Directors & Officers Insurance (D&O) is a relatively new branch of insurance in the United Arab Emirates (UAE) market.  Accordingly, issues such as allocation of costs have not yet been considered by UAE or Dubai International Financial Centre (DIFC) Courts.  This article provides guidance on certain issues that have arisen in handling claims under such policies, based on experience in other jurisdictions.

Overview

Most D&O policies are reimbursement-based, with the policyholder retaining a duty to defend itself.  This can create practical difficulties where the Claimant sues both the insured company (which does not of itself benefit from the cover) and the insured's directors, who do.  All defendants will (usually) have a common interest and defence, but how should costs be shared between them?  D&O policies normally contain allocation provisions to address this issue, but how is this applied in practice?  It is not a simple concept and allocation has been identified as one of the most controversial areas of D&O insurance policies.  There is no case law or literature on the subject in UAE and even internationally there are divergent approaches, which are examined below, by reference to the respective allocation of (a) Defence Costs and (b) Settlement Payments.

Allocation of Defence Costs

The question of how to apportion defence costs, when the proceedings in question also involve uninsured co-defendants, whose liability is inseparable from that of insured defendants, has been a cause of major concern over the years.

In order to resolve this issue, courts in the US developed the "Reasonably Related Defence Costs Test", by which defence costs are regarded as "reasonably related" to the defence of covered claims, if it can be shown that those costs would have been incurred even if the proceedings had been brought only against the directors/officers and not the Company, etc.  If the defence costs are "reasonably related", then they are payable in their entirety, irrespective of the fact that they may also benefit the uninsured parties.

This test was primarily developed in the matter of Continental Casualty Co v Board of Education of Charles County 489 A2d 536 (MD,1985) where it was explained in the following manner:

"Legal services and expenses are reasonably related to a covered count if they would have been rendered and incurred by reasonably competent counsel engaged to defend a suit against the Board and Assureds arising out of the same factual background as did the suit but which alleged only the matter of in the covered counts..."

This was a matter where a number of defendants, including a school and its directors, were sued by a construction contractor, which alleged seven breaches of a contract.  Of the seven, only two involved allegations against the directors.  The court held that only those two were covered by the D&O policy, but that the defence costs relating to those two breaches would be payable in full, including any costs incurred on those two breaches by the school itself.

Although expounded in 1985, the "reasonably related test" is still followed, in the US and elsewhere. It was endorsed and applied by the Privy Council in the matter of New Zealand Insurance Company Limited v New Zealand Forest Products Limited and Another (1995) 8 ANZ Ins 75, where all the defence costs were held to be payable because they related to the director's own liability, independent of the company's liability which was a co-defendant.

It was followed in the US in Safeway Stores Inc v National Union Fire Insurance Corp 64 F3d 1282 (9th Cir, 1995) where the court held:

"...Since Safeway was potentially liable as a result of supporting or assisting its directors and officers, the company's liability ought to be concurrent with that of the directors. The defence costs are covered under the policy as they are reasonably related to the insured directors and officers."

The principle applied in the New Zealand Insurance case was later applied by English courts in allocating defence costs in dealing with product liability policies, but (perhaps surprisingly) it has not been the subject of a court judgment in a D&O case.

In Australia, the Court of Appeal deliberated the legal position in Vero Insurance Limited v Baycorp Advantage Limited [2004] NSWCA 390, and its judgment remains applicable.  It examined the policy definition of Defence Costs and held that, as the definition did not specify that they are costs only for the defence of the insured parties, nor did it exclude costs incurred in the defence of the relevant company, the entire defence costs would be covered by the insurer.

Allocation of Settlement Costs

Three primary methods have been developed to allocate settlement costs, none of which has been used consistently. They are: (i) "pro-rata method"; (ii) "relative benefit"; and (iii) "larger settlement rule". The "pro-rata method" was used initially but was abandoned due to its excessive simplicity and lack of practicality. The method suggested payments in equal proportions between the company and the directors, but this could not cater for a scenario where there might be some uninsured directors or insured directors who were not directly liable. The method has fallen into disuse.

The "relative benefit" approach involves examining whether a settlement payment benefits the insured director more than the company.  If so then the settlement is considered more to his benefit in relative terms and the D&O cover must pay the entire amount.  We are not aware of a reported case in England that adopted this rule in dealing with settlement payments (generally settlement allocation was based on "common sense" principles) but the approach has been used in the US, where there have been instances of all of the settlement being allocated to the insurer, for example where fraud was alleged on the part of the director and a settlement reached that barely benefitted the company (Nodaway Valley Bank v Continental Casualty Co 715 F Supp 14588 (WD Mo,1989)).

The "larger settlement rule" simply states that if the presence of the uninsured company in the proceeding leads to a larger settlement payment, the insurer should only pay the amount that would have been payable if there was no company in the litigation.  The burden of proving the increased settlement lies with the company is on the insurer.  Again, this is a principle developed in the US, which has not been applied in any other jurisdiction.

A working solution to the apportionment of settlement payments is provided in Vero  v Baycorp case mentioned above.  The Court examined the terms of the settlement deed, which provided:

"Baycorp... on behalf of itself and each of the other defendants in the proceedings ...will pay [the plaintiffs a total of $10 million in respect of the claims in the Proceedings] in full and final settlement of the Proceedings ...inclusive of costs..."

"Loss" was defined in the policy to be:

"1. The amount (whether determined by judgment or settlement) which [a Baycorp Officer] is legally liable to pay in respect of a Claim and includes damages, interest and claimant's costs and expenses;

It was held by the court that the directors of Baycorp were not required to pay the settlement as the responsibility had been taken up by Baycorp and that therefore there was no loss in terms of the policy for the insurer to reimburse.

Conclusion

As is evident, common sense is the best guide to use when allocating costs of defending a claim or the settlement payments.  Any such matters in the UAE will invariably use guides laid down in these judgments quoted above.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.