D & O Insurance: Directors and Officers Coverage or Dead and Obsolete Coverage?

Construction Law Report Spring 2013

05/01/2013

James L. Guse

Homeowners associations routinely purchase Directors and Officers (“D&O”) insurance.  At first blush, purchasing D&O insurance is a wise risk-management tool.  Upon close inspection, however, associations may be surprised by the limitations of D&O policies.

D&O policies purport to cover both the association and its directors to the extent they are found liable for “wrongful acts” committed by insureds. In other words, if a former director is sued for the commission of a wrongful act, the insurance is intended to compensate the injured party.  Typically, the injured party is the association and its members. However, D&O policies now almost universally include some form of “insured v. insured” exclusion.  Two examples from a D&O policy are set forth below:

“This insurance does not apply to claims:

By, or for the benefit of, or at the behest of the Organization [Association] or a Subsidiary or any entity which controls, is controlled by, or is under common control with the Organization or a Subsidiary, or any person or entity which succeeds to the interest of the Organization or a Subsidiary.

Brought or maintained by or on behalf of an insured organization unless the ‘Claim’ is brought and maintained totally independent of, and totally without the solicitation, assistance, participation or intervention of any officer, director or trustee of an insured organization.”

Deciphering the insurance-speak, the policies exclude claims against current or former directors if the claim is brought by the association.  Therein lies the problem:  homeowners associations rarely, if ever, operate outside of the board of directors. In fact, if the claim relates to common elements or common funds, the association may be the only party with standing to bring such a claim.  As a result, the D&O coverage provides little protection to an association or its members for wrongful acts committed by current and former directors and officers.

Some may question the existence of an exclusion that essentially guts any meaningful coverage.  The exclusion first appeared as a result of “collusive” or “friendly” lawsuits by corporations:  When a company’s directors and/or officers made a bad business decision resulting in a loss to the company, the company sued its officers and directors to recover the loss.  In other words, insurance companies were asked to cover failed business decisions instead of legitimate wrongful acts.  Insurers responded by excluding claims by companies against their own directors and officers.

Unfortunately, the insurance companies cast too wide of a net. While the exclusion certainly curtailed “friendly” lawsuits, the “insured v. insured” exclusion also all but precluded legitimate lawsuits.  Companies and associations can rarely trigger coverage for the wrongful acts of their officers and directors, despite the fact that this is the very reason the coverage was procured.

Accordingly, before buying D&O coverage, one should discuss the “insured v. insured” exclusion with one’s insurance agent or broker as the insurer may be willing to delete or modify the exclusion.  Otherwise, associations should recognize that their premiums for D&O coverage might be little more than a donation to their insurance company.

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