A directors and officers coverage decision handed down in March in a favor of D&O insurers highlights a struggle between carriers and policyholders that's been percolating for years, experts say.

“It is a very hot topic,” said Steve Shappell, managing director of Aon Financial Service Group claim practice, Denver, Colo., referring to the insurability of settlements of securities lawsuits that allege violations of Section 11 of Securities Act of 1933. The decision in favor of insurers by a U.S. District Court in Florida (Middle District, Orlando Division), in CNL Hotels & Resorts Inc. v. Houston Casualty Company and Landmark American Insurance Company, holding that a particular Section 11 settlement was not insurable, “refocuses this issue and requires people to solve the [coverage] problem and address the issue via contractual language,” Mr. Shappell advised.

Section 11 of the 1933 Act, which relates to registrations of securities offerings, imposes strict liability for material misrepresentations made in registration statements to everyone involved.

In CNL Resorts, the district court agreed with two excess insurers that $35 million which CNL paid to settle a Section 11 case “represented CNL being compelled to return money that it wrongfully appropriated,” which is not a recoverable loss under the insurance policies at issue, and not insurable under Florida or New York law.

But the court went on to say that Section 11 claims are not uninsurable per se.

Joseph Monteleone, a partner with Tressler, Soderstrom, Maloney & Priess in New York, explained that the court was distinguishing between claims brought against a corporation, which are uninsurable, and those asserted against directors and officers, which may be.

Insurers believe that settlements of claims brought against the entity should not be insurable. These settlements amount to nothing more than having to disgorge part or all the proceeds of a public offering. “They're giving back to the investors what they should not have had in the first place,” Mr. Monteleone said.

In contrast, insurers will not have that coverage defense against directors and officers, because the individuals typically do not get the offer proceeds. “The proceeds go to the corporation–the issuer of securities.

Mr. Monteleone explained that in this case, CNL had put out stock in the public offering at a certain price ($20), but with proper disclosures, it would have gone out at a lower price ($12). The $8 difference was “an unentitled gain.”

Mr. Monteleone said that alarm in the insurance broker community that insurers will now say there is absolutely no coverage for Section 11 claims is unfounded. “I don't know any responsible D&O insurer that could take that position.”

He also cautions against proposed fixes to policy language that some insurers may contemplate to cover an entity in similar situations. Insurers “could be opening themselves up to fines or loss of license. An insurance department on a market conduct exam would find they were writing coverage against public policy.”

Mr. Shappell, however, said that cooperative attempts by insurers and brokers to address the issue have been in process for several years. “We're addressing this by recognizing the reality that corporations only act through their directors and officers. If the corporation is liable, it's because their directors and officer did something wrong.”

One approach, he said, is to structure the policy with predetermined allocation, under which parties contractually agree that in the event there are Section 11 claims, the liability is that of the directors and officers “who took the actions, made representations, signed registration documents.”

A handful of insurers are giving very good promises upfront that they will not raise the public policy argument in trying to allocate claim payments between the entity and individuals.

“That's why issuers purchased this insurance–to cover this risk. It's a mixed risk, and trying to separate it out is just wrong,” Mr. Shappell said.

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Special Reports /

CNL Resorts: A Win For D&O Insurers

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