Chapter 9

• Jurisdiction: United States

Chapter 9

Errors and Omissions and Directors and Officers Liability Insurance

§ 9.01 Overview

In addition to CGL insurance, there are some other types of third-party insurance policies¹ that may be relevant for all types of businesses including, among other things:

(1) directors and officers (“D&O”) liability insurance; and

(2) errors and omissions (“E&O”) liability insurance, which is also known as professional liability insurance.

D&O and E&O liability insurance policies are extremely different in scope, as they provide insurance coverage for incomparable risks. D&O liability insurance is important for all entities because no matter the size or corporate structure, businesses are managed by individuals who may make errors in such management. Businesses that are either publicly traded or have directors, officers, or other key employees answerable to investors, owners, or other third parties need D&O insurance because D&O insurance provides protection for liabilities that amount principally to economic losses suffered by these third parties as a result of a director’s, officer’s, or other key employee’s negligence or other breaches of duties committed in running the entity or in being in the entity’s employ.²

In contrast, E&O liability insurance is important for many business entities that offer professional services because it provides an additional layer of protection for economic losses suffered by a third party should a professional commit an act of negligence or other breach of duty in his or her professional capacity.³

Although D&O and E&O liability insurance differ markedly in the scope of the risks they insure, they share many of the same coverage issues. The similarity of issues stems from the fact that D&O and E&O liability insurance policies use similar language in their insuring agreements, exclusions, conditions, and limitations. As a result of the commonality of the D&O- and E&O-form policies’ language, they are combined as the subject of this chapter.

This chapter first sets forth the insuring agreements of the E&O⁴ and D&O⁵ policies and then covers their common elements.⁶ This is followed by a discussion of the significant coverage issues emanating from the common elements of the insuring agreements, including the identity of the policyholder,⁷ the scope of “loss,”⁸ “wrongful act” in the correct capacity,⁹ and the myriad of “claims-made” issues.¹⁰ Finally, the chapter discusses and analyzes some of the exclusions used in these types of policies.¹¹

§ 9.02 Insuring Agreements

[1]—E&O Insuring Agreement

A commonly used form of E&O insuring agreement provides:

“The Company will pay for all loss that the policyholder becomes legally obligated to pay as a result of claims first made against the policyholder and reported to the insurance company during the policy period and arising out of any actual or alleged Wrongful Act in the policyholder’s performance of professional services.” (emphasis added to highlight the coverage issues that emanate from the language of the agreement)¹²

[2]—D&O Insuring Agreement

Coverage under a regularly utilized form of D&O insurance provides:

“The Company will pay for all loss that the policyholder becomes legally obligated to pay as a result of claims first made against the policyholder and reported to the insurance company during the policy period and arising out of any actual or alleged Wrongful Act in the policyholder’s capacity as a director or officer.” (emphasis added to highlight the coverage issues that arise from the language of the agreement)¹³

[3]—Common Elements

E&O and D&O insurance policies both provide third-party liability insurance for principally economic harms,¹⁴ as opposed to liabilities for “bodily injury” or “property damage” suffered by third parties, which is covered under CGL insurance policies.¹⁵

D&O and E&O insurance policies share a number of other common issues and concepts including:

(1) Identity of the policyholder; ¹⁶

(2) “Loss”; ¹⁷

(3) “Claims-Made”; ¹⁸

(4) “Wrongful Act”; ¹⁹

(5) Capacity; ²⁰ and

(6) Exclusions. ²¹

§ 9.03 Coverage Issues

[1]—Identity of the Policyholder

Generally, the word “policyholder” includes all professionals and/or all directors/officers employed by the entity as well as the entity itself that employs those individual professionals or managerial employees.²² In fact, in D&O and E&O insurance, the employer may be entitled to entity coverage for both indemnification of the individual professional or director/officer, and separate coverage for entity liability for certain claims (i.e., employment and securities or professional liability).²³

However, the broad interpretation of “policyholder” (i.e., covering many individuals in the same organization) and the existence of entity coverage may have some coverage consequences. First, if there is a single aggregate indemnity or overall limit, the expansive definition actually may operate to reduce the limits available to protect each such “policyholder”—each employed individual professional, officer, and/or director and the employing entity itself.²⁴ As will be discussed, this presents a shrinking limits problem, the coverage-limiting effects of which can be minimized by adequate advance planning and use of skilled insurance professionals, such as brokers, consultants, and attorneys.²⁵ Moreover, expansive interpretations of “policyholder” and entity coverage present serious conflicts of interest issues that might require separate defense counsel and separate coverage counsel for each “policyholder.”²⁶

[2]—“Loss”

E&O and D&O insurance policies generally define “loss” to include all damages and judgments rendered against, or settlements entered into by, the policyholder.²⁷

[a]—Punitive Damages

[i]—Policy Language

Coverage for punitive damages presents an interesting “loss” issue. With respect to whether punitive damages are covered, the first place one would need to consult is the insurance policy itself, because an insurance policy is an ordinary, albeit specialized, contract whose language generally controls its construction and interpretation.²⁸ Within the insurance policy itself, one would first read the definition of “loss.”

If the question remains unresolved, one would then need to review the exclusions. For example, some policies exclude fines, penalties, and punitive damages from the definition of “loss.”²⁹ Many courts hold that these exclusions are unambiguous and exclude punitive damages from the scope of coverage.³⁰ An interesting issue arises as to whether treble or multiple damages, such as those awardable under various state and federal statutes, would be excluded by a “punitive damages” exclusion.³¹

[ii]—Implicit Exclusion

If the damages at issue (punitive, statutory, or otherwise) are not expressly excluded in the “loss” definition or in a specific “punitive damages” or similarly applicable exclusion, the next place one would consider would be other exclusions or other portions of the policy. The question would be whether the punitive damages would be excluded by implication. For instance, an “intentional act” exclusion might exclude such punitive or exemplary damages that are assessed for intentional misconduct.³²

Likewise, in a CGL policy, “occurrence” is defined as conduct resulting in unintentional and accidental losses. If punitive or similar damages are assessed based upon intentional conduct (as opposed to negligent, reckless, or other non-intentional conduct), the damages may be implicitly excluded as not resulting from an “occurrence.”³³ With respect to E&O and D&O liability policies, which are usually written on a “claims-made” basis,³⁴ the “occurrence” analysis will have no impact on the coverage determination. Nonetheless, one should consult the definition of “wrongful act” because such definition might explicitly or implicitly exclude penalties resulting from intentional conduct in ways similar to the ways the definition of “occurrence” does in CGL occurrence-based policies.³⁵

In both of these instances of implicit exclusion, there is a distinction between intentional conduct and reckless or grossly negligent conduct, and usually damages resulting only from the former would be implicitly excluded.³⁶

[iii]—Common Law/Public Policy

Where punitive damages are not excluded expressly or by implication, the common law would control. In some jurisdictions, punitive damages are uninsurable as a matter of public policy.³⁷ In other jurisdictions, directly assessed punitive damages are not insurable, but vicariously assessed punitive damages are insurable.³⁸ In a third set of jurisdictions, there is no public policy against insuring for punitive damages, regardless of whether they are vicariously or directly assessed.³⁹

[b]—Defense Costs

With respect to defense costs, E&O and D&O policies can be written in either of two ways. First, they can be written like a standard CGL insurance policy as “duty-to-defend” policies, which contain promises by the insurance companies to defend their policyholders in potentially covered actions. These duty-to-defend policies provide defense obligations that extend until establishment that the claims can no longer potentially be covered or until exhaustion of the indemnity limits.⁴⁰

On the other hand, the majority of E&O and D&O policies are “defense-cost reimbursement” policies, which contain promises to pay or indemnify the policyholder for “losses” incurred in connection with covered claims.⁴¹ In defense-cost reimbursement insurance policies, “loss” includes, in addition to judgments, settlements, and other monetary reparations paid to third parties, all costs of the policyholder’s defense—i.e., costs to investigate a claim and to pay for lawyers to defend the policyholder in a lawsuit.⁴² Accordingly, in the majority of cases, the “loss” element is satisfied as soon as a claim results in a defense cost expenditure.⁴³

Under both types of insurance policies, the obligation to defend is triggered by the existence...