[This article was posted on October 30, 2008 on the home page of ABA Banking Journal, www.ababj.com, and is copyright 2008 by the American Bankers Association.]
If you find yourself in court over subprime trouble, count on insurer resistance
Think you’re covered? Insurance carriers typically look for reasons
to leave you stranded when suits like the subprime aftermath get filed.
You may be fighting a two-front war
By Keith A. Meyer, a partner at Howrey LLP in Los Angeles.
He specializes in the representation of policyholders against their
insurers in complex insurance coverage disputes. Howrey LLP is an
international law firm with one of the largest insurance recovery
practices in the country. He can be reached at
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The inevitable lawsuits following the subprime mortgage aftermath have
begun. Officers and directors of financial companies that think they
may be sued, along with their companies, may be wondering what
protection they have under their directors and officers liability
policies and other coverages.
Already, suits have been filed over the course of 2008 by some of the
largest institutions that became involved in the subprime world. These
suits alleged that the companies and their officers issued materially
false and misleading statements concerning their companies’ exposure to
the subprime market. The common theme is that the company allegedly
overstated its financial results by failing to disclose the true extent
of its exposure to the subprime market, and thus falsely inflated the
prices that investors paid for the company’s securities.
As more companies are forced to adjust their balance sheets to reflect
losses arising from investments in subprime mortgages, more suits will
follow.
Potential insurance coverage—and potential resistance
Once claims are brought or even threatened, a company and its officers
and directors should determine what insurance policies may serve as
financial protection against these claims. First, these suits typically
name not only the companies as defendants, but the company’s key senior
executives and officers as well. This may enable the company to tap
into its directors and officers coverage and should allow the directors
or officers identified in the complaint direct access to those
policies. This type of coverage generally pays for losses arising out
of claims made against corporate directors and officers for alleged
“wrongful acts” while acting in their capacity as an officer or
director of the company. Many policies also provide coverage for the
company to the extent it has indemnified its corporate officers or
directors, or straight “entity coverage” for certain claims made
against the corporation directly, such a “securities action claim,”
which should not be overlooked.
Nearly all D & O policies are issued on a “claims made” basis. This
means that they only cover claims made against the directors and
officers during the policy period, regardless of when the alleged
wrongful acts are purported to have taken place. It is thus the timing
of the suit, not the timing of the wrongful acts themselves, that
determines which policy will respond to the claim. Prompt notice to the
primary insurer should be provided and, if the amount sought is
substantial, excess carriers should be placed on notice as well.
Given the magnitude of the losses, insurers will likely resist
paying these claims and raise a host of policy-based defenses. Based on
the approach taken by insurers when faced with other large-scale
financial crises (such as the savings and loan crisis many years ago
and the ongoing stock option backdating claims), the defenses on which
the insurers will rely have been predictable.
Initially, insurers will inspect the application for insurance to
determine if there were any misrepresentations, or any warranties in
the application by the proposed insured, that might have been breached.
For example, most applications require the proposed insured to warrant
that it is not aware of any circumstances that could lead to a claim or
suit. Many of the subprime lawsuits, however, allege that the company’s
officers and directors were aware of the company’s risky investments
and yet failed to take appropriate action to deal with the problems in
the credit and housing market that were looming on the horizon.
Similarly, many applications require a company to attach a financial
statement when applying for D & O insurance. Yet many of the
subprime lawsuits allege that the company’s financial statements were
misleading and failed to disclose the true extent of the company’s
losses in its subprime portfolio. In both cases, the insurer will
attempt to establish the same facts as the plaintiffs in the underlying
case in order to rescind the policy.
Thus, instead of partnering with its insured to defeat the
underlying suit, the insurer will likely be searching for facts that
could be used to void some or all of the coverage under the
policy—which may be the same facts that the underlying plaintiffs will
seek to establish to prove liability against the company and its
officers or directors. The insured may thus be forced to fight a
two-front war, with a supposed ally—its insurer—as one of its enemies.
Some counterpoints for insureds
Coverage is typically provided in D & O policies for “wrongful
acts,” which usually include “any breach of duty, neglect, error,
misstatement, misleading statement, omission or act by directors or
officers in their capacity as such.” Despite this broad coverage,
indemnification is usually provided only for negligent acts, not
intentional acts. Yet intentional acts that are done without the
intention to cause harm or violate the law should be covered. Insurers
will also attempt to show that the alleged misleading statements are
excluded from coverage as “dishonest, fraudulent or criminal
acts.” These policies generally contain a “dishonesty” exclusion,
but most policies limit the exclusion to cases where “a judgment or
other final adjudication” establishes the dishonest conduct. Thus, most
pre-judgment settlements should not be encompassed within the
exclusion, although the insurer can be expected to argue to the
contrary. Nor would defense costs.
One of the most frequent areas of dispute involving D & O
coverage relates to questions of allocation. Directors and officers
policies cover “loss,” i.e., defense and indemnity, but only for
“covered claims.” Therefore, if the suit alleges both covered and
noncovered claims, or names both covered and noncovered parties as
defendants, the insurer will contend that the defense and settlement
costs must be apportioned among the claims and parties involved. Thus,
the insurer will seek to pay only those defense and settlement costs
associated with covered claims and will attempt to minimize the costs
attributed to covered claims. The larger the claim, the more likely it
is that a court may be forced to determine the appropriate allocation.
In addition to standard D & O policies, the same charges levied
against corporate officers for their alleged mismanagement of the
company’s finances and its exposure to subprime debt may also trigger
coverage under the company’s professional errors and omissions
policies. This type of policy typically covers a professional for
negligence or malpractice arising out of the performance of
“professional services.” Similarly, coverage may exist under
other specialty lines of coverage, such as fiduciary liability
policies.
Shoals ahead for insureds
These are but a mere sampling of the issues that are likely to arise in
response to claims resulting from subprime lawsuits against directors
and officers of investment banks, lending companies, and other
financial institutions. If history is any guide, insurers are likely to
resist paying for the defense and/or settlement of these suits,
particularly given the size of the claimed losses. This may force the
policyholder not only to defeat the plaintiffs in the underlying suits,
but to prevail against its insurers in a coverage action. BJ
The preceding article appeared on www.ababj.com, the website of ABA
Banking Journal, and was posted in October 2008. Copyright 2008
American Bankers Association.
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