Dishonest, Fraudulent and Criminal Acts—Archived Article
October 2004
The dishonesty exclusion precludes coverage for dishonest, fraudulent and criminal acts committed by the individual insureds. An example of a broadly-worded form of the exclusion is shown below.
The insurer shall not be liable to make any payment for loss arising from, by reason of or in connection with:
(K) the fraudulent, dishonest or criminal acts of the assureds;
Home H36667F REV. 10-91
The above exclusion may appear reasonable because these actions are not normally insurable as a matter of public policy, nor are they generally indemnifiable by state law. A potential problem with such language, however, is that sometimes there is no specific exception to the exclusion which would allow coverage for defense when dishonesty is alleged but not proven. Many D&O forms, however, do contain language that amends the exclusion to only apply when a final judgment establishes that such fraudulent, dishonest or criminal acts did in fact occur. An example of this language is shown below.
The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against the Directors or Officers:
brought about or contributed to by the fraudulent, dishonest, or criminal acts of the Directors or Officers; provided, however, that this exclusion shall not apply unless it is established in fact that such Claim was brought about or contributed to by fraudulent, dishonest or criminal acts of the Directors and/or Officers;
Great American D100A (2/90)
Language requiring an establishment “in fact” as shown in the above example or, in some policies, a “judgment or other final adjudication”, means that the exclusion only applies when directors and officers have been found by a court to be guilty of dishonesty or other excluded acts. Such a requirement appears desirable from the insured's standpoint, especially considering that a large percentage of claims result in voluntary settlement without final adjudication or an admission of wrongdoing.
When a defendant insured enters into a voluntary settlement that requires the insurer's consent, the settlement effectively prevents an adjudication on the issue of dishonesty, which in turn prevents the exclusion from applying. Once the insurer consents to a settlement, the courts generally have barred any further litigation by the insurer to establish the insured's dishonesty.
Some policies contain an exclusion that allows coverage for dishonest, fraudulent or criminal acts if a judgment or other final adjudication fails to establish that such acts actually occurred. It is not always clear when dishonesty “in fact” occurs. However, this term may imply less of a threshold for proof than adjudication and, therefore, language requiring a final adjudication is preferable. Use of the term in fact may not bar the insurer from separately litigating the issue of an individual insured's dishonesty.
There is great variety in the wording of dishonesty exclusions. As illustrated below, many insurers combine fraudulent, dishonest and criminal acts in a single exclusion. Others break these offenses into separate, individual exclusions. Even when a unitary exclusion is used and is subject to an exception, the exception may only extend to one act, such as dishonesty, as in the example below taken from an old policy form:
by reason of any deliberately dishonest or fradulent [sic] act or omission, or any criminal or malicious act or omission, or any willful violation of law; however, notwithstanding the foregoing, the Directors or Officers shall be protected under the terms of this policy as to any claims upon which suit may be brought against them by reason of any alleged dishonesty on the part of the Directors or Officers, unless a judgement or other final adjudication thereof adverse to the Directors or Officers shall establish that acts of deliberate dishonesty, as aforesaid, committed by the Directors and Officers were material to the cause of action so adjudicated;
Reliance BD-8502 Ed. 1/82
Also note in the previous example that the exclusion is modified by use of the word deliberately. When used as an adjective, deliberately implies that the activity was decided upon after examination and reflection, and that the consequences of such deliberate action were weighed and carefully considered. It implies willful, as opposed to merely intentional, conduct. Such an adjective may limit the exclusion by making a finding of dishonesty more difficult, but the precise effect is difficult to judge.
When the exclusion requires an adjudication or a finding <169>in fact<170> of dishonesty, many D&O policies will provide defense coverage unless and until such time as the excluded dishonest act is proven to have occurred. Many forms also contain a severability or nonimputation provision that limits the dishonesty exclusion to only those insureds who have, or who are alleged to have committed the excluded acts. This severability or nonimputation provision is sometimes included within the wording of the exclusion, but more often appears elsewhere within the “Exclusions” section of the policy.
Dishonesty exclusions that do not preclude coverage unless the question of dishonesty is adjudicated are preferable to those exclusions that are triggered by a finding in fact. Also preferable is language requiring the excluded actions to be deliberate. Some exclusions apply the in-fact or final-adjudication exception only to the dishonesty part of the exclusion and not to criminal or fraudulent acts. This is undesirable because it may preclude defense coverage for claims based on alleged criminal or fraudulent acts. Policies that contain a severability or nonimputation provision as respects dishonest acts are similarly preferable to policies without such a provision.
Willful Violation of Laws
Some D&O policies exclude coverage for claims based on the willful violation of laws, rules, statutes, regulations, etc. The exclusion for such claims may be included within or in addition to the dishonesty exclusion.
While few would argue that the willful violation of laws with malice is a proper subject of insurance, use of the adjective willful may have a limiting effect on the scope of the exclusion in the same manner as use of the word deliberately. Violations of laws, regulations, rules, etc. that are not willful are not excluded by this provision.
Exclusions that refer to the unqualified violation of rules and regulations are unduly restrictive. Although in a legal sense a regulation means “law,” it also may refer to a corporation's bylaws, which may be mere self-imposed rules for management and control of corporate affairs. The meaning of the word rule is varied as well, and its significance depends upon the context in which it is used. Liberally interpreted, it could mean a corporation's rules of conduct for its employees, such as procedures to be followed when hiring and firing. Absent a clear definition or clarification on the insurer's intent, unqualified exclusions of violations of rules and regulations should be avoided.