In consideration of the premium charged, it is hereby understood and agreed that this Policy shall be deemed to have been executed in the State of New York and any interpretation of the policy relating to the construction, validity and performance of the Policy shall be made in accordance with the laws of the state of New York.

It is further understood and agreed that all disputes which arise under or in connection with this policy, including any determination of the amount of loss, shall be submitted to the American Arbitration Association under and in accordance with its then prevailing commercial arbitration rules. The arbitration will be held in New York, New York, U.S.A. The award rendered by the arbitrator(s) shall be final and binding upon the parties and judgment thereon may be entered in any court having jurisdiction thereof. National Union Arbitration Endorsement

Optional Binding Arbitration

Many policies contain arbitration provisions that are optional from the standpoint of the insured. This means that the insured has the option of whether a dispute is to be settled by binding arbitration or to pursue other means of resolution. The following is an example.

I. ARBITRATION If requested by the Insured, the Company shall submit any dispute, controversy or Claim arising out of or relating to this Policy or the breach, termination or invalidity thereof to final and binding arbitration pursuant to such rules and procedures as the parties may agree. If the parties cannot so agree, the arbitration shall be administered by the American Arbitration Association in accordance with its then prevailing commercial arbitration rules. The arbitration panel shall consist of one arbitrator selected by the Insured, one arbitrator selected by the Company, and a third in- dependent arbitrator selected by the first two arbitrators. Each party will bear its own legal fees and expenses.

It should be noted that when coverage disputes are submitted for arbitration, the arbitrators may not follow the traditional rule that ambiguities of the policy language are construed in favor of the insured. The arbitrators also may choose to ignore the doctrine of the insured's reasonable expectations, which has been adopted by the court systems of several states to protect purchasers with limited insurance knowledge. When the doctrine is applied, the insured may be able to recover loss—even though a policy unambiguously excludes coverage—if the insured's expectations of coverage are found to be objectively reasonable.

By agreeing to arbitrate, either voluntarily or through a policy requirement to do so, the insured gives up a valuable right—the opportunity to seek a judicial resolution of the dispute as guaranteed by the Seventh Amendment right of due process. In most cases arbitration does not allow appeal, there is no discovery, and arbitrators usually lack the resources to conduct any meaningful case research. An arbitrator's decision is not generally reviewable for errors of fact or of law even though such error may result in substantial injustice to the insured. In the sense that insureds benefit from consistency and certainty in the law, mandatory arbitration requirements in insurance contracts may actually be counterproductive.

Arbitration Provisions Impact Policy Interpretation

One of the most important problems in arbitration of insurance policy coverage disputes is that the conditions and conduct of arbitration affect how the policy shall be interpreted, sometimes to the detriment of the insured.

An arbitration requirement can also be restrictive when policy interpretation is to follow the laws of a specific jurisdiction. For example, the courts of some states, such as New York, have favored the insurer. Resolving advancement dispute where New York interpretation is a condition of the policy may stack the deck against the insured, effectively preordaining the outcome in favor of the insurer.

In most instances arbitration clauses dictate the forum and situs of dispute resolution. These can also be restrictive from a policyholder perspective. A clause may require submission of disputes to the American Arbitration Association and the arbitration to be held in New York. It may also provide for any interpretation of the policy to be in accordance with New York law. In contrast, another clause may mandate that arbitration be conducted in London, England. When a policy requires arbitration to be held in a foreign country, such as England or Bermuda, severe logistical problems can arise and prevent the insured from even raising a dispute. It is questionable whether many insureds will be familiar enough with foreign arbitration practices to determine the impact of such arbitration requirements.

These limitations inherent in arbitration may be sufficient reason to avoid policies with mandatory arbitration provisions or to negotiate such clauses out of the policy. In the absence of arbitration requirements, the insurer and insured still could agree to submit a coverage dispute to arbitration, and some insurers may provide mandatory arbitration language through endorsement when requested.

Best Efforts Provisions

While many D&O policy forms are silent regarding mandatory binding arbitration, some policies may contain language requiring certain types of disputes to be resolved by the insured and insurer simply using their best efforts. The following is a generic example.

With respect to (i) Defense Costs joint incurred by, (ii) any joint settlement made by, and/or (iii) any adjudicated judgment of joint and several liability against the Company and any Director or Officer, in connection with any Claim other than a Securities Claim, the Company and the Director(s) or Officer(s) and the Insurer agree to use their best efforts to determine a fair and proper allocation of the amounts as between the Company and the Director(s) or Officer(s) and the Insurer, taking into account the relative legal and financial exposures of and the relative benefits obtained by the Directors and Officers and the Company. If determination as to the amount of Defense Costs advanced under the policy cannot be agreed upon, then the Insurer shall advance such Defense Costs which the Insurer states to be fair and proper until a different amount shall be agreed upon to determined pursuant to the provisions of this policy and applicable law.

Sample "Best Effort" Requirement

Such language addresses problems associated with allocating loss between insured and uninsured parties, which frequently occurs when the corporation and individual insureds have been named as codefendants in some action. While both parties may be jointly defended by counsel, expenses allocated to the defense of the corporation generally are not covered by the D&O policy unless the policy provides coverage for direct actions against the corporate entity. The allocation of loss between parties often is tricky business, and disputes are common.

Another example of a mandatory dispute resolution provision follows. This provision requires resolution of disputes using either mediation or binding arbitration.

It is hereby understood and agreed that all disputes or differences which may arise under or in connection with this policy, whether arising before or after termination of this policy, including any determination of the amount of Loss, shall be submitted to the alternative dispute resolution ("ADR") process set forth in this clause. Either the Insurer or an Insured may elect the type of ADR process discussed below; provided, however, that such Insured shall have the right to reject the Insurer's choice of the type of ADR process at any time prior to its commencement, in which case such Insured's choice of ADR process shall control.

The Insurer and each and every Insured agrees that there shall be two choices of ADR process: (1) non-binding mediation administered by the American Arbitration Association, in which the Insurer and any such Insured shall try in good faith to settle the dispute by mediation under or in accordance with its then-prevailing Commercial Mediation Rules; or (2) arbitration submitted to the American Arbitration Association in accordance with its then-prevailing Commercial Arbitration Rules, in which the arbitration panel shall consist of three disinterested individuals. In either mediation or arbitration, the mediator or arbitrators shall have knowledge of the legal, corporate management, or insurance issues relevant to the matters in dispute. The mediator or arbitrators shall also give due consideration to the general principles of the law of the state where the Named Entity is incorporated in the construction or interpretation of the provisions of this policy. In the event of arbitration, the decision of the arbitrators shall be final and binding and provided to both parties, and the arbitrators' aware shall not include legal fees or other costs. In the event of mediation, either party shall have the right to commence a judicial proceeding; provided, however, that no such judicial proceeding shall be commenced until the mediation shall have been terminated and at least 120 days shall have elapsed from the date of the termination of the mediation. In all events, each party shall share equally the expenses of the ADR process. Either choice of ADR process may be commenced in New York, New York; Atlanta, Georgia; Chicago, Illinois; Denver, Colorado; or in the state indicated in Item 1(a) of the Declarations as the mailing address for the Named Entity. The Named Entity shall act on behalf of each Insured in deciding to proceed with an ADR process under this clause.

American International Companies, Executive & Organization Liability Insurance Policy 75011 (2/00)

Although the insurer may specify binding arbitration, the insured has the ultimate decision regarding which method will ultimately be used.

Conclusion

Care should be exercised when evaluating arbitration clauses. Too often these important policy conditions are overlooked, or their restrictive features misunderstood. Policies that contain unfavorable or restrictive mandatory arbitration clauses should be avoided whenever possible. Be aware also that onerous arbitrations provisions can be woven into other seemingly unrelated provisions of any insurance policy. Be alert for any provision that

• attempts to direct or define interpretation of the policy in favor of the insurer, • provides that the policy will be interpreted in an evenhanded fashion, rather than in favor of the insured, • states that if any language is deemed ambiguous, interpretation will be without regard to authorship, rather than recognizing that the policy is a "contract of adhesion" and should typically be interpreted in the insured's favor; • gives consideration to the customs and usages of insurance industry terminology, which again is unfavorable to the insured.

While these might at first blush appear reasonable, they may stack the deck in favor of the insurer and should be carefully reviewed before acceptance.

Understand also that although arbitration is widely perceived to be a cost and time saving alternative to litigation, in practice it is often just as expensive as regular litigation and includes discovery, motion practice and the arbitration itself. Many insureds will retain counsel to help prepare for the arbitration which adds to the cost of the arbitration process. Because insurance companies have great experience with arbitrators on a regular basis, finding a truly independent and objective arbitrator can be challenging. Unlike litigation, the arbitration is final and binding and there is no appeal unless significant bias can be proved.

Some insurers are willing to amend arbitration provisions so that they are optional at the discretion of the insured and non-binding. If you are concerned about the potential drawbacks and risks of mandatory and binding arbitration, ask your broker to convey your concerns to the insurer. In many instances chances are good a satisfactory modification can be achieved by just asking. By doing so at renewal time, you can increase your chance for success while you have the greatest leverage .

For more information, refer to the article Mandatory Arbitration Clauses in Insurance Contracts Stirs Controversy