Corporations and other entities commonly purchase directors and officers (D&O) liability insurance policies. These policies protect the assets of directors and officers who are sued by third parties for alleged or actual wrongful acts in the course of running the business or organization. D&O insurance also provides certain protections for the entity itself. As with other insurance products, misrepresenting or omitting information on a D&O insurance application can lead to serious consequences, including claim denial and policy rescission. But how do such consequences impact “innocent” directors and officers, who did not sign the application or know about the lie or omission?
Misrepresentations/Omissions on D&O Applications
D&O insurers request a host of information from applicants, which they use to evaluate the risks of providing coverage. Applications generally ask that the applicant identify all facts known to any of the directors and officers that might give rise to a claim, or else affirm that the directors and officers are unaware of any such facts. These applications usually state that the policy will not provide coverage for claims or actions arising from any such known facts. Although D&O applications ask about facts known to any of the directors or officers, they are typically only signed by a single director or officer.
A “material” misrepresentation or omission refers to a falsehood or omission that would have impacted the insurance company’s rate of coverage or its decision to issue coverage. When one director or officer misrepresents or fails to disclose material facts, and the insurer rescinds the policy, questions often arise as to the impact on other directors and officers, who were unaware of the misrepresentation or omission.
Questions about Innocent Officers
In Shapiro v. American Home Assurance Co., the court held that when a material misrepresentation is made by one corporate official in an application, this can relieve the insurer of its liability to all directors and officers under the policy – including those who had neither made a misrepresentation nor had any knowledge that a misrepresentation was made.1 The court stated that policy rescission was appropriate because the matters misrepresented by the company’s president, who signed the application, were so fundamental to the issuance of the policy that they “increase[d] the risk of loss” as a matter of law. The judge stated that he considered the question of coverage as one of contract interpretation. “The language in the application form, which was part of the insurance contract, is straightforward. The form…inquires about knowledge of any officer or director concerning facts which might give rise to claims under the policy. Because of the likelihood of joint and several liability being imposed on all directors for the wrongdoing of one, the facts known by [the president] were highly material not only to his potential liability, but to that of all other directors. Since [his] answer misrepresented the risk incurred in insuring all those covered by the policy, it follows that [the insurer] can avoid responsibility to all the insureds on the basis of that misrepresentation. Nothing in the contract indicates that the parties intended a different result.” Further, the court rejected the argument that the policy should be viewed as a series of separate contracts between the insurer and each individual officer and director. Rather, the court said, it was more appropriate to view the policy as one contract, since a single premium was paid by the corporation for coverage, the policy was obtained as a single unit and, given the possibility of “joint and several liability,” the multiple-contract interpretation would inadequately protect the interests of the likewise innocent insurer.
The court in National Union Fire Ins. Co. v. Federal Deposit Ins. Corp. reached a similar finding after the president and chair of the insured made material misrepresentations in financial statements in the D&O insurance application. The court found the insurer had no liability to any of the directors or officers under the policy, despite the individual directors and officers’ lack of involvement or knowledge of the misrepresentation.2 In Bird v. Penn Central Co., the court ruled against certain “innocent” directors, holding that the corporate official who misrepresented facts appeared to be acting as an “agent” for the other directors and officers when he signed the application.3 In American Int’l Specialty Lines Ins. Co. v. Towers Fin. Corp., the court noted that an alleged innocent director could have protected himself by requiring the policy to include a severability clause, in which a misrepresentation by another insured would result only in rescission of the D&O insurance policy as to the insured who made the misrepresentation.4
If you are involved in a dispute with your business insurance company, contact Schwartz, Conroy & Hack PC. We have the expertise, experience and tenacity to make insurance companies keep their promises to you and your business.
- Shapiro v. American Home Assurance Co., 584 F. Supp. 1245-53 (D. Mass. 1984)
- National Union Fire Ins. Co. v. Federal Deposit Ins. Corp., No. 03A01-9405-CH-00179 (Tenn. Ct. App. Feb. 8, 1995), appeal denied (Tenn. May 30, 1995)
- Bird v. Penn Central Co., 334 F. Supp. 255 (E.D. Pa. 1971), on rehearing, 341 F. Supp. 291 (E.D. Pa. 1972)
- American Int’l Specialty Lines Ins. Co. v. Towers Fin. Corp., No. 94 Civ. 2727 (WK) (AJP) (S.D.N.Y. Sept. 12, 1997
