Directors and Officers Liability Insurance: An Essential Coverage for the Real Estate and Construction Industry
Directors and Officers Liability Insurance: An Essential Coverage for the Real Estate and Construction Industry
A construction company defends a lawsuit alleging its executives misrepresented the scope of indemnification for building defects during the course of the project. A real estate developer responds to a homeowner association’s breach of fiduciary duty claim seeking damages and the costs to repair common areas of a mixed-use property. A real estate investment trust (“REIT”) settles a securities class action filed by a property management firm’s shareholders alleging misleading statements in connection with the REIT’s acquisition of the firm. All these real-world litigation scenarios potentially implicate directors and officers (“D&O”) insurance coverage for underlying losses and financial exposures. Unfortunately, the real estate and construction industry often overlooks D&O policies as an indispensable part of a company’s insurance portfolio to address risks not adequately covered by other lines of coverage.
The Five “Ws” of D&O Coverage for Real Estate and
Construction Companies
Who does it cover?
Generally, a D&O policy covers a company and its management for losses arising from third-party claims alleging corporate misconduct in running the business. The scope of coverage is determined by the D&O policy’s terms and conditions read together and the unique definition of key words and phrases within the policy form. The definition of “insured entity” or “named insured” typically includes the policyholder-entity that purchased the D&O policy, as well as its “subsidiaries” over which the policyholder exercises “management control” (i.e., an ownership stake or written agreement to select a majority of the board of directors). Publicly-traded corporations, privately-held companies and not-for-profit entities can structure D&O insurance programs with industry-specific wording tailored to their respective risk profiles. D&O policies also cover the company’s directors and officers as “insured persons” and commonly extend coverage to the General Counsel and Director of Risk Management positions. Many D&O policies also cover employees, including part-time and seasonal workers, under certain circumstances. Private company D&O policies insure direct “claims” against the policyholder-entity, whereas public company forms typically restrict coverage to “securities claims” alleging wrongdoing in connection with the offer, purchase and sale of securities or violations of securities law.
What types of risks, claims and losses trigger coverage?
D&O policies have three main insuring agreements or “sides” of coverage for underlying defense costs, settlements and judgments. “Side A” coverage responds to claims against directors and officers (and other individual insureds) resulting in losses not indemnified by the policyholder. “Side B” coverage insures the policyholder against losses incurred by directors and officers that the company is permitted or required to indemnify. “Side C” coverage applies to claims made directly against the policyholder or its subsidiary alleging wrongdoing as an organization.
Most D&O coverage grants require the policyholder to satisfy a self-insured retention before the insurer has a duty to defend or indemnify a potentially covered claim. However, Side A coverage for non-indemnifiable losses routinely provides “first dollar” loss protection with no retention, requiring the D&O insurer to defend or pay defense costs immediately with the onset of a claim. D&O policies also include coverage extensions and sublimits for specific operational risks, such as “books and records” demands from shareholders under Section 220 of the Delaware General Corporation Law and requests from regulatory “enforcement units” to interview the company’s management as part of an investigation.
Where are risks covered?
Most D&O programs have “territory” provisions stating coverage extends to risks anywhere in the world. However, for American companies with international operations, a global D&O program comprised of a US-based “master” policy with interlocking “local” policies placed in certain countries might be necessary. For example, for claims made against insureds in jurisdictions with laws against “non-admitted” insurance policies (i.e., a policy issued by a D&O insurer not licensed to conduct business in the jurisdiction), a US-based D&O policy may be unable to pay claims without the benefit of a locally-underwritten policy form. In addition, some D&O policies include dispute resolution, arbitration or choice of law clauses that determine the forum and insurance law precedents governing coverage disputes or policy interpretation issues.
When does the coverage respond?
Almost invariably, D&O insurers sell D&O policies on a “claims made” basis, meaning the policies only respond to claims made against insureds during the policy period. This differs from other “occurrence-based” policies, such as commercial general liability insurance, for which the timing of the injury (or injury-causing event) can trigger coverage. D&O policies also include a “cutoff” or retroactive date before which alleged wrongful acts are no longer covered regardless of when the claim originates. Thus, a company’s current D&O insurer might not have a coverage obligation for a claim made today if it alleges wrongdoing several years ago. Whether coverage is available depends on the negotiated retroactive date and the policy’s language, most notably the “prior events” exclusions barring coverage for claims relating back to earlier misconduct or reporting of matters.
Why real estate and construction companies should consider D&O coverage today?
If you are a chief financial officer, general counsel or risk manager for a real estate developer, contractor or a private equity firm with property-related assets, D&O insurance can address exposure to management liability claims and pass losses to the D&O insurer. Claims can emerge that commercial general liability or umbrella policies may not address or result in losses traditionally excluded by other liability policy forms.
For real estate developers, D&O coverage (and other forms of financial lines protection, such as professional liability insurance) can mitigate risks tied to every facet of a long-term project. For example, the transitional phase between completion of a large-scale residential property and conveyance of title to the homeowners association’s members could create losses covered by D&O programs. If the developer’s employees sit on the homeowners association’s board, alleged breaches of fiduciary duties could trigger the association’s D&O coverage or even the developer’s standalone D&O program, depending on the policy language. Keep in mind that insured “capacity” issues often determine if coverage is available for board service and coverage disputes can swing on whether the developer’s employee committed wrongful acts in his or her role for the association.
For contractors and especially privately-held organizations, D&O policies can respond to a wide array of claims brought by shareholders, creditors, vendors and business partners. Even a dispute between a commercial real estate owner and general contractor dispute could produce D&O coverage depending on the wording of the policy’s exclusions and the nature of the claims asserted. One impediment to coverage could be the contractual liability exclusion, found in private company D&O policies, which can bar coverage for claims arising from liability under a “written or oral contract or agreement.” However, many policies include an exception to the exclusion for defense costs and often a director’s or officer’s individual liability remains coverage eligible even if the claim arises from a contractual dispute.
For a REIT and other private equity firms with real estate holdings, a robust D&O program is crucial to address a variety of economic and liability risks. Such firms can purchase an “asset protection” or “portfolio management” D&O insurance “tower,” consisting of a primary policy and several layers of excess coverage, offering ample policy limits for securities claims targeting investment funds and their portfolio companies, special purpose entities and even their affiliates. Those asset-based D&O programs usually augment the portfolio company’s D&O coverage pursuant to “other insurance” clauses and the interaction between different policies. Private equity D&O coverage can also extend to fund advisers performing investment management services who often become embroiled in shareholder disputes and merger-related litigation as defendants. With respect to real estate investment trusts, economic downturns can impact the projected profitability of commercial property assets and holdings, prompting investor lawsuits against the REIT’s board of directors (including outside directors) alleging breach of fiduciary duty, misrepresentation and negligence. Certain allegations and theories of recovery within those claims could trigger D&O coverage for individual defendants or the trust itself.
Final Thoughts for the Real Estate or Construction Company
Seeking D&O Coverage
The real estate industry should keep in mind several guiding principles when thinking about the placement or renewal of a D&O program or reporting a claim for D&O coverage, including without limitation:
- The policy language controls: Courts attempt to interpret D&O policies as written and in accordance with the plain meaning of policy wording. In most jurisdictions, coverage grants will be interpreted broadly, while exclusions are narrowly construed and must be drafted in a clear and concise manner. Nevertheless, policyholders should always push for language enhancements to key policy provisions or seek coverage extensions via endorsement during the underwriting process.
- Avoid technical coverage defenses: As a policyholder, “good housekeeping” is important to ensure D&O coverage will not be squandered because certain conditions and duties were disregarded, sometimes allowing the D&O insurer to defeat coverage on technical grounds. Make sure you review your D&O policy’s notice and reporting of claims provision, as well as any requirements for insureds to cooperate with their insurers in the defense of underlying claims. In connection with settlement, always be aware of any duty to seek the consent of the insurer before entering into settlement negotiations or extending offers.
- Watch out for “hidden” exclusions: In the D&O policy’s exclusion section, the policyholder may find language barring coverage for fraudulent or intentional acts, receiving an illegal profit or financial advantage, or giving “prior notice” of wrongful acts under an earlier policy (among others). However, other areas of the policy form also contain language that can negatively affect coverage. For instance, D&O insurers often point to the “matters uninsurable” clause, typically found in the definition of “loss,” to attempt to deny coverage for damages they characterize as the disgorgement of ill-gotten gains. Thus, it is important to know the ins and outs of the entire D&O policy from the inception of a claim. Take steps to identify limiting clauses buried deep in the policy form’s definitions, conditions and endorsements that the D&O insurer might use to advance coverage defenses.
- Consult with experienced insurance recovery counsel: Real estate and construction companies should always consider working with counsel to maximize their chances at a significant D&O insurance recovery. Cox, Castle & Nicholson’s Risk Management & Insurance Recovery team can help you enhance and develop your D&O programs, resolve claim disputes and commence a coverage litigation if the D&O insurer refuses to withdraw its denial.