The challenges encountered by a company and its management can be complex and involve numerous stakeholders. Following the discovery of a wrongful act, it can take time for affected parties to evaluate their position and commence legal proceedings against company executives. Often it will take many months or even years, for a mere circumstance to materialise into a formal claim. As a result, D&O exposures are known as being ‘long tail’ in nature.
As a company develops within industry, it enlists the services of various executives to help it achieve its goals and financial objectives. The management of a company will naturally evolve over time, and therefore it requires its insurances to accommodate changes in personnel. A D&O policy can protect current, future and former executives for wrongful acts that have been committed in the past, including acts that occur prior to the date insurance was first arranged. This is known as retrospective cover. Despite the retrospective protection provided by D&O insurance, it is critical for company executives to understand the key conditions that can have a significant effect on the breadth of cover provided by their policy.
1. Claims-made and notified policies
D&O insurance grants cover on a claims-made and notified basis. This means that a claim will only be covered if the claim, or first knowledge of a circumstance that may lead to a claim, is notified to the insurer while the policy is in effect or within an agreed extended reporting period. In other words, if an executive becomes aware of a claim or potential claim, they must notify the insurer within the current period of insurance for the policy to respond.
A D&O policy provides retrospective cover for wrongful acts committed prior to the inception of the policy, provided that notification to the insurer satisfies the claims-made conditions. That is, if a wrongful act has been committed in the past, as long as notification of the claim is made within the current insurance period, an executive can seek indemnity under the policy.
2. The retroactive date outlines the time period of coverage
While we have established that D&O insurance provides cover for prior acts, a policy may include a retroactive date, which specifies how far back in time the retrospective cover applies. It is common for D&O policies to be issued with unlimited retrospective cover, however an insurer may limit their exposure by enforcing a retroactive or prior acts date. The existence of a retroactive date can have significant consequences for the policyholder, as cover will not apply for any alleged wrongful act which occurred prior that date.
Claim Example:
ABC Company has been operating for many years, and has only recently decided to purchase a D&O insurance policy. The insurer offers cover to the company and imposes a retroactive date of “policy inception”. During the policy period, the board of directors become aware that a government authority is to conduct formal investigations into alleged improper reporting practices, occurring three years ago. The board immediately notifies their insurer of this circumstance, satisfying the claims-made condition of the policy. However, the insurer denies cover as the claim relates to an act that occurred prior to the retroactive date, i.e. three years before the policy was first incepted.
3. Coverage excludes prior and pending litigation
Due to the claims-made nature of D&O, it’s not an insurers intention to provide cover for claims known about prior to the inception of a policy, or claims that should have been notified to insurers in past policy periods. In order to eliminate cover for claims that involve pre-existing legal action, an insurer may rely on a prior or pending litigation exclusion.
A prior/pending litigation date excludes cover for a claim, if that claim is any way related to litigation proceedings that have commenced prior to the specified date. The exclusion is absolute, and the policy will not provide any protection whatsoever for claims where legal action exists before the prior/pending date. The prior/pending litigation exclusion can affect the coverage afforded by a D&O in a range of scenarios. For example, if a legal action is bought against a company before the prior/pending date, and is later amended to include the directors of a company, indemnity will be denied to the directors on the basis that the original litigation had commenced before the prior/pending date.
Management can also be left exposed if a claimant files a legal suit with the courts before a prior/pending date, but the claim is not served against the company and its executives until afterwards. In this instance, it should be noted that even if directors and officers are unaware of imminent legal action, the claim would be denied by the insurer, as the litigation technically proceeded the prior/pending date.
Claim Example:
ABC Company has held a D&O policy for the past 10 years, with an unlimited retroactive date. On renewal of the policy the company transfers their D&O coverage to a new insurer, which imposes a prior/pending litigation date of “policy inception”, i.e. inception of the new policy. Prior to transferring insurer, a legal suit is filed to the courts by a former employee alleging wrongful dismissal. At this stage no verbal assertion or formal demand has been made of company management, and as such, they are not aware of the pending claim. Following renewal of the policy with the new insurer, the board of directors is served notice of the employee’s intent to litigate. Executives notify the new insurer of the claim, however indemnity is denied due to the fact that legal proceedings were pending prior to inception of the new policy.
What this means for directors and officers
Company executives must be prudent with taking an interest in their D&O policy. They should ensure that they have adequate understanding of the various conditions affecting retrospective cover. Without doing so, they can unwittingly be exposed to claims resulting from prior acts and/or litigation. To achieve the best result from D&O insurance, policyholders should consider the following:
- Directors and officers should familiarise themselves with the claims-made reporting conditions of their specific policy.
- A company applying for D&O should clearly communicate to the insurer what retrospective protection is required, and insist on an unlimited retroactive date where possible.
- Executives must be proactive with relevant legal departments to monitor pending litigation, and to provide insurers with prompt notification of circumstances which may lead to a claim.
