Modern business entities can be complex. Often, rather than monoliths, business can resemble networks, in which management, ownership and profit sharing follow different paths on the organization chart. In creating these networks, businesses often attempt to create a harmonious insurance program. Such attempts may not work out as initially envisions.

Consider how management liability insurance is designed: Most policies, for public and private companies, explicitly designate a named insured. Often, named insured is defined as the entity set out in the declarations as such. 

Delving into the policy, there are further definitions. “Insured” may be defined as the Company and any Subsidiary created or acquired before inception of the policy. 

Further, in the words of a common provision, “‘Subsidiary’ means any entity during any time in which the Parent Company owns, directly or through one or more Sudsidiary(ies), more than fifty percent (50%) of the outstanding securities representing the present right to vote for the election of such entity’s directors.”

This means that the named insured and whatever subsidiary for which it controls more than 50% of the “present right to vote for the election” of directors are insured under the policy. The subsidiary’s directors and officers would be individual insureds.

Yet, where among these definitions would be a joint venture between the named insured and another entity? Where would a limited liability corporation (LLC) fall? What if there is a complex network of affiliated entities, some offering management, some owning assets, with cross-indemnification agreements, but without clear-cut stock ownership of more than 50% by the named insured?

To make it more difficult, some policies state that ownership is determined directly or indirectly—making the trail of control even murkier.

Clearly, simply depending upon the base policy language may not extend coverage to all the entities for which coverage is desired. Moreover, carriers are unlikely to accept broad coverage enlargements, such as “all affiliated entities,” as such a term would be difficult to define. Would a joint venture partner with a 10% interest be an “affiliated entity?” An entity with a limited shared ownership interest, but completely overlapping officers and directors?

The preferred method of securing coverage for a business network, therefore, is to add every entity to the policy by a specific endorsement to the policy. Such endorsements are usually more than a simple list. Often, they will include a provision that limits coverage for the additional insured to activities related to the named insured’s business.

For example: Mega Realtor, Inc. owns many real estate sites and manages a number of others for an unrelated entity, Summa Realty. As part of its contractual arrangements, Summa insists on indemnification by Mega for claims arising from Mega’s management. As a cost-effective measure, Mega may add Summa to its policy, but only for claims arising from its management of Summa’s property.

This limitation will prevent Mega’s insurance coverage from being eroded by claims against Summa unrelated to its management relationship with Summa.

Using an additional insured endorsement has its limitations. The most obvious: Claims are rarely clear-cut. It may not be readily apparent when a claim relates to only the actions of one party more than another. Consider: If Summa insists Mega impose illegal covenants on tenants, leading to lawsuits, did that claim arise only from Mega’s management?²

In addition, businesses may enter into contractual arrangements that promise insurance coverage that is not available. Consider the transaction in which one party promised to provide indemnification for all liability of any officer, director, employee or agent, and to purchase a Directors & Officers insurance policy to provide that indemnification. No D&O policy provides coverage for all liability and its coverage will not extend to such a broad,
ill-defined group of insureds.

The most common issues are more mundane. In the example above, Mega Realtor may have a complex organization, with many affiliated entities. It provides a list of these entities to be added to its insurance program but, due to clerical error, one entity is left off, and the names of others are incorrectly listed. In the carrier’s view, there is no coverage for the entity omitted or the actual entities who were incorrectly listed. Courts will not readily reform the policy to meet coverage needs.

In Gemini Ins. Co. v. Kukui`ula Dev. Co. (Hawaii), LLC, ³ the court found that failing to name two related entities as “additional insureds” meant that there was no coverage available to those entities. In Lightfoot v. Hartford Fire Ins. Co.,⁴ even a closely related entity could not benefit from an insurance policy if it were not named or otherwise met the policy terms and conditions. A schedule of values was insufficient to create an additional insured relationship. In EMC Ins. Cos. v. Mid-Continent Cas. Co.,⁵ the court found that simply adding a corporation as an “additional insured” did not automatically add that corporation’s officers and directors as well. Other courts have agreed with carriers that leaving off an entity will lead to a finding of no coverage.⁶ Moreover, additional insureds, even when correctly included, will find coverage limited by the specific terms of the policy.⁷ 

A good broker may be able to negotiate with the carriers to reform the policy, but generally errors are discovered when there is a claim—an unfortunate time to negotiate coverage.

Obviously, careful review of all related documents is critical to insure appropriate coverage. This is a task that requires thorough interaction among all parties to assure that the correct coverage is in place.

Even when the policy appears to be correctly negotiated, however, difficulties can occur.

For example, consider the case of VEREIT, once known as American Realty Capital. VEREIT’s operations and investments were provided by AR Capital in the years 2011–2014. 

VEREIT and AR Capital—and a “complex web of interrelated companies”⁸—shared a number of officers and directors, including CEO and Chairman Nicholas S. Schorsch and CFO Brian F. Block (the AR Capital officers). According to one complaint filed in the underlying case, Schorsch, Block and the other AR Capital officers exercised control over the entire network, receiving over $900 million. 

In 2014, the board of VEREIT internalized management, removing AR Capital officers after accounting and reporting irregularities were found. In 2014 and 2015, VEREIT restated several financial statements issued during the period AR Capital was providing the management services. SEC investigations and securities class action lawsuits followed against VEREIT, AR Capital, and directors and officers at both companies.

During this time, VEREIT maintained an $80 million D&O insurance program. AR Capital had been added as an additional named insured by amending the definition of the term “company” to include AR Capital, for its actions relating to VEREIT.

At first, AR Capital sent its bills to VEREIT, which forwarded them to the carriers, but VEREIT stopped forwarding AR Capital’s invoices. AR Capital became concerned that the insurance proceeds were being depleted by payment of VEREIT’s expenses.

This was hardly a remote possibility. The pace of the litigation was intense, with major settlements in excess of the D&O proceeds.⁹ CFO Brian Block was convicted of accounting fraud and sentenced to prison.¹⁰

AR Capital filed a declaratory judgment action against the D&O insurers, seeking a declaration that it was covered under the insurance program and entitled to have its defense costs advanced. VEREIT intervened in the action “to protect its interests in the finite amount of available insurance proceeds.”

The Delaware Chancery Court¹¹ sorted through the various motions, ruling that AR Capital, as an additional named insured under the primary policy, was entitled to advancement of most of its defense costs, subject to later repayment if is determined that AR Capital is not entitled to coverage. Lastly, it chided the parties for their “Hunger Games” attitudes, and suggested they work together to maximize what was left of their insurance proceeds.

What Does This Mean for Our Clients?

Negotiating management liability coverage offers opportunities for amendments and endorsements. At the negotiation stage, carriers are generally willing to discuss options for expansion of coverage. Once a claim arises, however, carriers are less willing to provide
broader coverage than the policy provides. While a broker may be able to change a carrier’s position, that task is considerably harder in the face of a claim than in the earlier stages.

Simply adding many additional insureds to an insurance program is not a good strategy. In some cases, businesses want to add shareholders or even major creditors as insureds to management liability policies, despite the fact that shareholders are the most likely claimants and creditors interests may not be aligned with the insured. 

What the VEREIT case demonstrates is the need for a cold-eyed view of potential liability when negotiating insurance contracts. To some extent, VEREIT’s actions were completely ordinary: The insurance program was designed to protect the interest of the entire network of entities, their officers and directors, to the extent those insureds were involved in specific, core activities. The endorsement was drafted to provide that protection.

Yet VEREIT was a publicly traded corporation, with institutional investors holding substantial numbers of shares. In hindsight, it is clear that shareholders would not always have the same interests as the founding members. It is not clear when those interests diverged and, most likely, it did not happen all at once.

In short, insureds should carefully review their organization charts, corporate documents and contractual obligations, with an eye toward, if not the worst-case at least the honeymoon-is-over scenario. That examination should not ignore even small errors, such as misspellings or incorrect descriptions, as these errors can have an impact on coverage.

Moreover, this review should be performed at every renewal and whenever there is a major shift in corporate ownership or management. This is not a task that can be dropped on a broker’s desk at the last minute, but requires a coordinated effort of all involved.

Prudent risk management does not mean finding the least expensive methods but the most effective ones. As always, Gallagher professionals are ready to assist.

About the Author:

Donna Ferrara, Esq. is a senior vice president in Gallagher’s Management Liability practice. This group focuses on risk management services, including insurance placement related to executive and management liability issues. During Ms. Ferrara’s three decades in the industry, her vast experience includes litigating and analyzing insurance issues, drafting policies, and aiding the settlement process. Ms. Ferrara is a frequent participant in industry forums as well as a respected contributor of articles on insurance, law and technology, having been published in both legal and trade press. She has also been recognized as a Power Thought Leader by Risk & Insurance magazine.

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¹ It should be noted that management liability policies differ somewhat from comprehensive general liability and property policies in defining and treating additional insureds and additional named insureds. Overall, however, the issue is so complicated as to inspire a book, “The Additional Insured Book.”
² Contractual indemnity requirements alone may not be sufficient to tap coverage. In Waste Mgmt. v. Great Divide Ins. Co., 2019 U.S. Dist. LEXIS 59477 (ED VA 2019) the language of the additional insured endorsement precluded coverage for an entity being sued for its own negligence and not the negligence of the primary insured.
³ 855 F. Supp. 2d 1125, 1145 (Dist. Hawaii 2012).
⁴ 2010 U.S. Dist. LEXIS 153739 (ED LA 2010).
⁵ 884 F. Supp. 2d 1147 (D. CO 2012).
⁶ For example, in Canal Indem. Co. v. Regency Club Owners Ass’n, 924 F. Supp. 2d 1304 (MD Al, 2013), the court found that the entity “G&G Roofing” was not an additional insured under a policy issued to “Nicholson d/b/a GG Roofing” despite the common address the insured and G&G Roofing. Adding the customer of G&G to the policy as an additional insured was insufficient to make G&G an insured.
⁷ See, e.g. Clarendon Am. Ins. Co. v. State Farm Fire & Cas. Co., 2013 U.S. Dist. LEXIS 880 (D. OR 2013) (entity covered as a “property manager” is not covered as a “construction manager”); Catlin Specialty Ins., Co. v. L.A. Contrs., Ltd., 2015 U.S. Dist. LEXIS 149725 (SD TX 2015)(anti-subrogation provision in policy applied despite contractual obligations of the insured to claimant).
¹¹AR Capital, Llc, et al. v. Xl Specialty Insurance, No. N16C-04-154, (Dec. 12, 2018); 2018 Del. Super. LEXIS 1568
¹¹Langdale Company v. National Union, No., 14-12723 (11th Cir. 2015). See, also, Security National Insurance Co. v. H.O.M.E., Inc, 312 F. Supp. Ed 777 (Dist. N.D. 2018)