Hiding in Their D&O Policies
Many private companies believe that procuring a directors and officers liability (D&O) policy ensures that their executives are covered.
But, does the D&O policy really protect their C-Suites? The answer to that question often depends on the presence of the so-called “contract exclusion” contained in many D&O policies, how insurance carriers apply the contract exclusion, and how courts interpret the contract exclusion. While procuring a D&O policy is a critical part of a company protecting its officers, it is equally important that companies, and their agents or brokers, understand the risks associated with exclusions contained in the policy.
It is well established that D&O policies do not cover breach of contract claims because parties entering into contracts voluntarily undertake the associated risk and potential for liability. To address this principle, D&O policies routinely contain exclusions, for example, “the insurer shall not pay loss in connection with any claim based upon, arising from, or in any way related to any actual or alleged liability under any contract or agreement, provided that this exclusion shall not apply to the extent that liability would have been incurred in the absence of such contract or agreement.
The critical language contained in the contract exclusion that creates uncertainty is “arising from, or in any way related to …”.
Recently, insurers have applied an increasingly broad reading of this language to deny coverage for claims that many businesses reasonably expect to be covered. As an example, here is an excerpt from a recent coverage disclaimer from a large insurer:
An exclusion precluding insurance coverage for claims arising from a contract not only applies to claims sounding directly in contract but also to claims sounding in tort as long as they flowed from or had their origins in the breach of the contract.
The insurer in that particular case drew support for this position from an Eighth Circuit Court of Appeals opinion applying Missouri law, Spirtas Co. v. Federal Ins. Co. The Spirtas court determined that the contract exclusion barred coverage for the tort claims of conversion and unjust enrichment, rationalizing that those claims were “arising from” contractual liability.
Insurers rely on the Spirtas decision as a basis for disclaiming coverage for a wide variety of tort claims, such as tortious interference with a contract, negligent misrepresentation and fraud based on the Eighth Circuit’s statement that, “the term ‘arising from’ is construed broadly such that an exclusion precluding insurance coverage for claims arising from a contract not only applies to claims sounding directly in contract but also to claims sounding in tort as long as they ‘flowed from or had their origins in the breach of the contract.'”
Several other courts have taken a similarly broad view of the contract exclusion to uphold coverage denials.
There is, however, a growing body of authority providing that the contract exclusion does not apply to pre-contract wrongful acts. Courts have held that the contract exclusion does not exclude coverage for the tort claim of intentional misrepresentation where the misrepresentation was made before the transaction and the transaction was generated by and was a consequence of the misrepresentation. Determining when the claim arises in these cases is a critical aspect of distinguishing between tort and contract claims for coverage analysis.
The contract exclusion can render a D&O policy illusory, leaving the company’s c-suite at significant risk of facing liability with no coverage. Understanding the danger presented by the seemingly benign words “arising from, or in any way related to” is imperative to evaluating the risk. It is best to procure a D&O policy that does not contain this expansive language. If a D&O policy does contain this type of language, the company should push to modify the language of the contract exclusion to eliminate “arising from, or in any way related to” and replace it with “based upon any actual or alleged liability under any contract or agreement.” If a business repeatedly utilizes the same form contract, the business should consider including specific language in its D&O policy providing coverage for liability arising from that specific contract.
In any circumstance, careful review of the D&O policy is necessary before a claim arises. Consultation with legal counsel and/or the insurance broker regarding the scope of the contract exclusion in the D&O policy is helpful. As with all insurance issues, the time to review the policy is before the claim.
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