Power of disposal of the right to do insurance coverage when the policyholder is insolvent
Power of disposal of the right to do insurance coverage when the policyholder is insolvent
23. April 2020
In a recent judgment (judgment of 4 March 2020– IV ZR 110/19 (OLG [Oberlandesgericht, Higher Regional Court] Frankfurt a.M.), ZIP 2020, 672), the BGH [Bundesgerichtshof, German Federal Court of Justice] has strengthened the position of the governing bodies and senior management of a company in insolvency. As before, contractual rights resulting from a D&O insurance contract can only be asserted by the governing bodies and senior managers themselves if the terms of the policy so provide. The BGH holds that the insolvency of the policyholder is irrelevant in this respect.
I. Rise in D&O insurance claims due to the coronavirus crisis
Like any economic crisis, the effects of the coronavirus pandemic will prompt companies to carefully check and, where possible, to draw on their existing insurance coverage in order to reduce their financial losses. Equally, there are rising numbers of claims for compensation against management board members, managing directors and other senior managers in relation to breaches of their duty of care. This particularly applies to situations in which an insolvency administrator reviews the affairs of the company.
D&O insurance is a financial loss liability insurance for governing bodies and senior managers. The insurance is procured by a company and covers management board members, managing directors, senior managers and supervisory board members as insured persons. The very people who take or support difficult decisions, especially when a company is in crisis. Sadly, one such decision many companies are already faced with is the question whether the requirements for a suspension due to the coronavirus of the obligation to apply for insolvency have been met (see « Corona – suspension of obligation to file for insolvency: liability risks and other problems for managers and directors »). D&O insurance covers compensation claims which are asserted against the insured persons by the company itself or by third parties due to a breach of duty committed by the insured persons while exercising their office.
Due to the current coronavirus crisis, a significant rise in D&O insurance claims can therefore be expected in the medium term.
II. D&O insurance as so-called insurance for the account of a third party
D&O insurance is designed as a so-called insurance for the account of a third party. The company enters into the insurance contract with the insurer and is therefore the policyholder. Substantively, however, the insured persons hold the right to the insurance coverage resulting from this insurance contract (section 44(1) first sentence VVG [Gesetz über den Versicherungsvertrag 2008, Insurance Contract Act 2008]). According to the statutory model, however, these rights can only be asserted by the company as the policyholder (sections 44(2), 45 VVG). This is a case in which statute provides for derivative action, i.e. allows a party to claim the rights of a third party in its own name [Prozessstandschaft].
III. Right to coverage when the policyholder is insolvent
When the policyholder is insolvent, the power of disposal over the right to coverage from the D&O insurance contract generally passes to the insolvency administrator (section 80(1) InsO [Insolvenzordnung, Insolvency Statute]).
In addition, the insolvency administrator can decide whether or not to continue to perform the contract and pay the insurance premium due (section 103 InsO). If he decides not to pay the premium despite a warning letter from the insurer, the insurer may terminate the insurance contract after expiry of the payment deadline set which must be at least two weeks. In this situation, the insurer is not obligated to effect payment if the insured event occurs after expiry of the payment deadline and the policyholder has still not paid the premium (cf. section 38 VVG). The insolvency administrator may also terminate the insurance contract with future effect in accordance with the contractual notice periods.
IV. Risk when claiming after termination of the D&O insurance contract
D&O insurance is based on the so-called claims-made principle. This means that it only covers compensation claims which are asserted against the insured persons during the term of the insurance contract. The point in time of the alleged breach of duty is irrelevant.
Management board members and managing directors are therefore exposed to the considerable risk that the insolvency administrator decides not to continue the D&O insurance contract and they are left without insurance coverage in the event of future claims. A considerable liability risk remains because a claim for breaches of duty that were committed before the company became insolvent or in connection with the company’s insolvency can be made at a much later date in accordance with the applicable limitation periods. If the D&O insurance contract remained in force, these claims would generally be covered, even after the affected insured persons left the company.
V. Limiting risk by extending the reporting period?
The risk of coverage loss for insured persons after termination of the insurance contract is minimized by extending the reporting period in common D&O policy conditions. For those policies, the insurance coverage continues for a certain period after the insurance contract has been terminated if the claim is made after termination but before the extended reporting period expires.
If payment of an additional premium is agreed with regard to the extended reporting period, the principles regarding the loss of insurance coverage are the same as for payment of the regular annual premium. Accordingly, the insurer is not required to effect payment if the insolvency administrator is in in arrears as regards the payment of the additional premium.
However, the extended reporting period does not commonly incur an additional premium. Even if the extended reporting period does not incur an additional premium, however, it usually ceases to apply in accordance with the terms of the policy if the insurance contract as a whole is not duly terminated by the insolvency administrator but by the insurer due to the delay in payment of the premium. The GDV’s [Gesamtverband der deutschen Versicherer, German Insurance Association] model conditions “General insurance conditions for the financial loss liability insurance of supervisory board members, management board members and managing directors” (version May 2019) provide in clause A-5.3 an automatic extended reporting period that does not incur an additional premium. In addition, the model conditions grant the right to acquire an additional extended reporting period. However, under the model conditions, both the extended reporting period which does not incur an additional premium and the right to acquire an additional extended reporting period cease to apply once the insurer has terminated the insurance contract due to the delay in payment of the premium. Furthermore, the right to acquire an additional extended reporting period does not apply if the contract is terminated after an application to commence insolvency proceedings over the policyholder’s assets has been filed.
VI. Contractually agreed power of disposal of the insured persons
Clause A-8.1 of the GDV’s model conditions provides that not the policyholder but the insured persons have the power to dispose of the rights resulting from the insurance contract. This deviates from the statutory model. Most policy conditions on the market follow the GDV’s model conditions. The recent BGH case was also based on such provisions.
VII. Impact of the policyholder’s insolvency on the power of disposal
Initially, the BGH rightly points out that in any case, under substantive law, the insured person and not the policyholder holds the power of disposal. It therefore does not form part of the insolvent company’s assets but belongs to the insured person and the insured person has the right to separation or separation extending to the consideration received as a substitute for the object of separation in accordance with sections 47, 48 InsO. The BGH then once again (cf. BGH judgment of 5 April 2017 – IV ZR 360/15 (OLG Munich), ZIP 2017, 881) clarifies that a phrase in general terms and conditions of insurance which states that “only the insured persons can assert the right to insurance coverage” must be understood to mean that – in deviation from sections 44(2), 45 VVG – only the insured persons should have the power to dispose of this right.
For this reason, whether or not the insolvency administrator exercises his option to perform the D&O insurance contract according to section 103 InsO is initially irrelevant to the question whether the insured person holds a right under the insurance contract.
VIII. Relevance of the power of disposal to the insurance coverage
The power of disposal has practical advantages for the governing bodies and senior managers (who will usually have exited the company at this time) in the event of insolvency of the company. They can decide to pursue their right to coverage and are therefore not reliant on the actions of the policyholder. This is particularly relevant when the limitation period is about to expire.
Regardless of the question of the power of disposal, however, the conduct of the policyholder can have a negative impact on the insurance coverage. Breaches of obligation by the policyholder generally cause detriment to the insurance coverage of the insured person. If an obligation is breached, the insurer can therefore rely on its (at least partial) release from the obligation to effect payment also against the insured person.
In conclusion, if the insolvency administrator does not pay the premium due and the insurer then terminates the D&O insurance contract, the substantive insurance coverage may cease to apply, as set out above (cf. sections IV and V). The procedural power of disposal does not change this fact. It is therefore paramount to carefully check in each case whether the insured person has a right to coverage under substantive law.
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