Managing D&O claims expense

One of the standard features of the typical directors’ and officers’ liability insurance policy is the provision allowing the insureds to select their own defense counsel, subject only to the insurance carrier’s consent (such consent not to be unreasonably withheld). Under that policy provision, the insureds’ defense costs are reimbursed by the D&O carrier, subject only to the policy’s limits and the requirement that the defense costs be reasonable and necessary.

In a recent study of D&O claims handling, professor Tom Baker of the University of Connecticut School of Law and professor Sean Griffith of Fordham University School of Law found the “predictable effects” of this arrangement are that “D&O insurers are unable to control the costs of defending the claims.” They indicated that D&O insurers are “pressured” to settle claims “at greater expense than an insurer in full control of defense and settlement would allow.”

The D&O insurers’ general inability to control defense can present a significant issue, because the costs of defending D&O claims are substantial.

According to the 2006 “Towers Perrin Directors and Officers Liability Survey,” the survey respondents’ average cost of defending a shareholder claim in 2006 was $2.79 million, up from $2.14 million in 2005. Because defense expenses erode the limits that would otherwise be available to settle claims, controlling defense expenses is in both the carrier’s and the policyholders’ interests.

An April 20, 2007, opinion in coverage litigation arising from the bankruptcy proceedings of affiliates of Indotronix International Corp. sheds interesting light on these issues. In the Indotronix case, Judge Charles Brieant had previously held that the plaintiff was entitled to recover its reasonable and necessary costs of defending the claim. However, in an April 30 opinion, he held that the carrier did not have to pay amounts that were “facially excessive.”

The plaintiff insured sought to recover $443,496 in fees. Judge Brieant reviewed the defense firm’s fee statement and found that there were numerous occasions “when nothing was happening and all the papers due had been filed,” yet defense lawyers were “spending an awful lot of time looking at documents” and “days on end sitting at Indotronix.” Judge Brieant also found that the legal research “should not have required a great investment of time” and that the “number of hours spent looking at documents appears to be highly excessive.”

Based on his review, Judge Brieant found that the fees were “facially excessive” and that “far too much work was done at too great of a cost to be visited on the insurer.”

The judge also found the defense firm’s rate, “while perhaps reasonable in Manhattan, is in excess of rates reasonably charged for work” in Westchester County, N.Y., where the underlying case had been pending. Based on his review and applying the lower Westchester County rates, Judge Brieant reduced the fees from the requested $443,496 to “a reasonable award of $141,133,” leaving the plaintiff with an unreimbursed fee expense of $302,363.

That case will undoubtedly provide some comfort for D&O insurers, although it will be a rare case where any court will undertake the kind of detailed review that Judge Brieant assumed in the Indotronix case. The opinion also suggests some important steps D&O policyholders can take to try to avoid or reduce disputes over fees.

First, Judge Brieant not only examined the defense firm’s activities, he also reviewed the firm’s billing practices. It clearly did not help the insured plaintiff’s reimbursement request that “some hourly records are missing from the record and some services involved attending at proceedings [that were] not directly related to the Adversary Proceeding.” Policyholders will greatly improve the prospects for success of their reimbursement request by assuring that the substantiating documentation is complete, accurate and reflects only relevant charges.

Second, it appeared from the opinion that the insured did not seem to have subjected the fees or the attorneys’ work to review or oversight. The court’s finding that the fees were “facially excessive” and reflected “far too much work” implicitly suggested that the insured itself could have done more to monitor and control the attorneys’ work. The first step toward convincing a carrier that requested fees are reasonable and necessary is for the policyholder to first subject the fees to its own review, before even seeking reimbursement.

All parties in the claims process have a stake in ensuring that defense fees incurred are reasonable and necessary, and the policyholder has an important role to play in the process. Indeed, because defense expense depletes the policy limits, the policyholder has every incentive to ensure that the defense goes forward efficiently.

Finally, the key ingredient to avoid fee disputes is communication. The hourly rate charged, the amount of work done and even the completeness of the bills were all issues that arguably should have been sorted out during the unfolding of the claim, not afterward, when it was too late to alter the circumstances. In that case, the existence of potential coverage dispute with the carrier clearly did not help communications. Coverage uncertainty can often prove an insurmountable barrier to effective communication. But timely and accurate communication between the policyholder and the carrier, when possible, can frequently avert or minimize issues that can lead to significant defense expense disputes. The involvement of a skilled claims advocate can help to facilitate those communications, even where coverage remains uncertain.

Topics Carriers Claims Talent