This is a type of insurance coverage in Canada that is rarely publicized and for which there is little precedent law. The reference to ‘coverage’ as opposed to ‘policy’ is because there is no common insurance policy or wording and no regulation of wording or premium rates for this area of risk. This makes the consideration of Insurance, as a risk management vehicle, challenging, and it makes the buying decision and policy negotiation even more difficult. However, there is some new case law on the subject, which proves that D&O and ODL claims happen in Canada.
Below I will briefly summarize the newest case law on ODL and then provide more generic comments on options and concerns regarding ODL coverage.
New ODL Case Law:
The Ontario Court of Appeals recently came to a decision, here, where J. MacFarland J.A. writes for both E.A. Cronk J.A. and A. Karakatsanis J.A. on the issue of an ODL policy as a follow-form versus primary responding policy. The policy coverage being argued in this case would be the type of coverage available in option 3 below. This case is extremely important because it raises the issue of the Duty to Defend in any D&O policy. The case alone should heighten the concern of primary insurance buyers as to knowing how they want or expect their policy to respond, and how it is written to respond. It should also bring to the attention of ODL buyers and ODL insureds (not always the same people), that the wording of any and all underlying policies have a direct impact on the entities above them in the chain of loss.
The case involves a failed Canadian financial institution and a D&O lawsuit naming, in addition to many others, two prominent Toronto lawyers (important to note for limits and costs management, the two separately retained counsel) in their capacity as directors of the failed financial institution. There was a primary D&O policy ($10 million) in place for the financial institution written by a very large D&O insurer in Canada, and the law firm had an ODL policy ($5 million) written by Lloyd’s. The lawsuit claimed $40 million in damages. An application was brought by the lawyers to determine which insurer was required to pay their defence costs, but it is interesting to note that “At the time of their application, the claim had settled – payment having been made by (the primary insurer) – and their defence costs paid by their law firm.” Therefore, with the law firm paying their lawyers’ defence costs, it is my assumption the primary policy of the underlying Outside Entity, together with any indemnification from the Outside Entity itself, did not cover all of the defence costs, and the ODL carrier did not pay or want to pay those costs.
The primary insurance policy did not contain the insurer’s ‘duty to defend’, but included clauses allowing the insureds “under certain conditions (to) tender the defence of a claim”, and advance defence costs “prior to the final disposition of a claim.” Like many primary policies there was a generic ‘excess of any other valid insurance’ clause. There was a similar generic ‘excess’ clause in the ODL policy, and the ODL policy stated “it shall follow all terms… of the Underlying Insurance.” Therefore, the ODL insurer argued that its policy was ‘follow-form’ and should follow the Primary policy and not provide a Duty to Defend. However, the court made specific reference to Nicholls v. American Home, here, in its distinction between an insurer’s broad, but not unlimited, duty to defend and an insurer’s more restricted duty to indemnify. The court found that, 1) there was broad duty to defend language in many parts of the ODL policy, including the defence section, 2) there were a number of references to how the ODL policy would respond with a primary-type defence, 3) the follow-form language, if applied, would only apply to indemnification coverage not defence, 4) the ODL policy included language that would be unnecessary if it was in fact their intent to follow-form, and 5) the ODL policy included language that would be contrary to their follow-form intent if the underlying policy did provide a duty to defend.
Therefore, the Court of Appeal for Ontario dismissed the ODL carrier’s appeal and upheld the lower courts position that the ODL carrier had a duty to defend, even when the primary carrier did not.
The implication of this case, if it is not appealed and overturned by the Supreme Court, is that loss costs for a ODL claim may now be higher than originally considered by ODL carriers and higher prices or more restrictive wording should be expected.
An interesting note, the Court of Appeal went out of its way to state as being incorrect a position where the lower court suggested that the ODL’s policy costs were outside the limits even though that point was not argued before the lower court.
ODL Coverage Options and Concerns:
I should establish the use of the term ODL, as there is confusion between products addressing the unique risks of the ‘outside’ or ‘independent’ non-executive members of a board of directors, and products addressing the risk of any director, officer, or even employee, of a specific company, who holds a board position (the Outside Director or Outside Directorship) on any other company (the Outside Entity). This latter risk is the one more commonly associated with the term ODL in Canada. With the coverage provided by ODL, the Outside Entities have to be determined, either by specific ‘scheduling’ of each and every entity by name in an endorsement to the policy, or by a ‘broad form’ or ‘blanket’ inclusion of coverage for all entities who fit a common definition (best example of a broad form list is all non-profit or not-for-profit entities.) ODL coverage can be purchased, by a specific company, 1) as an extension to their directors’ and officers’ liability policy (D&O), 2) on a standalone policy basis, or 3) by subscribing on behalf of their employees to an industry based ‘program’ coverage. No matter what the form of coverage, it is commonly written as an ‘Excess Policy’, but usually an ‘Indirect Excess Policy’ because the underlying insurance policies are rarely specifically identified. The policy is also a multiple excess policy, because it traditionally only responds excess of the indemnification, deductible and insurance policy limits of the Outside Entity and, in some cases, of the company.
The first option is fairly simple – just request (of your broker) that your company’s D&O policy be extended to include any director, officer, or employee who sits on the board of an outside entity. If the answer is easy, be very careful because it is not and should not be an easy process. Most insurers will provide blanket coverage to all directors, officers and employees who sit on the board of any non-profit Outside Entity (aka ‘blanket entity’), at the knowledge or written consent of the company. Some insurers will even provide that blanket coverage to any ‘for profit’ Outside Entity, others will request a very short application and only provide the for-profit extension to specific individuals and their specific outside entity on a scheduled basis. Either way, any such extension creates a significant risk of eroding or exhausting the limit of liability of the company’s D&O policy, because there is only one limit of liability available and there is rarely the option to reinstate that limit if it is exhausted by any type of loss. Even if the extension is requested by the board of directors, the onus will be on management to identify and manage the additional risk to the board members. Any extension of their policy may be a relatively easy concept, until a claim is actually made. That is when the conflicts starts, and fingers are pointed at each other and at management. The best protection is paper work and (evidence of) communication.
The second option for coverage is ODL on a standalone basis. This comes at the cost of additional annual premium, but the benefit is a separate limit of liability dedicated to the risk of claims resulting form directors, officers and employees holding board positions on Outside Entities. Another benefit is the obvious paper trail of risk management, communication and decision making that is commonly missing in the ‘extension of coverage’ route. However, like every other insurance policy, the coverage is in the details. The standalone policy may offer blanket (persons) and blanket (outside entities) coverage, but it is more likely to offer blanket/blanket non-profit, and blanket/scheduled for-profit coverage (any individual but specifically scheduled entities.) This coverage option is commonly dismissed because of the extra cost, the low know frequency or severity of ODL based claims, a reliance on the Outside Entity having its own primary D&O policy, and because of the more onerous underwriting requirements and paperwork that is placed on company management. It is rare that the reason for not buying the coverage is because a detailed analysis of the risk has revealed a probable maximum loss that is willingly retained (self-insured) by the corporation and by the corporation’s individual directors, officers and employees.
The third option for ODL coverage is when a company subscribes to an ODL program that may be offered to the members of professional organizations. Here the company commonly pays the ODL program insurance premiums on behalf of certain individuals (directors, officers, employees, partners or affiliated individuals), who are members of that organization. There are not many of these professional ODL programs available in Canada, and they target professions like lawyers, accountants, actuaries, etc., who are motivated by their employers and by their clients to hold such board positions. The annual premium costs for this coverage, once multiplied by each member, can be material to the organization. And the underwriting or submission requirements can be extremely onerous. The benefit is that there is a dedicated limit of liability available to each member and therefore arguably a lesser risk of exhaustion of limits of liability of the company’s D&O program. The concern again is that coverage is in the details, and these details may change from one year to the next. The actual coverage available from these programs requires a detailed analysis and full understanding of the policy contract, and, like other claims-made liability insurance policies, the policy contract includes all applications for insurance (including aggressive and passive warranty statements), applications submission materials (which may include any publicly available information even if it was not actually attached to the application), exclusions and endorsements, and client actions required in that contract. The analysis should specifically address any possible sharing of limits between insureds within the same entity or even with insureds who are employed by another company. There may also be a primary limit ‘pool’ for any and all claims in a given period, which may or may not include adequate excess limits or reinsurance for the risk retained.
A key red flag for any of the ODL coverage options should be the ease of negotiation. The easier and cheaper it is the less value it probably has. Coverage details should include:
- Is the coverage considered Excess or Primary?
- What amounts must be paid (limits / deductible / indemnification), and by who (Outside Entity / Company / Individual Insured Persons) before the ODL coverage will respond?
- If excess, is it a ‘follow-form’ policy or a non-follow-form wording?
- Is recognition of the Outside Entity based on ‘knowledge and written consent of the board of directors of the company’, or it is an indefinable and non-measureable term ‘known to the company’?
- Is coverage blanket/blanket for non-profit entities and for-profit entities?
- Is there an exclusion for publicly listed securities, and if so, is this term defined and does it extend to all activities related to a public listing including the road-show and meetings contemplating the listing?
- Does the coverage change the definition of Insured in the policy and, therefore, further expand exclusionary wording like the Insured vs. Insured exclusion?
- Is there a ‘prior acts’ exclusion or ‘prior and pending litigation’ exclusion in the coverage?
- Is an application required for each outside entity and does it include a ‘warranty statement’?
- Is there full severability of application and exclusions?
- Is there an assumed minimum for the underlying insurance limit of liability?
- Does the ODL coverage require all underlying limits be exhausted by ‘payment of Losses’?
- Have all possible Outside Entities been identified?
- Have underlying insurance policies been identified?
- Has the company taken steps to evaluate the risk and risk mitigation efforts of each Outside Entity?
- Has the Outside Director requested the by-laws and an individual contractual indemnity from the Outside Entity and from their company?
There is no standard wording in the marketplace, and in many cases there is no explicit ODL coverage at all. ODL coverage can come in the form of the three options above, or it can be embedded into the base D&O Policy, Private Company D&O or Management Liability Policy or Non-Profit Policy. Without an analysis of the coverage and review of the insured entity’s policies and procedures, the existing D&O policy could be subject to exhaustion from risk of an unknown party and even an unknown individual. A company’s attempt to deny making a claim under its D&O insurance policy for an ODL claim (because the risk was not known to the board), may only result in a lawsuit against the board, which may be denied by the insurance carrier based on the Insured vs. Insured exclusion.
If the submission or underwriting process is viewed by company management, and by each affected person, as the perfect opportunity for risk management, it might make the risk identification and loss management activities slightly more palatable. The benefits are significant because the potential loss costs could be very high. The process of risk management, and more specifically the application for insurance coverage, has the additional benefit of bringing in experienced third parties (insurance companies and insurance broker) to help with the identification and evaluation of risk.
Outside Directorship Liability is a confusing and often misunderstood corporate and personal risk. If you would like to discuss your current program or your risk management activities, please call. We provide consulting services for identifying and evaluating risk, insurance program evaluation, and claim coverage response.
Please feel free to call me to expand on any of these issues, or provide you with other documents or other pertinent case law. You can also use the word search function on this blog to find other relevant postings.
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