The Do's and Don'ts of D&O Insurance - Obtaining the Right Policy
May 15, 2015
If you serve on your association’s board of directors, you know the experience can be both demanding and rewarding. You also know that, despite your best efforts and intentions, your decisions are not always well-received by members of your community.
Members constantly threaten lawsuits against associations and the individual members of the board of directors. Since most suits are filed against the association, many board members believe they cannot be sued individually. That is wrong! What is correct is a board member cannot be sued successfully unless a breach of fiduciary duty is proved. A judge or jury will make that decision based on the evidence presented by the board members’ attorney.
Who pays the attorneys fees and costs to defend an association and board members? The association. How does it pay? Out of pocket unless an association is covered by directors and officers liability insurance (D&O).
Community Association D&O insurance covers clams against an association as well as board members. Associations not covered by D&O insurance often have to impose a special assessment to pay those expenses.
D&O insurance covers claims for “wrongful acts.” Although not identical, D&O policies generally define a “wrongful act” as any actual or alleged error, misstatement, misleading statement, act or omission, or neglect or breach of duty, subject to exclusions.
Unlike, property and liability claims that seek to recover monetary damages, D&O claims generally seek non-monetary damages. Mostly, they seek a court’s intervention to order a board to either do something or stop doing something. The three most common claims against associations that are excluded from coverage from some policies are non-monetary claims (primarily injunctions and temporary restraining orders), discrimination claims (primarily violations of the Fair Housing Act), and claims to indemnify an association’s manager.
Those policies do not provide adequate coverage. It does not matter whether a suit has any merit. If a claim is excluded from coverage, an association must file an answer and otherwise respond to all of the proceedings at is own expense. If it fails to do so, the claim will be decided against the association.
D&O policies that provide adequate coverage do cover the most common claims. The insurer will either pay the cost of defense and any damages that are awarded or just the cost of defense. Either way, the primary expense of a D&O claim, cost of defense, is covered.
If you are currently a member of a community association board of directors or are thinking about running for the board, you should confirm that your association has D&O insurance and that it provides adequate coverage.
What is a “Claim?”
A particularly confusing aspect of D&O insurance is determining when is a threat a claim. D&O policies are written on a claims-made basis. That means the policy only covers those claims first made against the insured during the policy period. D&O policies do not cover claims based upon or arising out of a wrongful act that occurred before the inception date of the policy and which was known by any insured. They are known as prior acts and unless a D&O policy covers prior acts, there is no coverage for those claims. Many threats are made in the heat of the moment when a member has been told he or she cannot do something or advised that sanctions have been imposed for a violation of the association’s documents. “I’m going to sue you” is often stated, but rarely acted upon. Is each utterance or letter which contains that phrase a “claim” requiring notice to be given to the insurer or risk a declination in coverage? It depends on the policy.
Some D&O policies understand that boards and managers receive many verbal threats of lawsuits. As a result, those policies define a claim as written notice to an insured that a person or entity intends to hold the association responsible for a wrongful act. A claim is also a lawsuit or an administrative proceeding initiated against an insured. Other D&O policies do not define a claim. Instead, they have specific reporting and notice requirements that the insurer is to be notified as soon as possible of any wrongful act which may result in a claim. There is also a duty to notify the insurer of any claims made against or received by an insured. That may require notice of verbal threats “made against” the association.
Most board members and managers have the understanding that reporting claims or facts or circumstances that may give rise to a D&O claim will result in an increase in premium or cancellation of a D&O policy. While that is correct for reporting small property claims, that is not the case with a D&O policy. It is not the case because reporting a threat of a claim (I’m going to sue you) does not subject an insurer to the possibility of making a payment. Contrast that to a property or liability claim- the insurer is notified after the fire or accident. At that point, there are damages.
Since a D&O policy is a claims-made policy, and the insurer only has to respond to suits made during the policy, boards and managers assume significant risk for failing to report a letter from an owner threatening a suit or a significant verbal threat. If a suit is subsequently filed, either after the applicable policy period, or after an association has changed carriers, the claim will not be covered. It will be excluded under the new policy as a prior act and the association will have to pay all of the costs of defense. Even if the policy period has not expired, coverage can be denied for failure to report the claim in a timely manner.
We recommend associations notify a D&O carrier of any written threat of suit, regardless of the likelihood that the person will follow through with the threat. A board should never cavalierly dismiss a written threat of a lawsuit because they feel the person is only blowing off steam. Associations should also notify an insurer of specific verbal threats of a lawsuit. The notice can state it is for reporting purposes only, which most carriers will treat as that and not open a file. Boards should err on the side of reporting threats to avoid a denial of either because of late reporting or as a prior act, if the threat becomes a lawsuit.
D&O Claims May Be Liability Claims
Claims of a wrongful act may also involve an association’s general liability insurance policy. That is best explained by the following scenario.
Claims for monetary damages are common in lawsuits claiming water damage to the interior of a unit caused by a leaking roof. As a rule, an association is not liable for such damage unless it was negligent in the performance of its maintenance obligations. If, however, a board is advised by an expert that a roof needs to be replaced, but only approves patching the roof, subsequent damage that would not have occurred if the roof was replaced would be considered a wrongful act (breach of duty) that resulted in property damage. The wrongful act was the board’s decision not to replace the roof. That decision resulted in damage to the interior of the unit.
D&O policies do not cover claims for bodily damage or property damage. Such claims are more appropriately considered a claim under the association’s general liability policy that resulted from a board’s negligence. When an association has a single insurer that provides both liability and D&O coverage, it will be up to the company to decide whether to treat the claim as a liability claim or a D&O claim. If an association has different carriers for liability and D&O coverage, notice must be given to both companies. If notice is only given to the D&O carrier, a liability insurer can deny coverage for late reporting if it is first placed on notice of a claim after the D&O carrier denies coverage. In the scenario, the association would not be covered for the cost of defense or damages that are awarded for the property damage.
D&O policies vary from the basic definition of who is an insured, to exclusions for non-monetary damages, to what is a claim. Boards of directors, managers, and insurance agents must recognize this and must make sure an association is covered by an “adequate” D&O policy to discharge their joint obligation to properly insure an association. If you have a package policy of property, liability, and D&O insurance and your D&O is not adequate, you should obtain a stand-alone D&O policy that does cover the most common claims. The difference in cost is usually minimal, and the money you save in premiums if you do not purchase a standalone policy will be spent immediately in defending a claim. Most D&O policies do not cover claims for failure to purchase adequate insurance. That includes D&O insurance.