Companies routinely purchase directors and officers (D&O) liability insurance to shield their directors and officers in the event they are sued for alleged (or actual) wrongful acts committed in the course of managing the company. D&O insurance also provides certain protections for the entity itself. One of the most commonly litigated issues regarding D&O policies is the effect on coverage of material misrepresentations or omissions in the application for the policy. As with other types of insurance, misrepresenting or omitting information on a D&O application can lead to serious consequences, including claim denial and policy rescission.
D&O Applications
Insurers use the information provided in D&O applications to evaluate the risks of providing coverage. Among other things, applicants are generally asked to identify all facts that any of the directors or officers are aware of that could potentially lead to a claim, or to affirm that they are not aware of the existence of any such facts. Applications usually state that the policy will not provide coverage for claims or actions arising from any such known facts.
Material Misrepresentations
Many courts have allowed insurers to void D&O policies when applications contained material misrepresentations. For instance, the Tenth Circuit sided with an insurer who rescinded a D&O insurance policy based on misrepresentation in financial statements that accompanied the application.1 The court cited Utah law stating that rescission is proper if the insurer relied on a material misstatement that the insured knew or should have known was false. In a case heard by a federal district court in New York, an insurer sought to void its policies based on fraud on the part of the insureds in procuring coverage. The court held that the insurer was entitled to rescind its policies and had no obligation to cover the insureds’ defense. “Under New York law … an insurance policy issued in reliance on material misrepresentations is void from its inception,” the court said.2
Some courts have held that an insurer can rescind a policy without demonstrating that the insured intended to deceive with its material misrepresentation. As the Tenth Circuit stated in the aforementioned Utah case, “[a] misrepresentation is not innocent…if the applicant knew or should have known about its falsity.” Other courts, however, have found that an intent to deceive is necessary to nullify coverage.
Material Omissions
When information is not specifically requested by the insurer, some courts have held that an omission does not warrant rescission of the policy. In a variety of circumstances, courts have found that the fact an insurer did not ask for specific information in the application is evidence that the information was not material. As one court stated, “The insurer, not the insured, determines the materiality of information based on the questions it asks.… Questions left unasked are impliedly immaterial.”3
A dispute arose over a D&O insurance renewal application in which the policyholder failed to report that the Securities and Exchange Commission had made an informal inquiry into their recent trading and disclosures. The insurer argued that the insured had a duty to disclose the inquiry, that it was material information, and that the insured’s failure to disclose warranted rescission. While agreeing that misrepresentation can include “both false affirmative statements and the failure to disclose where such duty to disclose exists,” the court pointed to the general insurance disclosure rule, which states “[a]n applicant for insurance is under no duty to volunteer information where no question plainly and directly requires it to be furnished.” The court stated, “There is nothing so unique about D&O policies that should elevate the duty to disclose to a higher standard than the general disclosure rule.” The court further held that even if the insured had a duty to disclose the inquiry, the insurers had “not factually sustained their burden of establishing the materiality of the SEC inquiry to their underwriting decisions.” Thus the insurer did not have the right to rescind the policy.4
If you are involved in a dispute with your business insurance company, contact us. We have the expertise, experience and tenacity to make insurance companies keep their promises to you and your business.
1 See ClearOne Communications, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa., 494 F.3d 1238 (10th Cir. 2007)
2 Republic Ins. Co. v. Masters, Mates & Pilots Pension Plan, 77 F.3d 48, 52 (2d Cir. 1996)
3 Aguilera v. Pacific Ins. Co., No. 95 C 1163 (N.D. Ill. Jan. 10, 1996
4 See Home Ins. Co. v. Spectrum Info. Techs., Inc., 930 F. Supp. 825 (E.D.N.Y. 1996)