This language means that any settlement of claims or defense expenses incurred without the insurer's prior consent are not covered by the policy. Although most policies stipulate that consent to incur such costs shall not be unreasonably withheld, it may be arguable what “unreasonably withheld” means. What is reasonable is sometimes a question on which reasonable people cannot agree. The effect of such wording is that if the insurer withholds consent, the insured may have little recourse other than litigation. Because a claim of bad faith might be brought when consent is unreasonably withheld, insurers may often yield to the insureds short of such action.

 

Right of Association

 

Many D&O policy forms contain language reserving the insurer's right to participate and associate with the insured in the conduct of the insured's defense. Such a provision may also require the insurer's approval of the lawyers the insureds intend to employ. In all cases where the insurer has no duty to defend, the insurer retains the right of association. However, some policies go further and contain language that gives the insurer the right to assume the defense at any time. Such action by the insurer may be necessary if the insured retains unqualified counsel or engages in questionable or unsound defense strategies.

 

Advancement and Timing of Defense Expense Payments

 

The right of an insured to be reimbursed for defense expenses under a D&O policy as these expenses are incurred is a valuable feature. Litigation involving alleged wrongdoing by directors and officers is often expensive, complex and protracted. Defense costs are said to be “advanced” when they are paid contemporaneously, either on behalf of the insured or as prompt reimbursement.

 

When defense costs are advanced, the insurer often does so without certainty that coverage under the policy will apply. An example is when a claim alleging dishonesty of a director or officer is made. Claims arising out of dishonest acts generally are excluded by D&O insurance. However, coverage may apply under some policies unless and until the dishonesty is proven, which amounts to coverage for expenses incurred in the successful defense of a claim based on dishonesty.

 

When defense costs are advanced unless and until a director or officer is proven to have acted dishonestly, the interests of the insurer often will conflict with those of the insured. While insureds normally want defense expenses to be paid as they are incurred, the insurer likely will prefer to await the conclusion of the lawsuit before paying. Also, if the insurer pays expenses as they are incurred, it may be difficult or impossible for the insurer to recoup such amounts if the insured's actions are ultimately found to be excluded by the policy. Most policies contain an “undertaking” provision, which requires the insured agree in writing to repay any advanced amounts if it is ultimately established that the insurer has no obligation to pay a claim under the policy. The following is an example of an “undertaking” provision:

 

 

A problem with some D&O insurance policy forms is that the language is not always clear regarding whether the insurer has an affirmative obligation to advance defense expenses. Early D&O policy forms often contained no reference to who was responsible for tendering a defense—the insured or the insurer. As a practical matter, it was the corporation that usually assumed defense on behalf of its directors and officers, and insurers took the position that no obligation existed to pay expenses until claims and litigation had ultimately been concluded. Although insurers frequently did advance costs when there were no apparent coverage disputes, these payments often were made as an accommodation to the insured rather than as a duty of the insurer or pursuant to any specific wording in the policy.

 

In 1987, on appeal, a federal court in Okada v. MGIC Indemnity Corp., 823 F.2d 276, held that the insurer of a D&O policy was indeed responsible for the payment of defense expenses as they were incurred. In Okada, the policy in question, like earlier policy forms, was silent regarding the duty to defend, yet contained other provisions that were found to be pivotal to the case. The policy contained language promising to pay expenses when such expenses were agreed to by the insurer, yet did not specify when such expenses were to be paid. The policy also contained a clause that allowed the insurer to advance expenses at its option. The court found these clauses ambiguous and further noted that because the definition of loss included amounts the insured was legally obligated to pay, the policy should be viewed as a liability form. As such the policy was construed by this court to obligate the insurer to pay expenses on an interim basis.

 

Possibly as a result of the Okada case, most policy forms now include specific provisions regarding advancement of defense expenses. These policies generally state that there is no obligation by the insurer to advance costs and expenses prior to a final determination of liability. In the past some policies have contained an affirmative promise by an insurer to provide contemporaneous reimbursement or payment on behalf of an insured and it may be possible to find or negotiate such terms in more recent policy forms. Such a promise is highly desirable, as illustrated in the following examples.

 

 

Note the insurer's express promise to advance defense expenses prior to a final disposition of the claim. In this example, taken from an old National Union policy form, the obligation extends only to Coverage A, the individual-liability section. The insurer is not obligated to advance expenses when the corporation is required or permitted to do so but is unable or chooses not to. Advancement of expenses in such situations is left as an option of the insurer.

 

The following defense cost advancement provision is not limited to a specific coverage part. It is subject only to the condition that there is no contribution with other insurance policies.

 

 

The example that follows (from an older policy providing only individual-liability coverage) also contains an affirmative duty to advance expenses with limited conditions. This clause provides advancement of loss costs in instances where the corporation either refuses or is financially unable to do so. This is a desirable policy feature.

 

 

Some policy forms may not always specifically address the issue of expense advancement but provide that the insurer shall pay expenses, costs, and settlements when consent has been given by the insurer to incur such amounts. The following is an example of this approach.

 

 

The problem with provisions like this is that although the policy promises to pay costs, settlements, charges, and expenses, it does not state when it will pay, nor are costs and expenses always specifically defined to include defense. In addition, the consent of the insurer may be “withdrawn at any time,” thereby resulting in the possibility the insured will have to bear its defense expenses without the benefit of advancement from the insurer.

 

There is little similarity between policy forms as respects the issue of expense advancement. Policies providing an affirmative duty to pay are most desirable, but few insurers actually provide such coverage. Some forms provide advancement only conditionally or leave sole discretion to the insurer. Still others imply advancement but fall short of a complete commitment. The Okada case did not appear to have set any trends other than reinforcing the court's inclination to construe coverage in favor of the insured. Seemingly similar advancement provisions have been interpreted differently by different courts, finding a duty to advance expenses in one instance and finding no such duty in another case.

 

Loss Allocation

 

Often before an insurer will make a loss payment, a proper allocation between the covered and any uncovered portions of the loss must be established. It is common for the corporation and the corporation's directors and officers to be named in a suit as codefendants. Since the corporation normally is an insured only to the extent of the corporate reimbursement coverage part of the policy, those expenses stemming from defense of the corporation's alleged wrongdoings need to be removed from the loss before reimbursement of defense expenses can be undertaken. The insurer is normally responsible only for that portion of loss reasonably allocable to defense and settlement of claims against the individual insureds. Allocation of the claim can be a complicated issue, particularly if the same lawyers are used for both the individual insureds and the corporation.

 

The following is a typical example of allocation provisions in a D&O policy.

 

 

Such provisions can vary significantly, and it is critical for insureds to understand the ramifications relative to the claim process and the payment of loss.

 

For further discussion of issues related to loss allocation, see Allocation of Loss in Directors and Officers Insurance Policies.

 

Because of the complexities of interim advancement of defense costs, it generally is a good practice for the insured and insurer to enter into some sort of a funding agreement early in the claim process. Such an agreement can be useful in establishing when, how, and for what kinds of expenses advancement will be made. Details regarding documentation, billing and routine communications between defense counsel also should be addressed at an early stage in a claim to avoid problems later. Insureds not wishing to resolve their policy's advancement issues in court should seek a policy that provides unambiguous, affirmative-expense-advancement and allocation provisions. Even when a basic policy form does not provide an affirmative duty to advance expenses, an endorsement may be available that provides this feature.

 

Tendering Claims To Insurer

 

Under some D&O policies the insured is given the option either at the time of claim reporting or shortly thereafter to transfer control and responsibility of the defense to the insurer who then maintains a duty to defend the insureds. The following is an example of an endorsement extending such option to the insured:

 

 

Careful consideration should be given when deciding between the two defense options. Under a duty-to-defend D&O policy, the insurer will have the right to select defense counsel and control litigation. In selecting counsel, insurers usually pick from a list of panel counsel law firms or individual attorneys experienced in handling particular types of D&O litigation. Insurers are often able to negotiate very favorable billing rates with such firms, which helps to control litigation costs. Many smaller or less legally sophisticated insures prefer this approach as it relieves them of the significant administrative burden in selecting, monitoring, and overseeing legal activities. An additional advantage is that when there is an affirmative duty to defend, defense coverage is usually covered for 100 percent even though only a small part of the overall claim may be covered. As such, the insurer is prevented from allocating loss between covered and noncovered wrongful acts. Because the insurance company directly retains the defense counsel, any cash flow or other administrative issues in collection of claim cost advancement from the insurer are significantly reduced.

 

Larger firms or those that have internal legal counsel or are highly experienced in managing complex litigation often prefer to exert greater control over the underlying litigation by maintaining their duty to defend. Many organizations prefer the freedom of selecting their own counsel, which helps to avoid potential or perceived conflicts of interest that can arise when the insurance company assumes defense. As a practical matter, however, for most D&O policyholders, especially public corporations, there usually is no insurance company duty to defend option available.