Loss
April 29, 2016
Definition of “Loss”
The term “loss” (or sometimes “ultimate net loss”) is almost always defined in D&O policies. “Loss” is usually defined to mean or include damages, judgments, settlements, and claim or defense costs, subject to certain exclusions. However, because various policies define “loss” differently, the definition should be carefully reviewed. A typical definition of “loss” is shown in the following example.
“Loss” means “claims expenses”, compensatory damages, settlement amounts, legal fees and costs awarded pursuant to judgments. “Loss” does not include civil or criminal fines or penalties imposed by law, punitive or exemplary damages, the multiplied portion of multiplied damages, taxes, or matters that are uninsurable pursuant to applicable law.
ISO Properties, Inc., MP 00 01 04 03
Definition of “Claims Expense”
The term “claims expenses” in the previous example is also a defined term in the policy, as shown in the next example.
C. “Claims Expenses” means that part of a “loss” consisting of reasonable and necessary fees (including attorneys' and experts' fees) and expenses incurred in the defense or appeal of a “claim”, excluding the wages, salaries, benefits or expenses of any director, officer or employee of the “company”.ISO Properties, Inc., MP 00 01 04 03
The inclusion of defense expenses within the definition of “loss” in most D&O policies is significant in two important ways. First, it provides that the limit of liability includes defense costs. These expenses are generally not covered in addition to the limit of liability, as they are in the standard commercial general liability policy. Some policy forms will reinforce this position by clearly stating so in the policy, as illustrated in the following example.
E. “Claims expenses” are part of the “loss” and are not payable by us in addition to the Limit of Liability, but are payable within the Limit of Liability shown in the Declarations, thereby reducing the Limit of Liability shown in the Declarations.
ISO Properties, Inc., MP 00 01 04 03
Second, early policy forms that were written on a pay-on-behalf basis with definitions of “loss” that included defense expenses were liberally construed by the courts to mean that defense expenses were to be paid as they were incurred. This was a definite advantage to the insureds, as adjudication of claims against directors and officers often takes many years.
Timing and Payment Issues
Most policy forms used today contain specific provisions dealing with the timing and payment of defense costs. Some policies provide for an affirmative duty to pay defense expenses in advance of a final settlement or judgment. However, even if the definition of “loss” includes defense expenses and the insurer is promising to “pay on behalf,” the insureds may not have the benefit of contemporaneous payment of defense expenses. For more information, see Duty to Defend.
Punitive Damages
Although the definition of “loss” may encompass a wide range of costs, settlements, and judgments, such definitions will specifically exclude certain types of expenses. Fines, taxes, penalties, punitive damages, multiplied damages, salaries, wages, and overhead expenses of officers and employees, and matters uninsurable by law are frequently excluded in the definition.
Some policies, however, do include coverage for punitive damages “where permitted by law” in the definition of “loss” because some jurisdictions do not allow punitive damages to be insured, while other jurisdictions have no such laws. The following is an example of where punitive damages is included where insurable under the law.
10.Loss means monetary damages, judgments, settlements, pre-judgment or post judgment interest awarded by a court, and Costs, Charges and Expenses incurred by any of the Insureds. Loss does not include:
a. taxes, fines or penalties;
b. matters uninsurable under the laws pursuant to which this Policy is construed; or
c. punitive or exemplary damages, or the multiple portion of any multiplied damage award, except to the extent that such punitive or exemplary damages, or the multiple portion of any multiplied damage award are insurable under the internal laws of any jurisdiction most favors coverage for such damages and which has a substantial relationship to the Insureds, Insurer, this Policy or the Claim giving rise to such damages;
Westchester Fire Insurance Company, PF-15194NFP
Other policies are silent on the subject of punitive damages, neither affirmatively covering punitive damages nor specifically excluding them. The most desirable coverage is that which affirmatively covers punitive damages. The next best coverage is that which is silent on the subject of punitive damages. The least desirable is the policy that specifically excludes punitive damages.
Some D&O policies may limit punitive damages to a specific dollar amount that is considered part of, and not addition to, policy limits. The following is an example of this approach.
Loss means the total amount which the Insureds become legally obligated to pay on account of each Claim and for all Claims in each Policy Period and the Extended Reporting Period, if exercised, made against them for Wrongful Acts for which coverage applies, including, but not limited to, damages, judgments, settlements and Defense Costs. Loss does not include (1) any amount not indemnified by the Company for which the Insured Persons are absolved from payment by reason of any covenant, agreement or court order, (2) any amount incurred by the Company (including its board of directors, any committee of the board of directors or any Manager) in connection with the investigation or evaluation of any Claim or potential Claim made by or on behalf of the Company, (3) fines or penalties imposed by law or the multiple portion of any multiplied damage award, (4) punitive or exemplary damages, or (5) matters uninsurable under the law pursuant to which this policy is construed; provided, however, that it applicable law so permits, this definition does not exclude from coverage punitive or exemplary damages or the multiple portion of a multiplied damage award to the extent such damages or damage award is less than $100,000, such amount to be part of and not in addition to, the Limit of Liability set forth in Item 2 of the Declarations.
Zurich Insurance Co., U-DO-111-A(CW)
Legally Obligated to Pay
It should be noted that definitions of “loss” in these examples include only amounts that the insureds are legally obligated to pay. The term “legally obligated to pay” may preclude coverage for equitable relief. While many policies similarly limit their coverage to amounts the insureds are legally obligated to pay, the broadest policy forms do not contain this coverage restriction. The restriction, if present, usually is found in the definitions of “claim” or “loss” or in the insuring agreements.
The definition of “loss” can also contain exclusionary language one might expect to find elsewhere in the policy. Item (2) in the following definition, taken from a 1986 policy form, provides a broad exclusion for criminal and regulatory proceedings. Although this particular policy also contains an exclusion as respects administrative, regulatory, criminal, or grand jury proceedings, the language in the exclusion is different than the language in the definition of “loss.” The criminal acts exclusion states that the exclusion shall not apply unless an adverse judgment is found against the insureds. The language in the definition makes no such reference, stating only that amounts incurred in connection with such a proceeding are not considered loss under the policy.
The term “Loss” shall mean any amount which the Directors and Officers are legally obligated to pay for a claim or claims made against the Directors and Officers for Wrongful Act(s) and shall include only damages, judgments, settlements and costs, charges and expenses (excluding salaries of Officers or employees of the Bank) incurred in the defense of civil legal actions and appeals therefrom, and cost of attachment or similar bonds; provided however, such Loss shall not include (1) fines or penalties imposed by law, punitive or exemplary damages or multiple damages in excess of actual damages (including but not limited to double or treble damages), (2) any amounts incurred in connection with any administrative, regulatory, criminal or grand jury proceedings, or (3) matters which may be deemed uninsurable under the law pursuant to which this policy shall be construed. The Company shall have no obligation to pay any Loss in connection with any claim for Wrongful Act(s), including costs, charges and expenses, in advance of a final disposition of such claims as provided in Clause 5(b) hereof.
Fidelity & Deposit, S8550c Spec.
Also notice that this definition of “loss” provides that the insurer has no obligation to pay loss, including any defense or other expenses, in advance of a final disposition of the claim. This language contrasts with this same insurer's promise to “pay on behalf” in the policy's insuring agreement.
“Bump Up” Exclusion as Part of Loss
With the rise in merger and acquisition activity has come an increase in claims that allege wrongdoing in connection with such transactions. A common complaint brought on behalf of shareholders of the target company alleges that directors and officers of the target company failed to adequately negotiate an appropriate price for the merger or acquisition, or other terms and conditions. Such suits are sometimes referred to as “bump-up” suits because shareholders seek an increase in the buy-out price.
Most insurers take the position that a D&O policy is not intended to pay a company's transaction costs or to help fund the acquisition. Consequently, D&O policies may contain a so-called “bump-up” exclusion.
Such exclusions began to be added to D&O policies in the 1990s when D&O policies first included coverage for securities claims against the company. Early versions of the exclusion applied both to claims alleging the acquisition price was inadequate (i.e., plaintiffs sought a bump-up in the acquisition price) and to claims alleging the defendants paid an excessive purchase price (i.e., greenmail payments). More recently, the exclusion has been narrowed to apply only to bump-up claims.
In almost all D&O policies, the bump-up exclusion is contained in the definition of “loss.” The following is a generic example of such wording:
Loss does not include…any amount incurred by the Company that represents or is substantially equivalent to an increase in the consideration paid or proposed to be paid by a Company in connection with its purchase of any securities or assets.
This exclusion has several important features that limit its scope and effect but also create difficult coverage issues which are frequently not anticipated or well understood.
Other Exclusions within the Definition of “Loss”
The definition of “loss” will normally include a variety of exclusions in addition to those described previously. Over the years the scope of some exclusions have been reduced to offer insureds expanded coverage. The following is a list of common exclusions found within the definition of “loss” where modification may be possible in order to reduce their exclusionary scope.
•Fines and penalties: attempt to delete or have narrowed to only apply to fines or penalties for an intentional or willful violation of law. They also amend to include fines and penalties if insurable under the law.
•SOX Section 308: expands fines and penalties to cover civil penalties under civil penalties added to disgorgement funds for the relief of victims.
•Dodd-Frank Section 954 Penalties: attempt to provide coverage related to penalties related to compensation claw-back policies.
•Defense costs: expand to cover defense cost for otherwise excluded items.
•Non-Monetary Relief: regarding public company securities claims, removes exclusionary language related to costs to comply with nonmonetary relief.
It is important to recognize that there is a wide range of “loss” definitions in policy forms. While many “loss” definitions contain beneficial provisions relating to coverage for punitive, exemplary, and multiplied damages, other definitions of “loss” may contain onerous exclusionary and restrictive wording. Because of this, all D&O insurance policies should be read and evaluated in their entirety, including the coverage applications and all attached endorsements.