Closing the Property Gap
A complaint is filed against your organization’s board of directors. The board did nothing wrong — but they’ll still need to be defended against the claims. The good news: You have a D&O policy in place to protect them. The bad news: It may not be enough.
Nonprofit organizations and private companies whose business is in or related to property may, in certain circumstances, be faced with the unpleasant discovery that there’s a chink in their D&O armor. That chink comes in the form of the property exclusion included in all D&O policy forms.
The property exclusion seems an innocuous enough passage. And it’s there for a valid reason: Property policies — not D&O policies — should cover property damage. D&O underwriters don’t want to get stuck paying for things they never agreed to cover. So the language used in policy forms is intended to address every possible angle. But there are instances where policy language can inadvertently go a step too far, excluding exactly the type of claims that organizations use D&O policies to protect themselves from.
The primary sticking point, as it is with any exclusion, is a matter of language. Consider this sample wording from one D&O policy form:
“Insurer shall not be liable for loss … for actual or alleged bodily injury, sickness, disease or death of any person, or damage to or destruction of any tangible property including loss of use thereof; whether or not such property is physically injured … .”
The language is pretty straightforward, and does what it sets out to do — it excludes any claim that alleges the directors and officers’ actions caused damage to property. Got damage? Look to your property policy. Case closed.
By contrast, consider the exact same exclusion as written on another D&O policy form:
“This insurance does not apply to any ‘loss’ or ‘defense costs’ in connection with any claim made against an insured, arising out of, directly or indirectly resulting from, or in consequence of, or in any way involving any actual or alleged bodily injury, sickness … damage to or destruction of any tangible property including any loss of use or slander of title … .”
On its face, that wording could be used to exclude just about anything related to property damage in any way, including common complaints that should trigger coverage, such as failure to set adequate reserves or failure to have adequate insurance. If those acts can be tied to property damage in any peripheral way, the carrier can refuse to defend the board.
Explained Mark Weintraub, insurance and claims counsel for Lockton’s southeast region: “If the board makes a decision — ‘OK, an elevator broke and we’re going to repair it’ — they know that’s part of the property damage exclusion. They’re not worried about that. But if it’s ‘we’re going to make a global decision about reserving funds … or a decision based on disclosures or assessments,’ that’s something that the property damage exclusion shouldn’t reach.
“There’s that danger for anyone who deals with property on a regular basis that the property exclusion could reach out and steal away coverage for basic fiduciary acts,” said Weintraub. “It’s not something that I think anyone intends, but it can happen, especially as claims get larger. Carriers will look at their policies to try and see what they can do to restrict coverage — that’s just human nature.”
Court Rulings Clash
A handful of cases brought the property exclusion debate to the courts in 2013, with mixed results.
In a Florida case, Commodore Plaza Condominium Association vs. QBE Insurance Corp., a building suffered damage during Hurricane Wilma. The property managers allegedly made multiple missteps after the fact, causing additional damage to the property.
The court held that all claims related to that damage were subject to the property damage exclusion — not a surprise. But the court also held that the exclusion applied to other alleged acts such as failing to provide security; breaching the duty to not interfere with peaceful possession of property; failing to follow all valid laws, zoning ordinances, and regulations; hiring unlicensed and unqualified workers; and failing to perform repairs in accordance with the Florida Building Code.
The court determined that the damage from the hurricane was the underlying cause of all of these alleged breaches and, therefore, they all fell under the property exclusion. And while there’s arguably some gray area, the court’s decision amounts to this: Not only are breaches of duty that result in property damage excluded, but so are breaches of duty caused by property damage.
The following month, an Illinois court offered a particularly troublesome decision in Hess vs. Travelers Casualty and Surety Co. The court, as might be expected, upheld an exclusion of coverage for an alleged breach of a duty to make repairs related to a construction defect. However, the court also excluded coverage for the failure to establish a reserve fund for repairs — an occurrence that took place years before the issue of property damage would even be raised.
“If a board is going to be second-guessed by its carrier for claims saying the board breached its fiduciary duty by levying an assessment, really — what are they paying for? What is going to be covered in the end?” —Mark Weintraub, insurance and claims counsel, Lockton
The decision whether or not to establish a reserve fund is clearly and wholly a fiduciary matter, and one related to economic harm independent from property damage. Put another way — the lack of a reserve fund cannot cause property damage. As such, it might seem that it should be cut and dried that a carrier would have a duty to defend an insured against a complaint that its negligent reserving decision led to economic harm. That is, after all, one of the points of having a D&O policy.
However, the court in Hess didn’t see it that way. It reasoned that the claim for breach of fiduciary duty arose out of, or originated from, the construction defect. Therefore, it fell under the policy’s exclusion language. The board, in this case, was left squarely between a rock and hard place. The complaint didn’t fall under the organization’s D&O policy — but it didn’t fall under the property policy either. Board members were left to their own devices.
A later case, Pulliam vs. Travelers Indemnity Co., also involved multiple complaints including failure to establish a reserve fund and failure to disclose conflicts of interest in a developer-controlled property owner’s association. In this case, however, the court diverged from the Illinois court’s interpretation in Hess, making a clear distinction between property and economic damage:
“The duty to establish a reserve fund, while related to the property damage, did not result in physical damage to tangible property as required by the policy. The failure to establish a reserve fund resulted in respondents having to expend more from their own pockets to make the repairs than they might have otherwise had to expend — economic damage. Likewise, allegations that [the board] breached its fiduciary duty … do not allege a physical injury to tangible property constituting property damage.”
Weintraub said he’s seeing a slight uptick in this type of friction with D&O policies. “I’m not saying this is some growing, dangerous trend, but I have seen it coming up more, and I see that these cases could give it additional steam because they have case law to rely on.”
Closing the Gap
In these cases, as with any related cases, the underlying truth is that none of the insureds ever expected to find themselves battling their policy coverage in court. They assumed they could rest easy knowing they had protected their directors and officers with a D&O policy if a complaint arose.
But sometimes just a few key words can get in the way. And that can have deeper implications for those whose lifeblood depends upon property. Consider this scenario: A property management group fails to maintain a roof on one of its buildings. The roof begins to leak and massive property losses follow. There’s no occurrence, so the property policy isn’t triggered. So the occupants turn to the board for relief and discover there are inadequate reserves set aside for repairs.
“That’s exactly what happens in the gap,” said Steve Shappell, managing director of Aon Risk Solutions’ financial services group. “We didn’t have an occurrence so we can’t go to our CGL, we can’t go to our property insurer because we didn’t trigger the cover, but [the claim] is clearly related to and arising out of property damage.
It’s not all that hard to see how the lines could blur further.
“If you take this out to the extreme, let’s say … a decision in the assessment world; that’s always unpopular in a condominium,” said Weintraub. “If an assessment is levied, usually your residents are going to be up in arms because it’s going to cost them money, so that usually leads to claims. And if a board is going to be second-guessed by its carrier for claims saying the board breached its fiduciary duty by levying an assessment, really — what are they paying for? What is going to be covered in the end?”
It’s How You Write It
On the surface, the solution is in the language.
“If you want to trigger defense, what you need to do with that policy language is strike the ‘alleged, arising from’ language and use the words ‘for,’ ‘from’ or other soft words that don’t have that kind of restrictive component to them,” said Monica Minkel, senior vice president of executive protection at Poms & Associates Insurance Brokers Inc.
But Minkel and others acknowledged that may be easier said than done.
“The quick answer is to say get rid of that language,” said Weintraub. “But sometimes that can simply be impossible.”
“The devil’s in the details,” said Shappell. “Can you get rid of it completely? If you buy an A side only policy — which is not very popular with the nonprofts and the private companies — you probably can get rid of the property exclusion, but it doesn’t make a whole lot of sense because it only covers non-indemnifiable scenarios and you’ve got to have a lot of cash to operate that way.”
Whether or not the language can be negotiated — deciding which elements of the policy are make-or-break — is a judgment call that brokers and insureds need to work out together.
“You could check 100 components, but are you going to move the business if eight of those components don’t match what you had before or they’re not the best you can get? Some carriers will negotiate and some won’t,” said Minkel.
That said, there are other considerations that will help ensure that a D&O policy responds, Minkel said. The first is whether a duty to defend policy form is used and the other is the cost allocation language.
“We’re looking for 100 percent predetermined defense cost allocation. What that means is if you get a claim in the door that has five causes of action and two of them are in a gray area or clearly shouldn’t be covered under the policy … they’re going to defend you for 100 percent of the claim, they’re not going to allocate the defense expenses based on covered and uncovered loss.”
Weintraub said it’s up to brokers to make sure that insureds understand what the property exclusion is and how it can lead carriers to deny defense.
“Awareness is half the battle. If they know a property damage exclusion could leap up and bite them when they’re not expecting it, then the key is to just keep that in mind when they’re making their decisions — especially with clients who are property managers,” he said.
That also means documenting decisions to make it clear that they’re not property related, he added.
“Directors and officers should be free to make fiduciary decisions and they should know what’s on the table and what isn’t as far as coverage goes ahead of time,” said Weintraub. “You don’t want it to be something of a gotcha.”