German court ruling threatens D&O policies

Having worked out the full implications of the ruling experts now say that D&O insurers could use this potential weapon. “There is a danger for managers that their entire policy may be invalid and that they no longer have insurance cover,” said Düsseldorf-based lawyer Herbert Palmberger. Before buying D&O cover, each company has to answer a number of questions which help insurers make an accurate risk assessment. The companies are asked whether they are aware of breaches of duty by a manager, or whether executives are involved in litigation. “If a company has knowledge of previous claims and does not state them, this can already amount to wilful deceit,” explained Palmberger. The insurer then has the right to contest the policy at a later date. So far, no insurance company has done so. “Up to now, it was agreed that contesting a policy on the basis of wilful deceit does not nullify the cover for the managers who were not involved in the deceit,” he said. Usually, one single D&O policy provides cover for a whole range of executives from the management board to the supervisory board. However, most of these people are not involved in the preparation of the policy.hideIn order to protect this group of people, special clauses were included in the policies. Various types exist on the market. Insurers often renounce their right to contest; only those among the insured persons who commit wilful deceit and anyone else who knew about the deceit, are not covered by the policy. This current practice is now in danger because of the court ruling. The background to the ruling was a suit brought by the customer of a fraudulent money transporter firm Heros against Mannheimer Versicherung. Heros had operated a Ponzi scheme since the beginning of the 1990s. The security company transferred customers’ money to its own accounts first and then waited before transferring the money to the proper target account. The money was used for false purposes. When gaps arose they were filled by other customers' money. When the machinations became known and Heros went bankrupt in 2006, the damage caused to retailers amounted to more than €300m. Because Heros was insolvent, the client turned to the Mannheimer. Heros had taken out insurance cover for its customers with the Mannheimer which was designed to cover the loss of their cash. Some 90% of the Mannheimer-led risk was placed in the London market, brokered by Marsh. Mannheimer contested the claim, arguing that Heros had concealed its Ponzi scheme when it signed the policy. Although the policy contained a ‘waiver to contest’ clause similar to that in the D&O treaties, the Federal Supreme Court ruled in favour of the insurer. The Court said that an advance recissory waiver violates the freedom for resolution in legal transactions. The waiver enables a policy holder to gain benefit from the deceit without having to worry that the policy will be nullified, said the Court. The insurer's recissory waiver is also invalid for the insured customer because otherwise the insurer would be subject to the arbitrary decision of the policy holder. The effect of this ruling on D&O policies could be disastrous. D&O insurers that do not want to pay claims, can successfully challenge the treaty despite a waiver clause if and when a company or one of its insured executives can be proven to have wilfully provided false information. The D&O policy is then no longer valid. This means the insurer not only is able not to pay for the current claim but can also demand repayment of previously paid D&O claims. This also applies to executives who had nothing to do with the deceit. “The insured managers are in danger of losing their insurance for circumstances with which they have nothing to do,” Mr Palmberger said. Unlike the US, it is not possible to pursue a partial contest of treaties in Germany. The reversal transaction always affects the entire policy and thus all of the parties insured. The insurers are trying to calm customers. Market leader Allianz so far sees no need to take action. It understands the ruling to refer to transport policies only. “We will continue to use the old clauses until the highest court rules that the recent ruling also applies to D&O cover,” said Carsten Wiesenthal of Allianz affiliate Allianz Global Corporate & Specialty (AGCS). Insurer Zurich was cautious in its response. “We feel committed to the clauses in our terms and conditions,” said D&O expert Nicole Weyerstall. The company intends to honour any recissory waiver. “It is possible that other insurers will adopt a different position,” though she added. The problem is that if insurers do not challenge treaties, this can be interpreted as a breach of their duty to manage shareholders' assets carefully. The companies would then have to justify why they are spending money on claims which they don't really have to pay according to the court ruling. There is deep uncertainty in the market. Mr Palmberger advises changes to the body of terms and conditions. The parties to a treaty could, for example, introduce an anchor clause which states that in the case of a challenge caused by wilful deceit they must enter into negotiations to prevent parties which had nothing to do with the deceit from losing their insurance cover. “Thus, one could circumvent an advance recissory waiver,” advised the lawyer. Whether or not such a clause would be acceptable, would only be proven in court. It would be a dangerous game for the insured companies. “The ideal solution would be individual treaties for each manager,” said Mr Wiesenthal of AGCS. This would mean that, in the case of a challenge, not all executives would be affected. “The danger here is that there might not be sufficient capacity, and that the cover level is not uniform within the company,” he said. To arrange an individual treaty for each manager would also be extremely expensive. Düsseldorf-based D&O broker Michael Hendricks has since called on insurers to make a statement in which they declare that they will definitely not avail of their right to challenge. All 14 insurers that cooperate with the broker handed in such documents. However, they do not provide legal certainty for clients. Insurers can still contest D&O policies. “Clients can only hope that insurers will keep their word,” said Mr Hendricks.

German court ruling threatens D&O policies

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