Insurance Coverage During The Economic Crisis: Key Policyholder Considerations, Part I: Typical Claims And Avenues For Coverage

Monday, November 2, 2009 - 01:00

Financial instability and uncertainty are still present in today's business environment, and the prevalence of litigation arising from the past year's turbulence justifiably concerns many companies. Businesses can often mitigate these concerns as well as protect against financial strain inherent in litigation by analyzing and strengthening their insurance coverage.

Part I of this series reviews the most common types of claims and the potential for insurance coverage for each. Many policyholders fail to consider these insurance options, or mistakenly assume that no coverage applies and therefore lose a valuable asset.

All companies, whether or not currently facing litigation, should carefully review their insurance programs to assess limits and retentions, and to determine whether their programs provide maximum coverage tailored to specific business operations. Part II of this series will discuss some common insurance provisions to watch for and negotiate at your next renewal, as well as particular issues concerning bankruptcy and notice.

Common Claims And Potential Coverage

The current financial crisis has resulted in unprecedented market volatility, credit concerns, market losses, and bankruptcies affecting financial institutions and others. These economic conditions, in turn, have led to dramatic increases in litigation filings, regulatory activity, and criminal and administrative investigations and proceedings. A great number of these claims recently filed, 600 in the 18 months ending June 30, 2009, fell within five areas: 1) Securities Actions; 2) Contract Claims; 3) Borrowers' Class Actions; 4) Employee Class Actions; and 5) Bankruptcy-Related Actions. A brief description and the potential for insurance coverage for each type are outlined below. Special considerations concerning bankruptcy will be discussed in Part II of this series.

Securities Actions : Securities-related claims include: suits alleging misrepresentations by issuers or underwriters; claims against investment managers, brokers, and dealers; securities fraud cases; stock drop and auction-rate securities cases; suits alleging misrepresentations about the quality of assets or exposure to risk; and other related areas.

The most likely sources of insurance coverage for securities-related claims are Directors and Officers ("D&O"), Errors and Omissions ("E&O"), and Investment Advisors Professional Liability insurance policies. A variety of policy forms is available, and even small changes to policy language can significantly broaden or restrict coverage.

Basic D&O polices cover individual directors and officers relating to claims made during the policy period for loss arising from actual or alleged wrongful acts committed in their capacity as directors and officers. Most D&O policies provide coverage for the company as well. Public companies are often covered for "securities claims" only, while D&O policies covering private companies cover a wider variety of entity claims.

Policyholders should pay close attention to the specifics of their D&O policies. First, the term "Securities Claims" may be defined to include not only claims related to securities issued by the insured organization, but also to any claims alleging violation of state or federal securities laws or regulations, and even common law claims of similar nature. This would expand coverage to, for example, failed deal claims. Second, since most D&O policies do not contain a duty to defend, companies in litigation must determine whether the policy requires the insurer to advance defense costs on an on-going basis.

Third, policies may provide coverage for costs incurred in defending against criminal and regulatory investigations. The broadest of policies even covers informal regulatory investigations and Wells notices. Policyholders should not be misled by the fact that D&O policies often exclude "fraudulent," "dishonest," or "willfully illegal" conduct, and "personal profit." Policyholders may nonetheless find that their policies provide coverage for the significant costs associated with criminal and regulatory investigations, particularly where such exclusions apply only if there has been a final adjudication determining that the insured committed the alleged fraudulent or dishonest acts. As a result, D&O policies frequently cover defense and even settlement costs in such cases.

E&O policies, discussed further below, may also serve as a source of coverage for securities claims - especially claims involving bank underwritings, and broker deals regarding securitization.

Investment Advisors Professional Liability Insurance policies provide E&O and D&O coverage for mutual funds, private equity, hedge funds and/or venture capital funds. These policies may provide coverage for claims involving auction rate securities and investor claims challenging disclosure, risk and investment decisions. Policyholders should make certain that exclusions for dishonest acts are sufficiently narrow. This can be achieved, for example, by ensuring that the policy language excludes claims "for" dishonest or fraudulent acts, and not acts merely "arising out" of dishonest or fraudulent acts.

Contract Claims: E&O coverage will likely serve as the main source of coverage for contract-based claims which can arise from investment advisor relationships as well as breach of representations and warranties in transaction or sales contracts, including, notably, securitizations.

If faced with contract claims, policyholders should consider their E&O coverage. Although E&O policies often contain contractual liability exclusions, these exclusions may not bar coverage. For instance, a policy may exclude claims "arising out of, based upon or attributable to any actual or alleged breach of contract." However, many policies also include an exception for liability an insured would still have "in the absence of such a contract or agreement." A complaint's allegations of fraud or misrepresentation may provide a basis for coverage.

In addition, policyholders faced with contract claims should not overlook their fidelity bond policies as an additional source of coverage. Many fidelity bonds provide coverage broader than for merely embezzlement claims. Those policies covering forgery, alteration, or other claims involving unenforceable or illegal instruments may cover, or provide a defense to, mortgage securitization or pooling claims.

Borrowers' Class Actions: Of the five primary areas of exposure, borrowers' class actions represent the largest area of litigation arising out of the subprime crisis. Such claims typically allege inadequate disclosures in connection with the loan origination process, pricing or other discrimination against protected classes of people, and improper charges or payments. Both E&O and Comprehensive General Liability ("CGL") policies may provide coverage for borrowers' claims.

E&O (errors and omissions) insurance policies are designed to cover lenders or other professionals for negligence or malpractice. Like D&O coverage, these policies are typically "claims-made" policies that provide indemnity for claims made against the insured during the policy period and alleging wrongful acts committed in the insured's professional capacity.

Two common exclusions are particularly worth noting. First, E&O policies often contain exclusions for "return of fees." A policyholder faced with what appears to be a claim for fees should look closely at the complaint to determine if the claim is truly for fees or if the fee merely represents a measure of damages that would arguably be covered.

Second, like D&O policies, many E&O policies contain exclusions for claims arising from fraudulent or dishonest acts. However, many policies contain language that makes clear that the exclusion does not apply unless and until the insured has admitted to committing a fraudulent or dishonest act, or upon a final adjudication that the insured has committed such an act. If faced with allegations of fraud or dishonest acts, companies should check whether the exclusions are "severable" - meaning that fraudulent or dishonest acts committed by one individual insured will not be attributable to other "innocent" insureds. Companies may also protect their coverage by explicitly limiting the employees whose acts or representations may be attributable to the company. Many insurers agree to limit imputation to acts of Chief Executive Officers, Chief Financial Officers or other high-level employees.

Borrowers' class action claims may also be covered by CGL policies, which generally cover bodily injury, property damage, personal injury and advertising injury. Borrowers' class actions typically implicate only personal injury or advertising injury. Some older CGL policies provide coverage for "discrimination" as part of their personal injury coverage. Therefore, a policyholder may find coverage for a claim alleging discriminatory lending under the personal injury coverage. Most modern CGL policies limit advertising injury coverage to copyright and trademark infringement or misappropriation of advertising ideas, but some may also include liability for falsehoods in advertising as part of an advertising injury. Therefore, advertising injury coverage may be available for suits alleging misrepresentation in the advertising of loan terms or practices.

A notable benefit of CGL policies, unlike most D&O or E&O policies, is that they often impose a duty upon the insurer to defend the insured in all actions involving potentially covered claims. Additionally, CGL policies provide "occurrence"-based coverage, which means they cover damage or injury occurring during the policy period, regardless of when a claim is brought. Therefore, historic policies should be considered as a potential source of recovery, particularly for defense costs.

Employee Actions: Employee actions resulting from the economic downturn typically arise out of terminations, reductions in force, or bankruptcy filings, and include class actions brought by laid-off employees under the federal Worker Retraining and Notification or "WARN" Act.

Many CGL and D&O policies issued in recent years exclude employment-related claims, and stand-alone Employment Practices Liability ("EPL") insurance policies have become the standard source of coverage. EPL policies cover a broad array of claims, including discrimination, harassment, wrongful termination, wrongful failure to hire or promote and other wrongs arising from the employment context. EPL policies often exclude ERISA and benefits claims, fines, penalties and injunctive relief.

EPL policies may also exclude intentional acts. Insureds should pay careful attention to policy language regarding intentional acts and note that such exclusions should exclude only intentional harm, not the unintended results of intentional acts. Some insurers have begun to include language suggesting that unintended results of intentional acts will also be excluded. This is particularly problematic in EPL policies since acts of harassment or discrimination can easily be viewed as "intentional."

Because EPL policies are claims-made policies, policyholders must give prompt notice to their insurers once a claim has been made. Depending on the policy's definition of "claim," policyholders faced with an employment-related dispute should be cognizant that they may be required to give notice upon an employee's filing of a grievance with the EEOC. Thus, if a policyholder gives notice only after the employee has filed suit in a court of law, the insurer may attempt to deny coverage on the basis of untimely notice.

Conclusion

Because of the changing economic climate, companies should be especially diligent in recognizing insurance coverage as a valuable asset. In light of the increased litigation arising out of the current economic crisis and the attendant costs of defense, insurance policies may serve as substantial sources of protection, and a company's risk management officers should thoroughly review the coverage with its insurance brokers and legal advisors to ensure that all available coverage is utilized. As we will discuss in Part II of this series, companies not immediately faced with litigation should carefully consider their coverage needs and tailor their insurance programs to fit the companies' specific needs.

Marc E. Rosenthal is a Partner in the Insurance Recovery and Counseling Practice Group of Proskauer Rose LLP, and a resident in the firm's Chicago office. Bianca Chapman is an Associate in the Litigation & Dispute Resolution Department and a member of the Insurance Coverage Recovery and Counseling Practice Group, and also is a resident in the Chicago office.

Please email the authors at mrosenthal@proskauer.com or bchapman@proskauer.com with questions about this article.