamin Moore & Co. v. Aetna Cas. & Sur. Co., 179 N.J. 87 (2004), the Supreme Court addressed the question of the payment of deductibles for consecutive policies triggered under an Owens-Illinois allocation. This issue was not considered in either Owens-Illinois or Carter-Wallace. In Benjamin Moore, the insured sought a defense in connection with two class actions alleging bodily injury caused by exposure to lead paint. The insurer agreed to defend only after the deductibles for each triggered policy were exhausted. Since there were 10 triggered years, each with a deductible of $250,000, the insured faced a $2.5 million deductible before one penny of defense costs would be paid. The insured argued that it should have to pay the deductible from only one of the triggered policies prior to the insurer s payment of defense costs. Alternatively, Benjamin Moore proposed an application of an Owens-Illinois allocation to its deductibles. The Supreme Court, affirming the Law Division and the Appellate Division, found that the plain language of the insurance policies required the exhaustion of all deductibles prior to the payment of any insurance coverage. The court reached this result by taking the legal fiction of the continuous trigger and pretending that it was an unshakable reality. The decision stressed an adherence to the terms and limits of the insurance policy, holding that Owens-Illinois does not affect the insurance limits in any year of coverage and noting that Owens-Illinois... was never intended to displace basic insurance policy provisions except to the extent that those provisions are inconsistent with [Owens-Illinois]. The decision did not address Benjamin 9

14 Moore s reasonable expectations that the insurance policies it purchased would respond to covered claims. Rather, the court determined that Benjamin Moore bargained for higher deductibles in exchange for lower premiums. Under this holding, the deductibles are essentially transformed into a primary layer of self-insurance. The decision in Benjamin Moore elevates form over substance. An insured that purchased annual policies, each with a single deductible, could not envision that courts would later invent the continuous trigger, triggering consecutive policies and consecutive deductibles. As Justice Barry T. Albin noted in the dissent, the holding will come as a great surprise to many small business and property owners, who may find their assets completely depleted paying multiple deductibles before ever accessing the insurance for which they thought they had bargained. 10

15 CHAPTER IV Losing Insurance Coverage in Corporate Transactions In a decision that is a must-read for corporate lawyers, the Supreme Court of California disallowed the assignment of insurance policy rights from one corporation to another, leaving the second corporation without coverage for a $7.65 million settlement in an underlying suit. See Henkel Corp. v. Hartford Accident & Indena. Co., No. SO98242 (Cal. Feb. 3, 2003). The attempted assignment took place as part of a very common corporate transaction, and the decision is so broadly written that it may be impossible under California law to assign insurance policies in the context of an asset acquisition. While the court s summary of the corporate transactions involved is lengthy and complex, the key facts are simple. Union Carbide acquired Amchem Products by stock purchase and merger in Amchem became a Union Carbide subsidiary. Amchem had two different product lines. The existing Amchem (labeled Amchem No. 1 by the court) created a new corporation ( Amchem No. 2 ). By resolution of its board of directors, Amchem No. 1 transferred all of its rights, title and interest... in and to its domestic assets utilized in [one line of business] to Amchem No. 2. Id. at 2. The board of directors of Amchem No. 2 accepted the transfer of these assets and assumed all related liabilities as well. Amchem No. 1 s insurers denied coverage to Amchem No. 2 for a suit alleging injuries caused by exposure to Amchem products prior to the asset transfer. Amchem No. 2 (through its successor, Henkel, the plaintiff in this action) asserted that Amchem No. 1 s insurance rights were transferred along with the product line. This was the decision of the Court of Appeals which quoted an earlier 9 th Circuit decision, Northern Ins. Co. of New York v. Allied Mut. Ins., 955 F.2d 1353, 1357 (1992), in reaching its decision. The California Supreme Court, however, disagreed with the lower court s ruling. The court cited insurance policy language, which stated that an assignment of an interest under the policy was not valid unless the insurer consented. See Bergson v. Builders Ins. Co., 38 Cal. 541, 545 (1869); Greco v. Oregon Mut. Fire Ins. Co., 191 Cal. App.2d 674, 682 (1961). Amchem No. 1 had not obtained the consent of its insurers. A key factor in the court s findings was that the transfer was a voluntary transfer grounded in contract, and no basis was found by the court for imposing a transfer as a matter of law. The plaintiff made several arguments in support of its position. Many of these arguments have been accepted by courts in other jurisdictions, but the California Supreme Court rejected them all. First, the insured argued that the insurance coverage followed the liability by operation of law. The court found this to be true only when the liability itself transferred as a matter of law. The court found that Amchem No. 2 assumed the liability by contract. Second, the insured argued that the standard no assignment clause in the insurance policies does not apply when the event that invokes liability has already occurred. See Montrose 11

16 Chemical Corp. v. Admiral Ins. Co., 10 Cal.4 th 645, 689). The court instead held that when a claim is reduced to a sum of money, it becomes a chose in action and only then may be assigned. In Henkel s case, at the time of the original transfer, the insurers duties to defend and indemnify had not reached that stage. The underlying claim was not made until 1989, long after the assignment. Further, the court held that in an assignment of this kind, additional risk could be forced upon the insurer, even though the policies terms had already lapsed. The court speculated that the assignor and the assignee might quarrel over the existence and scope of the assignment and therefore over the insurance proceeds, creating a burden to the insurer. In the case at bar, the insurers who had originally insured just Amchem could have faced demands for defense and indemnity from the successors to both Amchem No. 1 and Amchem No. 2. The Henkel decision may portend negative consequences for corporate insureds facing liability for long-tail claims such as asbestos and silica exposure. In many of these cases, the corporate entity being sued is liable for harms that occurred many decades and many corporate transactions ago. The ability to access a predecessor s insurance coverage is therefore a critical consideration in a company s decision to acquire all or part of a business and/or to negotiate a more stringent indemnity for legacy liabilities. In many instances, Henkel can be distinguished on the basis of its specific fact pattern, in which a company was sold piecemeal, creating multiple companies that were amenable to suit for the same product injuries. Moreover, the Henkel court left open the important question of whether an asset purchaser may still accrue rights to insurance coverage by operation of law in situations where the successor is subjected to liability by operation of law, i.e., (1) when the transaction amounts to a merger, (2) when the purchasing corporation is a mere continuation of the seller, or (3) when the transfer of assets is for the fraudulent purpose of escaping liability (i.e., where the purchaser of defective products has no remedies against the original company). A recent decision by the Court of Appeals of Ohio may signal an even more limited application of Henkel s reasoning and a return to the trend of finding successor rights to insurance. See The Glidden Co. v. Lumbermens Mutual Casualty Co., et al., Civ. Act. No (holding that the present-day Glidden entity succeeded to its predecessor s insurance coverage for liabilities stemming from preacquisition sales of lead paint). The Glidden court rejected the reasoning of Henkel as contrary to well-settled law and refused to enforce antiassignment provisions against claims that arise from preassignment occurrences. The Glidden court is among several courts that have recognized that insurers risks have not increased when their duty to indemnify and defend relates to events occurring prior to transfer. Moreover, the court was cognizant that a contrary result could have the undesirable effect of restricting corporate restructuring, reorganization and sales, since acquiring corporations would succeed to a company s liabilities but have no way to insure against this exposure. Thus, the Glidden decision may signal a revival of the pre-henkel rule that insurance benefits follow liability for losses arising from preacquisition activities by operation of law. This is very good news for corporate insureds. 12

17 CHAPTER V D&O Insurance Directors and officers ( D&O ) insurance provides liability protection for economic loss resulting from business-related negligence or wrongdoing on the part of company executives or members of boards of directors. D&O policies generally consist of two coverage parts: (1) direct (or Side A ) coverage, which personally protects individual directors and officers from losses not indemnifiable by the company; and (2) corporate reimbursement (or Side B ) coverage, which covers a company for amounts it is obligated to pay on behalf of directors and officers for claims made against them. In addition to the base coverage, many insurers also offer some form of entity (or Side C ) coverage, which insures the corporation for direct claims made against it, typically (and sometimes limited to) securities claims. Further options may exist for packaging other types of insurance into a D&O policy, particularly employment practices, fiduciary, or errors and omissions ( E&O ) liability coverage. Typically, such combo policies are targeted at smaller companies with lesser premium budgets and/or perceived lower exposures; however, insureds should be wary of bundling other risks with their D&O coverage, because all D&O policies are subject to a total policy aggregate. By bundling other insurances with D&O, an insured runs the risk of exhausting its D&O limit on non-d&o claims. While that possibility may not bother a corporate risk manager trying to maximize his or her insurance budget, it should certainly concern the individual directors and officers whose personal assets are at stake. D&O policies are not standardized, off-the-shelf products; each insurer employs its own policy form (sometimes multiple ones) with subtle differences that can widely affect coverage. Because all D&O forms are not equal, the terms of any policy should be closely examined and actively negotiated prior to purchase. In purchasing its D&O coverage, an insured should be cognizant of the following critical issues: A. Claims-Made Policy and the Definition of Claim D&O policies are claims-made (not occurrence-based ) policies and cover only claims first made and concurrently reported within the effective policy period. Failure to give timely notice of claims is usually fatal, and an insurer will always raise late notice as a coverage defense when given a chance. Moreover, the definition of claim is not uniform among all D&O policies. Consequently, an insured must be aware of the breadth of its policy s definition of claim and be prepared to immediately notify its D&O insurers (primary and excess) of anything that might fall within that scope. The definition of claim is also crucial in determining how much coverage is afforded under a D&O policy. Claim can be defined narrowly or broadly. Lawsuits always fall within the definition, but other types of presuit demands may or may not fall within the scope. Covered claims can be limited to written demands for monetary damages, but many of today s policies define claim to include demands for nonmonetary relief, including (i) requests for 13

18 equitable or injunctive relief, (ii) administrative or regulatory proceedings, or (iii) target letters from regulatory authorities (e.g., SEC investigations). Most D&O policies also include a provision that allows an insured to report circumstances that may give rise to a claim, and not just an actual claim. If the reported conditions later ripen into a claim, the report will be considered timely made when notice of the claim is eventually received. When in doubt, insureds should avail themselves of this provision, because the risk of losing coverage for late notice is so high. B. No Duty to Defend Unlike general liability insurance, most D&O policies are not underwritten as duty to defend policies but instead require an insurer to advance defense costs (in excess of applicable retentions). This raises several concerns for insureds. First, advanced defense costs are often subject to reimbursement if it is ultimately determined that the loss incurred is not covered. Second, like other insurance policies, D&O forms exclude coverage for intentionally wrongful or fraudulent acts. If a plaintiff s complaint alleges only intentional or fraudulent acts, the insurer may refuse to defend. Therefore, an insured should seek final adjudication wording on its conduct (i.e., fraud, inside r trading, illegal remuneration & personal profit) exclusions, so that the insurer is obligated to defend the director or officer unless and until there is a final adjudication of wrongdoing. If final adjudication wording is unavailable, at a minimum, insureds should request in fact language, which requires the insurer to defend unless there is some established factual basis for not doing so. Finally, where there is no duty to defend, there may be no first dollar defense obligation. Before a carrier is obligated to advance defense costs, an insured may first need to satisfy its policy retention. While there is generally no retention on Side A coverage, Side B or C retentions can range from $25,000 to upward of $1,000,000 per claim, a significant outlay. C. Insurer Control of Litigation and Settlement Insurers typically control selection of counsel via a policy condition that the insured cannot incur any defense costs absent the insurer s consent. Thus, an insurer can insist on using a law firm that the insured either has no working relationship with or believes is not competent in the area of litigation. This can negatively affect the defense. Alternatively, the insurer can select a top-tier firm that bills endlessly and incurs costs without limit; such costs will be at the insured s expense (i) up to the policy deductible/retention, and (ii) for any amounts ultimately not covered (and reimbursable to the insurer). Besides that, on almost every D&O policy, defense costs are included within (and are not in addition to) the total policy limits. Attorney expenses thus reduce, dollar for dollar, the total indemnity amount available to the directors and officers. Furthermore, where an insured has a significant retention, the consent provision does not permit the insured to spend its own money as it best sees fit. As a result, an insured should (i) dialogue with its insurer about the law firms that can be used on claims; and 14

19 (ii) at minimum, request a provision giving it authority to settle claims within the retention. The insurer must also be notified of, and consent to, any proposed settlement. As a general rule, D&O policies provide that such consent will not be unreasonably withheld. But insurers may also control the outcome of any settlement via a hammer clause, a provision stating that if the insured refuses to consent to a settlement recommended by the insurer and acceptable to the claimant, then the insurer s liability for that claim shall not exceed the amount for which it could have settled, plus defense costs accrued up to the date of settlement recommendation. D. Severability Provisions Severability provisions protect innocent insureds. On D&O policies, insureds should seek to acquire both (i) severability of the exclusions, and (ii) severability of the application. As to the former, claimants frequently sue a company and all of its directors and officers because of the fraudulent conduct or misdeeds of one or several of its members. D&O policy exclusions for fraud and dishonesty are often written to impute deliberate misconduct of an individual director or officer to other innocent parties, thus precluding coverage for all. Thus, an effective severability of exclusions provision is necessary to prevent such an inequitable result. A severability of application provision provides that a misrepresentation (intentional or not) in the policy application will not void the policy for those without knowledge of the misrepresentation. This is extremely important in today s economy, where corporate financial restatements have increased in frequency, as have insurance company attempts to rescind policies based on such restatements. An insured s goal must be to obtain the maximum amount of both types of severability. E. Insured v. Insured Exclusion A staple of D&O policies, this exclusion applies to claims made by current or former directors or officers precisely those people who frequently bring suits. Historically, the exclusion was developed to eliminate coverage for collusive lawsuits brought to fund corporate liabilities from the D&O policy, but today, courts also apply it to noncollusive, adversarial suits. Thus, suits for wrongful termination aren t covered, and shareholder suits may not be, where a former director or officer is involved directly or behind the scenes. Questions also arise in bankruptcy, e.g., is the trustee or receiver considered an insured such that the exclusion bars coverage for claims made by them against the debtor s directors and officers? Typically, these uncertainties are dealt with via carve-backs : exceptions to the exclusion that diminish its scope. But not every policy includes each caveat, and wording varies significantly from one to another. Look for the policy with the narrowest insured v. insured exclusion. F. Bankruptcy Issues Uncertainties exist over whether or not directors and officers can access their D&O policies in the event of a corporate bankruptcy. Courts are split over whether policy proceeds as opposed to the policy itself are considered assets of the bankruptcy estate and thus subject 15

20 to the automatic stay (which, in turn, would preserve the policy limits by making them unavailable to the directors and officers during the stay period). The answer to this question often hinges on whether the policy includes entity coverage for the company. The likelihood that limits will be accessible to individual directors and officers in a bankruptcy is significantly increased when entity coverage is absent from the policy. A policy without entity coverage does not ensure to the bankrupt corporation s ultimate benefit, and therefore it cannot be considered an asset of the estate. See generally In re Louisiana World Exposition, 832 F.2d 1391 (5 th Cir. 1987). On the other hand, when entity coverage has been included on the policy, many courts have ruled that policy proceeds are property of the bankruptcy estate. To counter the uncertainty resulting from entity coverage, one option for the insured is to add a priority of payments or bankruptcy clause to its D&O policy, which provides that, in the event of bankruptcy, the D&O policy goes first to pay the directors and officers before the company. Many D&O insurers offer such a provision as either part of their standard policy or via endorsement. However, there are uncertainties related to this also: it is not clear how this provision works in practice or if a bankruptcy judge can override it. G. Conclusion Determine the needs of your company. Pay careful attention to policy wording. Obtain the maximum severability. 16

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