RISKVUE ARCHIVE | INDUSTRY WATCH >DIRECTORS & OFFICERS LIABILITY (D&O)

Fear Of Commitment:
Directors & Officers (D&O) Insurance Snags When Settling Underlying Claims

By Joshua Gold

The current claims handling environment for policyholders of directors’ and officers’ (“D&O”) liability insurance is worse than ever. Especially perilous is attempting to settle an underlying claim where the insurance company is offering anything but good hands. In the not too distant past, only certain insurance companies were notorious for nasty claims handling conduct and policyholder- unfriendly practices. Regrettably, the here and now finds a near uniformity in claims handling of the worst kind — hardly any D&O insurance company is customer-friendly these days. While in the aftermath of the capital markets’ meltdown, soaring premiums attract most of the attention in the business press, the reality is that attempting settlements with underlying claimants while wrangling with the insurance company for a commitment on coverage has become the challenge of the day. It is all too clear that many D&O insurance companies are not partners in risk after all.

Settlement Of The Underlying Claim

Whenever there is a dispute over the scope of insurance coverage, the policyholder often must defend and settle the underlying case without the help of its insurance company. If the underlying case is resolved by settlement, a question will arise as to the extent that the non-participating insurance company is bound by the settlement.

Most D&O insurance policies contain some form of consent to settlement provision. For example, one D&O insurance policy states in pertinent part:

The Insureds agree not to assume any liability, enter into any settlement agreement ... without the prior written consent of the Insurer.

This type of consent to settlement clause creates a significant problem where the insurance company does not commit itself to insurance coverage, but instead “reserves its rights” to deny insurance coverage on numerous grounds (sometimes specifically identified, other times not). Even when withholding a commitment to insurance coverage, the insurance company that finds the policyholder attempting to settle an underlying claim without written consent will routinely argue for a forfeiture of all coverage under the D&O insurance policy. No matter how specious this position may be, many insurance companies are not afraid to make it. A policyholder faced with this argument may be pressured into taking cents on the dollar to cover a settlement or else find itself having to enforce the insurance policy through the judicial system.

One New York case highlights the perils for policyholders in this regard. In TLC Beatrice International Holdings, Inc. v. CIGNA Insurance Co., the trial court held that a policyholder forfeited its insurance coverage when it settled an underlying derivative action without written consent from the D&O insurance company. In the TLC case, the policyholder, before entering into the settlement agreement, had received correspondence from the insurance company indicating that the insurance company was “disclaiming” insurance coverage. However, the insurance company termed the disclaimer “preliminary” which would only become “final” if no further information supporting insurance coverage was received from the policyholder within 30 days. Two subsequent disclaimers were sent by the insurance company, but both came after the policyholder entered into a stipulation of settlement. Despite the clear pattern by the insurance company of denying insurance coverage and leaving the policyholder “bare,” the court somehow decided that a distinction between “preliminary” declinations and “final” declinations was integral to the analysis. The court ultimately ruled that the policyholder violated the consent to settlement clause of the D&O policy and thus forfeited any rights to its insurance coverage. It is an understatement to say that this case is problematic for policyholders on a number of levels.

First, businesses need some form of certainty if they are to make responsible choices about settlement strategy. Having the specter of an insurance company withholding its consent to settlement but refusing to accept the risk of going the distance against the underlying claimant (especially where the exposure exceeds policy limits) places the policyholder in a nearly impossible situation. The “preliminary” versus “final” declination analysis does little to guide policyholders where insurance companies are taking a wait and see approach, or worse. As such, an insurance company must honor its good faith obligations (and comply with the state insurance code provisions governing unfair claims settlement practices) by disclosing coverage and communicating their coverage positions in a prompt and honest manner. Insurance company practices to the contrary are unacceptable. The TLC decision arguably fosters conduct contrary to that sought under the unfair claims settlement provisions of most states.

Second, the TLC decision does not promote a process of resolving lawsuits short of trial. Policyholders faced with the choice between preserving their insurance coverage rights and entering into a settlement that imperils their coverage rights may well choose to forgo settlement negotiations-notably, to the chagrin of many jurisdictions.

On the other end of the spectrum from TLC is Vitkus v. Beatrice Co., 127 F.3d 936 (10th Cir. 1997), a pro-insurance coverage case which arose out of the Silverado Savings and Loan debacle. In Vitkus, the policyholder agreed to a non-binding settlement with the Federal Deposit Insurance Corporation as a result of the actions of one of the policyholder’s officers, Richard Vitkus. The entire underlying lawsuit was settled for $26.5 million, of which $10 million was allocate to Richard Vitkus.

The policyholder’s D&O insurance policy provided insurance coverage for a “loss” which was described as “any amount which the Insureds are legally obligated to pay for a claim ... and shall include damages, judgments, [and] settlements ....” The questions to be decided by the U.S. federal appellate court were whether the policyholder was “legally obligated” to pay the settlement, and whether the amount and allocation between defendants of the settlement amount was binding on the insurance company, who had denied coverage and had not participated in the settlement negotiations.

The Vitkus court first held that a “settlement” was a sum which the policyholder was “legally obligated to pay.” The court aptly noted that to decide that otherwise would eviscerate the protection of all policyholders, and would undermine the public policy in favor of settlements. In conclusion, the court held that: “Where a reluctant insurer fails to participate in an insured’s settlement discussions, and the insured becomes party to a global settlement agreement, the insured may be indemnified for any amount of the total settlement package for which it can establish a reasonable anticipation of liability.”

Dealing With A Non-Committal D&O Insurance Company

Too frequently, insurance companies battle their policyholders in an effort to delay payment on or avoid altogether insurance coverage for sizeable claims. It is worth remembering that an insurance policy has value only if the insurance company pays when a covered claim is submitted. In the context of settlements, even where it is apparent that the insurance company has no intentions of honoring coverage, policyholders are well advised to treat the claim as if the insurance company was providing insurance coverage in full. No matter how baffling the insurance company’s communications (or “reservation of rights” letters) may be, the policyholder should err on the side of caution and treat the claims position as if it were nothing more than a “preliminary” declination of coverage. While realistically there may be no meaningful difference between “preliminary” denials of coverage and “final” ones, policyholders ought not take a chance. That requires, among other things, reporting to the insurance company any settlement developments and leaving enough time for an insurance company to review the settlement proposal before the policyholder enters into a binding commitment to settle the case. 

ABOUT THE AUTHOR

Joshua Gold is an attorney in the New York office of the law firm of Anderson Kill & Olick, P.C. The firm regularly represents and counsels policyholders in insurance coverage matters and disputes.

riskVue | The webzine for risk management profesionals
September 2003