Where Did My Insurance Go?

• Directors may find that their insurance policy is not there when they actually need it

• as the renewal season approaches, companies and their officers should be reviewing their D&O insurance to ensure the best possible coverage.

You know that your company has taken out D&O insurance, but will cover be there when you actually need it? Unless the policy adequately addresses the effect of the actions of fellow directors, you may find that the policy has effectively gone up in smoke

A change afoot?

With reports of the $150-170 million settlement in the landmark Aristocrat Leisure class action to be primarily funded by insurers, the coming insurance renewal season will be viewed with interest. Will insurers continue to treat Australia as a benign claims environment?

Although premiums are dependent on a variety of factors, substantial write-downs arising from the sub-prime crisis, poor investment returns and increased claims exposures are likely to result in a withdrawal of capacity and consequent hardening of the market. The federal government's announcement of a survey of company directors, which will canvass whether their liability exposure affects their decision-making, is unlikely to alter the liability landscape in the short term.

How does D&O fit in?

Apart from protection against any legal liability, it is vital that your D&O policy provides up-front defence costs cover, as such costs can be crippling regardless of whether you are ultimately liable for any wrongdoing.

D&O policies are some of the most diverse in the market and there is scope for significant differences between policies. It is therefore vital that they are reviewed to ensure adequate coverage.

The severability problem

One of the issues that refuses to go away is severability. As a single D&O policy covers a variety of directors and the company itself, the acts or omissions of one insured (e.g. a director) have the potential to prejudice the claims of another innocent insured.

D&O policies commonly provide that the wrongdoing of one insured shall not prejudice the rights of innocent insureds in respect of conduct exclusions (e.g. dishonesty) and that the insurance proposal will be considered a separate proposal for each insured. The intention is that non-disclosure or misrepresentation by one insured should not affect the rights of innocent insureds.

However, such protections only go so far. There has been a long-running debate as to whether they adequately protect against the insurer's right to cancel the policy or to avoid the policy from inception. Unless the policy is treated as a separate contract entered into with each insured (severable for all purposes), cancellation or avoidance of the contract may operate against all insureds, regardless of what is in the policy.

What to do about cancellation and avoidance?

To address concerns about cancellation and avoidance, some insurers have strengthened their severability clauses to provide that:

• they waive all rights to avoid or cancel the policy, except for the non-payment of premium

• they will only seek to reduce their exposure in the event of fraudulent misrepresentation or non-disclosure

• that such reduction of liability will only be asserted against the person guilty of the fraudulent misrepresentation or non-disclosure.

What about a statutory right that entitles avoidance?

Debate remains as to whether a clause in the policy itself will be effective where a statutory right exists entitling avoidance from inception thus, preventing the contract from coming into being in the first place. For this reason, some insureds have taken the additional step of putting the insurer's agreement to treat the policy as severable in a separate agreement. However, this is not yet commonplace in the Australian market given legal authority to the effect that, even where a contract is void from inception, the agreement of the parties in certain clauses may be preserved. It is therefore arguable that a clause in the policy providing that it should be treated as a separate contract with each insured would be given effect, even where the policy is void from inception.

An example – severable for all purposes?

From an insurer's perspective, concerns remain about treating the policy as severable for all purposes, as this may alter the intended effect of other sections of the policy. As an example, in the context of the compromise or settlement of a claim without the insurer's consent, it would seem contrary to the intention of the parties that one insured could make admissions and settle a claim while other directors assert that such admissions or settlement cannot be taken into account in respect of the claim under the policy.

The way forward

Severability remains a vexed issue. However, you can request that your policy be treated as a separate policy for each director (at least for certain purposes), so that the conduct of another director cannot affect your entitlements. The insurer could also agree to waive all rights to avoid or cancel a policy except for the non-payment of premium.

This complex issue is just one of many that can arise in the context of D&O insurance, and highlights the need for careful legal review of your policy, so it is there when you need it!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.