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Article | FINEX Observer

Broadening definitions of claim: Be careful what you wish for

Financial, Executive and Professional Risks (FINEX)
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By John D. Shugrue | November 18, 2019

The expansion of coverage for a broader range of claims sometimes has the opposite effect of limiting coverage, as insureds have not adequately addressed notice to D&O insurers.

As the song in the famous musical says, "No good deed goes unpunished." In the D&O coverage arena, this statement aptly can be applied to characterize the sometimes unfortunate (and always unintended) negative consequences on coverage of the broadening of the definition of claim and inclusion of coverage for certain pre-claim matters in D&O policies. The expansion and enhancement of coverage for a broader range of claims sometimes has produced the opposite effect of limiting coverage, as insureds have not adequately addressed notice to D&O insurers of the expanded range of events that qualify as claims.

Historically, efforts to expand the definition of claim and include coverage for pre-claims has been a reasonable response to a legitimate issue. For years, D&O coverage disputes arose as to whether and when a claim as defined in, and covered by, D&O policies existed. Although things like lawsuits and criminal indictments were easily recognized as claims, gray areas emerged as to pre-lawsuit subpoenas, administrative investigations, or verbal demand for payment (or, even more gray, for injunctive or equitable relief). The need for D&O coverage for such matters was heightened by the increasing and more aggressive use by regulatory and administrative agencies of investigative tools that could be implemented even without initiating formal litigation or administrative actions.

In order to address these issues, D&O coverage was gradually broadened to encompass activities that would not qualify as claims under the traditionally narrow definition, but nevertheless typically resulted in the insured having to incur legal costs in responding to or addressing the situation. Examples of the expanded coverage include broadening the definition of claim to include verbal demands, investigative subpoenas, "informal" administrative or regulatory requests for interviews of witnesses, and production of documents. The salutary effect of this broader coverage was to afford greater protection under D&O policies for circumstances that clearly crossed the line into adversarial, or at least quasi-adversarial, proceedings but were not lawsuits, written demands for payment, criminal indictments or the like.

However, the unintended and unfortunate (as well as typically unforeseen) consequence of this expansion of coverage has been to expose insureds to potentially adverse consequences (i.e., loss of coverage) for failure to timely or properly provide notice of the new brand of claims per the expanded definition of claim. D&O policies often cover only claims that are "first made" during the policy period. They also typically treat all related or interrelated claims as having been "first made" when the earliest such claim was made.

The gray-area type claims may not receive the same attention as would the filing of a lawsuit or issuance of an administrative order. Insureds that are less experienced or sophisticated in D&O insurance may fail to appreciate the need to provide notice of matters falling within the broader universe of covered claims. The trap for the unwary insured is, therefore, the failure to timely report a gray-area claim (such as a subpoena or administrative request for documents, request for interview of an individual insured, or a verbal demand for payment) and, as a result, forfeiting coverage for a later filed (and related) lawsuit or criminal indictment. The failure to report a gray-area claim is not unusual; in many circumstances insureds may not believe that it qualifies as a claim or may assume that unless it ripens into a lawsuit, notice is not required. The expansion of coverage, which should be beneficial to an insured, can thus become grounds for denying coverage for a legitimate claim. D&O insurers appear ready and willing to exploit these situations by aggressively asserting the coverage defense that a claim was not first made and reported during the policy period if there was a gray-area claim made against the insured in a prior period, but not reported at that time.

There are, however, ways to address this situation and ameliorate the unintended negative consequences of broad claim definitions. One way is to expressly provide in the policy that a failure to report certain gray-area claims or pre-claims during a prior policy period will not prejudice coverage for a later-reported (and related) lawsuit or other traditional type claim. Another option is to modify the policy provisions concerning related or interrelated claims to except gray-area claims or pre-claims from such provisions for purposes of excluding coverage for later-made traditional claims.

The tradeoff would be that an insured that fails to timely report the gray-area claim or pre-claim cannot obtain coverage for the gray area claim or pre-claim, although it may still obtain coverage for the later-reported traditional claim.

As a more practical matter, insureds need to be better informed and more diligent about both the scope of their D&O coverage and timely reporting the full array of covered claims to their D&O insurers. Coordination and communication between and among the insured's legal and risk functions is of paramount importance in this regard. Likewise, insureds should take full advantage of the expertise and experience of their outside insurance advisors, including brokers and coverage counsel.

Good deeds in the form of obtaining broader D&O coverage should be rewarded, not punished. Insureds that take appropriate steps to safeguard and maximize the value of their coverage will be duly rewarded for their efforts.

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Author

John D. Shugrue
Reed Smith LLP

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