Fraud allegations create significant legal, financial and reputational risks for companies. Allegations of fraud can also result in complex D&O scenarios. Many executives misunderstand where D&O coverage for fraud allegations begins and ends, increasing the likelihood of missteps as they navigate claims. By learning the truth about coverage, you can assess your policy terms and take steps to protect yourself and your company.
Does D&O Insurance Cover Fraud?
D&O insurance is not a get-out-of-jail-free card. It’s designed to cover allegations of misrepresentation and breaches of fiduciary duty. It’s not intended to cover criminal schemes. In fact, a typical D&O policy bars coverage for criminal and intentional acts of wrongdoing through a willful misconduct exclusion.
In other words, D&O insurance does not cover fraud.
However, an allegation of fraud is not the same as a conviction, and that distinction is where D&O coverage gets complicated.
Your D&O Policy Will Likely Cover Your Defense
If you are accused of fraud, your D&O policy will likely provide coverage for your defense. As with other types of allegations, the requirements and limits will depend on your policy.
For allegations of fraud, the policy’s final adjudication clause is of particular importance. This provision prevents the misconduct exclusion from being applied until there is a final ruling that finds the insured guilty of criminal wrongdoing.
Defense coverage is important because, in the U.S., you’re innocent until proven guilty. This is true in the legal system, and it’s also true in D&O coverage. Although fraud allegations are serious, it is possible for people to be wrongly accused, and they deserve a fair trial. It’s not until after the trial is over and the verdict has been reached that anyone is in a position to say with certainty whether the allegations were founded.
D&O Coverage Stops If You’re Found Guilty
Once guilt has been formally established, either through a verdict or a guilty plea, the D&O insurer can apply the willful misconduct provision and bar coverage. A D&O policy will not provide coverage for penalties or judgments.
Why Doesn’t D&O Insurance Cover Fraud?
Insurance is supposed to protect policyholders against unforeseen losses, not criminal activity. Furthermore, if business leaders could secure coverage for fraud, there would be less to discourage unethical individuals from committing fraud. The lack of coverage encourages ethical behavior.
Similar principles can be found in other types of insurance. A restaurant owner whose restaurant burns down may be entitled to an insurance payout, but not if the owner is found guilty of arson. A widow may be entitled to a life insurance payment, but not if she is found guilty of murdering her husband. Crime isn’t supposed to pay.
The Specific Language of Your Policy Matters
If you have D&O coverage and you’re accused of fraud, your policy will likely provide coverage for defense, but that coverage stops if guilt is formally established. However, there are many other scenarios to consider, and how your coverage works depends on the exact policy language.
As you review your coverage, here are some questions to consider:
Do you have to pay back defense costs if found guilty?
Until guilt has been established, coverage is in a state of limbo. Some policies allow the insurer to recoup defense costs if the insured is found guilty. However, other policies may include wording that prevents this from happening.
Will you have coverage for an appeal if you’re found guilty?
The word “final” can do a lot of heavy lifting here. According to the Hunton Insurance Recovery Blog, a California Court of Appeals ruled that a final adjudication clause in a D&O policy did not allow the insurer to refuse to pay for defense costs during an appeal. The verdict was not final if it could still be appealed.
However, in a separate case, The D&O Diary says a New York court reached a different conclusion. A post-conviction criminal sentencing constituted a final judgment, even if the insured could appeal, so the insurer could deny coverage and require repayment of the defense costs already paid.
Although state law and court interpretations can play a role in the outcome of disputes like this, the policy language is also important. Notably, the policy at the heart of the New York case referenced “final judgment,” not “final adjudication.”
If you settle before a ruling, will your policy provide coverage?
Settlements frequently avoid admissions of wrongdoing, so it’s important to consider how coverage would play out in this scenario.
How does coverage work if there are multiple allegations, only some of which involve criminal or intentional wrongdoing?
Lawsuits often involve multiple allegations. Some of these may be covered while others are excluded. Although the policy will typically provide coverage for defense costs, coverage for settlements and awards can be more complex.
Is Your Company Prepared to Handle Allegations of Fraud?
Fraud allegations can trigger immediate consequences, even if they are unfounded. How much coverage you have may come down to the exact wording in your D&O policy. Contact the Capital Market Group at NSI for D&O coverage guidance.
