Take the pollution out of your D&O policy

Is your directors and officers policy polluted? Shareholders and environmental groups are taking a closer look at the environmental disclosures made by public companies. The U.S. General Accounting Office issued a report in July 2004, questioning the transparency of environmental disclosures and calling on the Securities and Exchange Commission for greater oversight in that area. Many shareholder activists claim that public companies are consistently underreporting environmental liabilities. Underreporting reserves raises the D&O claim exposure to public companies and their directors and officers.

D&O insurers frequently include an express exclusion for claims “arising out of” the actual or alleged discharge of pollutants. Directors and officers may mistakenly believe that the exclusion applies only to formal environmental claims or lawsuits for cleanup costs and remediation. To the contrary, D&O insurers may invoke an “absolute” pollution exclusion to deny coverage for shareholder claims that arise out of environmental reserves or other related pollution issues.

Two recent cases illustrate that point. In Danis v. Great American Ins. Co., 823 N.E.2d 59, 159 Ohio App. 3d 119 (2004), the insured, Danis, sold various companies to Waste Management Inc., including Valleycrest landfill. After the sale, a lawsuit arose between Danis and Waste Management. The two settled, obligating Danis to indemnify Waste Management for all future Valleycrest claims. Shortly before the settlement, the Danis entities underwent various restructuring and recapitalization transactions. When Danis later denied indemnification to Waste Management under the settlement agreement for a Valleycrest claim, Waste Management sued for breach of the agreement.

Several counts of the suit were fraud-related tort claims directed at certain Danis directors and officers regarding the pre-settlement corporate restructurings and capitalizations. Nevertheless, the D&O insurer, Great American, denied coverage in total based on the D&O policy’s “absolute” pollution exclusion.

In the subsequent coverage litigation, the trial court found that the pollution exclusion did not apply to the “independent and intervening” alleged wrongful acts surrounding the restructuring and recapitalization transactions. The Ohio appellate court disagreed, finding that only one loss occurred – damage caused by the Valleycrest pollution site.

Absent the underlying settlement agreement relating to Valleycrest, the court said Waste Management would have had no basis to bring a cause of action against Danis and its directors and officers. The court found the tort claims in Waste Management’s lawsuit – although not formal claims for environmental remediation or cleanup costs -arose from pollution. Therefore, the claims were excluded by the policy’s pollution exclusion.

In another case , National Union Fire Ins. Co. of Pittsburgh v. U.S. Liquids Inc., 271 F.Supp.2d 926 (S.D. Texas 2003), the D&O insurer invoked a pollution exclusion to deny coverage for shareholder class action and derivative claims. The underlying securities lawsuit combined several class actions and derivative suits resulting from U.S. Liquids’ acquisition of another waste management company. The lawsuit alleged that U.S. Liquids’ directors and officers breached their fiduciary duties in causing U.S. Liquids to violate federal environmental and securities laws. U.S. Liquids sued National Union after it denied coverage based on the pollution exclusion.

U.S. Liquids’ D&O policy excluded any claim “alleging, arising out of, based upon, attributable to, or any way involving directly or indirectly the actual, alleged or threatened discharge, dispersal, release or escape of pollutants.” Focusing on the plain language of the exclusion, the court held that “arising out of” wording in a policy exclusion leads to a “broad, general and comprehensive interpretation” requiring only an “incidental relationship to the described conduct for the exclusion to apply.”

U.S. Liquids argued that the complaint merely alleged securities violations, none of which involved a pollution discharge. The court disagreed, finding that claims in the lawsuit would not exist “but for” the hazardous waste conduct by U.S. Liquids. Thus, the company and its directors and officers were without defense or indemnity coverage for the shareholder claims.

Despite the negative implications from those cases, many D&O insurers will modify pollution exclusion wording to provide broader protection against pollution-related D&O claims. Companies in the utility and related energy sector, for example, may find a good solution through a mutual insurer that does not include a pollution exclusion in its standard D&O form. Certain commercial D&O insurers also delete the pollution exclusion in its entirety for exceptional risks.

Most commercial D&O insurers include some pollution exclusion wording in their traditional D&O policy forms. Companies with significant environmental disclosures and/or environmental reserves should aggressively negotiate for a full shareholder claim exception to any pollution exclusion contained in the primary policy. Several commercial insurers have agreed to such a modification on a case-by-case basis.

At a minimum, try to negotiate a carve-out to the exclusion for non-indemnifiable claims asserted against individual insureds. Side A only coverage for pollution-related D&O claims is generally available, either as an express exception to the pollution exclusion in the traditional D&O policy form, or in the form of a Side A only Excess “Difference In Conditions” (DIC) policy that omits the exclusion altogether.

John Tanner is vice president and claims counsel to the Financial Services Division of insurance broker McGriff, Seibels and Williams Inc., a wholly owned subsidiary of BB&T. Phone: (404) 847-1607 or e-mail: jtanner@mcgriff.com. Tony Tatum is a senior associate in the Business Litigation Practice Group of the law firm King & Spalding. Phone: (404) 572-3519 or e-mail: ttatum@kslaw.com.

Topics Lawsuits Carriers USA Claims Pollution