The New Grey Area of Liability Coverage

Most people don’t have an issue with the idea that bad behaviour deserves to be punished. The “bad guys” should get what’s coming to them—or, at least, be held accountable for their actions, shouldn’t they? So it’s a fundamental principle of insurance that coverage shouldn’t be provided for deliberate illegal or reprehensible acts. Yet, as policies have evolved in the last few years, we’ve seen an evolution in language, expanding the bounds of coverage insurers have traditionally been willing to provide. Fraud, dishonesty and criminal acts certainly still remain outside the limits of insurance coverage, but a grey area has developed where coverage may be available for acts that flirt with the edges of the wrong side of the law.

Conrad Black and Nortel’s ex-CEO Frank Dunn (along with Nortel’s financial officers) are prime examples of executives accused of fraud, dishonesty and illegal profit, who relied on insurance coverage to allow them to fight these charges—and, in the case of the Nortel executives, avoid conviction. (Canadian Business put it well in declaring they were “not guilty, but not clean either.”) For Conrad Black, insurance was key to the defence funding that allowed him to take his case all the way to the Court of Appeal and, ultimately, to reduce the number of convictions and the length of his sentence. Bad guys or not, insurance played an integral role in allowing these executives to avoid or reduce the legal consequences of their actions.

It’s not always simple, of course, to determine what’s right, what’s wrong and what’s punishable. Canadian courts have struggled immensely with this problem in the context of deciding when the actions of an alleged wrongdoer meet the legal threshold of a “willful violation.” Many policies, in fact, contain a conduct exclusion that precludes coverage for acts or omissions that constitute such violations. Policy interpretations by our courts, however, have been inconsistent. Some have defined a willful violation very broadly and have imputed liability on the “bad guy” who intended his actions, even if he didn’t appreciate the consequences or mean to break the law. A narrower interpretation has also been applied, requiring a wrongdoer to have a “guilty mind” or to have purposeful malicious intent in carrying out the actions that violate the law.

Read: Top 20 Liability Insurers

Ignorance of the law might not be enough for an accused to escape legal liability in the courts, but experienced insurance brokers have successfully argued that coverage for violations done with some degree of ignorance should be available. As a result, qualifying language for conduct exclusions—which explicitly provides that the alleged wrongdoer must understand and intend the consequences of his/her actions—is now appearing in a number of liability insurance policies. 

Misrepresentations

The idea of intending consequence of wrongful actions also factors into the recent treatment of misrepresentations in insurance applications. An insured person undoubtedly has an obligation to be honest and deal fairly with an insurer. If not, they might end up in the position of those Nortel executives who had uncertain insurance coverage after Chubb partially rescinded their policy. (Chubb alleged that it relied on intentional misrepresentations in financial statements when subscribing to the Nortel risk in 2003.)

Policy language also eliminates coverage when there are statements in the application that are unintentionally inaccurate. Many will argue that the onus is on a person looking for insurance to be fully informed of the accuracy of their information. But does the person deserve to be denied coverage if they made an honest effort to be factual and errors were still made?

In some cases, these factual errors may result in insurers treating the policy as null and void and unavailable to any insured. Even if the signer of the application knew of the misrepresentations, should all those insured, even those who didn’t know, lose out? To balance the interests of both sides, policy language has been developed stating that no, one insured’s knowledge of the wrong information can’t be used to deny coverage to others who were in the dark. Many liability policies now also include language limiting when the insurer can treat the policy as void.

Fraud and Dishonesty

Where an insured is accused of fraud or dishonesty, some policy language has evolved to provide coverage until there is a final, binding and non-appealable determination of guilt. As a result, an insured could have defence cost coverage even when he’s made an incriminating admission in the proceedings. Is this pushing things too far? In our free and democratic society, we believe everyone is considered innocent until proven guilty and that alleged wrongdoers should have their day in court. Allowing an insurer to terminate defence cost coverage even when there is an admission of culpability, but before a court makes a judgment, would allow the insurer to usurp the role of judge and jury.

One insured’s knowledge of the wrong information can’t be used to deny coverage to others who were in the dark.

The effectiveness of our laws, rules and regulations depends to an extent on individuals believing that breaking them will result in unpleasant consequences. For example, fines and penalties act as deterrents to certain behaviour. Traditionally, insurers have used language excluding coverage for fines and penalties levied against a person—they believed insuring such losses would be against public policy. The language didn’t make a distinction between an executive fined in regulatory proceedings related to workplace safety and the death of an employee, or an executive facing a fine for failure to keep proper records. But are all fines and penalties the same? Criminal and quasi-criminal fines are clearly uninsurable, but what about fines that are less serious in nature, such as those for administrative violations? An increasing number of statutes are implementing administrative monetary penalties that are not intended to punish, but to encourage compliance. Some statutes also impose fines and penalties on management executives for corporate malfeasance that occurred on their watch whether they were active in the shenanigans or not.

There appears to be a growing acceptance among insurers that coverage for fines and penalties should be permitted in some cases. This has led to a shift in policy language offered by some markets to include civil or non-criminal fines and penalties as part of covered loss. Unfortunately, determining which fines are criminal or quasi-criminal, and therefore uninsurable, isn’t as clear in Canada as it is in other jurisdictions, like the U.S. Until Canadian courts weigh in on this topic, we won’t know whether the language will be effective in providing coverage and to what extent. In the meantime, brokers continue to ask for policy language that provides their clients the opportunity to argue that they’re insurable under the law.

The Gaining of improper Profit

It seems that not a day goes by without a news story questioning the circumstances surrounding an executive’s outrageous salary or decision to cash in handsomely on stock options. Insurance policies have historically precluded coverage where a claim arises from illegal profit or an unfair advantage. For example, if an insured bought his company’s shares based on insider information and such conduct was proven in a final judicial proceeding, coverage would be denied. But, in many cases, coverage might also have been denied for an executive who faced an allegation of improper profit following a shareholder-sanctioned award of compensation under “say on pay” regulations: a situation in which there may be no intent by the executive to defraud the company.

Read: Lessons in Liability

With the broadening of policy wording, coverage might be available to insured individuals if the company’s shareholders approved the executive compensation, but then changed their minds and brought an action to recover those fat pay cheques. This coverage, available by way of an exception to the illegal profit exclusion, is still subject to insurability under the law of the jurisdiction governing the policy. For the executive that’s at risk of being asked to return compensation, more flexible policy wording can be good news.

It’s reasonable to ask: have the boundaries been pushed too far? Will insured individuals close their eyes to their legal obligations, behave according to their whims, and avoid consequences because insurance will pick up the tab? It’s true that current policies are pushing the limits, but only because there’s a growing recognition that an allegation of fraud, misconduct or other contravention of the law does not equal a straightforward, clear-cut case of guilt.

The changes taking place within insurance policies are not intended to permit individuals to duck liability or punishment where it is warranted. They’re supposed to give the insured the benefit of the doubt until there’s a binding, legal determination of guilt, or a judicial or legislative decision that insurance shouldn’t cover the losses. Safeguards remain in place to ensure that this doesn’t go too far. Policies still contain conduct exclusions that provide an insurer with the ability to deny coverage where an insured knowingly and intentionally breaks the law or commits an egregious act. It’s also common for an insurance policy to exclude any amount that is not insurable under the law from the definition of loss.

While the changes in language suggest that insurers are becoming increasingly comfortable providing coverage to the extent permitted by law—even when in some cases that limit remains undetermined—allowing insurers to deny coverage when a scenario falls within a grey area makes them judge and jury. Just as with a determination of guilt, drawing the line on the limits of insurability is a decision for the courts or the legislature. Until we have those boundaries firmly drawn, the bounds of insurance should continue to be pushed—within reason. After all, while we want to protect the innocent, we do not want to let the bad guy off the hook.

Brian Rosenbaum is senior vice-president and national director of the legal and research practice of Aon Reed Stenhouse’s financial services group. Jennifer Drake is a member of the legal and research practice group.

___________________________________________________________________________
Copyright 2014 Rogers Publishing Ltd. This article first appeared in the September 2014 edition of Canadian Insurance Top Broker magazine

This story was originally published by Canadian Insurance Top Broker.